[JPRT 105-23-97]
[From the U.S. Government Publishing Office]
[JOINT COMMITTEE PRINT]
------------------------------------------------------------------------
GENERAL EXPLANATION OF TAX LEGISLATION ENACTED IN 1997
__________
Prepared by the Staff
of the
JOINT COMMITTEE ON TAXATION
DECEMBER 17, 1997
------
U.S. GOVERNMENT PRINTING OFFICE
45-107 WASHINGTON : 1997 JCS-23-97
For sale by the U.S. Government Printing Office
Superintendent of Documents, Mail Stop: SSOP, Washington, DC 20402-9328
ISBN 0-16-055897-2
JOINT COMMITTEE ON TAXATION
105th Congress, 1st Session
------
HOUSE SENATE
BILL ARCHER, Texas, WILLIAM V. ROTH, Jr., Delaware,
Chairman Vice Chairman
PHILIP M. CRANE, Illinois JOHN H. CHAFEE, Rhode Island
WILLIAM M. THOMAS, California CHARLES GRASSLEY, Iowa
CHARLES B. RANGEL, New York DANIEL PATRICK MOYNIHAN, New York
FORTNEY PETE STARK, California MAX BAUCUS, Montana
Kenneth J. Kies, Chief of Staff
Mary M. Schmitt, Deputy Chief of Staff (Law)
Bernard A. Schmitt, Deputy Chief of Staff (Revenue Analysis)
(II)
SUMMARY CONTENTS
----------
Page
Introduction..................................................... 1
Part One: GAirport and Airway Trust Fund Extension Act of 1997
(H.R. 668)..................................................... 2
Part Two: GTaxpayer Relief Act of 1997 (H.R. 2014)............... 6
Part Three: GRevenue Provisions of the Balanced Budget Act of
1997 (H.R. 2015)............................................... 493
Part Four: GTaxpayer Browsing Protection Act (H.R. 1226)......... 506
Part Five: GHighway Trust Fund Extension (sec. 9 of S. 1519)..... 508
Appendix: GEstimated Budget Effects of Tax Legislation Enacted in
1997........................................................... 511
(III)
C O N T E N T S
----------
Page
Introduction..................................................... 1
Part One: GAirport and Airway Trust Fund Extension Act of 1997
(H.R. 668)..................................................... 2
Part Two: Taxpayer Relief Act of 1997 (H.R. 2014)................ 6
Title I. Child Tax Credit.................................... 6
A. Child Tax Credit for Children Under Age 17 (sec.
101(a), (c), and (d))................................ 6
B. Expand Definition of High-Risk Individuals With
Respect to Tax-Exempt State-Sponsored Organizations
Providing Health Coverage (sec. 101(c)).............. 10
Title II. Education Tax Incentives........................... 11
A. Tax Benefits Relating to Education Expenses........... 11
1. HOPE tax credit and Lifetime Learning tax credit
for higher education tuition expenses (sec. 201). 11
2. Deduction for student loan interest (sec. 202).... 20
3. Penalty-free withdrawals from IRAs for higher
education expenses (sec. 203).................... 23
4. Tax treatment of qualified State tuition programs
and education IRAs; exclusion for certain
distributions from education IRAs used to pay
qualified higher education expenses (secs. 211
and 213)......................................... 24
B. Other Education-Related Tax Provisions................ 33
1. Extension of exclusion for employer-provided
educational assistance (sec. 221)................ 33
2. Modification of $150 million limit on qualified
501(c)(3) bonds other than hospital bonds (sec.
222)............................................. 34
3. Expansion of arbitrage rebate exception for
certain bonds (sec. 223)......................... 35
4. Enhanced deduction for corporate contributions of
computer technology and equipment (sec. 224)..... 36
5. Treatment of cancellation of certain student loans
(sec. 225)....................................... 39
6. Tax credit for holders of qualified zone academy
bonds (sec. 226)................................. 40
Title III. Savings and Investment Tax Incentives............. 42
A. Individual Retirement Arrangements (secs. 301-304).... 42
B. Capital Gains Provisions.............................. 48
1. Maximum rate of tax on net capital gains of
individuals (sec. 311)........................... 48
2. Exclusion of gain on sale of principal residence
(sec. 312)....................................... 54
3. Exception from real estate reporting requirements
for certain sales of principal residences (secs.
312(c) and 701).................................. 57
4. Rollover of gain from sale of certain small
business stock (sec. 313)........................ 58
5. Computation of alternative capital gains tax for
corporations (sec. 314).......................... 59
Title IV. Alternative Minimum Tax Provisions................. 60
A. Repeal Alternative Minimum Tax for Small
Businesses and Modify the Depreciation Adjustment
(secs. 401-402).................................. 60
B. Repeal AMT Installment Method Adjustment for
Farmers (sec. 403)............................... 61
Title V. Estate, Gift, and Generation-Skipping Tax
Provisions................................................. 63
A. Estate and Gift Tax Provisions........................ 63
1. Increase in estate and gift tax unified credit
indexing of certain other estate and gift tax
provisions (sec. 501)............................ 63
2. Estate tax exclusion for qualified family-owned
businesses (sec. 502)............................ 65
3. Installment payments of estate tax attributable to
closely held businesses (sec. 503)............... 71
4. Estate tax recapture from cash leases of
specially-valued property (sec. 504)............. 72
5. Clarify eligibility for extension of time for
payment of estate tax (sec. 505)................. 73
6. Gifts may not be revalued for estate tax purposes
after expiration of statute of limitations (sec.
506)............................................. 74
7. Repeal of throwback rules applicable to domestic
trusts (sec. 507)................................ 76
8. Reduction in estate tax for certain land subject
to permanent conservation easement (sec. 508).... 78
B. Generation-Skipping Tax Provision..................... 81
1. Modification of generation-skipping transfer tax
for transfer to individuals with deceased parents
(sec. 511)....................................... 81
Title VI. GExtension of Certain Expiring Tax Provisions...... 83
A Research Tax Credit (sec. 601)......................... 83
B. Contributions of Stock to Private Foundations (sec.
602)................................................. 86
C. Work Opportunity Tax Credit (sec. 603)................ 88
D. Orphan Drug Tax Credit (sec. 604)..................... 91
Title VII. GDistrict of Columbia Tax Incentives (sec. 701)... 93
Title VIII. GWelfare-to-Work Tax Credit (sec. 801)........... 107
Title IX. Miscellaneous Provisions........................... 109
A. Excise Tax Provisions................................. 109
1. Transfer of General Fund highway fuels tax
revenues to the Highway Trust Fund (sec. 901).... 109
2. Repeal excise tax on diesel fuel used in
recreational motorboats (sec. 902)............... 110
3. Continued application of tax on imported recycled
Halon-1211 (sec. 903)............................ 111
4. Uniform rate of excise tax on vaccines (sec. 904). 112
5. Treat certain gasoline ``chain retailers'' as
wholesale distributors under the gasoline excise
tax refund rules (sec. 905)...................... 113
6. Exemption of electric and other clean-fuel motor
vehicles from luxury automobile classification
(sec. 906)....................................... 114
7. Tax certain alternative fuels based on energy
equivalency to gasoline (sec. 907)............... 116
8. Reduce rate of alcohol excise tax on certain hard
ciders (sec. 908)................................ 117
9. Study feasibility of moving collection point for
distilled spirits excise tax (sec. 909).......... 118
10. Codify Treasury Department regulations regulating
wine labels (sec. 910)........................... 119
B. Disaster Relief Provisions............................ 120
1. Authority to postpone certain tax-related
deadlines by reason of Presidentially declared
disaster (sec. 911).............................. 120
2. Use of certain appraisals to establish amount of
disaster loss (sec. 912)......................... 121
3. Treatment of livestock sold on account of weather-
related conditions (sec. 913).................... 121
4. Mortgage bond financing for residence located in
Presidentially declared disaster areas (sec. 914) 122
5. Requirement to abate interest by reason of
Presidentially declared disaster (sec. 915)...... 123
C. Provisions Relating to Employment Taxes............... 124
1. Clarification of standard to be used in
determining tax status of retail securities
brokers (sec. 921)............................... 124
2. Clarification of exemption from self-employment
tax for certain termination payments received by
former insurance salesman (sec. 922)............. 125
D. Provisions Relating to Small Businesses............... 126
1. Delay imposition of penalties for failure to make
payments electronically through EFTPS (sec. 931). 126
2. Home office deduction: clarification of definition
of principal place of business (sec. 932)........ 128
3. Income averaging for farmers (sec. 933)........... 130
4. Increase deduction for health insurance costs of
self-employed individuals (sec. 934)............. 132
5. Moratorium on regulations regarding employment
taxes of limited partners (sec. 935)............. 132
E. Expensing of Environmental Remediation Costs
(``Brownfields'') (sec. 941)......................... 133
F. Empowerment Zones and Enterprise Communities (secs.
951-956)............................................. 136
G. Other Provisions...................................... 143
1. Shrinkage estimates for inventory accounting (sec.
961)............................................. 143
2. Treatment of workmen's compensation liability
under rules for certain personal injury liability
assignments (sec. 962)........................... 146
3. Tax-exempt status for certain State workmen's
compensation act companies (sec. 963)............ 148
4. Election for 1987 partnership to continue
exception from treatment of publicly traded
partnerships as corporations (sec. 964).......... 149
5. Exclusion from UBIT for certain corporate
sponsorship payments (sec. 965).................. 152
6. Timeshare associations (sec. 966)................. 155
7. Modification of advance refunding rules for
certain tax-exempt bonds issued by the Virgin
Islands (sec. 967)............................... 157
8. Deferral of gain on certain sales of farm product
refiners and processors (sec. 968)............... 158
9. Increased deduction for business meals while
operating under Department of Transportation
hours of service limitations (sec. 969).......... 160
10. Deductibility of meals provided for the
convenience of the employer (sec. 970)........... 161
11. Modify limits on depreciation of luxury
automobiles for certain clean-burning fuel and
electric vehicles (sec. 971)..................... 162
12. Temporary suspension of income limitations on
percentage depletion for production from marginal
wells (sec. 972)................................. 163
13. Increase in standard mileage rate for purposes of
computing charitable deduction (sec. 973)........ 164
14. Purchasing of receivables by tax-exempt hospital
cooperative service orgainzations (sec. 974)..... 165
15. Provide above-the-line-deduction for certain
business expenses in connection with service
performed by certain officials (sec. 975)........ 166
16. Combined employment tax reporting demonstration
project (sec. 976)............................... 167
17. Elective carryback of existing net operating
losses of the National Railroad Passenger
Corporation (Amtrak) (sec. 977).................. 168
H. Extension of Duty-Free Treatment Under the Generalized
System of Preferences (sec. 981)..................... 170
Title X. Revenue-Increase Provisions......................... 172
A. Financial Products.................................... 172
1. Require recognition of gain on certain appreciated
financial positions in personal property (sec.
1001(a))......................................... 172
2. Election of mark-to-market for securities traders
and for traders and dealers in commodities (sec.
1001(b))......................................... 180
3. Limitation on exception for investment companies
under section 351 (sec. 1002).................... 182
4. Gains and losses from certain terminations with
respect to property (sec. 1003).................. 185
5. Determination of original issue discount where
pooled debt obligations subject to acceleration
(sec. 1004)...................................... 190
6. Deny interest deduction on certain debt
instruments (sec. 1005).......................... 192
B. Corporate Organizations and Reorganizations........... 194
1. Require gain recognition for certain extraordinary
dividends (sec. 1011)............................ 194
2. Require gain recognition on certain distributions
of controlled corporation stock (sec. 1012)...... 197
3. Reform tax treatment of certain corporate stock
transfers (sec. 1013)............................ 206
4. Treat certain preferred stock as ``boot'' (sec.
1014)............................................ 209
5. Modify holding period for dividends-received
deduction (sec. 1015)............................ 213
C. Administrative Provisions............................. 214
1. Reporting of certain payments made to attorneys
(sec. 1021)...................................... 214
2. Information reporting on persons receiving
contract payments from certain Federal agencies
(sec. 1022)...................................... 216
3. Disclosure of tax return information for
administration of certain veterans programs (sec.
1023)............................................ 217
4. Establish IRS continuous levy and improve debt
collection (secs. 1024-1026)..................... 218
5. Consistency rule for beneficiaries of trusts and
estates (sec. 1027).............................. 220
6. Registration of confidential corporate tax
shelters and substantial understatement penalty
(sec. 1028)...................................... 221
D. Excise and Employment Tax Provisions.................. 225
1. Extension and modification of Airport and Airway
Trust Fund excise taxes (sec. 1031).............. 225
2. Extend diesel fuel excise tax rules to kerosene
(sec. 1032)...................................... 233
3. Reinstate Leaking Underground Storage Tank Trust
Fund excise tax (sec. 1033)...................... 235
4. Application of communications excise tax to
prepaid telephone cards (sec. 1034).............. 235
5. Extension of temporary Federal unemployment surtax
(sec. 1035)...................................... 238
E. Provisions Relating to Tax-Exempt Organizations....... 239
1. Extend UBIT rules to second-tier subsidiaries and
amend control test (sec. 1041)................... 239
2. Repeal grandfather rule with respect to pension
business of certain insurers (sec. 1042)......... 240
F. Foreign Provisions.................................... 242
1. Inclusion of income from notional principal
contracts and stock lending transactions under
Subpart F (sec. 1051)............................ 242
2. Restrict like-kind exchange rules for certain
personal property (sec. 1052).................... 244
3. Impose holding period requirement for claiming
foreign tax credits with respect to dividends
(sec. 1053)...................................... 246
4. Limitation on treaty benefits for payments to
hybrid entities (sec. 1054)...................... 249
5. Interest on underpayments that are reduced by
foreign tax credit carrybacks (sec. 1055)........ 251
6. Determination of period of limitations relating to
foreign tax credits (sec. 1056).................. 253
7. Repeal special exception to foreign tax credit
limitation for alternative minimum tax purposes
(sec. 1057)...................................... 254
G. Partnership Provisions................................ 255
1. Allocation of basis of properties distributed to a
partner by a partnership (sec. 1061)............. 255
2. Treatment of inventory items of a partnership
(sec. 1062)...................................... 258
3. Treatment of appreciated property contributed to a
partnership (sec. 1063).......................... 259
H. Pension and Employee Benefit Provisions............... 260
1. Cashout of certain accrued benefits (sec. 1071)... 260
2. Election to receive taxable cash compensation in
lieu of nontaxable parking benefits (sec. 1072).. 261
3. Repeal of excess distribution and excess
retirement accumulation taxes (sec. 1073)........ 262
4. Tax on prohibited transactions (sec. 1074)........ 263
5. Basis recovery rules (sec. 1075).................. 264
I. Other Revenue-Increase Provisions..................... 265
1. Phase out suspense accounts for certain large farm
corporations (sec. 1081)......................... 265
2. Modify net operating loss carryback and
carryforward rules (sec. 1082)................... 267
3. Modify general business credit carryback and
carryforward rules (sec. 1083)................... 269
4. Expand the limitations on deductibility of
interest and premiums with respect to life
insurance, endowment, and annuity contracts (sec.
1084)............................................ 269
5. Earned income credit compliance provisions (secs.
1085(a), (b) and (d))............................ 276
a. Deny EIC eligibility for prior acts of
recklessness or fraud (sec. 1085(a)(1))........ 278
b. Recertification required when taxpayer found to
be ineligible for EIC in past (sec. 1085(a)(1)) 279
c. Due diligence requirements for paid preparers
(sec. 1085(a)(2)).............................. 280
d. Modify the definition of AGI used to phase out
the EIC (secs. 1085(b) and (d))................ 281
6. Treatment of amounts received under the work
requirements of the Personal Responsibility and
Work Opportunity Act of 1996 (sec. 1085(c))...... 282
7. Eligibility for income forecast method (sec. 1086) 283
8. Modify the exception to the related-party rule of
section 1033 for individuals to only provide an
exception for de minimis amounts (sec. 1087)..... 286
9. Repeal of exception for certain sales by
manufacturers to dealers (sec. 1088)............. 287
10. Treatment of charitable remainder trusts (sec.
1089)............................................ 288
11. Expanded SSA records for tax enforcement (secs.
1090(a)(1) and 1090(b)).......................... 292
12. Using Federal case registry of child support
orders for tax enforcement purposes (secs.
1090(a)(2) and 1090(a)(3))....................... 292
13. Modification of estimated tax safe harbors (sec.
1091)............................................ 293
Title XI. Foreign Tax Provisions............................. 295
A. General Provisions................................... 295
1. Simplify foreign tax credit limitation for
individuals (sec. 1101).......................... 295
2. Simplify translation of foreign taxes (sec. 1102). 296
3. Election to use simplified foreign tax credit
limitation for alternative minimum tax purposes
(sec. 1103)...................................... 299
4. Simplify treatment of personal transactions in
foreign currency (sec. 1104)..................... 300
5. Simplify foreign tax credit limitation for
dividends from 10/50 companies (sec. 1105)....... 301
B. General Provisions Affecting Treatment of Controlled
Foreign Corporations (secs. 1111-1113)............... 303
C. Modification of Passive Foreign Investment Company
Provisions to Eliminate Overlap With Subpart F, to
allow Mark-to-Market Election, and to Require
Measurement Based on Value for PFIC Asset Test (secs.
1121-1124)........................................... 308
D. Simplfy Formation and Operation of International Joint
Ventures (secs. 1131, 1141-1145, and 1151)........... 314
E. Modification of Reporting Threshold for Stock
Ownership of a Foreign Corporation (sec. 1146)....... 318
F. Other Foreign Simplification Provisions............... 319
1. Transition rules for certain trusts (sec. 1161)... 319
2. Simplify stock and securities trading safe harbor
(sec. 1162)...................................... 320
3. Clarification of determination of foreign taxes
deemed paid (sec. 1163(a))....................... 321
4. Clarification of foreign tax credit limitation for
financial services income (sec. 1163(b))......... 322
G. Other Foreign Provisions.............................. 322
1. Eligibility of licenses of computer software for
foreign sales corporation benefits (sec. 1171)... 322
2. Increase dollar limitation on section 911
exclusion (sec. 1172)............................ 324
3. Treatment of certain securities positions under
the subpart F investment in U.S. property rules
(sec. 1173)...................................... 325
4. Treat service income of nonresident alien
individuals earned on foreign ships as foreign
source income and disregard the U.S. presence of
such individuals (sec. 1174)..................... 327
5. Exceptions under subpart F for active financing
income (sec. 1175)............................... 329
Title XII. GSimplification Provisions Relating to Individuals
and Businesses............................................. 335
A. Provisions Relating to Individuals.................... 335
1. Modifications to standard deduction of dependents,
AMT treatment of certain minor children (sec.
1201)............................................ 335
2. Increase de minimis threshold for estimated tax to
$1,000 for individuals (sec. 1202)............... 336
3. Treatment of certain reimbursed expenses of rural
letter carrier's vehicles (sec. 1203)............ 337
4. Travel expenses of Federal employees participating
in a Federal criminal investigation (sec. 1204).. 338
5. Payment of taxes by commercially acceptable means
(sec. 1205)...................................... 339
B. Provisions Relating to Businesses Generally........... 343
1. Modifications to look-back method for long-term
contracts (sec. 1211)............................ 343
2. Minimum tax treatment of certain property and
casualty insurance companies (sec. 1212)......... 346
3. Treatment of construction allowances provided to
lessees (sec. 1213).............................. 347
C. Partnership Simplification Provisions................. 349
1. General provisions................................ 349
a. Simplified flow-through for electing large
partnerships (sec. 1221)....................... 349
b. Simplified audit procedures for electing large
partnerships (sec. 1222)....................... 361
c. Due date for furnishing information to partners
of electing large partnerships (sec. 1223)..... 366
d. Partnership returns required on magnetic media
(sec. 1224).................................... 367
e. Treatment of partnership items of individual
retirement arrangements (sec. 1225)............ 367
2. Other partnership audit rules..................... 369
a. Treatment of partnership items in deficiency
proceedings (sec. 1231)........................ 369
b. Partnership return to be determinative of audit
procedures to be followed (sec. 1232).......... 371
c. Provisions relating to statute of limitations
(sec. 1233).................................... 371
d. Expansion of small partnership exception (sec.
1234).......................................... 374
e. Exclusion of partial settlements from 1-year
limitation on assessment (sec. 1235)........... 375
f. Extension of time for filing a request for
administrative adjustment (sec. 1236).......... 376
g. Availability of innocent spouse relief in
context of partnership proceedings (sec. 1237). 376
h. Determination of penalties at partnership level
(sec. 1238).................................... 377
i. Provisions relating to Tax Court jurisdiction
(sec. 1239).................................... 378
j. Treatment of premature petitions filed by notice
partners or 5-percent groups (sec. 1240)....... 378
k. Bonds in case of appeals from certain
proceedings (sec. 1241)........................ 379
l. Suspension of interest where delay in
computational adjustment resulting from certain
settlements (sec. 1242)........................ 380
m. Special rules for administrative adjustment
requests with respect to bad debts or worthless
securities (sec. 1243)......................... 380
3. Closing of partnership taxable year with respect
to deceased partner (sec. 1246).................. 381
D. Modifications of Rules for Real Estate Investment
Trusts (secs. 1251-1263)............................. 382
E. Repeal the ``Short-Short'' Test for Regulated
Investment Companies (sec. 1271)..................... 392
F. Taxpayer Protections.................................. 393
1. Provide reasonable cause exception for additional
penalties (sec. 1281)............................ 393
2. Clarification of period for filing claims for
refunds (sec. 1282).............................. 394
3. Repeal of authority to disclose whether a
prospective juror has been audited (sec. 1283)... 395
4. Clarify statute of limitations for items from
pass-through entities (sec. 1284)................ 396
5. Awarding of administrative costs and attorneys
fees (sec. 1285)................................. 396
Title XIII. GEstate, Gift, and Trust Simplification
Provisions................................................. 398
1. Eliminate gift tax filing requirements for gifts to
charities (sec. 1301)................................ 398
2. Clarification of waiver of certain rights of recovery
(sec. 1302).......................................... 399
3. Transitional rule under section 2056A (sec. 1303)..... 400
4. Treatment for estate tax purposes of short-term
obligations held by nonresident aliens (sec. 1304)... 400
5. Certain revocable trusts as part of estate (sec. 1305) 402
6. Distributions during first 65 days of taxable year of
estate (sec. 1306)................................... 403
7. Separate share rules available to estate (sec. 1307).. 404
8. Executor of estate and beneficiaries treated as
related persons for disallowance of losses (sec.
1308)................................................ 405
9. Simplified taxation of earnings of pre-need funeral
trusts (sec. 1309)................................... 406
10. Adjustments for gifts within 3 years of decent's
death (sec. 1310).................................... 407
11. Clarify relationship between community property
rights and retirement benefits (sec. 1311)........... 408
12. Treatment under qualified domestic trust rules of
forms of ownership which are not trusts (sec. 1312).. 410
13. Opportunity to correct certain failures under section
2032A (sec. 1313).................................... 411
14. Authority to waive requirement of U.S. trustee for
qualified domestic trusts (sec. 1314)................ 412
Title XIV. GExcise Tax and Other Simplification Provisions... 413
A. Excise Tax Simplification Provisions.................. 413
1. Increase de minimis limit for after-market
alternations subject to heavy truck and luxury
automobile excise taxes (sec. 1401).............. 413
2. Modify treatment of tires under the heavy highway
vehicle retail excise tax (sec. 1402)............ 414
3. Simplification of excise taxes on distilled
spirits, wines, and beer (sec. 1411-1422)........ 414
4. Authority for Internal Revenue Service to grant
exemptions from excise tax registration
requirements (sec. 1431)......................... 417
5. Repeal of expired excise tax provisions (sec.
1432)............................................ 418
6. Modifications to the excise tax on certain arrows
(sec. 1433)...................................... 418
7. Modifications to heavy highway vehicle retail
excise tax (sec. 1434)........................... 419
8. Treatment of skydiving flights as noncommercial
aviation (sec. 1435)............................. 420
9. Eliminate double taxation of certain aviation
fuels sold to producers by ``fixed base
operators'' (sec. 1436).......................... 421
B. Tax-Exempt Bond Provisions............................ 421
1. Repeal of $100,000 limitation on unspent proceeds
under 1-year exception from rebate (sec. 1441)... 422
2. Exception from rebate for earnings on bona fide
debt service fund under construction bond rules
(sec. 1442)...................................... 423
3. Repeal of debt service-based limitation on
investment in certain nonpurpose investments
(sec. 1443)...................................... 424
4. Repeal of expired provisions relating to student
loan bonds (sec. 1444)........................... 425
C. Tax Court Procedures.................................. 425
1. Overpayment determinations of Tax Court (sec.
1451)............................................ 425
2. Redetermination of interest pursuant to motion
(sec. 1452)...................................... 426
3. Application of net worth requirement for awards of
litigation costs (sec. 1453)..................... 426
4. Tax Court jurisdiction for determination of
employment status (sec. 1454).................... 427
D. Other Provisions...................................... 428
1. Due date for first quarter estimated tax payments
by private foundations (sec. 1461)............... 428
2. Witholding of Commonwealth income taxes from wages
of Federal employees (sec. 1462)................. 429
3. Certain notices disregarded under provision
increasing interest rate on large corporate
underpayments (sec. 1463)........................ 430
Title XV. Pension and Employee Benefit Provisions............ 432
A. Pension Simplification Provisions..................... 432
1. Matching contributions of self-employed
individuals not treated as elective deferrals
(sec. 1501)...................................... 432
2. Modifications of prohibition on assignment or
alienation (sec. 1502)........................... 433
3. Elimination of paperwork burdens on plans (sec.
1503)............................................ 434
4. Modification of section 403(b) exclusion allowance
to conform to section 415 modifications (sec.
1504)............................................ 435
5. Permanent moratorium on application of
nondiscrimination rules to State and local
governmental plans (sec. 1505)................... 436
6. Clarification of certain rules relating to ESOPs
of S corporations (sec. 1506).................... 437
7. Modification of 10-percent tax on nondeductible
contributions (sec. 1507)........................ 438
8. Modify funding requirements for certain plans
(sec. 1508)...................................... 439
9. Plans not disqualified merely by accepting
rollover contributions (sec. 1509)............... 440
10. New technologies in retirement plans (sec. 1510). 441
B. Miscellaneous Provisions Relating to Pensions and
Other Benefits....................................... 442
1. Increase in full funding limit (sec. 1521)........ 442
2. Contributions on behalf of a minister to a church
plan (sec. 1522 (a)(2)).......................... 443
3. Exclusion of ministers from discrimination testing
of certain non-church retirement plans (sec.
1522(a)(1))...................................... 444
4. Repeal application of UBIT to ESOPs of S
corporations (sec. 1523)......................... 444
5. Diversification in section 401(i) plan investments
(sec. 1524)...................................... 445
6. Cash or deferred arrangements for irrigation and
drainage entities (sec. 1525).................... 447
7. Portability of permissive service credit under
governmental pension plans (sec. 1526)........... 448
8. Removal of dollar limitation on benefits payments
from a defined benefit plan for police and fire
employees (sec. 1527)............................ 450
9. Survivor benefits of public safety officers killed
in the line of duty (sec. 1528).................. 451
10. Treatment of certain disability payments to
public safety employees (sec. 1529).............. 452
11. Gratuitous transfers for the benefits of
employees (sec. 1530)............................ 453
C. Certain Health Act Provisions......................... 455
1. Newborns' and mothers' health protection; mental
health parity (sec. 1531)........................ 455
2. Church plan exception to prohibition on
discrimination against individuals based on
health status (sec. 1532)........................ 456
D. Date for Adoption of Plan Amendments (sec. 1541)...... 457
Title XVI. Technical Corrections Provisions.................. 458
Technical Corrections to the Small Business Job
Protection Act of 1996................................. 458
A. Small Business-Related Provisions..................... 458
1. Returns relating to purchases of fish (sec.
1601(a)(1))...................................... 458
2. Charitable remainder trusts not eligible to be
electing small business trusts (sec. 1601(c)(1)). 458
3. Clarify the effective date for post-termination
transition period provision (sec. 1601(c)(2)).... 458
4. Treatment of qualified subchapter S subsidiaries
(sec. 1601(c)(3))................................ 459
B. Pension Provisions.................................... 460
1. Salary reduction simplified employee pensions
(``SARSEPS'') (sec. 1601(d)(1)(B))............... 460
2. SIMPLE retirement plans (secs. 1601(d)(1)(A) and
(d)(1)(C)-(F))................................... 460
a. Reporting requirements for SIMPLE IRAs
(1601(d)(1)(A))................................ 460
b. Notification requirement for SIMPLE IRAs (sec.
1601(d)(1)(C))................................. 461
c. Maximum dollar limitation for SIMPLE IRAs (sec.
1601(d)(1)(D))................................. 461
d. Application of exclusive plan requirement for
SIMPLE IRAs to noncollectively bargained
employees (sec. 1601(d)(1)(E))................. 462
e. Application of exclusive plan requirement for
SIMPLE IRAs in the case of mergers and
acquisitions (sec. 1601(d)(1)(F)).............. 462
f. Top-heavy exemption for SIMPLE 401(k)
arrangements (sec. 1601(d)(2)(A)).............. 463
g. Cost of living adjustments for SIMPLE 401(k)
arrangements (sec. 1601(d)(2)(B)).............. 463
h. Employer deduction for SIMPLE 401(k)
arrangements (sec. 1601(d)(2)(C)).............. 463
i. Notification and election periods for SIMPLE
401(k) arrangements (sec. 1601(d)(2)(D))....... 464
j. Treatment of Indian tribal governments under
section 403(b) (sec. 1601(d)(4))............... 464
k. Special rules for chaplains and self-employed
ministers (sec. 1601(d)(6)).................... 465
C. Foreign Provisions.................................... 465
1. Measurement of earnings of controlled foreign
corporations (sec. 1601(e))...................... 465
2. Transfers to foreign trusts at fair market value
(sec. 1601(i)(2))................................ 465
3. Treatment of trust as U.S. person (sec.
1601(i)(3))...................................... 466
D. Other Provisions...................................... 467
1. Phaseout and expiration of excise tax on luxury
automobiles (sec. 1601(f)(3)).................... 467
2. Treatment of certain reserves of thrift
institutions (sec. 1601(f)(5))................... 467
3. ``FASIT'' technical corrections (sec. 1601(f)(6)). 468
4. Qualified State tuition programs (sec. 1601(h)(1)) 469
5. Adoption credit (sec. 1601(h)(2))................. 470
6. Phaseout of adoption assistance exclusion (sec.
1601(h)(2))...................................... 471
Technical Corrections to the Health Insurance Portability
and Accountability Act of 1996......................... 472
A. Medical Savings Accounts (sec. 1602(a))............... 472
1. Additional tax on distributions not used for
medical programs................................. 472
2. Definition of permitted coverage.................. 472
3. Taxation of distributions......................... 472
4. Penalty for failure to provide required reports... 473
B. Definition of Chronically Ill Individual Under a
Qualified Long-Term Care Insurance Contract (sec.
1602(b))............................................. 473
C. Deduction for Long-Term Care Insurance of Self-
Employed Individuals (sec. 1602(c)).................. 474
D. Applicability of Reporting Requirements of Long-Term
Care Contracts and Accelerated Death Benefits (sec.
1602(d))............................................. 474
E. Consumer Protection Provisions for Long-Term Care
Insurance Contracts (sec. 1602(e))................... 475
F. Insurable Interests Under the COLI Provision (sec.
1602(f)(1)).......................................... 476
G. Applicable Period For Purposes of Applying the
Interest Rate For a Variable Rate Contract Under the
COLI Rules (sec. 1602(f)(2))......................... 476
H. Definition of 20-Percent Owner for Purposes of Key
Persons Exception Under COLI Rules (sec. 1602(f)(3)). 477
I. Effective Date of Interest Rate Cap on Key Persons and
Pre-1986 Contracts Under the COLI Rule (sec.
1602(f)(4)).......................................... 477
J. Clarification of Contract Lapses Under Effective Date
Provisions of the COLI Rule (sec. 1602(f)(5))........ 478
K. Requirement of Gain Recognition on Certain Exchanges
(sec. 1602(g)(1)).................................... 479
L. Suspension of 10-year Period in Case of Substantial
Diminution of Risk of Loss (sec. 1602(g)(3))......... 480
M. Treatment of Property Contributed to Certain Foreign
Corporations (sec. 1602(g)(4))....................... 480
N. Credit For Foreign Estate Tax (sec. 1602(g)(6))....... 480
Technical Corrections to the Taxpayer Bill of Rights 2... 482
A. Reasonable Cause Abatement for First-Tier Intermediate
Sanctions Excise Tax (sec. 1603(a)).................. 482
B. Reporting by Public Charities With Respect to
Intermediate Sanctions and Certain Other Excise Tax
Penalties (sec. 1603(b))............................. 483
Technical Corrections to Other Acts...................... 485
A. Correction of GATT Interest and Mortality Rate
Provisions in the Retirement Protection Act (sec.
1604(b)(3)).......................................... 485
B. Clarify Definition of Indian Reservation Under Section
168(j)(6) (sec. 1604(c))............................. 486
C. Treatment of ``Cost-Plus'' Contracts Under Section 833
(sec. 1604(d))....................................... 486
D. Related Parties Determined By Reference to Section 267
(sec. 1604(d))....................................... 487
Title XVII. GLimited Tax Benefits Subject to the Line Item
Veto Act (sec. 1701)....................................... 488
Part Three: GRevenue Provisions of the Balanced Budget Act of
1997 (H.R. 2015)............................................... 493
A. Taxation of Medicare + Choice Medical Savings Accounts
(sec. 4006).......................................... 493
B. Tax Treatment of Hospitals which Participate in
Provider-Sponsored Organizations (sec. 4041)......... 496
C. Provision of Employer Identification Numbers by
Medicare Providers (sec. 4313)....................... 498
D. Disclosure of Tax Return Information for Verification
of Employment Status of Medicare Beneficiaries and
the Spouse of a Medicare Beneficiary (sec. 4631(c)).. 498
E. Unemployment Tax Provisions........................... 499
1. Exemption from service performed by election
workers from the Federal unemployment tax (sec.
5405)............................................ 499
2. Treatment of certain services performed by inmates
(sec. 5406)...................................... 500
3. Exemption of service performed for an elementary
or secondary school operated primarily for
religious purposes from the Federal unemployment
tax (sec. 5407).................................. 500
F. Earned Income Credit Provision........................ 501
1. Authorization of appropriations for enforcement
initiatives related to the earned income credit
(sec. 5702)...................................... 501
G. Increase in Excise Tax on Tobacco Products (sec. 9302) 502
H. Identification of Limited Tax Benefits Subject to Line
Item Veto (sec. 9304)................................ 504
Part Four: GTaxpayer Browsing Protection Act (H.R. 1226)......... 506
Part Five: GExtension of Highway Trust Fund (Sec. 9 of S. 1519).. 508
Appendix: GEstimated Budget Effects of Tax Legislation Enacted in
1997........................................................... 511
INTRODUCTION
This pamphlet,\1\ prepared by the staff of the Joint
Committee on Taxation in consultation with the staffs of the
House Committee on Ways and Means and Senate Committee on
Finance, provides an explanation of tax legislation enacted in
1997.
---------------------------------------------------------------------------
\1\ This pamphlet may be cited as follows: Joint Committee on
Taxation, General Explanation of Tax Legislation Enacted in 1997 (JCS-
23-97), December 17, 1997.
---------------------------------------------------------------------------
A committee report on legislation issued by a Congressional
committee sets forth the committee's explanation of the bill as
it was reported by that committee. In some instances, a
committee report does not serve as an explanation of the final
provisions of the legislation as enacted. This is because the
version of the bill enacted after action by the conference
committee may differ significantly from the versions of the
bill reported by the House and Senate. The material contained
in this pamphlet is prepared so that Members of Congress, tax
practitioners, and other interested parties can have an
explanation of the final tax legislation enacted in 1997 in one
publication.
Part One of the pamphlet is an explanation of the
provisions of the Airport and Airway Trust Fund Reinstatement
Act of 1997 (H.R. 668, P.L. 105-2) relating to the temporary
extension (through September 30, 1997) of Airport and Airway
Trust Fund excise taxes.\2\ Part Two is an explanation of the
Taxpayer Relief Act of 1997 (H.R. 2014, P.L. 105-34). Part
Three is an explanation of the revenue provisions of the
Balanced Budget Act of 1997 (H.R. 2015, P.L. 105-33). Part Four
is an explanation of the Taxpayer Browsing Protection Act (H.R.
1226, P.L. 105-35) relating to prohibitions on tax return/tax
information browsing. Part Five is an explanation of section 9
of S. 1519 (P.L. 105-130). The Appendix provides estimates of
the effects of tax legislation enacted in 1997 on Federal
fiscal year receipts for 1997-2007.
---------------------------------------------------------------------------
\2\ See also section 1031 of the Taxpayer Relief Act of 1997 (H.R.
2014, P.L. 105-34) in Part Two of this pamphlet for subsequent
extension and modifications to the Airport and Airway Trust fund excise
taxes.
---------------------------------------------------------------------------
The first footnote in each part of the pamphlet gives the
legislative history of each of the 1997 Acts.
Further, footnote references are included with respect to
related provisions in the Tax Technical Corrections Act of 1997
(Title VI of H.R. 2676 as passed by the House on November 5,
1997). The Tax Technical Corrections Act of 1997 was reported
by the House Committee on Ways and Means in H.R. 2645 on
October 29, 1997 (H. Rept. 105-356), and was added as an
amendment to H.R. 2676. (Titles I-V of H.R. 2676, the Internal
Revenue Service Restructuring and Reform Act of 1997, was
reported by the House Committee on Ways and Means on October
31, 1997; H. Rept. 105-364, Part I.)
PART ONE: AIRPORT AND AIRWAY TRUST FUND EXTENSION ACT OF 1997 (H.R.
668) \3\
Prior Law
Tax rates
Excise taxes are imposed on commercial air passenger and
freight transportation and on fuels used in general aviation
(i.e., transportation on noncommercial aircraft which is not
for hire) to fund the Airport and Airway Trust Fund (``Airport
Trust Fund''). These taxes generally had expired after December
31, 1996.
---------------------------------------------------------------------------
\3\ P.L. 105-2; February 28, 1997. H.R. 668 was reported by the
House Committee on Ways and Means on February 13, 1997 (H. Rept. 105-
5). The bill was passed by the House on February 26, 1997, and by the
Senate on February 27, 1997. H.R. 668 was signed by the President on
February 28, 1997.
See also Part Two for a description of the subsequent 10-year
extension and modification of the Airport Trust Fund excise taxes in
the Taxpayer Relief Act of 1997 (sec. 1031 of H.R. 2014).
---------------------------------------------------------------------------
The Airport Trust Fund excise taxes which had expired
included three taxes on commercial air transportation:
(1) A 10-percent excise tax on domestic air passenger
transportation;
(2) A $6 per person international air passenger
departure tax; and
(3) A 6.25-percent domestic air freight excise tax.
Noncommercial aviation (e.g., corporate aircraft) was
subject to Airport Trust Fund excise taxes on the fuels it used
rather than the commercial aviation passenger ticket and
freight excise taxes. The Airport Trust Fund rates for these
excise taxes were 17.5 cents per gallon for jet fuel and 15
cents per gallon for aviation gasoline.
Collection and deposit of tax
The air passenger ticket and freight excise taxes are
collected from passengers and freight shippers by the
commercial air carriers. The air carriers then remit the funds
to the Treasury Department; however, the air carriers are not
required to remit monies immediately. Excise tax returns are
filed quarterly (similar to annual income tax returns) with
taxes being deposited on a semi-monthly basis (similar to
estimated income taxes). For air transportation sold during a
semi-monthly period, air carriers may elect to treat the taxes
as collected on the last day of the first week of the second
following semi-monthly period.\4\ Under these ``deemed
collected'' rules, for example, the taxes on air transportation
sold between October 1 and October 15, are treated as collected
by the air carriers on or before November 7. These amounts
generally must be deposited with the Treasury by November 10.
Thus, on average, revenues from commercial air passenger
transportation generally are not received by the Federal
Government until approximately one month after the air carrier
actually sells the transportation.
---------------------------------------------------------------------------
\4\ Air carriers generally make this election because it allows
them to delay remitting tax beyond the date when remittance otherwise
would be required.
---------------------------------------------------------------------------
Like income tax withholding and estimated tax payments, the
excise taxes contain payment safe harbors for avoiding
underpayment penalties. In general, Treasury Department
regulations provide that commercial air carriers are not
subject to underpayment penalties if their semi-monthly
deposits of passenger ticket and freight waybill taxes for a
quarter equal to least the amount of taxes they were required
to remit during the second preceding calendar quarter (the
``look back'' rules). For example, air carriers generally would
not be subject to underpayment penalties if their semi-monthly
deposits for the fourth quarter (October 1 through December 31)
equaled at least the amount they were required to remit during
the second quarter (April 1 through June 30) of the same year.
In a general information letter to the Air Transport
Association of America, dated August 30, 1996, the Internal
Revenue Service advised the air carriers that, notwithstanding
that no excise taxes were required to be remitted during a
look-back quarter, applicable Treasury Department regulations
in 1997 permitted the air carriers to continue to avail
themselves of the safe harbor and avoid remitting taxes
collected from consumers during September, October, and
November of 1996 until the air carriers filed their quarterly
excise tax returns for that period on February 28, 1997.
(Similarly, the air carriers were expected to retain most taxes
collected from consumers during December 1996 until their
excise tax returns for the first quarter of 1997 were due on
May 31, 1997.)
Trust fund deposits
The Airport Trust Fund received gross receipts attributable
to the excise taxes described above. The Code provided that
taxes received by the Treasury Department through the end of
the period when the taxes were last imposed (i.e., through
December 31, 1996 at the time of the legislation) were
deposited in the Airport Trust Fund. Thus, under prior law,
taxes received after December 31, 1996, were not transferred to
the Airport Trust Fund.
Reasons for Change
The Treasury Department credited the Airport Trust Fund
with approximately $1.2 billion based on incorrect estimates of
excise tax deposits. Subsequently, the Treasury learned that
air carriers would not remit taxes attributable to the fourth
quarter of 1996 to the Treasury until February 28, 1997. The
Treasury Department planned to reverse this error. As a result,
the combination of the remaining uncommitted balance in the
Airport Trust Fund and General Fund appropriations available to
the FAA were believed to be sufficient only to support the
FAA's operational expenses through the fiscal year 1997, and to
allow new capital commitments (assuming previously anticipated
commitment levels) to be made through March 1997. However,
because best available estimates of the effect of this error on
the FAA budget did not include any estimates of the costs of
terminating certain multiple phase contracts, the FAA projected
that it would have to stop making new commitments and begin
notifying contractors of its intent to terminate multiple phase
contracts on March 1, 1997, or earlier, absent legislative
action.
The Congress determined that a short-term extension of the
Airport Trust Fund excise taxes was needed in order to fund the
FAA budget commitments through the fiscal year ending September
30, 1997, and to give Congress time for review of proposals
related to a longer-term extension of the aviation taxes.
Explanation of Provision
Reinstate air transportation excise taxes
The Act reinstated the air transportation excise taxes that
expired after December 31, 1996, during the period beginning
seven days after the date of enactment and ending after
September 30, 1997.
Transfer revenues to the Airport Trust Fund
The Act authorized the Treasury Department to transfer to
the Airport Trust Fund receipts attributable to excise taxes
described above that were imposed on commercial and general
aviation. This permitted transfer of receipts attributable to
taxes imposed both during the period August 27, 1996, through
December 31, 1996, and during the period beginning seven days
after the date of enactment.
Modify Treasury Department excise tax deposit regulations
To prevent a delay in depositing tax similar to that which
occurred with respect to the fourth quarter of 1996, the
provisions of Treasury Department regulations providing an
exception to penalties for underpayment of estimated excise
taxes based on a look-back period were made inapplicable when
tax was not imposed throughout the look-back period. In such a
case, taxpayers could continue to use an alternative safe
harbor that provides that no underpayment penalty is imposed as
long as the taxpayer has paid at least 95 percent of the
current quarter's liability.
Effective Date
The provisions reinstating the commercial air
transportation excise taxes were effective for (1)
transportation beginning during the period beginning seven days
after the date of enactment (March 7, 1997) and ending after
September 30, 1997, and (2) amounts paid during such period for
transportation occurring after September 30, 1997. Refunds
would have been provided for any taxes paid on air passenger
and air freight transportation purchased before October 1,
1997, for transportation that occurs at a time when the taxes
are not in effect. (This refund provision was rendered moot by
provisions of the Taxpayer Relief Act of 1997 (see sec. 1031)
that extended the Airport Trust Fund excise taxes, as modified
in that Act, for 10 years, through September 30, 2007.)
The provisions reinstating the general aviation gasoline
excise tax were effective for gasoline removed during the
period beginning seven days after the date of enactment (March
7, 1997) and ending after September 30, 1997. The provision
reinstating the general aviation jet fuel excise tax was
effective for fuels sold by producers during the same period.
Floor stocks taxes were imposed on these fuels held beyond the
removal or producer level on the date which is seven days after
the date of enactment (March 7, 1997).
The provisions relating to transfer of receipts to the
Airport Trust Fund and the modification of the Treasury
Department's excise tax deposit regulations were effective on
the date of enactment (February 28, 1997).
Revenue Effect
The provisions are estimated to increase Federal fiscal
year budget receipts by $2,730 million in 1997, and to reduce
fiscal year budget receipts by $54 million in 1998.
PART TWO: TAXPAYER RELIEF ACT OF 1997 (H.R. 2014) \5\
TITLE I. CHILD TAX CREDIT
A. Child Tax Credit For Children Under Age 17 (sec. 101(a), (b) and (d)
of the Act and new sec. 24 of the Code)
Prior Law
In general
Prior law did not provide tax credits based solely on the
taxpayer's number of dependent children. Taxpayers with
dependent children, however, generally are able to claim a
personal exemption for each of these dependents. The total
amount of personal exemptions is subtracted (along with certain
other items) from adjusted gross income (``AGI'') in arriving
at taxable income. The amount of each personal exemption is
$2,650 for 1997, and is adjusted annually for inflation. In
1997, the amount of the personal exemption is phased out for
taxpayers with AGI in excess of $121,200 for single taxpayers,
$151,500 for heads of household, and $181,800 for married
couples filing joint returns. These phaseout thresholds are
adjusted annually for inflation.
---------------------------------------------------------------------------
\5\ P.L. 105-34; August 5, 1997. H.R. 2014 was reported by the
House Committee on the Budget on June 24, 1997 (H. Rept. 105-148),
after the revenue reconciliation provisions were approved by the House
Committee on Ways and Means on June 13, 1997. The bill, as amended, was
passed by the House on June 26, 1997.
S. 949 was reported by the Senate Committee on Finance on June 20,
1997 (S. Rept. 105-33). The bill was considered by the Senate on June
25-27, 1997, and the provisions of the bill as amended, were
incorporated in the Senate-passed version of H.R. 2014 on June 27,
1997. A conference report on H.R. 2014 was filed in the House on July
30, 1997 (H. Rept. 105-220); the House agreed to the conference report
on July 31, 1997; and the Senate also agreed to the conference report
on July 31, 1997. H.R. 2014 was signed by the President on August 5,
1997.
Two provisions in the conference agreement on H.R. 2014 as passed
by the House and the Senate were canceled by the President under the
Line Item Veto Act: (1) temporary exceptions under subpart F for
certain active financing income; and (2) nonrecognition of gain on the
sale of stock in agricultural processors facilities to certain farmer's
cooperatives. Modified versions of these two canceled provisions were
passed by the House in H.R. 2513, as amended, on November 8, 1997. (See
report of the Committee on Ways and Means on H.R. 2513; H. Rept. 105-
318, Part I, October 9, 1997. H.R. 2513 was referred to the House
Committee on the Budget, and the bill was discharged from the Committee
on the Budget on October 22, 1997.)
Further, section 977 of H.R. 2014 (relating to carryback of
existing net operating losses of the National Railroad Passenger
Corporation (Amtrak)) was contingent on the enactment of Amtrak reform
legislation. S. 738 (``Amtrak Reform and Accountability Act of 1997'')
was reported by the Senate Committee on Commerce, Science, and
Transportation on May 14, 1997 (S. Rept. 105-85), and was passed by the
Senate, as amended, on November 7, 1997. S. 738 was passed by the
House, with amendment, on November 13, 1997, and the Senate agreed to
the House amendment on November 13, 1997. S. 738 was signed by the
President on December 2, 1997 (P.L. 105-134).
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that the individual income tax
structure does not reduce tax liability by enough to reflect a
family's reduced ability to pay taxes as family size increases.
In part, this is because over the last 50 years the value of
the dependent personal exemption has declined in real terms by
over one-third. The Congress believed that a tax credit for
families with dependent children will reduce the individual
income tax burden of those families, will better recognize the
financial responsibilities of raising dependent children, and
will promote family values.
Explanation of Provision
In general
Present law provides a $500 ($400 for taxable year 1998)
tax credit for each qualifying child under the age of 17. A
qualifying child is defined as an individual for whom the
taxpayer can claim a dependency exemption and who is a son or
daughter of the taxpayer (or a descendent of either), a stepson
or stepdaughter of the taxpayer or an eligible foster child of
the taxpayer.
Phase-out range
For taxpayers with AGI in excess of certain thresholds, the
otherwise allowable child credit is phased out. Specifically,
the otherwise allowable child credit is reduced by $50 for each
$1,000 of modified AGI (or fraction thereof) in excess of the
threshold (``the modified AGI phase-out''). For these purposes
modified AGI is computed by increasing the taxpayer's AGI by
the amount otherwise excluded from gross income under Code
sections 911, 931, or 933 (relating to the exclusion of income
of U.S. citizens or residents living abroad; residents of Guam,
American Samoa, and the Northern Mariana Islands; and residents
of Puerto Rico, respectively). For married taxpayers filing
joint returns, the threshold is $110,000. For taxpayers filing
single or head of household returns, the threshold is $75,000.
For married taxpayers filing separate returns, the threshold is
$55,000. These thresholds are not indexed for inflation. The
length of the phase-out range is affected by the number of the
taxpayer's qualifying children. For example, in 1999, the
phase-out range for a single person with one qualifying child
will be between $75,000 and $85,000 of modified AGI. The phase-
out range for a single person with two qualifying children will
be between $75,000 and $95,000 of modified AGI in 1999.
Tax liability limitation; refundable credits
In general, the amount of the child credit, together with
the other nonrefundable personal credits, is limited to the
excess of the taxpayer's regular tax over the taxpayer's
tentative minimum tax (determined without regard to the
alternative tax minimum foreign tax credit) (sec. 26(a)).
In the case of an individual with three or more qualifying
children, the taxpayer also may be allowed a refundable child
credit (sec. 24(d)).\6\ The amount of the refundable child
credit is the amount that the nonrefundable personal credits
would increase if the tax liability limitation of section 26(a)
were increased by the excess of the taxpayer's social security
taxes over the taxpayer's earned income credit (if any).\7\ The
amount of the refundable child credit is limited to the amount
of the child credit allowable under section 24, determined
without regard to section 26(a). The social security taxes
means the individual's share of FICA taxes and one-half of the
SECA tax liability. The amount of the refundable child credit
is reduced by the amount of the alternative minimum tax imposed
by section 55 that did not result in a reduction of the earned
income credit under section 32(h).
---------------------------------------------------------------------------
\6\ The provision is described as set forth in Title VI (sec.
603(a)) of H.R. 2676, the Tax Technical Corrections Act of 1997, as
passed by the House on November 5, 1997.
\7\ For this purpose, the earned income credit is determined
without regard to the supplemental earned income credit discussed
below.
---------------------------------------------------------------------------
The amount of the refundable child credit under section
24(d) will reduce the amount of the nonrefundable child credit
(determined without regard to section 26). This will result in
the proper calculation of personal credit carryovers.
The following examples illustrate the operation of credit
for a taxpayer with three or more qualifying children:
Example 1.--Assume that in 1999, A, an unmarried individual
with three qualifying children and an adjusted gross income
below $75,000, incurs a regular tax liability in excess of the
tentative minimum tax in the amount of $1,000. Assume also that
A's employee share of FICA taxes is $3,000. Also assume that A
is not entitled to any other credits. A is allowed a $1,000
nonrefundable credit, as limited by section 26(a). A is also
allowed a refundable credit of $500 by reason of section 24(d).
The amount of this credit is the lesser of (1) $1,500 (the
credit that would be allowed under section 24(a) without regard
to the tax limitation of section 26) or (2) $500 (the excess of
$1,500 (the amount of subpart A credits which would be allowed
if A's $3,000 social security taxes were added to the $1,000
section 26(a) limit) over $1,000 (the subpart A credits
otherwise allowed)).
Example 2.--Assume the same facts as in example 1, except
that A is also allowed a $960 dependent care credit (without
regard to section 26). A is allowed $1,000 of nonrefundable
credits. A is also allowed a refundable credit of $1,460 by
reason of section 24(d). The amount of this credit is the
lesser of (1) $1,500 (as in example 1) or (2) $1,460 (the
excess of $2,460 (the amount of subpart A credits which would
be allowed if A's $3,000 social security taxes were added to
the $1,000 section 26(a) limit) over $1,000 (the subpart A
credits otherwise allowed)).
Example 3.--Assume the same facts as in example 2, except
that A is also allowed a $5,000 adoption credit (without regard
to section 26). A is allowed $1,000 of nonrefundable credits. A
is also allowed a refundable credit of $1,500. The amount of
this credit is the lesser of (1) $1,500 (as in example 2) or
(2) $3,000 (the excess of $4,000 (the amount of the subpart A
credits which would be allowed if A's $3,000 social security
taxes were added to the $1,000 section 26(a) limit) over $1,000
(the subpart A credits otherwise allowed)).
$4,960 of the adoption credit may be carried forward under
section 23(c) ($5,000 credit under section 23(a) in excess of
$40 (the excess of the $1,000 credit limitation under section
26(a) over the $960 of credits allowed by subpart A other than
section 23)). For purposes of computing the credits allowed by
subpart A, the $1,500 child credit is not taken into account
because it is allowed under subpart C.
Supplemental child credit
Part or all of the child credit may be treated as a
supplemental child credit under the earned income credit (sec.
32(n)).\8\ The amount treated as a supplemental child credit
under section 32(n) reduces the amount of the child credit
under section 24, but does not change the total amount of child
credits allowed and has no effect on determining the amount of
any other credit for any taxable year.
---------------------------------------------------------------------------
\8\ The provision is described as set forth in Title VI (sec.
603(b)) of H.R. 2676, the Tax Technical Corrections Act of 1997, as
passed by the House on November 5, 1997.
---------------------------------------------------------------------------
The amount of the supplemental child credit is the amount
by which the personal credits would be reduced if the section
26(a) tax liability limitation were reduced by an amount equal
to the excess of the taxpayer's earned income credit (without
regard to the supplemental child credit) over the taxpayer's
social security taxes (as defined above). The amount of the
supplemental child credit cannot exceed the amount of the
nonrefundable child credit under section 24, determined without
regard to the tax liability limitation of section 26. The
eligibility provisions of section 32 are disregarded in
determining the amount of supplemental child credit which is
allowed to the taxpayer.
For example, assume an individual with two qualifying
children is allowed an earned income credit of $1,300 under
section 32(a), has a $500 regular tax liability, no other
personal credits, and pays social security taxes of $1,000.
Without regard to section 32(n), the individual would be
allowed a child credit of $500 under section 24(a), as limited
by section 26(a). However, section 32(n) provides that $300 of
the child credit will be allowed as supplemental child credit
under section 32 rather than as a child credit under section
24. $300 is the amount that the nonrefundable child credit
would have been reduced if the section 26(a) limitation had
been reduced by the excess of the $1,300 regular earned income
credit over the $1,000 social security taxes. Thus, the
individual will be allowed a supplemental child credit under
section 32(n) of $300 and a child credit under section 24 of
$200. This provision will not change the total amount of
credits allowed to the taxpayer.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $2,710 million in 1998, $18,119 million in
1999, $21,549 million in 2000, $21,401 million in 2001, $21,258
million in 2002, $20,901 million in 2003, $20,430 million in
2004, $19,702 million in 2005, $18,997 million in 2006, and
$18,317 million in 2007.
B. Expand Definition of High-Risk Individuals with Respect to Tax-
Exempt State-Sponsored Organizations Providing Health Coverage (sec.
101(c) of the Act and sec. 501(c)(26) of the Code)
Present and Prior Law
Present and prior law provide tax-exempt status to any
membership organization that is established by a State
exclusively to provide coverage for medical care on a nonprofit
basis to certain high-risk individuals, provided certain
criteria are satisfied.\9\ The organization may provide
coverage for medical care either by issuing insurance itself or
by entering into an arrangement with a health maintenance
organization (``HMO'').
---------------------------------------------------------------------------
\9\ No inference is intended as to the tax treatment of other types
of State-sponsored organizations.
---------------------------------------------------------------------------
High-risk individuals eligible to receive medical care
coverage from the organization must be residents of the State
who, due to a pre-existing medical condition, are unable to
obtain health coverage for such condition through insurance or
an HMO, or are able to acquire such coverage only at a rate
that is substantially higher than the rate charged for such
coverage by the organization. The State must determine the
composition of membership in the organization. For example, a
State could mandate that all organizations that are subject to
insurance regulation by the State must be members of the
organization.
The State or members of the organization are required to
fund the liabilities of the organization to the extent that
premiums charged to eligible individuals are insufficient to
cover such liabilities. Finally, no part of the net earnings of
the organization can inure to the benefit of any private
shareholder or individual.
Reasons for Change
The Congress believed that including the spouse and certain
children of high-risk individuals in the group of individuals
to whom such an organization may provide medical care coverage
will assist States in providing medical care coverage for
uninsured children.
Explanation of Provision
The provision expands the definition of high-risk
individuals to include a child of an individual who meets the
present-law definition of a high-risk individual, subject to
certain requirements. The requirements are: (1) the taxpayer is
allowed a deduction for a personal exemption for the child for
the taxable year; (2) the child has not attained the age of 17
as of the close of the calendar year in which the taxable year
of the taxpayer begins; and (3) the child is a son or daughter
of the taxpayer (or a descendant of either), a stepson or
stepdaughter of the taxpayer, or an eligible foster child of
the taxpayer. The definition of high-risk individuals is also
expanded to include the spouse of an individual who meets the
prior-law definition of a high-risk individual.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $1 million in 1998 and by $2 million per
year in each of 1999 through 2007.
TITLE II. EDUCATION TAX INCENTIVES
A. Tax Benefits Relating to Education Expenses
1. HOPE tax credit and Lifetime Learning tax credit for higher
education tuition expenses (sec. 201 of the Act and new secs.
25A and 6050S of the Code)
Present and Prior Law
Deductibility of education expenses
Taxpayers generally may not deduct education and training
expenses. However, a deduction for education expenses generally
is allowed under section 162 if the education or training (1)
maintains or improves a skill required in a trade or business
currently engaged in by the taxpayer, or (2) meets the express
requirements of the taxpayer's employer, or requirements of
applicable law or regulations, imposed as a condition of
continued employment (Treas. Reg. sec. 1.162-5). However,
education expenses are not deductible if they relate to certain
minimum educational requirements or to education or training
that enables a taxpayer to begin working in a new trade or
business. In the case of an employee, education expenses (if
not reimbursed by the employer) may be claimed as an itemized
deduction only if such expenses meet the above-described
criteria for deductibility under section 162 and only to the
extent that the expenses, along with other miscellaneous
deductions, exceed 2 percent of the taxpayer's adjusted gross
income (AGI).
Exclusion for employer-provided educational assistance
A special rule allows an employee to exclude from gross
income for income tax purposes and from wages for employment
tax purposes up to $5,250 annually paid by his or her employer
for educational assistance (sec. 127). In order for the
exclusion to apply, certain requirements must be satisfied,
including a requirement that not more than 5 percent of the
amounts paid or incurred by the employer during the year for
educational assistance under a qualified educational assistance
program can be provided for the class of individuals consisting
of more than 5-percent owners of the employer and the spouses
or dependents of such more than 5-percent owners. This special
rule for employer-provided educational assistance expires with
respect to courses beginning after May 31, 2000, and does not
apply to graduate-level courses.
For purposes of the special exclusion, educational
assistance means the payment by an employer of expenses
incurred by or on behalf of the employee for education of the
employee including, but not limited to, tuition, fees, and
similar payments, books, supplies, and equipment. Educational
assistance also includes the provision by the employer of
courses of instruction for the employee (including books,
supplies, and equipment). Educational assistance does not
include tools or supplies which may be retained by the employee
after completion of a course or meals, lodging, or
transportation. The exclusion does not apply to any education
involving sports, games, or hobbies.
In the absence of the special exclusion, employer-provided
educational assistance is excludable from gross income and
wages as a working condition fringe benefit (sec. 132(d)) only
to the extent the education expenses would be deductible under
section 162.
Exclusion for interest earned on savings bonds
Another special rule (sec. 135) provides that interest
earned on a qualified U.S. Series EE savings bond issued after
1989 is excludable from gross income if the proceeds of the
bond upon redemption do not exceed qualified higher education
expenses paid by the taxpayer during the taxable year.\10\
``Qualified higher education expenses'' include tuition and
fees (but not room and board expenses) required for the
enrollment or attendance of the taxpayer, the taxpayer's
spouse, or a dependent of the taxpayer at certain colleges,
universities, or vocational schools.\11\ The exclusion provided
by section 135 is phased out for certain higher-income
taxpayers, determined by the taxpayer's modified AGI during the
year the bond is redeemed. For 1997, the exclusion is phased
out for taxpayers with modified AGI between $50,850 and $65,850
($76,250 and $106,250 for joint returns). To prevent taxpayers
from effectively avoiding the income phaseout limitation
through issuance of bonds directly in the child's name, section
135(c)(1)(B) provides that the interest exclusion is available
only with respect to U.S. Series EE savings bonds issued to
taxpayers who are at least 24 years old.
---------------------------------------------------------------------------
\10\ If the aggregate redemption amount (i.e., principal plus
interest) of all Series EE bonds redeemed by the taxpayer during the
taxable year exceeds the qualified education expenses incurred, then
the excludable portion of interest income is based on the ratio that
the education expenses bear to the aggregate redemption amount (sec.
135(b)).
\11\ The Act amended section 135 to allow taxpayers to redeem U.S.
Savings Bonds and be eligible for the exclusion under that section (as
if the proceeds were used to pay qualified higher education expenses)
provided that the proceeds from the redemption are contributed to a
qualified State tuition program defined under section 529, or to an
education IRA defined under section 530, on behalf of the taxpayer, the
taxpayer's spouse, or a dependent. Title VI of H.R. 2676, the Tax
Technical Corrections Act of 1997, as passed by the House on November
5, 1997, includes a technical correction provision that conforms the
definition of ``eligible educational institution'' under section 135 to
the broader definition of that term under sections 529 and 530. The
result of this technical correction would be that, for purposes of
section 135, as under sections 529 and 530, the term ``eligible
educational institution'' would be defined as an institution which is
(1) described in section 481 of the Higher Education Act of 1965 (20
U.S.C. 1088) and (2) eligible to participate in Department of Education
student aid programs.
---------------------------------------------------------------------------
Qualified scholarships
Section 117 excludes from gross income amounts received as
a qualified scholarship by an individual who is a candidate for
a degree and used for tuition and fees required for the
enrollment or attendance (or for fees, books, supplies, and
equipment required for courses of instruction) at a primary,
secondary, or post-secondary educational institution. The tax-
free treatment provided by section 117 does not extend to
scholarship amounts covering regular living expenses, such as
room and board. There is, however, no dollar limitation for the
section 117 exclusion, provided that the scholarship funds are
used to pay for tuition and required fees. In addition to the
exclusion for qualified scholarships, section 117 provides an
exclusion from gross income for qualified tuition reductions
for education below the graduate level provided to employees
(and their spouses and dependents) of certain educational
organizations.\12\ Section 117(c) specifically provides that
the exclusion for qualified scholarships and qualified tuition
reductions does not apply to any amount received by a student
that represents payment for teaching, research, or other
services by the student required as a condition for receiving
the scholarship or tuition reduction.
---------------------------------------------------------------------------
\12\ A special rule provides that qualified tuition reductions
under section 117(d) may be provided for graduate-level courses in
cases of graduate students who are engaged in teaching or research
activities for the educational organization (sec. 117(d)(5)).
---------------------------------------------------------------------------
Student loan forgiveness
In the case of an individual, section 108(f) provides that
gross income subject to Federal income tax does not include any
amount from the forgiveness (in whole or in part) of certain
student loans, provided that the forgiveness is contingent on
the student's working for a certain period of time in certain
professions for any of a broad class of employers (e.g.,
providing health care services to a nonprofit organization).
Student loans eligible for this special rule must be made to an
individual to assist the individual in attending an education
institution that normally maintains a regular faculty and
curriculum and normally has a regularly enrolled body of
students in attendance at the place where its education
activities are regularly carried on. Loan proceeds may be used
not only for tuition and required fees, but also to cover room
and board expenses (in contrast to tax-free scholarships under
section 117, which are limited to tuition and required fees).
In addition, the loan must be made by (1) the United States (or
an instrumentality or agency thereof), (2) a State (or any
political subdivision thereof), (3) certain tax-exempt public
benefit corporations that control a State, county, or municipal
hospital and whose employees have been deemed to be public
employees under State law, or (4) an educational organization
that originally received the funds from which the loan was made
from the United States, a State, or a tax-exempt public benefit
corporation. Thus, loans made with private, nongovernmental
funds are not qualifying student loans for purposes of the
section 108(f) exclusion. As with section 117, there is no
dollar limitation for the section 108(f) exclusion.
The Act expanded section 108(f) to apply to cancellations
of student loans made by an educational organization with its
own funds, provided that the cancellation is contingent on the
student working for a certain period of time in certain
professions for any of a broad class of employers and provided
that the student's work satisfies a public service requirement.
Qualified State tuition programs
Section 529 provides tax-exempt status to ``qualified State
tuition programs,'' meaning certain programs established and
maintained by a State (or agency or instrumentality thereof)
under which persons may (1) purchase tuition credits or
certificates on behalf of a designated beneficiary that entitle
the beneficiary to a waiver or payment of qualified higher
education expenses of the beneficiary, or (2) make
contributions to an account that is established for the purpose
of meeting qualified higher education expenses of the
designated beneficiary of the account. ``Qualified higher
education expenses'' are defined as tuition, fees, books,
supplies, and equipment required for the enrollment or
attendance at a college or university (or certain vocational
schools). Under the Act, qualified higher education expenses
also include certain room and board expenses, provided that the
student is enrolled at an eligible educational institution on
at least a half-time basis. Section 529 also provides that no
amount shall be included in the gross income of a contributor
to, or beneficiary of, a qualified State tuition program with
respect to any distribution from, or earnings under, such
program, except that (1) amounts distributed or educational
benefits provided to a beneficiary (e.g., when the beneficiary
attends college) will be included in the beneficiary's gross
income (unless excludable under another Code section) to the
extent such amounts or the value of the educational benefits
exceed contributions made on behalf of the beneficiary, and (2)
amounts distributed to a contributor (e.g., when a parent
receives a refund) will be included in the contributor's gross
income to the extent such amounts exceed contributions made by
that person. Section 529(c)(3)(C) allows tax-free rollovers of
credits or account balances in qualified State tuition programs
(and redesignations of named beneficiaries) between certain
relatives.
Reasons for Change
To assist low- and middle-income families and students in
paying for the costs of post-secondary education, the Congress
believed that taxpayers should be allowed to claim a credit
against Federal income taxes for certain tuition and related
expenses incurred when a student attends a college or
university (or certain vocational schools).
Explanation of Provisions
HOPE credit
Allowance of credit.--Individual taxpayers are allowed to
claim a non-refundable HOPE credit against Federal income taxes
up to $1,500 per student per year for qualified tuition and
related expenses paid for the first two years of the student's
post-secondary education in a degree or certificate program.
The HOPE credit rate is 100 percent on the first $1,000 of
qualified tuition and related expenses, and 50 percent on the
next $1,000 of qualified tuition and related expenses.\13\ The
maximum HOPE credit amount will be indexed for inflation
occurring after the year 2000.\14\ The qualified tuition and
related expenses must be incurred on behalf of the taxpayer,
the taxpayer's spouse, or a dependent. The HOPE credit is
available with respect to an individual student for two taxable
years, provided that the student has not completed the first
two years of post-secondary education before the beginning of
the second taxable year.\15\
---------------------------------------------------------------------------
\13\ Thus, an eligible student who incurs $1,000 of qualified
tuition and related expenses is eligible (subject to the AGI phaseout)
for a $1,000 HOPE credit; and if such a student incurs $2,000 of
qualified tuition and related expenses, then he or she is eligible for
a $1,500 HOPE credit.
\14\ The maximum HOPE credit amount will be indexed for inflation
occurring after the year 2000, by increasing the cap on qualified
tuition and related expenses subject to the 100-percent credit rate and
the cap on such tuition and related expenses subject to the 50-percent
credit rate, both caps rounded down to the closest multiple of $100.
(Some printed versions of the Act incorrectly indicated that the caps
would be rounded down to the closest multiple of $1,000.) The first
taxable year for which the inflation adjustment could be made to
increase the caps on qualified tuition and related expenses will be
2002.
\15\ The HOPE credit may not be claimed against a taxpayer's
alternative minimum tax (AMT) liability.
---------------------------------------------------------------------------
The HOPE credit amount that a taxpayer may otherwise claim
is phased out ratably for taxpayers with modified AGI between
$40,000 and $50,000 ($80,000 and $100,000 for joint returns).
Modified AGI includes amounts otherwise excluded with respect
to income earned abroad (or income from Puerto Rico or U.S.
possessions). The income phase-out ranges will be indexed for
inflation occurring after the year 2000, rounded down to the
closest multiple of $1,000. The first taxable year for which
the inflation adjustment could be made to increase the income
phase-out ranges will be 2002.\16\
---------------------------------------------------------------------------
\16\ If a taxpayer is married (within the meaning of section 7703),
the HOPE credit may be available only if the taxpayer and his or her
spouse file a joint return for the taxable year.
---------------------------------------------------------------------------
The HOPE credit is available in the taxable year the
expenses are paid, subject to the requirement that the
education commence or continue during that year or during the
first three months of the next year. Qualified tuition and
related expenses paid with the proceeds of a loan generally are
eligible for the HOPE credit (rather than repayment of the loan
itself).
Dependent students.--A taxpayer may claim the HOPE credit
with respect to an eligible student who is not the taxpayer or
the taxpayer's spouse (e.g., in cases where the student is the
taxpayer's child) only if the taxpayer claims the student as a
dependent for the taxable year for which the credit is claimed.
If a student is claimed as a dependent by the parent or other
taxpayer, the eligible student him- or herself is not entitled
to claim a HOPE credit for that taxable year on the student's
own tax return. If a parent (or other taxpayer) claims a
student as a dependent, any qualified tuition and related
expenses paid by the student are treated as paid by the parent
(or other taxpayer) for purposes of the provision.
Election of HOPE credit, Lifetime Learning credit, or
exclusion from gross income for certain distributions from
education IRAs.--For each taxable year, a taxpayer may elect
with respect to an eligible student the HOPE credit or the
``Lifetime Learning'' credit (described below), or an exclusion
from gross income under section 530 for certain distributions
from an education IRA (described at A.4, below). Thus, for
example, if a parent claims a child as a dependent for a
taxable year, then all qualified tuition and related expenses
paid by both the parent and child are deemed paid by the
parent, and the parent may claim the HOPE credit (assuming that
the AGI phaseout does not apply) on the parent's return. As an
alternative, the parent may elect for that taxable year the
Lifetime Learning credit for qualified tuition and related
expenses (or an exclusion from gross income for certain
distributions from an education IRA) with respect to the
dependent child (as described below).\17\ On the other hand, if
a child is not claimed as a dependent by the parent (or by any
other taxpayer) for the taxable year, then the child him- or
herself has the option of electing either the HOPE credit, or
the Lifetime Learning credit, or the section-530 exclusion for
certain distributions from an education IRA for the taxable
year.
---------------------------------------------------------------------------
\17\ For any taxable year, a taxpayer may claim the HOPE credit for
qualified tuition and related expenses paid with respect to one student
and also claim the Lifetime Learning credit or the section-530
exclusion with respect to one or more other students. If the HOPE
credit is claimed with respect to one student for one or two taxable
years, then the Lifetime Learning credit or the section-530 exclusion
may be available with respect to that same student for subsequent
taxable years.
---------------------------------------------------------------------------
Qualified tuition and related expenses.--The HOPE credit is
available for ``qualified tuition and related expenses,''
meaning tuition and fees required for the enrollment or
attendance of an eligible student at an eligible educational
institution. Charges and fees associated with meals, lodging,
student activities, athletics, insurance, transportation, and
similar personal, living or family expenses are not included.
The HOPE credit is not available for expenses incurred to
purchase books. The expenses of education involving sports,
games, or hobbies are not qualified tuition and related
expenses unless this education is part of the student's degree
program.
Qualified tuition and related expenses generally include
only out-of-pocket expenses. Qualified tuition and related
expenses do not include expenses covered by educational
assistance that is not required to be included in the gross
income of either the student or the taxpayer claiming the
credit. Thus, total qualified tuition and related expenses are
reduced by any scholarship or fellowship grants excludable from
gross income under present-law section 117 and any other tax-
free educational benefits received by the student during the
taxable year. No reduction of qualified tuition and related
expenses is required for a gift, bequest, devise, or
inheritance within the meaning of section 102(a). Under the
provision, a HOPE credit is not allowed with respect to any
education expense for which a deduction is claimed under
section 162 or any other section of the Code.\18\
---------------------------------------------------------------------------
\18\ In addition, the Act amends section 135 to provide that the
amount of qualified higher education expenses taken into account for
purposes of that section is reduced by the amount of such expenses
taken into account in determining the HOPE credit claimed by any
taxpayer with respect to the student for the taxable year.
---------------------------------------------------------------------------
Eligible students.--An eligible student for purposes of the
HOPE credit is an individual who is enrolled in a degree,
certificate, or other program (including a program of study
abroad approved for credit by the institution at which such
student is enrolled) leading to a recognized educational
credential at an eligible educational institution. The student
must pursue a course of study on at least a half-time basis.
(In other words, for at least one academic period which begins
during the taxable year, the student must carry at least one-
half the normal full-time work load for the course of study the
student is pursuing.) To be eligible for the HOPE credit, a
student must not have been convicted of a Federal or State
felony consisting of the possession or distribution of a
controlled substance.
Eligible educational institutions.--Eligible educational
institutions are defined by reference to section 481 of the
Higher Education Act of 1965. Such institutions generally are
accredited post-secondary educational institutions offering
credit toward a bachelor's degree, an associate's degree, or
another recognized post-secondary credential. Certain
proprietary institutions and post-secondary vocational
institutions also are eligible educational institutions. The
institution must be eligible to participate in Department of
Education student aid programs.
Regulations.--The Secretary of the Treasury is granted
authority to issue regulations to implement the provision,
including regulations providing for a recapture of the HOPE
credit where there is a refund of tuition and related expenses
with respect to which a credit was claimed in a prior year
(sec. 25A(i)). In addition, new Code section 6050S provides
that eligible educational institutions which receive payments
for qualified tuition and related expenses, and certain other
persons who make reimbursements or refunds of qualified tuition
and related expenses,\19\ are required to furnish information
returns to the IRS and students (and individuals claiming the
student as a dependent) as prescribed by Treasury Department
regulations, in order to assist students, their parents, and
the IRS in calculating the amount of the HOPE credit
potentially available.
---------------------------------------------------------------------------
\19\ Title VI of H.R. 2676, the Tax Technical Corrections Act of
1997, as passed by the House on November 5, 1997, includes a provision
that clarifies that, under section 6050S, information returns
containing information with respect to qualified tuition and related
expenses must be filed by a person that is not an eligible educational
institution only if such person is engaged in a trade or business of
making payments to any individual under an insurance arrangement as
reimbursements or refunds (or similar payments) of qualified tuition
and related expenses. Section 6050S will continue to require the filing
of information returns by persons engaged in a trade or business if, in
the course of such trade or business, the person receives from any
individual interest aggregating $600 or more for any calendar year on
one or more qualified education loans within the meaning of section
221(e)(1).
---------------------------------------------------------------------------
Lifetime Learning credit for qualified tuition and related expenses
Allowance of credit.--The Act provides that individual
taxpayers are allowed to claim a nonrefundable ``Lifetime
Learning'' credit against Federal income taxes equal to 20
percent of qualified tuition and related expenses incurred
during the taxable year on behalf of the taxpayer, the
taxpayer's spouse, or any dependents. For expenses paid after
June 30, 1998, and prior to January 1, 2003, up to $5,000 of
qualified tuition and related expenses per taxpayer return will
be eligible for the 20-percent Lifetime Learning credit (i.e.,
the maximum credit per taxpayer return will be $1,000). For
expenses paid after December 31, 2002, up to $10,000 of
qualified tuition and related expenses per taxpayer return will
be eligible for the 20-percent Lifetime Learning credit (i.e.,
the maximum credit per taxpayer return will be $2,000).
In contrast to the HOPE credit, a taxpayer may claim the
Lifetime Learning credit for an unlimited number of taxable
years. Also in contrast to the HOPE credit, the maximum amount
of the Lifetime Learning credit that may be claimed on a
taxpayer's return will not vary based on the number of students
in the taxpayer's family--that is, the HOPE credit is computed
on a per-student basis, while the Lifetime Learning credit is
computed on a family-wide basis.
The Lifetime Learning credit is phased out ratably over the
same phase-out range that applies for purposes of the HOPE
credit--i.e., taxpayers with modified AGI between $40,000 and
$50,000 ($80,000 and $100,000 for joint returns). The income
phase-out ranges will be indexed for inflation occurring after
the year 2000, rounded down to the closest multiple of $1,000.
The first taxable year for which the inflation adjustment could
be made to increase the income phase-out ranges will be
2002.\20\
---------------------------------------------------------------------------
\20\ If a taxpayer is married (within the meaning of section 7703),
the Lifetime Learning credit may be available only if the taxpayer and
his or her spouse file a joint return for the taxable year.
---------------------------------------------------------------------------
The Lifetime Learning credit is available in the taxable
year the expenses are paid, subject to the requirement that the
education commence or continue during that year or during the
first three months of the next year. Qualified tuition and
related expenses paid with the proceeds of a loan generally are
eligible for the Lifetime Learning credit (rather than
repayment of the loan itself).
Dependent students.--As with the HOPE credit, a taxpayer
may claim the Lifetime Learning credit with respect to a
student who is not the taxpayer or the taxpayer's spouse (e.g.,
in cases where the student is the taxpayer's child) only if the
taxpayer claims the student as a dependent for the taxable year
for which the credit is claimed. If a student is claimed as a
dependent by the parent or other taxpayer, the student him- or
herself is not entitled to claim the Lifetime Learning credit
for that taxable year on the student's own tax return. If a
parent (or other taxpayer) claims a student as a dependent, any
qualified tuition and related expenses paid by the student are
treated as paid by the parent (or other taxpayer) for purposes
of the provision.
Election of Lifetime Learning credit, HOPE credit, or
exclusion from gross income for certain distributions from
education IRAs.--A taxpayer may claim the Lifetime Learning
credit for a taxable year with respect to one or more students,
even though the taxpayer also claims a HOPE credit (or claims
the section-530 exclusion for distributions from an education
IRA) for that same taxable year with respect to other students.
If, for a taxable year, a taxpayer claims a HOPE credit with
respect to a student (or claims an exclusion for certain
distributions from an education IRA with respect to a student),
then the Lifetime Learning credit will not be available with
respect to that same student for that year (although the
Lifetime Learning credit may be available with respect to that
same student for other taxable years).
Qualified tuition and related expenses.--The Lifetime
Learning credit is available for ``qualified tuition and
related expenses,'' meaning tuition and fees required for the
enrollment or attendance of the eligible student at an eligible
institution. Charges and fees associated with meals, lodging,
student activities, athletics, insurance, transportation, and
similar personal, living or family expenses are not included.
The Lifetime Learning credit is not available for expenses
incurred to purchase books. The expenses of education involving
sports, games, or hobbies are not qualified tuition expenses
unless this education is part of the student's degree program.
In contrast to the HOPE credit, qualified tuition and
related expenses for purposes of the Lifetime Learning credit
include tuition and fees incurred with respect to undergraduate
or graduate-level (and professional degree) courses.\21\
---------------------------------------------------------------------------
\21\ The HOPE credit is available only with respect to the first
two years of a student's undergraduate education.
---------------------------------------------------------------------------
As with the HOPE credit, qualified tuition and fees
generally include only out-of-pocket expenses. Qualified
tuition and fees do not include expenses covered by educational
assistance that is not required to be included in the gross
income of either the student or the taxpayer claiming the
credit. Thus, total qualified tuition and fees are reduced by
any scholarship or fellowship grants excludable from gross
income under present-law section 117 and any other tax-free
educational benefits received by the student during the taxable
year (such as employer-provided educational assistance
excludable under section 127). No reduction of qualified
tuition and fees is required for a gift, bequest, devise, or
inheritance within the meaning of section 102(a). Under the
provision, a Lifetime Learning credit is not allowed with
respect to any education expense for which a deduction is
claimed under section 162 or any other section of the Code.\22\
---------------------------------------------------------------------------
\22\ In addition, the Act amends present-law section 135 to provide
that the amount of qualified higher education expenses taken into
account for purposes of that section is reduced by the amount of such
expenses taken into account in determining the Lifetime Learning credit
claimed by any taxpayer with respect to the student for the taxable
year.
---------------------------------------------------------------------------
Eligible students.--In addition to allowing a credit for
the tuition and related expenses of a student who attends
classes on at least a half-time basis as part of a degree or
certificate program, the Lifetime Learning credit also is
available with respect to any course of instruction at an
eligible educational institution (whether enrolled in by the
student on a full-time, half-time, or less than half-time
basis) to acquire or improve job skills of the student.
Undergraduate and graduate students are eligible for the
Lifetime Learning credit. Moreover, in contrast to the HOPE
credit, the eligibility of a student for the Lifetime Learning
credit does not depend on whether or not the student has been
convicted of a Federal or State felony consisting of the
possession or distribution of a controlled substance.
Eligible educational institutions.--Eligible educational
institutions are (as with the HOPE credit) defined by reference
to section 481 of the Higher Education Act of 1965. Such
institutions generally are accredited post-secondary
educational institutions offering credit toward a bachelor's
degree, an associate's degree, graduate-level or professional
degree, or another recognized post-secondary credential.
Certain proprietary institutions and post-secondary vocational
institutions also are eligible educational institutions. The
institution must be eligible to participate in Department of
Education student aid programs.
Regulations.--As with the HOPE credit, the Secretary of the
Treasury is granted authority to issue regulations to implement
the provision, including regulations providing for a recapture
of the Lifetime Learning credit where there is a refund of
tuition and related expenses with respect to which a credit was
claimed in a prior year (sec. 25A(i)). In addition, the new
Code section 6050S requires information reporting (as
prescribed by Treasury Department regulations) by eligible
educational institutions which receive payments for qualified
tuition and related expenses, and certain other persons who
make reimbursements or refunds of qualified tuition and related
expenses, in order to assist students, their parents, and the
IRS in calculating the amount of the Lifetime Learning credit
potentially available.\23\
---------------------------------------------------------------------------
\23\ Title VI of H.R. 2676, the Tax Technical Corrections Act of
1997, as passed by the House on November 5, 1997, includes a provision
that clarifies that, under section 6050S, information returns
containing information with respect to qualified tuition and related
expenses must be filed by a person that is not an eligible educational
institution only if such person is engaged in a trade or business of
making payments to any individual under an insurance arrangement as
reimbursements or refunds (or similar payments) of qualified tuition
and related expenses.
---------------------------------------------------------------------------
Effective Date
The HOPE credit is available for expenses paid after
December 31, 1997, for education furnished in academic periods
beginning after such date. The Lifetime Learning credit is
available for expenses paid after June 30, 1998, for education
furnished in academic periods beginning after such date.
Revenue Effect
The provisions are estimated to reduce Federal fiscal year
budget receipts by $2,083 million in 1998, $6,469 million in
1999, $7,393 million in 2000, $7,907 million in 2001, $7,707
million in 2002, $8,620 million in 2003, $8,754 million in
2004, $8,893 million in 2005, $9,035 million in 2006, and
$9,180 million in 2007.
2. Deduction for student loan interest (sec. 202 of the Act and new
sec. 221 of the Code)
Present and Prior Law
The Tax Reform Act of 1986 repealed the deduction for
personal interest. Student loan interest generally is treated
as personal interest and thus is not allowable as an itemized
deduction from income.
Taxpayers generally may not deduct education and training
expenses. However, a deduction for education expenses generally
is allowed under section 162 if the education or training (1)
maintains or improves a skill required in a trade or business
currently engaged in by the taxpayer, or (2) meets the express
requirements of the taxpayer's employer, or requirements of
applicable law or regulations, imposed as a condition of
continued employment (Treas. Reg. sec. 1.162-5). Education
expenses are not deductible if they relate to certain minimum
educational requirements or to education or training that
enables a taxpayer to begin working in a new trade or business.
In the case of an employee, education expenses (if not
reimbursed by the employer) may be claimed as an itemized
deduction only if such expenses relate to the employee's
current job and only to the extent that the expenses, along
with other miscellaneous deductions, exceed 2 percent of the
taxpayer's adjusted gross income (AGI).
Reasons for Change
The Congress understood that many students incur
considerable debt in the course of obtaining undergraduate and
graduate education. The Congress believed that permitting a
deduction for interest on certain student loans will help to
ease the financial burden that such obligations represent.
Explanation of Provision
Under the Act, certain individuals who have paid interest
on qualified education loans may claim an above-the-line
deduction for such interest expenses, up to a maximum deduction
of $2,500 per year. The deduction is allowed only with respect
to interest paid on a qualified education loan during the first
60 months in which interest payments are required. Months
during which the qualified education loan is in deferral or
forbearance do not count against the 60-month period. No
deduction is allowed to an individual if that individual is
claimed as a dependent on another taxpayer's return for the
taxable year.
A qualified education loan generally is defined as any
indebtedness incurred to pay for the qualified higher education
expenses of the taxpayer, the taxpayer's spouse, or any
dependent of the taxpayer as of the time the indebtedness was
incurred in attending (1) post-secondary educational
institutions and certain vocational schools defined by
reference to section 481 of the Higher Education Act of 1965,
or (2) institutions conducting internship or residency programs
leading to a degree or certificate from an institution of
higher education, a hospital, or a health care facility
conducting postgraduate training. Qualified education loans do
not include indebtedness owed to persons related (within the
meaning of sections 267(b) or 707(b)(1)) to the taxpayer.
Qualified higher education expenses are defined as the
student's cost of attendance as defined in section 472 of the
Higher Education Act of 1965 (generally, tuition, fees, room
and board, and related expenses), reduced by (1) any amount
excluded from gross income under section 135, (2) any amount
distributed from an education IRA and excluded from gross
income, and (3) the amount of any scholarship or fellowship
grants excludable from gross income under present-law section
117, as well as any other tax-free educational benefits, such
as employer-provided educational assistance that are excludable
from the employee's gross income under section 127. Such
expenses must be paid or incurred within a reasonable period
before or after the indebtedness is incurred, and must be
attributable to a period when the student is at least a half-
time student.
The maximum deduction is phased in over 4 years, with a
$1,000 maximum deduction in 1998, $1,500 in 1999, $2,000 in
2000, and $2,500 in 2001. The maximum deduction amount is not
indexed for inflation. In addition, the deduction is phased out
ratably for individual taxpayers with modified AGI of $40,000-
$55,000 ($60,000-$75,000 for joint returns); such income ranges
will be indexed for inflation occurring after the year 2002,
rounded down to the closest multiple of $5,000. Thus, the first
taxable year for which the inflation adjustment could be made
will be 2003. Modified AGI includes amounts otherwise excluded
with respect to income earned abroad (or income from Puerto
Rico or U.S. possessions) as well as amounts excludable from
gross income under section 137 (qualified adoption expenses)
\24\, and is calculated after application of section 86 (income
inclusion of certain Social Security benefits), section 219
(deductible IRA contributions), and section 469 (limitation on
passive activity losses and credits).\25\
---------------------------------------------------------------------------
\24\ For purposes of section 137, adjusted gross income is
determined without regard to the deduction for student loan interest.
\25\ For purposes of sections 86, 135, 219, and 469, adjusted gross
income is determined without regard to the deduction for student loan
interest.
---------------------------------------------------------------------------
No deduction is allowed for any amount for which a
deduction is otherwise allowable under chapter 1 of the Code.
In addition, no deduction is allowed for any amount that is
disallowed as a deduction under section 261. For example, no
deduction would be allowed as interest on a qualified education
loan for any amount that is disallowed under section 264
(relating to certain amounts paid in connection with insurance
contracts).
Any person in a trade or business or any governmental
agency that receives $600 or more in qualified education loan
interest from an individual during a calendar year must provide
an information report on such interest to the IRS and to the
payor.
The Congress expressed its expectation that the Secretary
of Treasury will issue regulations setting forth reporting
procedures that will facilitate the administration of this
provision. Specifically, such regulations should require
lenders separately to report to borrowers the amount of
interest that constitutes deductible student loan interest
(i.e., interest on a qualified education loan during the first
60 months in which interest payments are required). In this
regard, the regulations should include a method for borrower
certification to a lender that the loan proceeds are being used
to pay for qualified higher education expenses. The regulations
also should provide guidance as to how a lender can fulfill its
reporting obligations (both to borrowers and to the IRS) with
respect to interest that constitutes deductible student loan
interest in the case of a revolving line of credit.\26\
---------------------------------------------------------------------------
\26\ Such guidance could provide, for example, that interest on
loans (or other lines of credit) the proceeds of which are used in part
to pay qualified higher education expenses and in part to pay other
expenses cannot be reported as qualified education loan interest under
this provision unless the portion of the loan or line of credit that is
attributable to the qualified higher education expenses is separately
stated and accounted for. Under such an approach, interest on a
revolving line of credit that is used in part to pay qualified higher
education expenses and in part to pay other, nonqualifying expenses
generally could not be reported as qualified education loan interest.
However, if the amount of the line of credit or loan that is
attributable to the higher education expenses is identified at the time
the loan is made or the account is established, and such amount is
separately accounted for such that the applicable 60-month period and
other requirements of the provision, including the lender reporting
requirements, can be satisfied, then the interest could be reported as
qualified education loan interest.
---------------------------------------------------------------------------
Effective Date
The provision is effective for interest payments due and
paid after December 31, 1997, on any qualified education loan.
Thus, in the case of already existing qualified education
loans, interest payments qualify for the deduction to the
extent that the 60-month period has not expired. For purposes
of counting the 60 months, any qualified education loan and all
refinancing (that is treated as a qualified education loan) of
such loan are treated as a single loan.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $18 million in 1998, $69 million in 1999,
$122 million in 2000, $204 million in 2001, $277 million in
2002, $308 million in 2003, $326 million in 2004, $346 million
in 2005, $368 million in 2006, and $391 million in 2007.
3. Penalty-free withdrawals from IRAs for higher education expenses
(sec. 203 of the Act and sec. 72(t) of the Code)
Present and Prior Law
Under present and prior law, amounts held in an individual
retirement arrangement (``IRA'') generally are includible in
income when withdrawn (except to the extent the withdrawal is a
return of nondeductible contributions). Amounts withdrawn prior
to attainment of age 59\1/2\ are subject to an additional 10-
percent early withdrawal tax, unless the withdrawal is due to
death or disability, is made in the form of certain periodic
payments, is used to pay medical expenses in excess of 7.5
percent of AGI, or is used to purchase health insurance of an
unemployed individual.
Reasons for Change
The Congress believed that it is both appropriate and
important to allow individuals to withdraw amounts from their
IRAs for purposes of paying higher education expenses without
incurring an additional 10-percent early withdrawal tax.
Explanation of Provision
The Act provides that the 10-percent early withdrawal tax
does not apply to distributions from IRAs (including new Roth
IRAs created by the Act) if the taxpayer uses the amounts to
pay qualified higher education expenses (including those
related to graduate-level courses) of the taxpayer, the
taxpayer's spouse, or any child, or grandchild of the taxpayer
or the taxpayer's spouse.
The penalty-free withdrawal is available for ``qualified
higher education expenses,'' meaning tuition, fees, books,
supplies, and equipment required for enrollment or attendance,
at an eligible educational institution (defined by reference to
sec 481 of the Higher Education Act of 1965). Certain room and
board expenses also are qualified higher education expenses,
provided that the student is enrolled at an eligible
educational institution at least on a half-time basis.
Qualified higher education expenses are reduced by any amount
excludable from gross income under section 135 relating to the
redemption of a qualified U.S. savings bond and certain
scholarships and veterans benefits.
Effective Date
The provision is effective for distributions after December
31, 1997, with respect to expenses paid after such date for
education furnished in academic periods beginning after such
date.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $78 million in 1998, $201 million in 1999,
$181 million in 2000, $175 million in 2001, $177 million in
2002, $179 million in 2003, $182 million in 2004, $184 million
in 2005, $186 million in 2006, and $189 million in 2007.
4. Tax treatment of qualified State tuition programs and education
IRAs; exclusion for certain distributions from education IRAs
used to pay qualified higher education expenses (secs. 211 and
213 of the Act and sec. 529 and new sec. 530 of the Code)
Present and Prior Law
Exclusion for interest earned on savings bonds
Section 135 provides that interest earned on a qualified
U.S. Series EE savings bond issued after 1989 is excludable
from gross income if the proceeds of the bond upon redemption
do not exceed qualified higher education expenses paid by the
taxpayer during the taxable year.\27\ ``Qualified higher
education expenses'' include tuition and fees (but not room and
board expenses) required for the enrollment or attendance of
the taxpayer, the taxpayer's spouse, or a dependent of the
taxpayer at certain colleges, universities, or vocational
schools.\28\ The exclusion provided by section 135 is phased
out for certain higher-income taxpayers, determined by the
taxpayer's modified AGI during the year the bond is redeemed.
For 1997, the exclusion is phased out for taxpayers with
modified AGI between $50,850 and $65,850 ($76,250 and $106,250
for joint returns). To prevent taxpayers from effectively
avoiding the income phaseout limitation through issuance of
bonds directly in the child's name, section 135(c)(1)(B)
provides that the interest exclusion is available only with
respect to U.S. Series EE savings bonds issued to taxpayers who
are at least 24 years old.
---------------------------------------------------------------------------
\27\ If the aggregate redemption amount (i.e., principal plus
interest) of all Series EE bonds redeemed by the taxpayer during the
taxable year exceeds the qualified expenses incurred, then the
excludable portion of interest income is based on the ratio that the
education expenses bears to the aggregate redemption amount (sec.
135(b)).
\28\ The Act amended section 135 to allow taxpayers to redeem U.S.
Savings Bonds and be eligible for the exclusion under that section (as
if the proceeds were used to pay qualified higher education expenses)
provided that the proceeds from the redemption are contributed to a
qualified State tuition program defined under section 529, or to an
education IRA defined under section 530, on behalf of the taxpayer, the
taxpayer's spouse, or a dependent. Title VI of H.R. 2676, the Tax
Technical Corrections Act of 1997, as passed by the House on November
5, 1997, includes a technical correction provision that conforms the
definition of ``eligible educational institution'' under section 135 to
the broader definition of that term under sections 529 and 530. The
result of this technical correction would be that, for purposes of
section 135, as under sections 529 and 530, the term ``eligible
educational institution'' would be defined as an institution which is
(1) described in section 481 of the Higher Education Act of 1965 (20
U.S.C. 1088) and (2) eligible to participate in Department of Education
student aid programs.
---------------------------------------------------------------------------
Qualified State tuition programs
Section 529 (enacted as part of the Small Business Job
Protection Act of 1996) provides tax-exempt status to
``qualified State tuition programs,'' meaning certain programs
established and maintained by a State (or agency or
instrumentality thereof) under which persons may (1) purchase
tuition credits or certificates on behalf of a designated
beneficiary that entitle the beneficiary to a waiver or payment
of qualified higher education expenses of the beneficiary, or
(2) make contributions to an account that is established for
the purpose of meeting qualified higher education expenses of
the designated beneficiary of the account. ``Qualified higher
education expenses'' are defined as tuition, fees, books,
supplies, and equipment required for the enrollment or
attendance at a college or university (or certain vocational
schools). Under prior law, qualified higher education expenses
did not include any room and board expenses. Section 529 also
provides that no amount shall be included in the gross income
of a contributor to, or beneficiary of, a qualified State
tuition program with respect to any distribution from, or
earnings under, such program, except that (1) amounts
distributed or educational benefits provided to a beneficiary
(e.g., when the beneficiary attends college) will be included
in the beneficiary's gross income (unless excludable under
another Code section) to the extent such amounts or the value
of the educational benefits exceed contributions made on behalf
of the beneficiary, and (2) amounts distributed to a
contributor (e.g., when a parent receives a refund) will be
included in the contributor's gross income to the extent such
amounts exceed contributions made by that person.\29\
---------------------------------------------------------------------------
\29\ Specifically, section 529(c)(3)(A) provides that any
distribution under a qualified State tuition program shall be
includible in the gross income of the distributee in the same manner as
provided under present-law section 72 to the extent not excluded from
gross income under any other provision of the Code.
---------------------------------------------------------------------------
A qualified State tuition program is required to provide
that purchases or contributions only be made in cash.
Contributors and beneficiaries are not allowed to direct any
investments made on their behalf by the program. The program is
required to maintain a separate accounting for each designated
beneficiary. A specified individual must be designated as the
beneficiary at the commencement of participation in a qualified
State tuition program (i.e., when contributions are first made
to purchase an interest in such a program), unless interests in
such a program are purchased by a State or local government or
a tax-exempt charity described in section 501(c)(3) as part of
a scholarship program operated by such government or charity
under which beneficiaries to be named in the future will
receive such interests as scholarships. A transfer of credits
(or other amounts) from one account benefiting one designated
beneficiary to another account benefiting a different
beneficiary will be considered a distribution (as will a change
in the designated beneficiary of an interest in a qualified
State tuition program) unless the beneficiaries are members of
the same family.\30\ Earnings on an account may be refunded to
a contributor or beneficiary, but the State or instrumentality
must impose a more than de minimis monetary penalty unless the
refund is (1) used for qualified higher education expenses of
the beneficiary, (2) made on account of the death or disability
of the beneficiary, or (3) made on account of a scholarship
received by the designated beneficiary to the extent the amount
refunded does not exceed the amount of the scholarship used for
higher education expenses.
---------------------------------------------------------------------------
\30\ For this purpose, the term ``member of the family'' was
defined under prior law by reference to section 2032A(e)(2).
---------------------------------------------------------------------------
Estate and gift tax rules
In general, a taxpayer may exclude $10,000 of gifts made by
an individual ($20,000 in the case of a married couple that
elects to split their gifts) to any one donee during a calendar
year (sec. 2503(b)).\31\ This annual exclusion does not apply
to gifts of future interests, and thus may not be applicable to
contributions made to a State tuition program.
---------------------------------------------------------------------------
\31\ The Act provides that, after 1998, the annual gift-tax
exclusion of $10,000 in the case of an individual, or $20,000 in the
case of a married couple that splits their gifts, will be indexed for
inflation.
---------------------------------------------------------------------------
Under prior law, contributions made to a qualified State
tuition program were treated as incomplete gifts for Federal
gift tax purposes. Thus, any Federal gift tax consequences were
determined at the time that a distribution was made from an
account under the program. The waiver (or payment) of qualified
higher education expenses of a designated beneficiary by (or
to) an educational institution under a qualified State tuition
program was treated as a qualified transfer for purposes of
present-law section 2503(e). Amounts contributed to a qualified
State tuition program (and earnings thereon) were includible in
the contributor's estate for Federal estate tax purposes in the
event that the contributor died before such amounts were
distributed under the program.
Individual retirement arrangements (``IRAs'')
An individual may make deductible contributions to an
individual retirement arrangement (``IRA'') for each taxable
year up to the lesser of $2,000 or the amount of the
individual's compensation for the year if the individual is not
an active participant in an employer-sponsored qualified
retirement plan (and, if married, the individual's spouse also
is not an active participant). Contributions may be made to an
IRA for a taxable year up to April 15th of the following year.
An individual who makes excess contributions to an IRA, i.e.,
contributions in excess of $2,000, is subject to an excise tax
on such excess contributions unless they are distributed from
the IRA before the due date for filing the individual's tax
return for the year (including extensions). Under prior law, if
the individual (or his or her spouse, if married) is an active
participant, the $2,000 limit was phased out between $40,000
and $50,000 of adjusted gross income (``AGI'') for married
couples and between $25,000 and $35,000 of AGI for single
individuals.\32\
---------------------------------------------------------------------------
\32\ The Act increases the income phase-out limits for active
participants in employer-sponsored retirement plans and modifies the
limit for an individual who is not an active participant but whose
spouse is. The Act also creates a new nondeductible IRA called a ``Roth
IRA.'' If certain conditions are satisfied, distributions from a Roth
IRA are not includible in income. (See Title III.A., below.)
---------------------------------------------------------------------------
Prior law permitted individuals to make nondeductible
contributions (up to $2,000 per year) to an IRA to the extent
an individual is not permitted to (or does not) make deductible
contributions.\33\ Earnings on such contributions are
includible in gross income when withdrawn.
---------------------------------------------------------------------------
\33\ Under the Act, nondeductible contributions are permitted to
the extent the individual can not or does not make deductible
contributions or contributions to a Roth IRA. (See Title III., A,
below.)
---------------------------------------------------------------------------
An individual generally is not subject to income tax on
amounts held in an IRA, including earnings on contributions,
until the amounts are withdrawn from the IRA. Amounts withdrawn
from an IRA are includible in gross income (except to the
extent of nondeductible contributions). In addition, a 10-
percent additional tax generally applies to distributions from
IRAs made before age 59-\1/2\, unless the distribution is made
(1) on account of death or disability, (2) in the form of
annuity payments, (3) for medical expenses of the individual
and his or her spouse and dependents that exceed 7.5 percent of
AGI, or (4) for medical insurance of the individual and his or
her spouse and dependents (without regard to the 7.5 percent of
AGI floor) if the individual has received unemployment
compensation for at least 12 weeks, and the withdrawal is made
in the year such unemployment compensation is received or the
following year.\34\
---------------------------------------------------------------------------
\34\ The Act provides an exception from the early withdrawal tax
for withdrawals for qualified higher education expenses (see 3., above)
and for withdrawals for first-time home purchase (up to $10,000). (See
Title III. A., below.)
---------------------------------------------------------------------------
Reasons for Change
To encourage families and students to save for future
education expenses, the Congress believed that tax-exempt
status should be granted to certain education investment
accounts (referred to as ``education IRAs'' \35\) established
by taxpayers on behalf of future students. The Congress further
believed that modifications should be made to the rules
governing qualified State tuition programs, in order to allow
greater flexibility in the use of such programs.
---------------------------------------------------------------------------
\35\ ``Education IRAs''--although they are referred to as ``IRAs''
and are subject to some of the same rules as individual retirement
arrangements--are not, in fact, individual retirement arrangements
within the meaning of the Code.
---------------------------------------------------------------------------
Explanation of Provisions
Qualified State tuition programs
The Act makes the following modifications to present-law
section 529, which governs the tax treatment of qualified State
tuition programs.
Room and board expenses.--The Act expands the definition of
``qualified higher education expenses'' under section 529(e)(3)
to include room and board expenses (meaning the minimum room
and board allowance applicable to the student as determined by
the institution in calculating costs of attendance for Federal
financial aid programs under sec. 472 of the Higher Education
Act of 1965) for any period during which the student is at
least a half-time student. In addition to such room and board
expenses, ``qualified higher education expenses'' include (as
under prior law) tuition, fees, books, supplies, and equipment
required for the enrollment or attendance of a designated
beneficiary at an eligible educational institution.
Eligible educational institution.--The Act expands the
definition of ``eligible educational institution'' for purposes
of section 529 by defining such term by reference to section
481 of the Higher Education Act of 1965. Such institutions
generally are accredited post-secondary educational
institutions offering credit toward a bachelor's degree, an
associate's degree, a graduate-level or professional degree, or
another recognized post-secondary credential. Certain
proprietary institutions and post-secondary vocational
institutions also are eligible institutions. The institution
must be eligible to participate in Department of Education
student aid programs.
Definition of ``member of family''.--The Act expands the
definition of the term ``member of the family'' for purposes of
allowing tax-free transfers or rollovers of credits or account
balances in qualified State tuition programs (and
redesignations of named beneficiaries), so that the term means
persons described in paragraphs (1) through (8) of section
152(a)--e.g., sons, daughters, brothers, sisters, nephews and
nieces, certain in-laws, etc.--and any spouse of such
persons.\36\
---------------------------------------------------------------------------
\36\ The Act also provides a special rule that, in the case of any
contract issued prior to August 20, 1996 (i.e., the date of enactment
of section 529), section 529(c)(3)(C) will be applied without regard to
the requirement that a distribution be transferred to a member of the
family (or the requirement that a change in beneficiaries may be made
only to a member of the family) in order for such distribution or
change in beneficiaries to be tax free.
---------------------------------------------------------------------------
Prohibition against investment direction.--The Act
clarifies the prior-law rule contained in section 529(b)(5)
that qualified State tuition programs may not allow
contributors or designated beneficiaries to direct the
investment of contributions to the program (or earnings
thereon) by specifically providing that contributors and
beneficiaries may not ``directly or indirectly'' direct the
investment of contributions to the program (or earnings
thereon).
Interaction with HOPE credit and Lifetime Learning
credit.--Under the Act (as under prior law), no amount will be
includible in the gross income of a contributor to, or
beneficiary of, a qualified State tuition program with respect
to any contribution to or earnings on such a program until a
distribution is made from the program, at which time the
earnings portion of the distribution (whether made in cash or
in-kind) will be includible in the gross income of the
distributee.\37\ However, to the extent that a distribution
from a qualified State tuition program is used to pay for
qualified tuition and fees, the distributee (or another
taxpayer claiming the distributee as a dependent) will be able
to claim the HOPE credit or Lifetime Learning credit provided
for by the Act with respect to such tuition and fees (assuming
that the other requirements for claiming the HOPE credit or
Lifetime Learning credit are satisfied and the modified AGI
phaseout for those credits does not apply).\38\
---------------------------------------------------------------------------
\37\ Title VI of H.R. 2676, the Tax Technical Corrections Act of
1997, as passed by the House on November 5, 1997, clarifies that, under
rules contained in present-law section 72, distributions from qualified
State tuition programs are treated as representing a pro-rata share of
the principal (i.e., contributions) and accumulated earnings in the
account, and also makes certain conforming changes to section 72. In
particular, the Tax Technical Corrections Act of 1997 provides that,
under section 72(e)(8)(B), the determination of the ratio that the
aggregate amount of contributions to a qualified State tuition program
on behalf of a beneficiary bears to the total balance (or value) of the
account for the beneficiary is to be made at the time of the
distribution or at such other time as the Secretary of the Treasury may
prescribe.
\38\ In cases where in-kind benefits are provided to a beneficiary
under a qualified State tuition program, section 529(c)(3)(B) provides
that the provision of such benefits is treated as a distribution to the
beneficiary. Thus, to the extent such in-kind benefits, if paid for by
the beneficiary, would constitute payment of qualified tuition and fees
for purposes of the HOPE credit or Lifetime Learning credit, the
beneficiary (or another taxpayer claiming the beneficiary as a
dependent) may be able to claim the HOPE credit or Lifetime Learning
credit with respect to payments that are deemed to be made by the
beneficiary with respect to the in-kind benefit.
---------------------------------------------------------------------------
Education IRAs
In general.--The Act provides tax-exempt status to
``education IRAs,'' meaning certain trusts (or custodial
accounts) which are created or organized in the United States
exclusively for the purpose of paying the qualified higher
education expenses of a named beneficiary.\39\ Contributions to
education IRAs may be made only in cash.\40\ Annual
contributions to education IRAs may not exceed $500 per
designated beneficiary (except in cases involving certain tax-
free rollovers, as described below), and may not be made after
the designated beneficiary reaches age 18.\41\ Moreover, the
Act imposes a penalty excise tax under section 4973 if a
contribution is made by any person to an education IRA
established on behalf of a beneficiary during any taxable year
in which any contributions are made by anyone to a qualified
State tuition program (defined under sec. 529) on behalf of the
same beneficiary.
---------------------------------------------------------------------------
\39\ Education IRAs generally are not subject to Federal income
tax, but are subject to the unrelated business income tax (``UBIT'')
imposed by section 511.
\40\ The Act allows taxpayers to redeem U.S. Savings Bonds and be
eligible for the exclusion under section 135 (as if the proceeds were
used to pay qualified higher education expenses) if the proceeds from
the redemption are contributed to an education IRA (or qualified State
tuition program) on behalf of the taxpayer, the taxpayer's spouse, or a
dependent. In such a case, the beneficiary's basis in the bond proceeds
contributed on his or her behalf to the education IRA or qualified
tuition program will be the contributor's basis in the bonds (i.e., the
original purchase price paid by the contributor for such bonds).
\41\ An excise tax penalty may be imposed under present-law section
4973 to the extent that excess contributions above the $500 annual
limit are made to an education IRA. However, Title VI of H.R. 2676, the
Tax Technical Corrections Act of 1997, as passed by the House on
November 5, 1997, clarifies that neither the excise tax penalty under
section 4973 nor the additional 10-percent tax under section 530(d)(4)
(described infra) may be imposed in cases where contributions (and any
earnings thereon) are distributed from the education IRA before the
date that a return is required to be filed (including extensions of
time) by the beneficiary for the year in which the contribution was
made (or, if the beneficiary is not required to file such a return,
April 15th of the year following the taxable year during which the
contribution was made).
---------------------------------------------------------------------------
Phase-out of contribution limit.--The $500 annual
contribution limit for education IRAs is phased out ratably for
contributors with modified AGI between $95,000 and $110,000
($150,000 and $160,000 for joint returns). Individuals with
modified AGI above the phase-out range are not allowed to make
contributions to an education IRA established on behalf of any
other individual.
Treatment of distributions.--Amounts distributed from
education IRAs are excludable from gross income to the extent
that the amounts distributed do not exceed qualified higher
education expenses of an eligible student incurred during the
year the distribution is made (provided that a HOPE credit or
Lifetime Learning credit is not claimed with respect to the
beneficiary for the same taxable year).\42\ If a HOPE credit or
Lifetime Learning credit is claimed with respect to a student
for a taxable year, then a distribution from an education IRA
may (at the option of the taxpayer) be made on behalf of that
student during that taxable year, but an exclusion is not
available under the Act for the earnings portion of such
distribution.\43\
---------------------------------------------------------------------------
\42\ The exclusion will not be a preference item for alternative
minimum tax (AMT) purposes.
\43\ If a HOPE credit or Lifetime Learning credit was claimed with
respect to a student for an earlier taxable year, the exclusion
provided for by the Act may be claimed with respect to the same student
for a subsequent taxable year with respect to a distribution from an
education IRA made in that subsequent taxable in order to cover
qualified higher education expenses incurred during that year.
Conversely, if an exclusion is claimed for a distribution from an
education IRA with respect to a particular student, then a HOPE credit
or Lifetime Learning credit will be available in a subsequent taxable
year with respect to that same student (provided that no exclusion is
claimed in such other taxable years for distributions from an education
IRA on behalf of that student and provided that the requirements of the
HOPE credit or Lifetime Learning credit are satisfied in the subsequent
taxable year).
---------------------------------------------------------------------------
Distributions from an education IRA generally will be
deemed to consist of distributions of principal (which, under
all circumstances, are excludable from gross income) and
earnings (which may be excludable from gross income under the
Act) by applying the ratio that the aggregate amount of
contributions to the account for the beneficiary bears to the
total balance of the account.\44\ If the qualified higher
education expenses of the student for the year are at least
equal to the total amount of the distribution (i.e., principal
and earnings combined) from an education IRA, then the earnings
in their entirety will be excludable from gross income. If, on
the other hand, the qualified higher education expenses of the
student for the year are less than the total amount of the
distribution (i.e., principal and earnings combined) from an
education IRA, then the qualified higher education expenses
will be deemed to be paid from a pro-rata share of both the
principal and earnings components of the distribution. Thus, in
such a case, only a portion of the earnings will be excludable
under the Act (i.e., a portion of the earnings based on the
ratio that the qualified higher education expenses bear to the
total amount of the distribution) and the remaining portion of
the earnings will be includible in the distributee's gross
income.\45\
---------------------------------------------------------------------------
\44\ Title VI of H.R. 2676, the Tax Technical Corrections Act of
1997, as passed by the House on November 5, 1997, clarifies that, under
rules contained in present-law section 72, distributions from education
IRAs are treated as representing a pro-rata share of the principal
(i.e., contributions) and accumulated earnings in the account, and also
makes certain conforming changes to section 72. In particular, the Tax
Technical Corrections Act of 1997 provides that, under section
72(e)(8)(B), the determination of the ratio that the aggregate amount
of contributions to an education IRA bears to the account balance is to
be made at the time of the distribution or at such other time as the
Secretary of the Treasury may prescribe.
\45\ For example, if an education IRA has a total balance of
$10,000, of which $4,000 represents principal (i.e., contributions) and
$6,000 represents earnings, and if a distribution of $2,000 is made
from such an account, then $800 of that distribution will be treated as
a return of principal (which under no event is includible in the gross
income of the distributee) and $1,200 of the distribution will be
treated as accumulated earnings. In such a case, if qualified higher
education expenses of the beneficiary during the year of the
distribution are at least equal to the $2,000 total amount of the
distribution (i.e., principal plus earnings), then the entire earnings
portion of the distribution will be excludible under new Code section
530, provided that a HOPE credit or Lifetime Learning credit is not
claimed for that same taxable year on behalf of the beneficiary. If,
however, the qualified higher education expenses of the beneficiary for
the taxable year are less than the total amount of the distribution,
then only a portion of the earnings will be excludable from gross
income under section 530. Thus, in the example discussed above, if the
beneficiary incurs only $1,500 of qualified higher education expenses
in the year that a $2,000 distribution is made, then only $900 of the
earnings will be excludable from gross income under section 530 (i.e.,
an exclusion will be provided for the pro-rata portion of the earnings,
based on the ratio that the $1,500 of qualified higher education
expenses bears to the $2,000 distribution) and the remaining $300 of
the earnings portion of the distribution will be includible in the
distributee's gross income.
---------------------------------------------------------------------------
Distributions from an education IRA that exceed qualified
higher education expenses of the designated beneficiary during
the year of the distribution are includible in the
distributee's gross income. Moreover, an additional 10-percent
tax is imposed on any distribution from an education IRA to the
extent that the distribution exceeds qualified higher education
expenses of the designated beneficiary (unless the distribution
is made on account of the death or disability of, or
scholarship received by, the designated beneficiary).\46\
---------------------------------------------------------------------------
\46\ A technical correction is needed to section 530(d)(4) to
clarify that the 10-percent additional tax should not be imposed in
cases where a distribution (although used to pay for qualified higher
education expenses) is includible in gross income because the taxpayer
elects the HOPE or Lifetime Learning credit on behalf of the student
for the same taxable year.
---------------------------------------------------------------------------
The Act allows tax-free (and penalty-free) transfers or
rollovers of account balances from one education IRA benefiting
one beneficiary to another education IRA benefiting another
beneficiary (as well as redesignations of the named
beneficiary), provided that the new beneficiary is a member of
the family of the old beneficiary.\47\
---------------------------------------------------------------------------
\47\ For this purpose, a ``member of the family'' means persons
described in paragraphs (1) through (8) of section 152(a)--e.g., sons,
daughters, brothers, sisters, nephews and nieces, certain in-laws,
etc.--and any spouse of such persons.
---------------------------------------------------------------------------
The legislative history to the Act provides that any
balance remaining in an education IRA will be deemed to be
distributed within 30 days after the date that the named
beneficiary reaches age 30 (or, if earlier, within 30 days of
the date that the beneficiary dies).\48\
---------------------------------------------------------------------------
\48\ A technical correction providing that any balance remaining in
an education IRA will be deemed distributed within 30 days after the
date that the designated beneficiary reaches age 30 is included in
Title VI of H.R. 2676, the Tax Technical Corrections Act of 1997, as
passed by the House on November 5, 1997.
---------------------------------------------------------------------------
Qualified higher education expenses.--The term ``qualified
higher education expenses'' includes tuition, fees, books,
supplies, and equipment required for the enrollment or
attendance of a student at an eligible education institution,
regardless of whether the beneficiary is enrolled at an
eligible educational institution on a full-time, half-time, or
less than half-time basis. Moreover, the term ``qualified
higher education expenses include room and board expenses
(meaning the minimum room and board allowance applicable to the
student as determined by the institution in calculating costs
of attendance for Federal financial aid programs under sec. 472
of the Higher Education Act of 1965) for any period during
which the student is at least a half-time student. Qualified
higher education expenses include expenses with respect to
undergraduate or graduate-level courses. In addition, the Act
specifically provides that qualified higher education expenses
include amounts paid or incurred to purchase tuition credits
(or to make contributions to an account) under a qualified
State tuition program for the benefit of the beneficiary of the
education IRA.
Qualified higher education expenses generally include only
out-of-pocket expenses. Such qualified higher education
expenses do not include expenses covered by educational
assistance that is not required to be included in the gross
income of either the student or the taxpayer claiming the
credit. Thus, total qualified higher education expenses are
reduced by scholarship or fellowship grants excludable from
gross income under present-law section 117, as well as any
other tax-free educational benefits, such as employer-provided
educational assistance that is excludable from the employee's
gross income under section 127. In addition, qualified higher
education expenses do not include expenses paid with amounts
that are excludible under section 135. No reduction of
qualified higher education expenses is required for a gift,
bequest, devise, or inheritance within the meaning of section
102(a). Qualified higher education expenses do not include any
education expense for which a deduction is claimed under
section 162 or any other section of the Code.
Eligible educational institution.--Eligible educational
institutions are defined by reference to section 481 of the
Higher Education Act of 1965. Such institutions generally are
accredited post-secondary educational institutions offering
credit toward a bachelor's degree, an associate's degree, a
graduate-level or professional degree, or another recognized
post-secondary credential. Certain proprietary institutions and
post-secondary vocational institutions also are eligible
institutions. The institution must be eligible to participate
in Department of Education student aid programs.
Estate and gift tax treatment
For Federal estate and gift tax purposes, any contribution
to a qualified State tuition program or education IRA will be
treated as a completed gift of a present interest from the
contributor to the beneficiary at the time of the contribution.
Annual contributions are eligible for the present-law gift tax
exclusion provided by Code section 2503(b) and also are
excludable for purposes of the generation-skipping transfer tax
(provided that the contribution, when combined with any other
contributions made by the donor to that same beneficiary, does
not exceed the annual gift-tax exclusion limit of $10,000, or
$20,000 in the case of a married couple).\49\ Contributions to
a qualified State tuition program or to an education IRA will
not, however, be eligible for the educational expense exclusion
provided by Code section 2503(e). In no event will a
distribution from a qualified State tuition program or
education IRA be treated as a taxable gift.
---------------------------------------------------------------------------
\49\ The Act provides that, after 1998, the annual gift-tax
exclusion of $10,000 in the case of an individual, or $20,000 in the
case of a married couple that splits their gifts, will be indexed for
inflation.
---------------------------------------------------------------------------
If a contribution in excess of $10,000 ($20,000 in the case
of a married couple) is made in one year--which, under the Act,
can occur only in the case of a qualified State tuition program
and not an education IRA (which cannot receive contributions in
excess of $500 per year)--the contributor may elect to have the
contribution treated as if made ratably over five years
beginning in the year the contribution is made. For example, a
$30,000 contribution to a qualified State tuition program could
be treated as five annual contributions of $6,000, and the
donor could therefore make up to $4,000 in other transfers to
the beneficiary each year without payment of gift tax. Under
this rule, a donor may contribute up to $50,000 every five
years ($100,000 in the case of a married couple) with no gift
tax consequences, assuming no other gifts are made by the donor
to the beneficiary in the five-year period. A gift tax return
must be filed with respect to any contribution in excess of the
annual gift-tax exclusion limit, and the election for five-year
averaging must be made on the contributor's gift tax return.
If a donor making an over-$10,000 contribution to a
qualified State tuition program dies during the five-year
averaging period, the portion of the contribution that has not
been allocated to the years prior to death is includible in the
donor's estate. For example, if a donor makes a $40,000
contribution, elects to treat the transfer as being made over a
five-year period, and dies the following year, $8,000 would be
allocated to the year of contribution, another $8,000 would be
allocated to the year of death, and the remaining $24,000 would
be includible in the donor's estate.
If a beneficiary's interest in a qualified State tuition
program or education IRA is rolled over to another beneficiary,
there are no transfer tax consequences if the two beneficiaries
are in the same generation. If a beneficiary's interest is
rolled over to a beneficiary in a lower generation (e.g.,
parent to child or uncle to niece), the five-year averaging
rule described above may be applied to exempt up to $50,000 of
the transfer from gift tax.
For Federal estate tax purposes, the value of any interest
in a qualified State tuition program or education IRA will be
includible in the estate of the designated beneficiary. Such
interests will not be includible in the estate of the
contributor.
The Federal estate and gift tax treatment of qualified
State tuition programs and education IRAs has no effect on the
actual rights and obligations of the parties pursuant to the
terms of the contracts under State law.
Effective Date
The modifications to section 529 generally are effective
after December 31, 1997. The expansion of the term ``qualified
higher education expenses'' to cover certain room and board
expenses is effective as if included in the Small Business Job
Protection Act of 1996 (enacted on August 20, 1996). The
provisions governing education IRAs apply to taxable years
beginning after December 31, 1997. The gift tax provisions are
effective for contributions (or transfers) made after August 5,
1997, and the estate tax provisions are effective for decedents
dying after June 8, 1997.
Revenue Effect
The provisions are estimated to reduce Federal fiscal year
budget receipts by $192 million in 1998, $751 million in 1999,
$1,030 million in 2000, $1,190 million in 2001, $1,269 million
in 2002, $1,605 million in 2003, $1,925 million in 2004, $2,244
million in 2005, $2,569 million in 2006, and $2,910 million in
2007.
B. Other Education-Related Tax Provisions
1. Extension of exclusion for employer-provided educational assistance
(sec. 221 of the Act and sec. 127 of the Code)
Present and Prior Law
Under present and prior law, an employee's gross income and
wages do not include amounts paid or incurred by the employer
for educational assistance provided to the employee if such
amounts are paid or incurred pursuant to an educational
assistance program that meets certain requirements. This
exclusion is limited to $5,250 of educational assistance with
respect to an individual during a calendar year. Under prior
law, the exclusion did not apply to graduate level courses
beginning after June 30, 1996. Under prior law, the exclusion
expired with respect to courses beginning after June 30,
1997.\50\ In the absence of the exclusion, educational
assistance is excludable from income only if it is related to
the employee's current job.
---------------------------------------------------------------------------
\50\ The legislative history reflects congressional intent that the
provision expire with respect to courses beginning after May 31, 1997.
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that the exclusion for employer-
provided education assistance has enabled millions of workers
to advance their education and improve their job skills without
incurring additional taxes and a reduction in take-home pay. In
addition, the exclusion lessens the complexity of the tax laws.
Without the special exclusion, a worker receiving educational
assistance from his or her employer is subject to tax on the
assistance, unless the education is related to the worker's
current job. Because the determination of whether particular
educational assistance is job-related is based on the facts and
circumstances, it may be difficult to determine with certainty
whether the educational assistance is excludable from income.
This uncertainty may lead to disputes between taxpayers and the
Internal Revenue Service.
Explanation of Provision
The Act extends the exclusion for employer-provided
educational assistance for undergraduate education with respect
to courses beginning before June 1, 2000. The exclusion does
not apply with respect to graduate level courses.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1996.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $534 million in 1998, $369 million in 1999,
and $250 million in 2000.
2. Modification of $150 million limit on qualified 501(c)(3) bonds
other than hospital bonds (sec. 222 of the Act and sec. 150 of
the Code)
Present and Prior Law
Interest on State and local government bonds generally is
excluded from income if the bonds are issued to finance
activities carried out and paid for with revenues of these
governments. Interest on bonds issued by these governments to
finance activities of other persons, e.g., private activity
bonds, is taxable unless a specific exception is included in
the Code. One such exception is for private activity bonds
issued to finance activities of private, charitable
organizations described in Code section 501(c)(3) (``section
501(c)(3) organizations'') when the activities do not
constitute an unrelated trade or business.
Present and prior law treats section 501(c)(3)
organizations as private persons; thus, bonds for their use may
only be issued as private activity ``qualified 501(1)(3)
bonds,'' subject to the restrictions of Code section 145. Under
prior law, the most significant of these restrictions limited
the amount of outstanding bonds from which a section 501(c)(3)
organization could benefit to $150 million. In applying this
``$150 million limit,'' all section 501(c)(3) organizations
under common management or control were treated as a single
organization. The limit did not apply to bonds for hospital
facilities, defined to include only acute care, primarily
inpatient, organizations.
Reasons for Change
The Congress believed a distinguishing feature of American
society is the singular degree to which the United States
maintains a private, non-profit sector of higher education and
other charitable institutions in the public service. The
Congress found inappropriate the restrictions of prior law
which placed these section 501(c)(3) organizations at a
financial disadvantage relative to substantially identical
governmental institutions. For example, a public university
generally had unlimited access to tax-exempt bond financing,
while a private, non-profit university was subject to a $150
million limitation on outstanding bonds.
Explanation of Provision
The Act repeals the $150 million limit for bonds issued
after the date of enactment to finance capital expenditures
incurred after the date of enactment. Because this provision of
the Act applies only to bonds issued with respect to capital
expenditures incurred after the date of enactment, the $150
million limit will continue to govern issuance of other non-
hospital qualified 501(c)(3) bonds (e.g., refunding bonds with
respect to capital expenditures incurred before the date of
enactment or new-money bonds for capital expenditures incurred
before that date).\51\ Thus, the Congress understood that bond
issuers will continue to need Treasury Department guidance on
the application of this limit in the future, and expects that
the Treasury will continue to provide interpretative rules on
this limit.
---------------------------------------------------------------------------
\51\ See colloquy between Senators Moynihan and Roth, Cong. Record,
July 31, 1997, S8466-67, clarifying that bonds to which the $150
million limit does not apply under the Act are not taken into account
in applying the $150 million limit to other bonds.
---------------------------------------------------------------------------
Effective Date
The provision was effective for bonds issued after the date
of enactment (August 5, 1997) to finance capital expenditures
incurred after such date.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $6 million in 1998, $45 million in 1999, $75
million in 2000, $89 million in 2001, $99 million in 2002, $106
million in 2003, $115 million in 2004, $125 million in 2005,
$138 million in 2006, and $162 million in 2007.
3. Expansion of arbitrage rebate exception for certain bonds (sec. 223
of the Act and sec. 148 of the Code)
Present and Prior Law
Interest on State and local government bonds generally is
excluded from income if the bonds are issued to finance
activities carried out and paid for with revenues of these
governments. Interest on bonds issued by these governments to
finance activities of other persons, e.g., private activity
bonds, is taxable unless a specific exception is included in
the Code. In the case of bonds the interest on which is
excluded from income, generally, all arbitrage profits earned
on investments unrelated to the purpose of the borrowing
(``nonpurpose investments'') when such earnings are permitted
must be rebated to the Federal Government.
An exception is provided for bonds issued by governmental
units having general taxing powers if the governmental unit
(and all subordinate units) issues $5 million or less of
governmental bonds during the calendar year (``the small-issuer
exception''). This exception does not apply to private activity
bonds.
Reasons for Change
The Congress recognized the need for additional monies to
address public school infrastructure needs. It believed that
this provision will reduce the compliance costs of issuers of
tax-exempt debt issued for public school construction.
Explanation of Provision
The Act provides that up to $5 million dollars of bonds
used to finance public school capital expenditures incurred
after December 31, 1997, is excluded from application of the
present-law $5 million limit. Thus, otherwise qualified issuers
will continue to benefit from the small issue exception from
arbitrage rebate if they issue no more than $10 million in
governmental bonds per calendar year and no more than $5
million of the bonds is used to finance expenditures other than
public school capital expenditures.
Effective Date
The provision is effective for bonds issued after December
31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $1 million in 1998, $4 million in 1999, $7
million in 2000, $11 million in 2001, $14 million in 2002, $27
million in 2003, $30 million in 2004, $33 million in 2005, $36
million in 2006, and $38 million in 2007.
4. Enhanced deduction for corporate contributions of computer
technology and equipment (sec. 224 of the Act and new sec.
170(e)(6) of the Code)
Present and Prior Law
In computing taxable income, a taxpayer who itemizes
deductions generally is allowed to deduct the fair market value
of property contributed to a charitable organization.\52\
However, in the case of a charitable contribution of inventory
or other ordinary-income property, short-term capital gain
property, or certain gifts to private foundations, the amount
of the deduction is limited to the taxpayer's basis in the
property. In the case of a charitable contribution of tangible
personal property, a taxpayer's deduction is limited to the
adjusted basis in such property if the use by the recipient
charitable organization is unrelated to the organization's tax-
exempt purpose (sec. 170(e)(1)(B)(i)).
---------------------------------------------------------------------------
\52\ The amount of the deduction allowable for a taxable year with
respect to a charitable contribution may be reduced depending on the
type of property contributed, the type of charitable organization to
which the property is contributed, and the income of the taxpayer
(secs. 170(b) and 170(e)). Corporations are entitled to claim a
deduction for charitable contributions, generally limited to 10 percent
of their taxable income (computed without regard to the contributions)
for the taxable year.
---------------------------------------------------------------------------
Special rules in the Code provide augmented deductions for
certain corporate \53\ contributions of inventory property for
the care of the ill, the needy, or infants \54\ (sec.
170(e)(3)), and certain corporate contributions of scientific
equipment constructed by the taxpayer, provided the original
use of such donated equipment is by the donee for research or
research training in the United States in physical or
biological sciences (sec. 170(e)(4)).\55\ Under these special
rules, the amount of the augmented deduction available to a
corporation making a qualified contribution is equal to its
basis in the donated property plus one-half of the amount of
ordinary income that would have been realized if the property
had been sold.\56\ However, the augmented deduction cannot
exceed twice the basis of the donated property.
---------------------------------------------------------------------------
\53\ S corporations are not eligible donors for purposes of section
170(e)(3) or section 170(e)(4).
\54\ Treas. Reg. sec. 1.170A-4(b)(2)(ii)(F) defines an ``infant''
as a minor child (as determined under the laws of the jurisdiction in
which the child resides). Treas. Reg. sec. 1.170A-4(b)(2)(ii)(G)
provides that the ``care of an infant'' means performance of parental
functions and provision for the physical, mental, and emotional needs
of the infant.
\55\ Eligible donees under section 170(e)(3) are public charities
(but not governmental units) and private operating foundations.
Eligible donees under section 170(e)(4) are limited to post-secondary
educational institutions, scientific research organizations, and
certain other organizations that support scientific research.
\56\ For purposes of section 170(e)(3), however, no deduction is
allowed for any portion of gain that would have been recognized as
ordinary income (had the property been sold) because of the application
of the recapture provisions in sections 617, 1245, 1250, or 1252. No
such limitation applies under section 170(e)(4) because qualified
contributions for purposes of section 170(e)(4) are limited to
nondepreciable inventory property.
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that providing an incentive for
businesses to invest their computer equipment and software for
the benefit of primary and secondary school students will help
to provide America's schools with the technological resources
necessary to prepare both teachers and students for a
technologically advanced present and future.
Explanation of Provision
The Act specifically provides that certain contributions of
computer and other equipment to eligible donees to be used for
the benefit of elementary and secondary school children qualify
for an augmented deduction similar to the deduction currently
available under Code section 170(e)(3). Under the Act,
qualified contributions mean gifts of computer technology and
equipment (i.e., computer software, computer or peripheral
equipment, and fiber optic cable related to computer use) to
eligible donees to be used within the United States for
educational purposes in any of grades K-12.
Eligible donees are (1) any educational organization that
normally maintains a regular faculty and curriculum and has a
regularly enrolled body of pupils in attendance at the place
where its educational activities are regularly carried on, and
(2) Code section 501(c)(3) entities that are organized
primarily for purposes of supporting elementary and secondary
education. A private foundation also is an eligible donee,
provided that, within 30 days after receipt of the
contribution, the private foundation contributes the property
to an eligible donee described above.
Qualified contributions are limited to gifts made no later
than two years after the date the taxpayer acquired or
substantially completed the construction of the donated
property. In addition, the original use of the donated property
must commence with the donor or the donee. Accordingly,
qualified contributions generally are limited to property that
is no more than two years old. Such donated property could be
computer technology or equipment that is inventory or
depreciable trade or business property in the hands of the
donor.\57\
---------------------------------------------------------------------------
\57\ In the case of depreciable trade or business property, the
limitation of section 170(e)(3)(C) does not apply for purposes of
determining the amount of the deduction under the provision. Thus, a
deduction is allowed under the provision for a portion of the gain that
would have been recognized as ordinary income (had the property been
sold) because of the application of the recapture provisions relating
to depreciation, certain mining and exploration expenditures, certain
soil and water conservation expenditures, and certain land-clearing
expenditures.
---------------------------------------------------------------------------
The Act generally provides that the donee organizations
cannot transfer the donated property for money or services
(e.g., a donee organization cannot sell the computers).
However, a donee organization may transfer the donated property
in furtherance of its exempt purposes and be reimbursed for
shipping, installation, and transfer costs. For example, if a
corporation contributes computers to a charity that
subsequently distributes the computers to several elementary
schools in a given area, the charity could be reimbursed by the
elementary schools for shipping, transfer, and installation
costs.\58\
---------------------------------------------------------------------------
\58\ In the case of contributions made through private foundations,
the Act permits the payment by the ultimate recipient to the private
foundation of shipping, transfer, and installation costs.
---------------------------------------------------------------------------
The special treatment applies only to donations made by C
corporations; as under present law section 170(e)(4), S
corporations, personal holding companies, and service
organizations are not eligible donors.
Effective Date
The provision is effective for contributions made in
taxable years beginning after December 31, 1997, and before
January 1, 2001.\59\
---------------------------------------------------------------------------
\59\ A technical correction is necessary to provide that the
provision is effective for contributions made during a three-year
period ending December 31, 2000.
---------------------------------------------------------------------------
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $46 million in 1998, $48 million in 1999,
$77 million in 2000, $49 million in 2001, $5 million in 2002,
and $1 million in 2003.
5. Treatment of cancellation of certain student loans (sec. 225 of the
Act and sec. 108(f) (of the Code)
Present and Prior Law
In the case of an individual, gross income subject to
Federal income tax does not include any amount from the
forgiveness (in whole or in part) of certain student loans,
provided that the forgiveness is contingent on the student's
working for a certain period of time in certain professions for
any of a broad class of employers (sec. 108(f)).
Student loans eligible for this special rule must be made
to an individual to assist the individual in attending an
educational institution that normally maintains a regular
faculty and curriculum and normally has a regularly enrolled
body of students in attendance at the place where its education
activities are regularly carried on. Loan proceeds may be used
not only for tuition and required fees, but also to cover room
and board expenses (in contrast to tax free scholarships under
section 117, which are limited to tuition and required fees).
In addition, the loan must be made by (1) the United States (or
an instrumentality or agency thereof), (2) a State (or any
political subdivision thereof), (3) certain tax-exempt public
benefit corporations that control a State, county, or municipal
hospital and whose employees have been deemed to be public
employees under State law, or (4) an educational organization
that originally received the funds from which the loan was made
from the United States, a State, or a tax-exempt public benefit
corporation. Thus, loans made with private, nongovernmental
funds are not qualifying student loans for purposes of the
section 108(f) exclusion.
Reasons for Change
The Congress believed that it is appropriate to expand
present-law section 108(f), so that certain loan cancellation
programs of educational organizations receive Federal income
tax treatment comparable to that provided for similar
government-sponsored programs. This provision promotes the
establishment of programs that encourage students to use their
education and training in valuable community service.
Explanation of Provision
The Act expands section 108(f) so that an individual's
gross income does not include amounts from the forgiveness of
loans made by educational organizations (and certain tax-exempt
organizations in the case of refinancing loans) if the proceeds
of such loans are used to pay costs of attendance at an
educational institution or to refinance outstanding student
loans \60\ and the student is not employed by the lender
organization. As under present law, the section 108(f)
exclusion applies only if the forgiveness is contingent on the
student's working for a certain period of time in certain
professions for any of a broad class of employers. In addition,
in the case of loans made or refinanced by educational
organizations (as well as refinancing loans made by certain
tax-exempt organizations), the student's work must fulfill a
public service requirement.\61\ The student must work in an
occupation or area with unmet needs and such work must be
performed for or under the direction of a tax-exempt charitable
organization or a governmental entity.
---------------------------------------------------------------------------
\60\ A technical correction is required to clarify that gross
income does not include amounts from the forgiveness of loans made by
educational organizations and certain tax-exempt organizations to
refinance any existing student loan (and not just loans made by
educational organizations). A provision to this effect is included in
Title VI (sec. 604(e)) of H.R. 2676, the Tax Technical Corrections Act
of 1997, as passed by the House on November 5, 1997.
\61\ A technical correction is required to clarify that refinancing
loans made by educational organizations and certain tax-exempt
organizations must be made pursuant to a program of the refinancing
organization (e.g., school or private foundation) that requires the
student to fulfill a public service work requirement. A provision to
this effect is included in Title VI (sec. 604(e)) of H.R. 2676, the Tax
Technical Corrections Act of 1997, as passed by the House on November
5, 1997.
---------------------------------------------------------------------------
Effective Date
The provision applies to discharges of indebtedness after
August 5, 1997, the date of enactment.
Revenue Effect
The provision is estimated to have a negligible revenue
effect on Federal fiscal year budget receipts in each of 1998
through 2007.
6. Tax credit for holders of qualified zone academy bonds (sec. 226 of
the Act and new sec. 1397E of the Code)
Present and Prior Law
Interest on State and local governmental bonds generally is
excluded from gross income for Federal income tax purposes if
the proceeds of the bonds are used to finance direct activities
of these governmental units, including the financing of public
schools (Code sec. 103).
Pursuant to the Omnibus Budget Reconciliation Act of 1993
(OBRA 1993), the Secretaries of the Department of Housing and
Urban Development (HUD) and the Department of Agriculture
designated a total of nine empowerment zones and 95 enterprise
communities on December 21, 1994 (sec. 1391). Designated
empowerment zones and enterprise communities were required to
satisfy certain eligibility criteria, including specified
poverty rates and population and geographic size limitations
(sec. 1392). The Code provides special tax incentives for
certain business activities conducted in empowerment zones and
enterprise communities (secs. 1394, 1396, and 1397A). In
addition, the Taxpayer Relief Act of 1997 provides for the
designation of 22 additional empowerment zones (secs.
1391(b)(2) and 1391(g)).
Explanation of Provision
Under the provision, certain financial institutions (i.e.,
banks, insurance companies, and corporations actively engaged
in the business of lending money) that hold ``qualified zone
academy bonds'' are entitled to a nonrefundable tax credit in
an amount equal to a credit rate (set by the Treasury
Department) multiplied by the face amount of the bond. The
credit rate applies to all such bonds issued in each month. A
taxpayer holding a qualified zone academy bond on the credit
allowance date (i.e., each one-year anniversary of the issuance
of the bond) is entitled to a credit. The credit is includible
in gross income (as if it were an interest payment on the
bond). The credit may be claimed against regular income tax and
AMT liability.\62\
---------------------------------------------------------------------------
\62\ A technical correction may be necessary to clarify that the
credit also may be claimed against estimated tax liability on the
credit allowance date.
---------------------------------------------------------------------------
The Treasury Department will set the credit rate each month
at a rate estimated to allow issuance of qualified zone academy
bonds without discount and without interest cost to the issuer.
The maximum term of the bond issued in a given month also is
determined by the Treasury Department so that the present value
of the obligation to repay the bond is 50 percent of the face
value of the bond. Such present value will be determined using
as a discount rate the average annual interest rate of tax-
exempt obligations with a term of 10 years or more issued
during the month.
``Qualified zone academy bonds'' are defined as any bond
issued by a State or local government, provided that (1) 95
percent of the proceeds are used for the purpose of renovating,
providing equipment to, developing course materials for use at,
or training teachers and other school personnel in a
``qualified zone academy'' and (2) private entities have
promised to contribute to the qualified zone academy certain
equipment, technical assistance or training, employee services,
or other property or services with a value equal to at least 10
percent of the bond proceeds.
A school is a ``qualified zone academy'' if (1) the school
is a public school that provides education and training below
the college level, (2) the school operates a special academic
program in cooperation with businesses to enhance the academic
curriculum and increase graduation and employment rates, and
(3) either (a) the school is located in an empowerment zone or
enterprise community (including empowerment zones designated or
authorized to be designated under the Act), or (b) it is
reasonably expected that at least 35 percent of the students at
the school will be eligible for free or reduced-cost lunches
under the school lunch program established under the National
School Lunch Act.
A total of $400 million of ``qualified zone academy bonds''
may be issued in each of 1998 and 1999. The $800 million
aggregate bond cap will be allocated to the States according to
their respective populations of individuals below the poverty
line. A State may carry over any unused allocation into
subsequent years. Each State, in turn, will allocate the credit
to qualified zone academies within such State.
Effective Date
The provision is effective for qualified zone academy bonds
issued after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $8 million in 1998, $27 million in 1999, $43
million in 2000, and $47 million in each of years 2001 through
2007.
TITLE III. SAVINGS AND INVESTMENT TAX INCENTIVES
A. Individual Retirement Arrangements (secs. 301-304 of
the Act and secs. 72, 219, and 408 of the Code and new
sec. 408A of the Code)
Present and Prior Law
Under present and prior law, an individual may make
deductible contributions to an individual retirement
arrangement (``IRA'') up to the lesser of $2,000 or the
individual's compensation if the individual is not an active
participant in an employer-sponsored retirement plan. Under
present and prior law, in the case of a married couple,
deductible IRA contributions of up to $2,000 can be made for
each spouse (including, for example, a home maker who does not
work outside the home) if the combined compensation of both
spouses is at least equal to the contributed amount.
Under present and prior law, if the individual (or the
individual's spouse) is an active participant in an employer-
sponsored retirement plan, the $2,000 deduction limit is phased
out over certain adjusted gross income (``AGI'') levels. Under
prior law, the limit was phased out between $40,000 and $50,000
of AGI for married taxpayers filing joint returns, and between
$25,000 and $35,000 of AGI for single taxpayers. Under present
and prior law, contributions cannot be made to a deductible IRA
after age 70\1/2\. Under prior law, an individual could make
contributions to a nondeductible IRA to the extent the
individual could not (or did not) make contributions to a
deductible IRA.
Under present and prior law, amounts held in a deductible
or nondeductible IRA are includible in income when withdrawn
(except to the extent the withdrawal is a return of
nondeductible contributions). Includible amounts withdrawn
prior to attainment of age 59\1/2\ are subject to an additional
10-percent early withdrawal tax, unless the withdrawal is due
to death or disability, is made in the form of certain periodic
payments, is used to pay medical expenses in excess of 7.5
percent of AGI, or is used to purchase health insurance of an
unemployed individual.
Under present and prior law, distributions from a
deductible or nondeductible IRA are required to begin at age
70\1/2\. An excise tax is imposed if the minimum required
distributions are not made. Distributions to the beneficiary of
an IRA are generally required to begin within 5 years of the
death of the IRA owner, unless the beneficiary is the surviving
spouse.
Under present and prior law, IRAs generally may not be
invested in collectibles. Under prior law, coins were
considered collectibles, other than coins issued by a State and
certain gold and silver coins issued by the U.S. Mint.
Reasons for Change
The Congress was concerned about the national savings rate,
and believed that individuals should be encouraged to save. The
Congress believed that the ability to make deductible
contributions to an IRA was a significant savings incentive.
However, this incentive was not available to all taxpayers
under prior law. Further, the prior-law income thresholds for
IRA deductions were not indexed for inflation so that fewer
Americans will be eligible to make a deductible IRA
contribution each year. The Congress believed it was
appropriate to encourage individual saving and that deductible
IRAs should be available to more individuals.
In addition, the Congress believed that some individuals
would be more likely to save if funds set aside in a tax-
favored account could be withdrawn without tax after a
reasonable holding period for retirement or certain special
purposes. Some taxpayers might find such a vehicle more
suitable for their savings needs.
The Congress believed that providing an incentive to save
for certain special purposes was appropriate. The Congress
believed that many Americans may have difficulty saving enough
to ensure that they will be able to purchase a home. Home
ownership is a fundamental part of the American dream.
The Congress believed that the prior-law rules relating to
deductible IRAs penalize American homemakers. The Congress
believed that an individual should not be precluded from making
a deductible IRA contribution merely because his or her spouse
participates in an employer-sponsored retirement plan.
Finally, the Congress believed that IRAs should not be
precluded from investing in bullion.
Explanation of Provision
In general
The Act (1) increases the AGI phase-out limits for
deductible IRAs, (2) modifies the AGI phase-out limits for an
individual who is not an active participant in an employer-
sponsored retirement plan but whose spouse is, (3) provides an
exception from the early withdrawal tax for withdrawals for
first-time home purchase (up to $10,000),\63\ and (4) creates a
new nondeductible IRA called the Roth IRA. Individuals with AGI
below certain levels may make nondeductible contributions of up
to $2,000 annually to a Roth IRA. In addition, the $2,000
maximum contribution limit is reduced to the extent an
individual makes contributions to any other IRA in the same
taxable year. A Roth IRA is an IRA which is designated at the
time of establishment as a Roth IRA in the manner prescribed by
the Secretary. Qualified distributions from a Roth IRA are not
includible in income.
---------------------------------------------------------------------------
\63\ The Act also provides for penalty-free withdrawals from IRAs
for education expenses. (See Title II.A.3., above.) The penalty-free
withdrawal exceptions for first-time homebuyer and education expenses
do not apply to distributions from employer-sponsored retirement plans.
A technical correction may be necessary to prevent the avoidance of the
early withdrawal tax by participants in employer-sponsored retirement
plans who roll over hardship distributions into an IRA and withdraw the
funds from the IRA. A technical correction to that effect is included
in Title VI (sec. 605) of H.R. 2676, the Tax Technical Corrections Act
of 1997, as passed by the House on November 5, 1997. The technical
correction would provide that hardship distributions cannot be rolled
over into an IRA.
---------------------------------------------------------------------------
The Act modifies the prior-law rules relating to
nondeductible IRAs. Thus, an individual may make nondeductible
contributions to an IRA to the extent they cannot or do not
make deductible contributions and contributions to a Roth IRA.
Modification to active participant rule and increase income phase-out
ranges for deductible IRAs
Under the Act, the maximum deductible IRA contribution for
an individual who is not an active participant in an employer-
sponsored retirement plan, but whose spouse is, is phased out
for taxpayers with AGI between $150,000 and $160,000.
Under the Act, the deductible IRA income phase-out limits
are increased as follows:
Joint Returns
Taxable years beginning in: Phase-out range
1998................................................. $50,000--60,000
1999................................................. 51,000--61,000
2000................................................. 52,000--62,000
2001................................................. 53,000--63,000
2002................................................. 54,000--64,000
2003................................................. 60,000--70,000
2004................................................. 65,000--75,000
2005................................................. 70,000--80,000
2006................................................. 75,000--85,000
2007 and thereafter.................................. 80,000--100,000
Single Taxpayers
Taxable years beginning in: Phase-out range
1998................................................. $30,000--40,000
1999................................................. 31,000--41,000
2000................................................. 32,000--42,000
2001................................................. 33,000--43,000
2002................................................. 34,000--44,000
2003................................................. 40,000--50,000
2004................................................. 45,000--55,000
2005 and thereafter.................................. 50,000--60,000
The following examples illustrate the income phase-out
rules.
Example 1.--W is an active participant in an employer-
sponsored retirement plan, and W's husband, H, is not. Further
assume that the combined AGI of H and W for the year is
$200,000. Neither W nor H is entitled to make deductible
contributions to an IRA for the year.
Example 2.--Same as example 1, except that the combined AGI
of W and H is $125,000. H can make deductible contributions to
an IRA. However, a deductible contribution could not be made
for W.
Modifications to early withdrawal tax
The Act provides that the 10-percent early withdrawal tax
does not apply to withdrawals from an IRA (including a Roth
IRA) for up to $10,000 of first-time homebuyer expenses.\64\
---------------------------------------------------------------------------
\64\ The Act also provides for penalty-free withdrawals from IRAs
for education expenses. (See Title II.A.3., above.) The penalty-free
withdrawal exceptions for first-time homebuyer and education expenses
do not apply to distributions from employer-sponsored retirement plans.
A technical correction may be necessary to prevent the avoidance of the
early withdrawal tax by participants in employer-sponsored retirement
plans who roll over hardship distributions into an IRA and withdraw the
funds from the IRA. A technical correction to that effect is included
in Title VI (sec. 605) of H.R. 2676, the Tax Technical Corrections Act
of 1997, as passed by the House on November 5, 1997. The technical
correction would provide that hardship distributions cannot be rolled
over into an IRA.
---------------------------------------------------------------------------
Under the Act, qualified first-time homebuyer distributions
are withdrawals of up to $10,000 during the individual's
lifetime that are used within 120 days to pay costs (including
reasonable settlement, financing, or other closing costs) of
acquiring, constructing, or reconstructing the principal
residence of a first-time homebuyer who is the individual, the
individual's spouse, or a child, grandchild, or ancestor of the
individual or individual's spouse. A first-time homebuyer is an
individual who has not had an ownership interest in a principal
residence during the 2-year period ending on the date of
acquisition of the principal residence to which the withdrawal
relates. The Act requires that the spouse of the individual
also meet this requirement as of the date the contract is
entered into or construction commences. The date of acquisition
is the date the individual enters into a binding contract to
purchase a principal residence or begins construction or
reconstruction of such a residence. Principal residence is
defined as under the provisions relating to the rollover of
gain on the sale of a principal residence.
Under the Act, any amount withdrawn for the purchase of a
principal residence is required to be used within 120 days of
the date of withdrawal. The 10-percent additional tax on early
withdrawals is imposed with respect to any amount not so used.
If the 120-day rule cannot be satisfied due to a delay in the
acquisition of the residence, the taxpayer may recontribute all
or part of the amount withdrawn to a Roth IRA prior to the end
of the 120-day period without adverse tax consequences.
IRA investments in coins and bullion
Under the Act, IRA assets may be invested in certain
bullion. The Act applies to any gold, silver, platinum or
palladium bullion of a fineness equal to or exceeding the
minimum fineness required for metals which may be delivered in
satisfaction of a regulated futures contract subject to
regulation by the Commodity Futures Trading Commission. The
provision does not apply unless the bullion is in the physical
possession of an IRA trustee. The Act also provides that IRA
assets may be invested in certain platinum coins issued by the
U.S. mint.\65\
---------------------------------------------------------------------------
\65\ The Act does not modify the prior-law rule permitting IRAs to
be invested in State coins and certain coins issued by the U.S. Mint.
---------------------------------------------------------------------------
Roth IRAs
Contributions to Roth IRAs
The maximum annual contribution that may be made to a Roth
IRA is the lesser of $2,000 or the individual's compensation
for the year. As under the rules relating to IRAs generally, a
contribution of up to $2,000 for each spouse may be made to a
Roth IRA provided the combined compensation of the spouses is
at least equal to the contributed amount. The maximum annual
contribution that can be made to a Roth IRA is phased out for
single individuals with AGI between $95,000 and $110,000 and
for joint filers with AGI between $150,000 and $160,000.\66\
---------------------------------------------------------------------------
\66\ For this purpose, AGI does not include amounts includible in
income as a result of a conversion of an IRA into a Roth IRA. It was
intended that the phase-out range for married taxpayers filing
separately be $0 to $10,000. A technical correction is necessary so
that the statute reflects this intent. See Title VI (sec. 605) of H.R.
2676, the Tax Technical Corrections Act of 1997, as passed by the House
on November 5, 1997.
---------------------------------------------------------------------------
Contributions to a Roth IRA may be made even after the
individual for whom the account is maintained has attained age
70\1/2\.
Taxation of distributions
Qualified distributions from a Roth IRA are not includible
in gross income, nor subject to the additional 10-percent tax
on early withdrawals. A qualified distribution is a
distribution that (1) is made after the 5-taxable year period
beginning with the first taxable year in which the individual
made a contribution to a Roth IRA,\67\ and (2) which is (a)
made on or after the date on which the individual attains age
59\1/2\, (b) made to a beneficiary (or to the individual's
estate) on or after the death of the individual, (c)
attributable to the individual's being disabled, or (d) a
qualified special purpose distribution. A qualified special
purpose distribution is a distribution that is exempt from the
10-percent early withdrawal tax because it is for first-time
homebuyer expenses.
---------------------------------------------------------------------------
\67\ As is the case with IRAs generally, contributions to a Roth
IRA may be made for a year by the due date for the individual's tax
return for the year (determined without regard to extensions). In the
case of a contribution to a Roth IRA made after the end of the taxable
year, the 5-year holding period begins with the taxable year to which
the contribution relates, rather than the year in which the
contribution is actually made.
---------------------------------------------------------------------------
Distributions from a Roth IRA that are not qualified
distributions are includible in income to the extent
attributable to earnings, and subject to the 10-percent early
withdrawal tax (unless an exception applies). The same
exceptions to the early withdrawal tax that apply to IRAs apply
to Roth IRAs.
An ordering rule applies for purposes of determining what
portion of a distribution that is not a qualified distribution
is includible in income. Under the ordering rule, distributions
from a Roth IRA are treated as made from contributions first,
and all of an individual's Roth IRAs are treated as a single
Roth IRA. Thus, no portion of a distribution from a Roth IRA is
treated as attributable to earnings (and therefore includible
in gross income) until the total of all distributions from all
the individual's Roth IRAs exceeds the amount of contributions.
The pre-death minimum distribution rules that apply to IRAs
generally do not apply to Roth IRAs.
Distributions from a Roth IRA may be rolled over tax free
to another Roth IRA.
Conversions of an IRA to a Roth IRA
All or any part of amounts in a present-law deductible or
nondeductible IRA may be converted into a Roth IRA. If the
conversion is made before January 1, 1999,\68\ the amount that
would have been includible in gross income if the individual
had withdrawn the converted amounts is included in gross income
ratably over the 4-taxable year period beginning with the
taxable year in which the conversion is made. The early
withdrawal tax does not apply to such conversions.\69\
---------------------------------------------------------------------------
\68\ If the conversion is made by means of an actual withdrawal
followed by a rollover contribution to a Roth IRA, the withdrawal must
occur in 1998 for the 4-year income inclusion rule to apply. In such a
case, the 4-year income inclusion begins with the year in which the
withdrawal was made, even if the rollover to the Roth IRA does not
occur until 1999. As is the case with rollovers generally, a rollover
to a Roth IRA must be made within 60 days of the withdrawal from the
IRA.
\69\ In the case of conversions from an IRA to a Roth IRA, the 5-
taxable year holding period begins with the taxable year in which the
conversion was made.
---------------------------------------------------------------------------
Under the Act, only taxpayers with AGI of $100,000 \70\ or
less are eligible to convert an IRA into a Roth IRA. In the
case of a married taxpayer, AGI is the combined AGI of the
couple. Married taxpayers filing a separate return are not
eligible to make a conversion.
---------------------------------------------------------------------------
\70\ For this purpose, AGI is determined before any amount
includible in income as a result of the conversion.
---------------------------------------------------------------------------
A conversion of an IRA into a Roth IRA can be made in a
variety of different ways and without taking a withdrawal. For
example, an individual may make a conversion simply by
notifying the IRA trustee. Or, an individual may make the
conversion in connection with a change in IRA trustees through
a rollover or a trustee-to-trustee transfer. If a part of an
IRA balance is converted into a Roth IRA, the Roth IRA amounts
may have to be held separately.\71\
---------------------------------------------------------------------------
\71\ The rules relating to conversions of IRAs into Roth IRAs were
not intended to allow individuals receiving premature distributions
from a Roth conversion IRA while retaining the benefits of 4-year
income averaging and the nonpayment of the early withdrawal tax. A
technical correction may be necessary so that the statute reflects this
intent. See Title VI (sec. 605) of H.R. 2676, the Tax Technical
Corrections Act of 1997, as passed by the House on November 5, 1997. In
general, the proposed technical correction would provide that, if
converted amounts are withdrawn within the 5-year period beginning with
the year of conversion, then amounts withdrawn which were includible in
income due to the conversion would be subject to the 10-percent early
withdrawal tax and, if the 4-year income inclusion rule applied to the
conversion, an additional 10-percent tax. If the 4-year income
inclusion rule applied to the conversion, the converted amounts would
still be includible in income under such rule, that is, there would be
no acceleration of the income inclusion.
---------------------------------------------------------------------------
Effective Date
The provisions are effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The provisions are estimated to reduce Federal fiscal year
receipts by $367 million in 1998, $345 million in 1999, $346
million in 2001, $860 million in 2002, $1,830 million in 2003,
$3,292 million in 2004, $3,842 million in 2005, $4,424 million
in 2006, and $5004 million in 2007. The provisions are
estimated to increase Federal fiscal year receipts by $86
million in 2000.
B. Capital Gains Provisions
1. Maximum rate of tax on net capital gain of individuals (sec. 311 of
the Act and sec. 1(h) of the Code)
Prior Law
In general, gain or loss reflected in the value of an asset
is not recognized for income tax purposes until a taxpayer
disposes of the asset. On the sale or exchange of capital
assets, the net capital gain was taxed at the same rate as
ordinary income, except that individuals were subject to a
maximum marginal rate of 28 percent of the net capital gain.
Net capital gain is the excess of the net long-term capital
gain for the taxable year over the net short-term capital loss
for the year. Gain or loss is treated as long-term if the asset
is held for more than one year.
A capital asset generally means any property except (1)
inventory, stock in trade, or property held primarily for sale
to customers in the ordinary course of the taxpayer's trade or
business, (2) depreciable or real property used in the
taxpayer's trade or business, (3) specified literary or
artistic property, (4) business accounts or notes receivable,
or (5) certain U.S. publications. In addition, the net gain
from the disposition of certain property used in the taxpayer's
trade or business is treated as long-term capital gain. Gain
from the disposition of depreciable personal property is not
treated as capital gain to the extent of all previous
depreciation allowances. Gain from the disposition of
depreciable real property is generally not treated as capital
gain to the extent of the depreciation allowances in excess of
the allowances that would have been available under the
straight-line method of depreciation.
Reasons for Change
The Congress believed it is important that tax policy be
conducive to economic growth. Economic growth cannot occur
without saving, investment, and the willingness of individuals
to take risks. The greater the pool of savings, the greater the
monies available for business investment. It is through such
investment that the United States' economy can increase output
and productivity. It is through increases in productivity that
workers earn higher real wages. Hence, greater saving is
necessary for all Americans to benefit through a higher
standard of living.
The Congress believed that, by reducing the effective tax
rates on capital gains, American households will respond by
increasing saving. The Congress believed it is important to
encourage risk taking and believed a reduction in the taxation
of capital gains will have that effect. The Congress also
believed that a reduction in the taxation of capital gains will
improve the efficiency of the capital markets, because the
taxation of capital gains upon realization encourages investors
who have accrued past gains to keep their monies ``locked in''
to such investment even when better investment opportunities
present themselves. A reduction in the taxation of capital
gains should reduce this ``lock in'' effect.
Explanation of Provision
Under the Act,\72\ the maximum rate of tax on the adjusted
net capital gain of an individual is reduced from 28 percent to
20 percent. In addition, any adjusted net capital gain which
otherwise would be taxed at a 15 percent rate is taxed at a 10
percent rate. These rates apply for purposes of both the
regular tax and the alternative minimum tax.
---------------------------------------------------------------------------
\72\ The Act is described as it would be modified by the technical
corrections set forth in a letter dated September 29, 1997, to Donald
Lubick, Acting Assistant Secretary for Tax Policy, from Chairman
Archer, Chairman Roth, Congressman Rangel, and Senator Moynihan. These
changes are included in Title VI (sec. 605(d)) of H.R. 2676, the Tax
Technical Corrections Act of 1997, as passed by the House on November
5, 1997.
---------------------------------------------------------------------------
The ``adjusted net capital gain'' of an individual is the
net capital gain reduced (but not below zero) by the sum of the
28-percent rate gain and the unrecaptured section 1250 gain. As
under prior law, the net capital gain is reduced by the amount
of gain which the individual treats as investment income for
purposes of determining the investment interest limitation
under section 163(d). The Act does not change the definitions
in section 1222 relating to capital gains and losses, but
rather taxes portions of the net capital gain at different tax
rates.\73\
---------------------------------------------------------------------------
\73\ Gain from the sale of a capital asset held more than one year
remains ``long-term capital gain'' for purposes of the Code. Thus, for
example, the deduction for charitable contributions of appreciated
property (under sec. 170(e)) is not changed by this provision.
---------------------------------------------------------------------------
The term ``28-percent rate gain'' means the amount of net
gain attributable to long-term capital gains and losses from
property held more than one year but not more than 18 months,
long-term capital gains and losses from the sale or exchange of
collectibles (as defined in section 408(m) without regard to
paragraph (3) thereof) held more than 18 months (``collectibles
gain and loss''),\74\ an amount of gain equal to the amount of
gain excluded from gross income under section 1202 relating to
certain small business stock (``section 1202 gain''),\75\ the
net short-term capital loss for the taxable year, and any long-
term capital loss carryover to the taxable year.
---------------------------------------------------------------------------
\74\ Only gains taken into account in computing gross income, and
only losses taken into account in computing taxable income are included
in collectibles gains and losses. See section 1222(l)-(4) for a similar
rule in defining various categories of capital gain. A look-through
rule is provided in the case of the sale of a partnership interest.
\75\ For example, assume an individual has $300,000 gain from the
sale of qualified stock in a small business corporation and $120,000 of
the gain (50 percent of $240,000) is excluded from gross income under
section 1202, as limited by section 1202(b). The entire $180,000 of
gain included in gross income is included in the computation of net
capital gain and $120,000 of that gain will be taken into account in
computing 28-percent rate gain. The combination of the 50-percent
exclusion and the 28-percent maximum rate will result in a maximum
effective regular tax rate of 14 percent on the $240,000 gain from the
sale of the small business stock to which the 50-percent section 1202
exclusion applies, and the maximum rate on the remaining $60,000 of
gain is 20 percent.
---------------------------------------------------------------------------
``Unrecaptured section 1250 gain'' means the amount of
long-term capital gain (not otherwise treated as ordinary
income) which would be treated as ordinary income if section
1250 recapture applied to all depreciation (rather than only to
depreciation in excess of straight-line depreciation) from the
sale or exchange of property held more than 18 months,\76\
reduced by the net loss (if any) attributable to the items
taken into account in computing 28-percent rate gain. The
amount of unrecaptured section 1250 gain (before the reduction
for the net loss) attributable to the disposition of property
to which section 1231 applies shall not exceed the net section
1231 gain for the year. Thus, if a taxpayer sells a building
used in a trade or business held more than 18 months for a gain
of $20,000 attributable entirely to depreciation adjustments
not otherwise recaptured as ordinary income, and sells land
used in a trade or business held for more than one year for a
loss of $5,000, the net section 1231 gain is $15,000 and
$15,000 (rather than $20,000) will be taken into account in
computing the unrecaptured section 1250 gain for the year.
---------------------------------------------------------------------------
\76\ Section 1250 will continue to treat gain attributable to
certain depreciation (generally the amount of depreciation in excess of
the amount allowable under the straight-line method) as ordinary
income. Thus, for example, assume a taxpayer sold a building for $1
million, which originally cost $500,000, and the taxpayer was allowed
$400,000 depreciation of which $100,000 is additional depreciation (as
defined in section 1250(b)). As under prior law, $100,000 is treated as
ordinary income under section 1250, and $800,000 is treated as long-
term capital gain (assuming that section 1231(a)(2) does not apply).
Under the Act, $300,000 will be taken into account in computing
unrecaptured section 1250 gain since, if section 1250 had applied to
all depreciation (rather than only additional depreciation), $300,000
of the $800,000 long-term capital gain would have been treated as
ordinary income, and only $500,000 would have been treated as long-term
capital gain.
In the case of a disposition of a partnership interest held more
than 18 months, the amount of long-term capital gain (not otherwise
treated as ordinary income) which would be treated as ordinary income
under section 751(a) if section 1250 applied to all depreciation, will
be taken into account in computing unrecaptured section 1250 gain.
---------------------------------------------------------------------------
The unrecaptured section 1250 gain is taxed at a maximum
rate of 25 percent, and the 28-percent rate gain is taxed at a
maximum rate of 28 percent. (secs. 1(h)(1) and 55(b)(3)). Any
amount of unrecaptured section 1250 gain or 28-percent rate
gain otherwise taxed at a 15-percent rate will continue to be
taxed at the 15-percent rate.\77\
---------------------------------------------------------------------------
\77\ In order to arrive at this result, section 1(h)(1) provides
that the amount taxed at a 25-percent rate is limited to the net
capital gain and is further adjusted to take into account amounts
otherwise taxed at the 15-percent rate (or not taxed at all by reason
of a taxpayer's ordinary loss), and that the amount taxed at a 28-
percent rate is the amount of taxable income reduced by the sum of the
amounts taxed at the regular section 1 rates and the 10-, 20-, and 25-
percent capital gains rates.
---------------------------------------------------------------------------
The following examples illustrate the application of these
rules. (For purposes of the examples, assume the maximum amount
of taxable income in the rate schedule applicable to the
individual taxed at the 15-percent rate is $40,000 and the
maximum amount of taxable income taxed at a rate below 31
percent is $80,000.)
Example 1.--Assume an individual has taxable income of
$100,000, with an adjusted net capital gain of $50,000. $50,000
will be taxed at regular tax rates (i.e., $40,000 at 15 percent
and $10,000 at 28 percent), and the $50,000 adjusted net
capital gain will be taxed at 20 percent.
Example 2.--Assume an individual has taxable income of
$100,000 with an adjusted net capital gain of $70,000. $30,000
will be taxed at regular tax rates (i.e., 15 percent), and
$10,000 of the adjusted net capital gain will be taxed at 10
percent and the remaining $60,000 of the adjusted net capital
gain will be taxed at 20 percent.
Example 3.--Assume an individual has taxable income of
$100,000, with a net capital gain of $50,000, and a 28-percent
rate gain of $20,000, resulting in an adjusted net capital gain
of $30,000. $50,000 will be taxed at the regular tax rates
(i.e., $40,000 at 15 percent and $10,000 at 28 percent), the
$30,000 of adjusted net capital gain will be taxed at 20
percent, and the remaining $20,000 will be taxed at 28 percent.
Example 4.--Assume an individual has taxable income of
$150,000, with a net capital gain of $50,000, and a 28-percent
rate gain of $20,000, resulting in an adjusted net capital gain
of $30,000. $100,000 will be taxed at regular tax rates (i.e.,
$40,000 at 15 percent, $40,000 at 28 percent, and $20,000 at 31
percent), the $30,000 of adjusted net capital gain will be
taxed at 20 percent, and the remaining $20,000 will be taxed at
28 percent.
Example 5.--Assume an individual has taxable income of
$80,000, with a net capital gain of $50,000, and a 28-percent
rate gain of $20,000, resulting in an adjusted net capital gain
of $30,000. $40,000 will be taxed at the regular tax rates
(i.e., 15 percent); the $30,000 adjusted net capital gain will
be taxed at 20 percent; and the remaining $10,000 will be taxed
at 28 percent.
Example 6.--Assume an individual has taxable income of
$60,000, with a net capital gain of $50,000, and a 28-percent
gain of $20,000, resulting in an adjusted net capital gain of
$30,000. $30,000 will be taxed at the regular tax rates (i.e.,
15 percent); $10,000 of the adjusted net capital gain will be
taxed at 10 percent; and $20,000 of the adjusted net capital
gain will be taxed at 20 percent.
Example 7.--Assume an individual has taxable income of
$40,000, with a net capital gain of $50,000, and a 28-percent
rate gain of $20,000, resulting in an adjusted net capital gain
of $30,000. $10,000 will be taxed at the regular tax rates
(i.e., 15 percent); and the $30,000 adjusted net capital gain
will be taxed at 10 percent.
Example 8.--Assume an individual has taxable income of
$150,000, with a net capital gain of $50,000, an unrecaptured
section 1250 gain of $10,000 and a 28-percent rate gain of
$10,000, resulting in an adjusted net capital gain of $30,000.
$100,000 will be taxed at regular tax rates (i.e., $40,000 at
15 percent, $40,000 at 28 percent, and $20,000 at 31 percent);
the unrecaptured section 1250 gain of $10,000 will be taxed at
25 percent; the $30,000 adjusted net capital gain will be taxed
at 20 percent; and the remaining gain of $10,000 will be taxed
at 28 percent.
Example 9.--Assume an individual has taxable income of
$80,000, with a net capital gain of $50,000, an unrecaptured
section 1250 gain of $10,000 and a 28-percent rate gain of
$10,000, resulting in an adjusted net capital gain of $30,000.
$40,000 will be taxed at the regular tax rates (i.e., 15
percent); the $30,000 adjusted net capital gain will be taxed
at 20 percent; and the remaining $10,000 will be taxed at 28
percent. No amount will be taxed at 25 percent.\78\
---------------------------------------------------------------------------
\78\ The amount taxed at 25 percent is determined by starting with
the $10,000 unrecaptured section 1250 gain and subtracting $10,000,
which is the excess of $90,000 (i.e., the sum of the amount taxed at
the regular rates ($40,000) plus the net capital gain ($50,000)) over
$80,000 (i.e., the taxable income). This results in no amount taxed at
25 percent.
---------------------------------------------------------------------------
Example 10.--Assume an individual has taxable income of
$60,000, with a net capital gain of $50,000, an unrecaptured
section 1250 gain of $10,000, and a 28-percent rate gain of
$10,000, resulting in an adjusted net capital gain of $30,000.
$30,000 will be taxed at the regular tax rates (i.e., 15
percent); $10,000 of the adjusted net capital gain will be
taxed at 10 percent; and $20,000 of the adjusted net capital
gain will be taxed at 20 percent.
Example 11.--Assume an individual has taxable income of
$40,000, with a net capital gain of $50,000, an unrecaptured
section 1250 gain of $10,000, and a 28-percent rate gain of
$10,000, resulting in an adjusted net capital gain of $30,000.
$10,000 will be taxed at the regular tax rates (i.e., 15
percent) and the $30,000 adjusted net capital gain will be
taxed at 10 percent.
Example 12.--Assume an individual has taxable income of
$150,000, with an unrecaptured section 1250 gain of $120,000,
and a loss of $20,000 from the sale of a capital asset held
more than 18 months, resulting in a net capital gain of
$100,000 and no adjusted net capital gain. $50,000 will be
taxed at the regular tax rates (i.e., $40,000 at 15 percent and
$10,000 at 28 percent); and $100,000 will be taxed at 25
percent.
Example 13.--Assume an individual has taxable income of
$150,000, with an unrecaptured section 1250 gain of $90,000, a
28-percent rate gain of $30,000, and a loss of $20,000 from the
sale of a capital asset held more than 18 months, resulting in
a net capital gain of $100,000 and no adjusted net capital
gain. $50,000 will be taxed at the regular tax rates (i.e.,
$40,000 at 15 percent and $10,000 at 28 percent); the $90,000
unrecaptured section 1250 gain will be taxed at 25 percent and
the remaining gain of $10,000 will be taxed at 28 percent.
Example 14.--Assume an individual has taxable income of
$150,000, with an unrecaptured section 1250 gain of $110,000, a
28-percent rate gain of $10,000, and a loss of $20,000 from the
sale of a capital asset held more than 18 months, resulting in
a net capital gain of $100,000 and no adjusted net capital
gain. $50,000 will be taxed at the regular tax rates (i.e.,
$40,000 at 15 percent and $10,000 at 28 percent); and $100,000
(the lesser of unrecaptured section 1250 gain or net capital
gain) will be taxed at 25 percent.
For taxable years beginning after December 31, 2000, any
gain from the sale or exchange of property held more than 5
years which would otherwise be taxed at the 10-percent rate
instead will be taxed at an 8-percent rate.
Any gain from the sale or exchange of property held more
than 5 years and the holding period for which begins after
December 31, 2000, which would otherwise be taxed at a 20-
percent rate will be taxed at an 18-percent rate. For purposes
of determining whether the holding period begins after December
31, 2000, the holding period of any property acquired pursuant
to the exercise of an option (or other right or obligation)
shall include the period such option (or other right or
obligation) was held. Thus, the sale or exchange of property
acquired after December 31, 2000, pursuant to the exercise of
an option acquired before January 1, 2001, will not qualify for
the 18-percent rate.\79\ In addition, a taxpayer holding a
capital asset or property used in the trade or business on
January 1, 2001, may elect to treat the asset as having been
sold on such date for an amount equal to its fair market value,
and having been reacquired for an amount equal to such value.
If the election is made, the asset will be eligible for the 18-
percent rate if sold after being held for more than 5 years
after December 31, 2000. Any gain resulting from the election
will be treated as received on the date of the deemed sale. Any
loss will not be allowed (and the disallowed loss will not be
added to the basis of the asset). A taxpayer may make the
election with respect to some assets and not with respect to
others.
---------------------------------------------------------------------------
\79\ The option rule applies solely for purposes of determining
whether the property meets the requirement that the holding period
began on or after January 1, 2001, in order to determine whether the
gain qualifies for the 18-percent maximum rate. It does not apply for
determining the holding period for any other purpose of the Code,
including whether the 5-year holding period is met.
---------------------------------------------------------------------------
The Act \80\ contains several conforming amendments to
coordinate the multiple holding periods with other provisions
of the Code. Inherited property (section 1223(11) and (12)) and
certain patents (section 1235) will be deemed to have a holding
period of more than 18 months, allowing the lower 10- and 20-
percent rates to apply. The Act treats the long-term capital
gain or loss on a section 1256 contract as attributable to
property held more than 18 months. Rules similar to the short
sale holding period rules of section 1233(b) and (d) and the
holding period rules of section 1092(f) will apply where the
applicable property is held more than one year but not more
than 18 months. Amounts treated as ordinary income by reason of
section 1231(c) will be allocated among categories of net
section 1231 gain in accordance with IRS forms or
regulations.\81\
---------------------------------------------------------------------------
\80\ These provisions were not contained in the 1997 Act itself but
are contained the Tax Technical Corrections Act of 1997, Title VI of
H.R. 2676 as passed by the House on November 5, 1997.
\81\ See IRS Notice 97-59 (Oct. 27, 1997) for rules relating to
recharacterizing section 1231 gains under section 1231(c).
---------------------------------------------------------------------------
The Act allows the Treasury Department to prescribe
regulations applying these capital gains rates to pass-through
entities, i.e., regulated investment companies, real estate
investment trusts, S corporations, partnerships, estates,
trusts, common trust funds, foreign investment companies to
which section 1247 applies, and qualified electing funds (as
defined in section 1295).
The Act also gives the Treasury Department regulatory
authority to modify the application of section 904(b)(2) and
(3) to the extent necessary to properly reflect capital gain
rate differentials and the computation of net capital gain.
These regulations may take into account that the net capital
gain includes gains and losses in different categories of
income under section 904(d).
These maximum capital gain rates also apply for purposes of
computing the alternative minimum tax.\82\ In addition, the
minimum tax preference (under section 57(a)(7)) for the
excluded portion of the gain from certain small business stock
is reduced to 42 percent, resulting in an inclusion for minimum
tax purposes of 71 percent (50 percent under the regular tax
plus an additional 21 percent) of the gain from the sale of
small business stock. Thus, the maximum rate of tax on this
gain under the minimum tax will be 19.88 percent (.71 of 28
percent). For gains which, but for section 1202, would be taxed
at an 18-percent rate beginning in 2006, the minimum tax
preference will be 28 percent, resulting in a minimum tax rate
of 17.92 percent.\83\
---------------------------------------------------------------------------
\82\ The amount of net capital gain, adjusted net capital gain,
unrecaptured section 1250 gain and 28-percent rate gain will be
computed with any adjustments (such as differences in adjusted bases)
used in computing alternative minimum taxable income.
\83\ See Title VI (sec. 605(d)(3)) of H.R. 2676, the Tax Technical
Corrections Act of 1997 as passed by the House on November 5, 1997.
---------------------------------------------------------------------------
Effective Date
The provision applies to taxable years ending after May 6,
1997.
Long-term capital gains and losses properly taken into
account before May 7, 1997, are taken into account in computing
28-percent rate gain for the taxable year. This generally has
the effect of applying the lower rates to capital assets sold
or exchanged (or installment payments received) on or after May
7, 1997, and subjecting the earlier portion of the capital gain
to the prior-law maximum rate of 28 percent. In the case of
gain taken into account by a pass-through entity, the date
taken into account by the entity is the appropriate date for
applying this rule.
The 18-month holding period is effective for amounts
properly taken into account after July 28, 1997. Thus, amounts
properly taken into account after May 6, 1997, and before July
29, 1997, with respect to property (other than collectibles)
held more than 1 year but not more than 18 months will be
eligible for the 10- and 20-percent rates (as well as the 25-
percent rate in the case of the disposition of section 1250
property).
Revenue Effect
The revenue effect of this provision is included in item 5,
below.
2. Exclusion of gain on sale of principal residence (sec. 312 of the
Act and secs. 121 and 1034 of the Code)
Prior Law
Under prior law, no gain was recognized on the sale of a
principal residence if a new residence at least equal in cost
to the sales price of the old residence was purchased and used
by the taxpayer as his or her principal residence within a
specified period of time (sec. 1034). This replacement period
generally began two years before and ended two years after the
date of sale of the old residence. The basis of the replacement
residence was reduced by the amount of any gain not recognized
on the sale of the old residence by reason of this gain
rollover rule.
Also, under prior law, in general, an individual, on a one-
time basis, could exclude from gross income up to $125,000 of
gain from the sale or exchange of a principal residence if the
taxpayer (1) had attained age 55 before the sale, and (2) had
owned the property and used it as a principal residence for
three or more of the five years preceding the sale (old sec.
121).
Reasons for Change
Calculating capital gain from the sale of a principal
residence was among the most complex tasks faced by a typical
taxpayer. Many taxpayers buy and sell a number of homes over
the course of a lifetime, and are generally not certain of how
much housing appreciation they can expect. Thus, even though
most homeowners never paid any income tax on the capital gain
on their principal residences, as a result of the rollover
provisions and the $125,000 one-time exclusion under prior law,
detailed records of transactions and expenditures on home
improvements had to be kept, in most cases, for many decades.
To claim the exclusion, many taxpayers had to determine the
basis of each home they owned, and appropriately adjust the
basis of their current home to reflect any untaxed gains from
previous housing transactions. This determination could involve
augmenting the original cost basis of each home by expenditures
on improvements. In addition to the record-keeping burden this
created, taxpayers faced the difficult task of drawing a
distinction between improvements that add to basis, and repairs
that do not. The failure to account accurately for all
improvements could lead to errors in the calculation of capital
gains, and hence to an under- or over-payment of the capital
gains on principal residences. By excluding from taxation
capital gains on principal residences below a relatively high
threshold, few taxpayers will have to refer to records in
determining income tax consequences of transactions related to
their house.
To have postponed the entire capital gain from the sale of
a principal residence under prior law, the purchase price of a
new home must have been greater than the sales price of the old
home. This provision of prior law encouraged some taxpayers to
purchase larger and more expensive houses than they otherwise
would in order to avoid a tax liability, particularly those who
move from areas where housing costs are high to lower-cost
areas. This promoted an inefficient use of taxpayer's financial
resources.
Prior law also may have discouraged some older taxpayers
from selling their homes. Taxpayers who would have realized a
capital gain in excess of $125,000 if they sold their home and
taxpayers who had already used the exclusion may have chosen to
stay in their homes even though the home no longer suited their
needs. By raising the $125,000 limit and by allowing multiple
exclusions, this constraint to the mobility of the elderly was
removed.
While most homeowners do not pay capital gains tax when
selling their homes, prior law created certain tax traps for
the unwary that resulted in significant capital gains taxes or
loss of the benefits of the prior-law exclusion. For example,
an individual was not eligible for the one-time capital gains
exclusion if the exclusion was previously utilized by the
individual's spouse. This restriction had the unintended effect
of penalizing individuals who married someone who had already
taken the exclusion. Households that moved from a high housing-
cost area to a low housing-cost area may have incurred an
unexpected capital gains tax liability. Divorcing couples may
have incurred substantial capital gains taxes if they did not
carefully plan their house ownership and sale decisions.
Explanation of Provision
Under the Act, a taxpayer generally is able to exclude up
to $250,000 ($500,000 if married filing a joint return) of gain
realized on the sale or exchange of a principal residence. The
exclusion is allowed each time a taxpayer selling or exchanging
a principal residence meets the eligibility requirements, but
generally no more frequently than once every two years. The Act
provides that gain would be recognized to the extent of any
depreciation allowable with respect to the rental or business
use of such principal residence for periods after May 6, 1997.
To be eligible for the exclusion, a taxpayer must have
owned the residence and occupied it as a principal residence
for at least two of the five years prior to the sale or
exchange. A taxpayer who fails to meet these requirements by
reason of a change of place of employment, health, or other
unforseen circumstances is able to exclude the fraction of the
$250,000 ($500,000 if married filing a joint return) equal to
the fraction of two years that these requirements are met.\84\
---------------------------------------------------------------------------
\84\ The partial exclusion is a fraction of the maximum exclusion
(i.e., $250,000 or $500,000 if married filing a joint return), not the
realized gain on the sale or exchange. A technical correction may be
needed so that the statute reflects this intent. See Title IV (sec.
605(e)) of H.R. 2676, The Tax Technical Corrections Act of 1997, as
passed by the House on November 5, 1997.
---------------------------------------------------------------------------
In the case of joint filers not sharing a principal
residence, an exclusion of $250,000 is available on a
qualifying sale or exchange of the principal residence of one
of the spouses. Similarly, if a single taxpayer who is
otherwise eligible for an exclusion marries someone who has
used the exclusion within the two years prior to the marriage,
the Act would allow the newly married taxpayer a maximum
exclusion of $250,000. Once both spouses satisfy the
eligibility rules and two years have passed since the last
exclusion was allowed to either of them, the taxpayers may
exclude up to $500,000 of gain on their joint return.
Under the Act, the gain from the sale or exchange of the
remainder interest in the taxpayer's principal residence may
qualify for the otherwise allowable exclusion.
The provision limiting the exclusion to only one sale
every two years by the taxpayer does not prevent a husband and
wife filing a joint return from each excluding up to $250,000
of gain from the sale or exchange of each spouse's principal
residence provided that each spouse would be permitted to
exclude up to $250,000 of gain if they filed separate returns.
Effective Date
The provision is available for all sales or exchanges of a
principal residence occurring after May 6, 1997, and replaces
the present-law rollover and one-time exclusion provisions
applicable to principal residences.
A taxpayer may elect to apply present law (rather than the
new exclusion) to a sale or exchange (1) made on or before the
date of enactment of the Act,\85\ (2) made after the date of
enactment pursuant to a binding contract in effect on such date
or (3) where the replacement residence was acquired on or
before the date of enactment (or pursuant to a binding contract
in effect of the date of enactment) and the rollover provision
would apply. If a taxpayer acquired his or her current
residence in a rollover transaction, periods of ownership and
use of the prior residence would be taken into account in
determining ownership and use of the current residence.
---------------------------------------------------------------------------
\85\ A technical correction may be needed so that the statute
reflects Congressional intent that the prior-law election be available
to sales or exchanges on the date of enactment. See Title VI (sec.
605(e)) of H.R. 2676, the Tax Technical Corrections Act of 1997, as
passed by the House on November 5, 1997.
---------------------------------------------------------------------------
Revenue Effect
The revenue effect of this provision is included in item
5, below.
3. Exception from real estate reporting requirements for certain sales
of principal residences (secs. 312(c) and 701 of the Act and
secs. 6045 and 1400C(f) of the Code)
Present and Prior Law
Persons who close real estate transactions are required to
file information returns with the IRS. These returns, filed on
Form 1099S, are required to show the name and address of the
seller of the real estate, details with regard to the gross
proceeds of the sale, and the portion of any real property tax
which is treated as a tax imposed on the purchaser. Code
section 6045(e) also provides for reporting where any financing
of the seller was federally-subsidized indebtedness, but
Treasury regulations do not currently require the reporting of
this information.
Reasons for Change
The Congress believed that information returns should not
generally be required on sales of personal residences where
there is no possibility of the gain being taxable and
information regarding the transaction is not otherwise required
to be reported.
Explanation of Provision
The Act excludes most sales of personal residences with a
gross sales price of $500,000 or less ($250,000 or less in the
case of a seller who is not married) from the real estate
transaction reporting requirement. The Secretary of the
Treasury has the discretion to increase these dollar thresholds
if the Secretary determines that such an increase will not
materially reduce revenues to the Treasury. In order to be
eligible for this exclusion, the person who would otherwise be
required to file the information return must obtain written
assurances from the seller of the real estate, in a form
acceptable to the Secretary of the Treasury, that any gain will
be exempt from Federal income tax under section 121(a).
The Secretary of the Treasury is authorized under present
and prior law to require information as to whether there is
federally subsidized mortgage financing assistance with respect
to mortgages on residences. However, the Secretary does not at
this time require such information to be provided in connection
with the reporting of real estate transactions under section
6045(e). Should the Secretary require such reporting in the
future, the exception to the real estate transaction reporting
requirement created by this provision will not apply unless the
person otherwise required to file the information return also
obtains assurances that there is no such assistance with
respect to the mortgage on the residence.
The Act separately establishes a credit of $5,000 for
first-time home buyers in the District of Columbia. The
Congress anticipates that the Secretary of the Treasury will
require such information as is necessary to verify eligibility
for the D.C. first-time home buyer credit. In order to allow
such information to be collected in an efficient manner, the
exclusion from the real estate transaction reporting
requirement does not apply to sales of homes that are eligible
for this credit, if the Secretary requires such information
reporting.
Effective Date
The provision was effective with regard to sales or
exchanges occurring after the date of enactment (August 5,
1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by a negligible amount.
4. Rollover of gain from sale of certain small business stock (sec. 313
of the Act and sec. 1045 of the Code)
Present and Prior Law
The Revenue Reconciliation Act of 1993 provided
individuals a 50-percent exclusion for the sale of certain
small business stock acquired at original issue and held for at
least five years. In order to qualify as a small business, when
the stock is issued, the gross assets of the corporation may
not exceed $50 million. The corporation also must meet an
active trade or business requirement.
Reasons for Change
The Congress hoped that by providing deferral of gain
recognition for funds reinvested in qualifying small businesses
that investors will make more capital available to the new,
small businesses that are important to the long term growth of
the economy.
Explanation of Provision
The Act allows an individual \86\ to roll over gain from
the sale or exchange of small business stock held more than six
months where the taxpayer uses the proceeds to purchase other
qualifying small business stock within 60 days of the sale of
the original stock. For purposes of this provision, the
replacement stock must meet the active business requirement of
section 1202 for the six-month period following the purchase.
The holding period of the replacement stock generally will
include the holding period of the stock sold, except that the
replacement stock itself must be held for more than six months
to do another tax-free rollover.
---------------------------------------------------------------------------
\86\ Title VI (sec. 605(f)) of H.R. 2676, the Tax Technical
Corrections Act of 1997, as passed the House on November 5, 1997,
provides that a partnership or S corporation can roll over gain from
small business stock held more than six months if (and only if) all the
interests in the partnership or S corporation are held by individuals
or estates at all times during the taxable year. The term ``estate'' is
intended to include both the estate of a decedent and the estate of an
individual in bankruptcy.
---------------------------------------------------------------------------
Effective Date
The provision applies to stock sold after August 5, 1997.
Revenue Effect
The revenue effect of this provision is included in item
5, below.
5. Computation of alternative capital gains tax for corporations (sec.
314 of the Act and sec. 1201 of the Code)
Prior Law
Under prior law, the Code provided that if the regular
corporate tax rate exceeded 35 percent, the corporate tax could
not exceed a tax computed at the regular tax rates on the
taxable income reduced by the net capital gain plus a tax of 35
percent of the net capital gain. Because the regular corporate
tax rates do not exceed 35 percent, this provision has no
effect under the present and prior law rate structure.
Reasons for Change
The Congress wished to provide a more appropriate formula
for taxing the net capital gain of a corporation with an
ordinary loss, in the event that the alternative corporate
capital gain rate becomes effective at some future time.
Explanation of Provision
The Act provides that the amount taxed at the maximum
corporate capital gain rate (under section 1201(a)(2)) may not
exceed the amount of a corporation's taxable income. Because
the section 1201 alternative rate does not apply under the
current rate structure, this change will have no effect without
further amendment to the Code.
Effective Date
The provision is effective for taxable years ending after
December 31, 1997.
Revenue Effect
The capital gains provisions for items 1, 2, 4 and 5,
above, are estimated to increase Federal fiscal year budget
receipts in 1997 by $1,254 million, in 1998 by $6,371 million,
and in 1999 by $171 million and to reduce Federal fiscal year
budget receipts in 2000 by $2,954 million, in 2001 by $2,934
million, in 2002 by $1,785 million, in 2003 by $3,742 million,
in 2004 by $3,981 million, in 2005 by $4,179 million, in 2006
by $4,424 million, and in 2007 by $4,958 million.
TITLE IV. ALTERNATIVE MINIMUM TAX PROVISIONS
A. Repeal Alternative Minimum Tax for Small Businesses and Modify the
Depreciation Adjustment (secs. 401 and 402 of the Act and secs. 55 and
56 of the Code)
Present and Prior Law
In general
Present law imposes a minimum tax on an individual or a
corporation to the extent the taxpayer's minimum tax liability
exceeds its regular tax liability. The individual minimum tax
is imposed at rates of 26 and 28 percent on alternative minimum
taxable income in excess of a phased-out exemption amount; the
corporate minimum tax is imposed at a rate of 20 percent on
alternative minimum taxable income in excess of a phased-out
$40,000 exemption amount. Alternative minimum taxable income
(``AMTI'') is the taxpayer's taxable income increased by
certain preference items and adjusted by determining the tax
treatment of certain items in a manner that negates the
deferral of income resulting from the regular tax treatment of
those items. In the case of a corporation, in addition to the
regular set of adjustments and preferences, there is a second
set of adjustments known as the ``adjusted current earnings''
adjustment.
The most significant alternative minimum tax adjustment of
businesses relates to depreciation. Under prior law, in
computing AMTI, depreciation on property placed in service
after 1986 was computed by using the class lives prescribed by
the alternative depreciation system of section 168(g) and
either (1) the straight-line method in the case of property
subject to the straight-line method under the regular tax or
(2) the 150-percent declining balance method in the case of
other property. For regular tax purposes, depreciation on
tangible personal property generally is computed using shorter
recovery periods and more accelerated methods than are allowed
for alternative minimum tax purposes.
Reasons for Change
The Congress believed that the alternative minimum tax
inhibits capital formation and business enterprise. Therefore,
the Act modified the depreciation adjustment of the alternative
minimum tax (the most significant business-related adjustment
of the alternative minimum tax) with respect to new
investments. In addition, the Congress believed that the
alternative minimum tax is administratively complex. Therefore,
the Act repealed the alternative minimum tax for small
corporations.
Explanation of Provision
Repeal of the alternative minimum tax for small corporations
The alternative minimum tax is repealed for small
corporations for taxable years beginning after December 31,
1997. A corporation that had average gross receipts of less
than $5 million for the three-year period beginning after
December 31, 1993,\87\ is a small corporation for its first
taxable year beginning after December 31, 1997. A corporation
that meets the $5 million gross receipts test will continue to
be treated as a small corporation exempt from the alternative
minimum tax so long as its average gross receipts do not exceed
$7.5 million. If a corporation no longer qualifies as a small
corporation, it will become subject to the corporate
alternative minimum tax only with respect to adjustments and
preferences relating to investments made, and transactions
entered into, in taxable years beginning with the first taxable
year the corporation does not so qualify.
---------------------------------------------------------------------------
\87\ Legislative history erroneously refers to the three-year
period beginning after December 31, 1994.
---------------------------------------------------------------------------
In addition, the alternative minimum tax credit allowable
to a small corporation is limited to the amount by which the
corporation's regular tax liability (reduced by other credits)
exceeds 25 percent of the excess (if any) of the corporation's
regular tax (reduced by other credits) over $25,000.
Modification to the depreciation adjustment
For property (including pollution control facilities)
placed in service after December 31, 1998, the Act conforms the
recovery periods (but not the methods) used for purposes of the
alternative minimum tax depreciation adjustment to the recovery
periods used for purposes of the regular tax under present law.
Effective Date
Except as provided above, the provision is effective for
taxable years beginning after December 31, 1997.
Revenue Effect
The provision that exempts small corporations from the
alternative minimum tax is estimated to reduce Federal fiscal
year budget receipts by $97 million in 1998, $171 million in
1999, $131 million in 2000, $100 million in 2001, $77 million
in 2002, $59 million in 2003, $45 million in 2004, $34 million
in 2005, $26 million in 2006, and $20 million in 2007. The
provision that modifies the depreciation adjustment is
estimated to reduce Federal fiscal year budget receipts $580
million in 1999, $1,653 million in 2000, $2,230 million in
2001, $2,358 million in 2002, $2,561 million in 2003, $2,622
million in 2004, $2,350 million in 2005, $2,044 million in
2006, and $1,920 million in 2007.
B. Repeal AMT Installment Method Adjustment for Farmers (sec. 403 of
the Act and sec. 56 of the Code)
Present and Prior Law
The installment method allows gain on the sale of property
to be recognized as payments are received. Under the regular
tax, dealers in personal property are not allowed to defer the
recognition of income by use of the installment method on the
installment sale of such property. For this purpose, dealer
dispositions do not include sales of any property used or
produced in the trade or business of farming. For alternative
minimum tax purposes, the installment method is not available
with respect to the disposition of any property that is the
stock in trade of the taxpayer or any other property of a kind
which would be properly included in the inventory of the
taxpayer if held at year end, or property held by the taxpayer
primarily for sale to customers. No explicit exception is
provided for installment sales of farm property under the
alternative minimum tax.
Reasons for Change
The Congress understood that the Internal Revenue Service
(``IRS'') took the position that the installment method may not
be used for sales of property produced on a farm for
alternative minimum tax purposes. The Congress further
understood that the IRS had announced that it generally will
not enforce this position for taxable years beginning before
January 1, 1997, so long as the farmer changes its method of
accounting for installment sales for taxable years beginning
after December 31, 1996.\88\ The Congress believed that this
issue should be clarified in favor of the farmer.
---------------------------------------------------------------------------
\88\ Notice 97-13, January 28, 1997.
---------------------------------------------------------------------------
Explanation of Provision
The Act repeals the minimum tax adjustment relating to the
installment method of accounting. Thus, sales reported under
the installment method for regular tax purposes may be reported
under such method for alternative minimum tax purposes as well.
Effective Date
The provision generally is effective for dispositions in
taxable years beginning after December 31, 1987.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $8 million in 1997, $157 million in 1998,
$158 million in 1999, $167 million in 2000, $164 million in
2001, $157 million in 2002, and $148 million in 2003; and to
increase Federal fiscal year budget receipts by $22 million in
2004, $22 million in 2005, $21 million in 2006, and $21 million
in 2007.
TITLE V. ESTATE, GIFT, AND GENERATION-SKIPPING TAX PROVISIONS
A. Estate and Gift Tax Provisions
1. Increase in estate and gift tax unified credit; indexing of certain
other provisions (sec. 501 of the Act and secs. 2010, 2032A,
2503, 2631, and 6601(j) of the Code)
Present and Prior Law
In general
A gift tax is imposed on lifetime transfers by gift and an
estate tax is imposed on transfers at death. Since 1976, the
gift tax and the estate tax have been unified so that a single
graduated rate schedule applies to cumulative taxable transfers
made by a taxpayer during his or her lifetime and at death.\89\
Under prior law, a unified credit of $192,800 was provided
against the estate and gift tax, which effectively exempted the
first $600,000 in cumulative taxable transfers from tax (sec.
2010). For transfers in excess of $600,000, estate and gift tax
rates began at 37 percent and reached 55 percent on cumulative
taxable transfers over $3 million (sec. 2001(c)). In addition,
a 5-percent surtax was imposed upon cumulative taxable
transfers between $10 million and $21,040,000, to phase out the
benefits of the graduated rates and the unified credit (sec.
2001(c)(2)).\90\
---------------------------------------------------------------------------
\89\ Prior to 1977, separate tax rate schedules applied to the gift
tax and the estate tax.
\90\ Thus, if a taxpayer made cumulative taxable transfers equaling
$21,040,000 or more, his or her average transfer tax rate was 55
percent. The phaseout has the effect of creating a 60-percent marginal
transfer tax rate on transfers in the phaseout range.
---------------------------------------------------------------------------
Annual exclusion for gifts
A taxpayer could exclude $10,000 of gifts of present
interests in property made by an individual ($20,000 per
married couple) to each donee during a calendar year (sec.
2503).
Special use valuation
An executor may elect for estate tax purposes to value
certain qualified real property used in farming or a closely-
held trade or business at its current use value, rather than
its ``highest and best use'' value (sec. 2032A). The maximum
reduction in value under such an election was $750,000.
Generation-skipping transfer (``GST'') tax
An individual was allowed an exemption from the GST tax of
up to $1,000,000 for generation-skipping transfers made during
life or at death (sec. 2631).
Installment payment of estate tax
An executor may elect to pay the Federal estate tax
attributable to an interest in a closely held business in
installments over, at most, a 14-year period (sec. 6166). The
tax on the first $1,000,000 in value of a closely-held business
was eligible for a special 4-percent interest rate (sec.
6601(j)).
Reasons for Change
The Congress believed that increasing the amount of the
estate and gift tax unified credit would encourage saving,
promote capital formation and entrepreneurial activity, and
help to preserve existing family-owned farms and businesses.
The Congress further believed that increasing the unified
credit exemption equivalent amount over time, and annually
indexing for inflation the annual exclusion for gifts, the
ceiling on special use valuation, the generation-skipping
transfer tax exemption, and the ceiling on the value of a
closely-held business eligible for the special low interest
rate, was appropriate to reduce the transfer tax consequences
that result from increases in asset value attributable solely
to inflation.
Explanation of Provision
The Act increases the present-law unified credit beginning
in 1998, from an effective exemption of $600,000 to an
effective exemption of $1,000,000 in 2006. The increase in the
effective exemption is phased in according to the following
schedule: the effective exemption is $625,000 for decedents
dying and gifts made in 1998; $650,000 in 1999; $675,000 in
2000 and 2001; $700,000 in 2002 and 2003; $850,000 in 2004;
$950,000 in 2005; and $1 million in 2006 and thereafter. The
effective exemption amount is not indexed for inflation.
The Act also provides that, after 1998, the $10,000 annual
exclusion for gifts, the $750,000 ceiling on special use
valuation, the $1,000,000 generation-skipping transfer tax
exemption,\91\ and the $1,000,000 ceiling on the value of a
closely-held business eligible for the special low interest
rate (as modified below), are indexed annually for inflation
occurring after 1997. Indexing of the annual exclusion is
rounded to the next lowest multiple of $1,000 and indexing of
the other amounts is rounded to the next lowest multiple of
$10,000.
---------------------------------------------------------------------------
\91\ A technical correction may be necessary to clarify that
indexing of the $1,000,000 generation-skipping transfer tax exemption
is effective with respect to all generation-skipping transfers (i.e.,
direct skips, taxable terminations, and taxable distributions) made
after 1998. See Title VI (sec. 606(a)) of H.R. 2676, the Tax Technical
Corrections Act of 1997, as passed by the House on November 5, 1997.
---------------------------------------------------------------------------
Conforming amendments to reflect the increased unified
credit are made (1) to the 5-percent surtax to conform the
phase out of the increased unified credit and graduated
rates,\92\ (2) to the general filing requirements for an estate
tax return under section 6018(a), and (3) to the amount of the
unified credit allowed under section 2102(c)(3) with respect to
nonresident aliens with U.S. situs property who are residents
of certain treaty countries.
---------------------------------------------------------------------------
\92\ A technical correction may be necessary to properly phase out
the benefits of the unified credit and the graduated rates.
---------------------------------------------------------------------------
Effective Date
The increases in the unified credit are effective for
decedents dying, and gifts made, after December 31, 1997.
Indexing of the annual exclusion for gifts, the ceiling on
special use valuation, the generation-skipping transfer tax
exemption, and the ceiling on the value of a closely-held
business eligible for the special low interest rate is
effective for decedents dying, and gifts made, after December
31, 1998.
Revenue Effect
This provision, in combination with the provision described
in item 2., below, is estimated to reduce Federal fiscal year
budget receipts by $843 million in 1999, $1,259 million in
2000, $1,816 million in 2001, $2,013 million in 2002, $2,596
million in 2003, $2,997 million in 2004, $5,656 million in
2005, $7,279 million in 2006, and $8,638 million in 2007.
2. Estate tax exclusion for qualified family-owned businesses (sec. 502
of the Act and new sec. 2033A of the Code)
Present and Prior Law
Under prior law, there were no special estate tax rules for
qualified family-owned businesses. All taxpayers were allowed a
unified credit in computing the taxpayer's estate and gift tax,
which effectively exempted a total of $600,000 in cumulative
taxable transfers from the estate and gift tax (sec. 2010). An
executor also could elect, under section 2032A, to value
certain qualified real property used in farming or another
qualifying closely-held trade or business at its current use
value, rather than its highest and best use value (up to a
maximum reduction of $750,000). In addition, an executor may
elect to pay the Federal estate tax attributable to a qualified
closely-held business in installments over, at most, a 14-year
period (sec. 6166). The tax attributable to the first
$1,000,000 in value of a closely-held business was eligible for
a special 4-percent interest rate (sec. 6601(j)).
Reasons for Change
The Congress believed that a reduction in estate taxes for
qualified family-owned businesses would protect and preserve
family farms and other family-owned enterprises, and prevent
the liquidation of such enterprises in order to pay estate
taxes. The Congress further believed that the protection of
family enterprises would preserve jobs and strengthen the
communities in which such enterprises are located.
Explanation of Provision
The Act allows an executor to elect special estate tax
treatment for qualified ``family-owned business interests'' if
such interests comprise more than 50 percent of a decedent's
estate and certain other requirements are met. The exclusion
for family-owned business interests may be taken only to the
extent that the exclusion for family-owned business interests,
plus the amount effectively exempted by the unified credit,
does not exceed $1.3 million.\93\
---------------------------------------------------------------------------
\93\ A technical correction may be necessary to revise the rules
correlating the increase in the unified credit with a decrease in the
family-owned business exclusion to ensure that there is neither an
increase nor a decrease in the total estate tax on estates holding
family-owned businesses as increases in the unified credit are phased
in. See Title VI (sec. 606(b)(1)) of H.R. 2676, the Tax Technical
Corrections Act of 1997, as passed by the House on November 5, 1997. A
further modification may be necessary to reflect Congressional intent.
---------------------------------------------------------------------------
This new exclusion for qualified family-owned business
interests is provided in addition to the unified credit (which
currently effectively exempts $600,000 of taxable transfers
from the estate and gift tax, and will be increased to an
effective exemption of $1,000,000 of taxable transfers under
other provisions of the Act), the special-use provisions of
section 2032A (which permit a qualifying farm or other closely-
held business in a decedent's estate to be valued at the value
in its current use), and the provisions of section 6166 (which
provide for the installment payment of estate taxes
attributable to closely held businesses).
Qualified family-owned business interests
For purposes of the provision, a qualified family-owned
business interest is defined as any interest in a trade or
business (regardless of the form in which it is held) with a
principal place of business in the United States if ownership
of the trade or business is held at least 50 percent by one
family, 70 percent by two families, or 90 percent by three
families, as long as the decedent's family owns at least 30
percent of the trade or business. Under the provision, members
of an individual's family are defined using the same definition
as is used for the special-use valuation rules of section
2032A, and thus include (1) the individual's spouse, (2) the
individual's ancestors, (3) lineal descendants of the
individual, of the individual's spouse, or of the individual's
parents, and (4) the spouses of any such lineal descendants.
For purposes of applying the ownership tests in the case of a
corporation, the decedent and members of the decedent's family
are required to own the requisite percentage of the total
combined voting power of all classes of stock entitled to vote
and the requisite percentage of the total value of all shares
of all classes of stock of the corporation. In the case of a
partnership, the decedent and members of the decedent's family
are required to own the requisite percentage of the capital
interest, and the requisite percentage of the profits interest,
in the partnership.
In the case of a trade or business that owns an interest in
another trade or business (i.e., ``tiered entities''), special
look-through rules apply. Each trade or business owned
(directly or indirectly) by the decedent and members of the
decedent's family is separately tested to determine whether
that trade or business meets the requirements of a qualified
family-owned business interest. In applying these tests, any
interest that a trade or business owns in another trade or
business is disregarded in determining whether the first trade
or business is a qualified family-owned business interest. The
value of any qualified family-owned business interest held by
an entity is treated as being proportionately owned by or for
the entity's partners, shareholders, or beneficiaries. In the
case of a multi-tiered entity, such rules are sequentially
applied to look through each separate tier of the entity.
For example, if a holding company owns interests in two
other companies, each of the three entities will be separately
tested under the qualified family-owned business interest
rules. In determining whether the holding company is a
qualified family-owned business interest, its ownership
interest in the other two companies is disregarded. Even if the
holding company itself does not qualify as a family-owned
business interest, the other two companies still may qualify if
the direct and indirect interests held by the decedent and his
or her family members satisfy the requisite ownership
percentages and other requirements of a qualified family-owned
business interest. If either (or both) of the lower-tier
entities qualify, the value of the qualified family-owned
business interests owned by the holding company are treated as
proportionately owned by the holding company's shareholders.
An interest in a trade or business does not qualify if the
business's (or a related entity's) stock or securities were
publicly-traded at any time within three years of the
decedent's death. An interest in a trade or business also does
not qualify if more than 35 percent of the adjusted ordinary
gross income of the business for the year of the decedent's
death was personal holding company income (as defined in
section 543). This personal holding company restriction does
not apply to banks or domestic building and loan associations.
The value of a trade or business qualifying as a family-
owned business interest is reduced to the extent the business
holds passive assets or excess cash or marketable securities.
Under the provision, the value of qualified family-owned
business interests does not include any cash or marketable
securities in excess of the reasonably expected day-to-day
working capital needs of the trade or business. For this
purpose, it is intended that day-to-day working capital needs
be determined based on a historical average of the business's
working capital needs in the past, using an analysis similar to
that set forth in Bardahl Mfg. Corp., 24 T.C.M. 1030 (1965). It
is further intended that accumulations for capital acquisitions
not be considered ``working capital'' for this purpose. The
value of the qualified family-owned business interests also
does not include certain other passive assets. For this
purpose, passive assets include any assets that: (1) produce
dividends, interest, rents, royalties, annuities and certain
other types of passive income (as described in sec. 543(a));
(2) are an interest in a trust, partnership or REMIC (as
described in sec. 954(c)(1)(B)(ii)); (3) produce no income (as
described in sec. 954(c)(1)(B)(iii)); (4) give rise to income
from commodities transactions or foreign currency gains (as
described in sec. 954(c)(1)(C) and (D)); (5) produce income
equivalent to interest (as described in sec. 954(c)(1)(E)); or
(6) produce income from notional principal contracts or
payments in lieu of dividends (as described in new secs.
954(c)(1)(F) and (G), added elsewhere in the Act). In the case
of a regular dealer in property, such property is not
considered to produce passive income under these rules, and
thus, is not considered to be a passive asset.
Qualifying estates
A decedent's estate qualifies for the special treatment
only if the decedent was a U.S. citizen or resident at the time
of death, and the aggregate value of the decedent's qualified
family-owned business interests that are passed to qualified
heirs exceeds 50 percent of the decedent's adjusted gross
estate (the ``50-percent liquidity test''). For this purpose,
qualified heirs include any individual who has been actively
employed by the trade or business for at least 10 years prior
to the date of the decedent's death, and members of the
decedent's family. If a qualified heir is not a citizen of the
United States, any qualified family-owned business interest
acquired by that heir must be held in a trust meeting
requirements similar to those imposed on qualified domestic
trusts (under present-law sec. 2056A(a)), or through certain
other security arrangements that meet the satisfaction of the
Treasury Secretary. The 50-percent liquidity test generally is
applied by adding all transfers of qualified family-owned
business interests made by the decedent to qualified heirs at
the time of the decedent's death, plus certain lifetime gifts
of qualified family-owned business interests made to members of
the decedent's family,\94\ and comparing this total to the
decedent's adjusted gross estate. To the extent that a decedent
held qualified family-owned business interests in more than one
trade or business, all such interests are aggregated for
purposes of applying the 50-percent liquidity test.
---------------------------------------------------------------------------
\94\ A technical correction may be necessary to clarify the formula
for determining the amount of gifts of family-owned business interests
made to members of the decedent's family that are not otherwise
includible in the decedent's gross estate. See Title VI (sec.
606(b)(2)) of H.R. 2676, the Tax Technical Corrections Act of 1997, as
passed by the House on November 5, 1997.
---------------------------------------------------------------------------
The 50-percent liquidity test is calculated using a ratio,
the numerator and denominator of which are described below.
The numerator is determined by aggregating the value of all
qualified family-owned business interests that are includible
in the decedent's gross estate and are passed from the decedent
to a qualified heir, plus any lifetime transfers of qualified
business interests that are made by the decedent to members of
the decedent's family (other than the decedent's spouse),
provided such interests have been continuously held by members
of the decedent's family and were not otherwise includible in
the decedent's gross estate. For this purpose, qualified
businessinterests transferred to members of the decedent's
family during the decedent's lifetime are valued as of the date of such
transfer. This amount then is reduced by all indebtedness of the
estate, except for the following: (1) indebtedness on a qualified
residence of the decedent (determined in accordance with the
requirements for deductibility of mortgage interest set forth in
section 163(h)(3)); (2) indebtedness incurred to pay the educational or
medical expenses of the decedent, the decedent's spouse or the
decedent's dependents; and (3) other indebtedness of up to $10,000.
The denominator is equal to the decedent's gross estate,
reduced by any indebtedness of the estate, and increased by the
amount of the following transfers, to the extent not already
included in the decedent's gross estate: (1) any lifetime
transfers of qualified business interests that were made by the
decedent to members of the decedent's family (other than the
decedent's spouse), provided such interests have been
continuously held by members of the decedent's family, plus (2)
any transfers of assets other than qualified family-owned
business interests from the decedent to the decedent's spouse
that were made within 10 years of the date of the decedent's
death, plus (3) any other transfers made by the decedent within
three years of the decedent's death, except non-taxable
transfers made to members of the decedent's family. The
Secretary of the Treasury is granted authority to disregard de
minimis gifts. In determining the amount of gifts made by the
decedent, any gift that the donor and the donor's spouse
elected to have treated as a split gift (pursuant to sec. 2513)
is treated as made one-half by each spouse for purposes of this
provision.
Participation requirements
To qualify for the beneficial treatment provided under the
Act, the decedent (or a member of the decedent's family) must
have owned and materially participated in the trade or business
for at least five of the eight years preceding the decedent's
date of death. In addition, each qualified heir (or a member of
the qualified heir's family) is required to materially
participate in the trade or business for at least five years of
any eight-year period within 10 years following the decedent's
death. For this purpose, ``material participation'' is defined
as under present-law section 2032A (special use valuation) and
the regulations promulgated thereunder. See, e.g., Treas. Reg.
sec. 20.2032A-3. Under such regulations, no one factor is
determinative of the presence of material participation and the
uniqueness of the particular industry (e.g., timber, farming,
manufacturing, etc.) must be considered. Physical work and
participation in management decisions are the principal factors
to be considered. For example, an individual generally is
considered to be materially participating in the business if he
or she personally manages the business fully, regardless of the
number of hours worked, as long as any necessary functions are
performed.
If a qualified heir rents qualifying property to a member
of the qualified heir's family on a net cash basis, and that
family member materially participates in the business, the
material participation requirement will be considered to have
been met with respect to the qualified heir for purposes of
this provision. For example, if the qualified heir rents his
property to his sister on a net cash basis, and his sister
materially participates in the business, his sister's
participation is sufficient to satisfy the requirement that the
qualified heir or a member of his family materially
participates in the business.
Recapture provisions
The benefit of the exclusions for qualified family-owned
business interests are subject to recapture if, within 10 years
of the decedent's death and before the qualified heir's death,
one of the following ``recapture events'' occurs: (1) the
qualified heir ceases to meet the material participation
requirements (i.e., if neither the qualified heir nor any
member of his or her family has materially participated in the
trade or business for at least five years of any eight-year
period); (2) the qualified heir disposes of any portion of his
or her interest in the family-owned business, other than by a
disposition to a member of the qualified heir's family or
through a conservation contribution under section 170(h); (3)
the principal place of business of the trade or business ceases
to be located in the United States; or (4) the qualified heir
loses U.S. citizenship. A qualified heir who loses U.S.
citizenship may avoid such recapture by placing the qualified
family-owned business assets into a trust meeting requirements
similar to a qualified domestic trust (as described in present
law sec. 2056A(a)), or through certain other security
arrangements. For this purpose, a sale or disposition, in the
ordinary course of business, of assets such as inventory or a
piece of equipment used in the business (e.g., the sale of
crops or a tractor) does not constitute a disposition of ``a
portion of a family-owned business interest'' that would result
in recapture of the benefits of the qualified family-owned
business exclusion.
If one of the above recapture events occurs, an additional
tax is imposed on the date of such event. As under section
2032A, each qualified heir is personally liable for the portion
of the recapture tax that is imposed with respect to his or her
interest in the qualified family-owned business. Thus, for
example, if a brother and sister inherit a qualified family-
owned business from their father, and only the sister
materially participates in the business, her participation will
cause both her and her brother to meet the material
participation test. If she ceases to materially participate in
the business within 10 years after her father's death (and the
brother still does not materially participate), the sister and
brother would both be liable for the recapture tax; that is,
each would be liable for the recapture tax attributable to his
or her interest.
The portion of the reduction in estate taxes that is
recaptured would be dependent upon the number of years that the
qualified heir (or members of the qualified heir's family)
materially participated in the trade or business after the
decedent's death. If the qualified heir (or his or her family
members) materially participated in the trade or business after
the decedent's death for less than six years, 100 percent of
the reduction in estate taxes attributable to that heir's
interest is recaptured; if the participation was for at least
six years but less than seven years, 80 percent of the
reduction in estate taxes is recaptured; if the participation
was for at least seven years but less than eight years, 60
percent is recaptured; if the participation was for at least
eight years but less than nine years, 40 percent is recaptured;
and if the participation was for at least nine years but less
than 10 years, 20 percent of the reduction in estates taxes is
recaptured. In general, there is no requirement that the
qualified heir (or members of his or her family) continue to
hold or participate in the trade or business more than 10 years
after the decedent's death. As under present-law section 2032A,
however, the 10-year recapture period may be extended for a
period of up to two years if the qualified heir does not begin
to use the property for a period of up to two years after the
decedent's death.
If a recapture event occurs with respect to any qualified
family-owned business interest (or portion thereof), the amount
of reduction in estate taxes attributable to that interest is
determined on a proportionate basis. For example, if the
decedent's estate included $2 million in qualified family-owned
business interests and $1 million of such interests received
beneficial treatment under this proposal, one-half of the value
of the interest disposed of is deemed to have received the
benefits provided under this proposal.
Effective Date
The provision is effective with respect to the estates of
decedents dying after December 31, 1997.
Revenue Effect
This provision, in combination with the provision described
in item 1., above, is estimated to reduce Federal fiscal year
budget receipts by $843 million in 1999, $1,259 million in
2000, $1,816 million in 2001, $2,013 million in 2002, $2,596
million in 2003, $2,997 million in 2004, $5,656 million in
2005, $7,279 million in 2006, and $8,638 million in 2007.
3. Installment payments of estate tax attributable to closely held
businesses (secs. 503 of the Act and secs. 6601(j) and 6166 of
the Code)
Present and Prior Law
In general, the Federal estate tax is due within nine
months of a decedent's death. Under Code section 6166, an
executor generally may elect to pay the estate tax attributable
to an interest in a closely held business in installments over,
at most, a 14-year period. If the election is made, the estate
may pay only interest for the first four years, followed by up
to 10 annual installments of principal and interest. Interest
generally is imposed at the rate applicable to underpayments of
tax under section 6621 (i.e., the Federal short-term rate plus
3 percentage points). Under prior law, a special 4-percent
interest rate was applied to the amount of deferred estate tax
attributable to the first $1,000,000 in value of the closely-
held business. Interests in holding companies and non-readily-
tradable business interests were not eligible for the reduced
interest rate under prior or present law.
To qualify for the installment payment election, the
business must be an active trade or business and the value of
the decedent's interest in the closely held business must
exceed 35 percent of the decedent's adjusted gross estate. An
interest in a closely held business includes: (1) any interest
as a proprietor in a business carried on as a proprietorship;
(2) any interest in a partnership carrying on a trade or
business if the partnership has 15 or fewer partners, or if at
least 20 percent of the partnership's assets are included in
determining the decedent's gross estate; or (3) stock in a
corporation if the corporation has 15 or fewer shareholders, or
if at least 20 percent of the value of the voting stock is
included in determining the decedent's gross estate.
Reasons for Change
The Congress believed that the provision, by eliminating
the deductibility of interest paid on estate taxes deferred
under section 6166 (and reducing the interest rate
accordingly), would eliminate the need to file annual
supplemental estate tax returns and make complex iterative
computations to claim an estate tax deduction for interest
paid.
Explanation of Provision
The Act reduces the 4-percent interest rate to 2 percent,
and makes the interest paid on estate taxes deferred under
section 6166 non-deductible for estate or income tax purposes.
The 2-percent interest rate is imposed on the amount of
deferred estate tax attributable to the first $1,000,000 in
taxable value of the closely held business (i.e., the first
$1,000,000 in value in excess of the effective exemption
provided by the unified credit and any other exclusions).\95\
The interest rate imposed on the amount of deferred estate tax
attributable to the taxable value of the closely held business
in excess of $1,000,000 is reduced to an amount equal to 45
percent of the rate applicable to underpayments of tax.\96\
---------------------------------------------------------------------------
\95\ The $1,000,000 threshold is indexed under other provisions of
the Act.
\96\ A technical correction may be necessary to clarify that
deferred payments of estate tax on holding companies and non-readily
tradable business interests do not qualify for the 2-percent interest
rate, but instead are subject to a non-deductible interest rate of 45
percent of the regular deficiency rate. See Title VI (sec. 606(c)) of
H.R. 2676, the Tax Technical Corrections Act of 1997, as passed by the
House on November 5, 1997.
---------------------------------------------------------------------------
Effective Date
The provision is effective for decedents dying after
December 31, 1997. Estates deferring estate tax under current
law may make a one-time election to use the lower interest
rates and forego the interest deduction for installments due
after the date of the election (but such estates do not receive
the benefit of the increase in the amount eligible for the
6601(j) interest rate--i.e., only the amount that was
previously eligible for the 4-percent rate would be eligible
for the 2-percent rate).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $9 million in 1999, $17 million in 2000, $25
million in 2001, $33 million in 2002, $41 million in 2003, $47
million in 2004, $53 million in 2005, $58 million in 2006, and
$65 million in 2007.
4. Estate tax recapture from cash leases of specially-valued property
(sec. 504 of the Act and sec. 2032A of the Code)
Present and Prior Law
A Federal estate tax is imposed on the value of property
passing at death. Generally, such property is included in the
decedent's estate at its fair market value. Under section
2032A, the executor may elect to value certain ``qualified real
property'' used in farming or other qualifying trade or
business at its current use value rather than its highest and
best use. If, after the special-use valuation election is made,
the heir who acquired the real property ceases to use it in its
qualified use within 10 years (15 years for individuals dying
before 1982) of the decedent's death, an additional estate tax
is imposed in order to ``recapture'' the benefit of the
special-use valuation (sec. 2032A(c)).
Under prior law, some courts had held that cash rental of
specially-valued property after the death of the decedent was
not a qualified use under section 2032A because the heirs no
longer bear the financial risk of working the property and,
therefore, resulted in the imposition of the additional estate
tax under section 2032A(c). See Martin v. Commissioner, 783
F.2d 81 (7th Cir. 1986) (cash lease to unrelated party not
qualified use); Williamson v. Commissioner, 93 T.C. 242 (1989),
aff'd, 974 F.2d 1525 (9th Cir. 1992) (cash lease to family
member not a qualified use); Fisher v. Commissioner, 65 T.C.M.
2284 (1993) (cash lease to family member not a qualified use);
cf. Minter v. U.S., 19 F.3d 426 (8th Cir. 1994) (cash lease to
family's farming corporation is qualified use); Estate of Gavin
v. U.S., 1997 U.S. App. Lexis 10383 (8th Cir. 1997) (heir's
option to pay cash rent or 50 percent crop share is qualified
use).
With respect to a decedent's surviving spouse, a special
rule provides that the surviving spouse will not be treated as
failing to use the property in a qualified use solely because
the spouse rents the property to a member of the spouse's
family on a net cash basis. (Sec. 2032A(b)(5)). Under section
2032A, members of an individual's family include (1) the
individual's spouse, (2) the individual's ancestors, (3) lineal
descendants of the individual, of the individual's spouse, or
of the individual's parents, and (4) the spouses of any such
lineal descendants.
Reasons for Change
The Congress believed that cash leasing of farmland among
family members was consistent with the purposes of the special-
use valuation rules, which are intended to prevent family farms
(and other qualifying businesses) from being liquidated to pay
estate taxes in cases where members of the decedent's family
continue to participate in the business.
Explanation of Provision
The Act provides that the cash lease of specially-valued
real property by a lineal descendant of the decedent to a
member of the lineal descendant's family, who continues to
operate the farm or closely held business, does not cause the
qualified use of such property to cease for purposes of
imposing the additional estate tax under section 2032A(c).
Effective Date
The provision is effective for cash rentals occurring after
December 31, 1976.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $25 million in 1998, and $2 million per year
thereafter.
5. Clarify eligibility for extension of time for payment of estate tax
(sec. 505 of the Act and new sec. 7479 of the Code)
Present and Prior Law
In general, the Federal estate tax is due within nine
months of a decedent's death. Under Code section 6166, an
executor generally may elect to pay the estate tax attributable
to an interest in a closely held business in installments over,
at most, a 14-year period. If the election is made, the estate
may pay only interest for the first four years, followed by up
to 10 annual installments of principal and interest. To qualify
for the installment payment election, the business must meet
certain requirements. If certain events occur during the
repayment period (e.g., the closely held business is sold),
full payment of all deferred estate taxes is required at that
time.
Under prior law, there was limited access to judicial
review of disputes regarding initial or continuing eligibility
for the deferral and installment election under section 6166.
If the Commissioner determined that an estate was not initially
eligible for deferral under section 6166, or had lost its
eligibility for such deferral, the estate was required to pay
the full amount of estate taxes asserted by the Commissioner as
being owed in order to obtain judicial review of the
Commissioner's determination.
Reasons for Change
The Congress believed that taxpayers should have access to
the courts to resolve disputes over an estate's eligibility for
the section 6166 election, without requiring potential
liquidation of the assets that the installment provisions of
section 6166 are designed to protect.
Explanation of Provision
The Act authorizes the U.S. Tax Court to provide
declaratory judgments regarding initial or continuing
eligibility for deferral under section 6166.\97\
---------------------------------------------------------------------------
\97\ A technical correction may be necessary to clarify that the
jurisdiction of the U.S. Tax Court to determine whether an estate
qualifies for installment payment of estate tax on closely-held
businesses extends to determining which businesses in an estate are
eligible for the deferral. See Title VI (sec. 606(d)) of H.R. 2676, the
Tax Technical Corrections Act of 1997, as passed by the House on
November 5, 1997.
---------------------------------------------------------------------------
Effective Date
The provision applies to decedents dying after date of
enactment.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $15 million in each of fiscal years 1999-
2004, $14 million in 2005, $12 million in 2006, and $11 million
in 2007.
6. Gifts may not be revalued for estate tax purposes after expiration
of statute of limitations (sec. 506 of the Act and secs. 2001,
6501(c)(9) and 7477 of the Code)
Present and Prior Law
The Federal estate and gift taxes are unified so that a
single progressive rate schedule is applied to an individual's
cumulative gifts and bequests. The tax on gifts made in a
particular year is computed by determining the tax on the sum
of the taxable gifts made that year and all prior years and
then subtracting the tax on the prior years taxable gifts and
the unified credit. Similarly, the estate tax is computed by
determining the tax on the sum of the taxable estate and prior
taxable gifts and then subtracting the tax on taxable gifts and
the unified credit. Under a special rule applicable to the
computation of the gift tax (sec. 2504(c)), the value of gifts
made in prior years is the value that was used to determine the
prior year's gift tax. There is no comparable rule in the case
of the computation of the estate tax.
Generally, any estate or gift tax must be assessed within
three years after the filing of the return. No proceeding in a
court for the collection of an estate or gift tax can be begun
without an assessment within the three-year period. If no
return is filed, the tax may be assessed, or a suit commenced
to collect the tax without assessment, at any time. If an
estate or gift tax return is filed, and the amount of
unreported items exceeds 25 percent of the amount of the
reported items, the tax may be assessed or a suit commenced to
collect the tax without assessment, within six years after the
return was filed (sec. 6501).
Commencement of the statute of limitations generally does
not require that a particular gift be disclosed. A special
rule, however, applies to certain gifts that are valued under
the special valuation rules of Chapter 14. The gift tax statute
of limitations runs for such a gift only if it is disclosed on
a gift tax return in a manner adequate to apprise the Secretary
of the Treasury of the nature of the item.
Under prior law, most courts had permitted the Commissioner
to redetermine the value of a gift for which the statute of
limitations period for the gift tax has expired in order to
determine the appropriate tax rate bracket and unified credit
for the estate tax. See, e.g., Evanson v. United States, 30
F.3d 960 (9th Cir. 1994); Stalcup v. United States, 946 F. 2d
1125 (5th Cir. 1991); Estate of Levin, 1991 T.C. Memo 1991-208,
aff'd 986 F. 2d 91 (4th Cir. 1993); Estate of Smith v.
Commissioner, 94 T.C. 872 (1990). But see Boatman's First
National Bank v. United States, 705 F. Supp. 1407 (W.D. Mo.
1988) (Commissioner not permitted to revalue gifts).
Reasons for Change
Revaluation of lifetime gifts at the time of death requires
the taxpayer to retain records for a potentially lengthy
period. Rules that encourage a determination within the gift
tax statute of limitations ease transfer tax administration by
eliminating reliance on stale evidence and reducing the period
for which retention of records is required.
Explanation of Provision
The Act provides that a gift for which the limitations
period has passed cannot be revalued for purposes of
determining the applicable estate tax bracket and available
unified credit. For gifts made in calendar years ending after
the date of enactment, the Act also extends the special rule
governing gifts valued under Chapter 14 to all gifts. Thus, the
statute of limitations will not run on an inadequately
disclosed transfer in calendar years ending after the date of
enactment, regardless of whether a gift tax return was filed
for other transfers in that same year.
It is intended that, in order to revalue a gift that has
been adequately disclosed on a gift tax return, the IRS must
issue a final notice of redetermination of value (a ``final
notice'') within the statute of limitations applicable to the
gift for gift tax purposes (generally, three years). This rule
is applicable even where the value of the gift as shown on the
return does not result in any gift tax being owed (e.g.,
through use of the unified credit or the annual exclusion). It
also is anticipated that the IRS will develop an administrative
appeals process whereby a taxpayer can challenge a
redetermination of value by the IRS prior to issuance of a
final notice.\98\
---------------------------------------------------------------------------
\98\ A technical correction to this provision may be necessary. See
Title VI (sec. 606(e)) of H.R. 2676, the Tax Technical Corrections Act
of 1997, as passed by the House on November 5, 1997. The technical
correction would clarify that in determining the amount of taxable
gifts made in preceding calendar periods, the value of prior gifts is
the value of such gifts as finally determined, even if no gift tax was
assessed or paid on that gift. For this purpose, final determinations
would include, e.g., the value reported on the gift tax return (if not
challenged by the IRS prior to the expiration of the statute of
limitations), the value determined by the IRS (if not challenged
through the declaratory judgment procedure by the taxpayer), the value
determined by the courts, or the value agreed to by the IRS and the
taxpayer in a settlement agreement.
---------------------------------------------------------------------------
A taxpayer who is mailed a final notice may challenge the
redetermined value of the gift (as contained in the final
notice) by filing a motion for a declaratory judgment with the
Tax Court. The motion must be filed on or before 90 days from
the date that the final notice was mailed. The statute of
limitations is tolled during the pendency of the Tax Court
proceeding.
Effective Date
The provision generally applies to gifts made after the
date of enactment (August 5, 1997). The extension of the
special rule under chapter 14 to all gifts applies to gifts
made in calendar years ending after the date of enactment.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $16 million in 1999, $18 million in 2000,
$21 million in 2001, $26 million in 2002, $32 million in 2003,
$38 million in 2004, $45 million in 2005, $53 million in 2006,
and $61 million in 2007.
7. Repeal of throwback rules applicable to domestic trusts (sec. 507 of
the Act and secs. 644(e) and 665 of the Code)
Present and Prior Law
A nongrantor trust is treated as a separate taxpayer for
Federal income tax purposes. Such a trust generally is treated
as a conduit with respect to amounts distributed currently \99\
and taxed with respect to any income which is accumulated in
the trust rather than distributed. A separate graduated tax
rate structure applies to trusts which historically has
permitted accumulated trust income to be taxed at lower rates
than the rates applicable to trust beneficiaries. This benefit
often was compounded through the creation of multiple trusts.
---------------------------------------------------------------------------
\99\ The conduit treatment is achieved by allowing the trust a
deduction for amounts distributed to beneficiaries during the taxable
year to the extent of distributable net income and by including such
distributions in the beneficiaries' income.
---------------------------------------------------------------------------
The Internal Revenue Code has several rules intended to
limit the benefit that would otherwise occur from using the
lower rates applicable to one or more trusts. Under the so-
called ``throwback'' rules, the distribution of previously
accumulated trust income to a beneficiary will be subject to
tax (in addition to any tax paid by the trust on that income)
where the beneficiary's average top marginal rate in the
previous five years is higher than those of the trust.
Under section 643(f), two or more trusts are treated as one
trust if (1) the trusts have substantially the same grantor or
grantors and substantially the same primary beneficiary or
beneficiaries, and (2) a principal purpose for the existence of
the trusts is to avoid Federal income tax. For trusts that were
irrevocable as of March 1, 1984, section 643(f) applies only to
contributions to corpus after that date.
Under prior law, section 644 provided that if property was
sold within two years of its contribution to a trust, the gain
that would have been recognized had the contributor sold the
property would be taxed at the contributor's marginal tax
rates. In effect, section 644 treated such gains as if the
contributor had realized the gain and then transferred the net
after-tax proceeds from the sale to the trust as corpus.
Sections 665 through 668 apply different rules to
distributions of previously accumulated trust income from a
foreign trust than to distributions of such income from
domestic trusts. If a foreign trust accumulates income, changes
its situs so as to become a domestic trust, and then makes a
distribution that is deemed to have been made in a year in
which the trust was a foreign trust, the distribution is
treated as a distribution from a foreign trust for purposes of
the accumulation distribution rules. Rev. Rul. 91-6, 1991-1
C.B. 89.
Reasons for Change
The throwback rules and section 644 were intended to
eliminate the potential tax reduction arising from taxation at
the trust level, rather than the beneficiary or contributor
level. When those provisions were enacted, a taxpayer could
reduce his or her overall tax liability substantially by
transferring property to one or more trusts, so that any income
from the property would be taxed at lower income tax rates. In
the Tax Reform Act of 1984, Congress curtailed the tax
avoidance use of multiple trusts. Moreover, in the Tax Reform
Act of 1986, Congress provided a new rate schedule for estates
and trusts under which the maximum tax benefit of the graduated
rate structure applicable to estates or trusts was reduced
substantially to slightly more than $600 per year for a trust
or estate. (Because of indexing of the rate brackets, that
benefit has increased to $845 per year per trust or estate.)
The Congress determined that the insignificant potential tax
reduction available through the transfer of property to trusts
no longer warranted the complexity of the throwback rules and
section 644.
Explanation of Provision
The Act generally exempts from the throwback rules amounts
distributed by a domestic trust after the date of enactment.
The throwback rules continue to apply with respect to (1)
foreign trusts, (2) domestic trusts that were once treated as
foreign trusts (except as provided in Treasury regulations),
and (3) domestic trusts created before March 1, 1984, that
would be treated as multiple trusts under sec. 643(f) of the
Code.
The Act also provides that precontribution gain on property
sold by a domestic trust no longer is subject to section 644
(i.e., taxed at the contributor's marginal tax rates).
Effective Date
The provision with respect to the throwback rules is
effective for distributions made in taxable years beginning
after the date of enactment (August 5, 1997). The modification
to section 644 applies to sales or exchanges after the date of
enactment.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $11 million per year in fiscal years 1999
through 2007.
8. Reduction in estate tax for certain land subject to permanent
conservation easement (sec. 508 of the Act and sec. 2031 of the
Code)
Present and Prior Law
A deduction is allowed for estate and gift tax purposes for
a contribution of a qualified real property interest to a
charity (or other qualified organization) exclusively for
conservation purposes (secs. 2055(f), 2522(d)). For this
purpose, a qualified real property interest means the entire
interest of the transferor in real property (other than certain
mineral interests), a remainder interest in real property, or a
perpetual restriction on the use of real property (sec.
170(h)). A ``conservation purpose'' is (1) preservation of land
for outdoor recreation by, or the education of, the general
public, (2) preservation of natural habitat, (3) preservation
of open space for scenic enjoyment of the general public or
pursuant to a governmental conservation policy, and (4)
preservation of historically important land or certified
historic structures. Also, a contribution will be treated as
``exclusively for conservation purposes'' only if the
conservation purpose is protected in perpetuity.
The same definition of qualified conservation contributions
also applies for purposes of determining whether such
contributions qualify as charitable deductions for income tax
purposes.
A donor making a qualified conservation contribution
generally was not allowed to retain an interest in minerals
which could be extracted or removed by any surface mining
method. However, deductions for contributions of conservation
interests satisfying all of the above requirements were
permitted if two conditions were satisfied. First, the surface
and mineral estates in the property with respect to which the
contribution is made must have been separated before June 13,
1976 (and remain so separated) and, second, the probability of
surface mining on the property with respect to which a
contribution is made must have been so remote as to be
negligible (sec. 170(h)(5)(B)).
Reasons for Change
The Congress believed that a reduction in estate taxes for
land subject to a qualified conservation easement would ease
existing pressures to develop or sell off open spaces in order
to raise funds to pay estate taxes, and would thereby help to
preserve environmentally significant land.
Explanation of Provision
Reduction in estate taxes for certain land subject to permanent
conservation easement
The Act allows an executor to elect to exclude from the
taxable estate 40 percent of the value of any land subject to a
qualified conservation easement that meets the following
requirements: (1) the land is located within 25 miles of a
metropolitan area (as defined by the Office of Management and
Budget) or a national park or wilderness area, or within 10
miles of an Urban National Forest (as designated by the Forest
Service of the U.S. Department of Agriculture); (2) the land
has been owned by the decedent or a member of the decedent's
family at all times during the three-year period ending on the
date of the decedent's death; and (3) a qualified conservation
contribution (within the meaning of sec. 170(h)) of a qualified
real property interest (as generally defined in sec.
170(h)(2)(C)) was granted by the decedent or a member of his or
her family. For purposes of the provision, preservation of a
historically important land area or a certified historic
structure does not qualify as a conservation purpose.
In order to qualify for the exclusion, a qualifying
easement must have been granted by the decedent, a member of
the decedent's family, the executor of the decedent's estate,
or the trustee of a trust holding the land, no later than the
date of the election. To the extent that the value of such land
is excluded from the taxable estate, the basis of such land
acquired at death is a carryover basis (i.e., the basis is not
stepped-up to its fair market value at death). Property
financed with acquisition indebtedness is eligible for this
provision only to the extent of the net equity in the property.
For example, if a $1 million property is subject to an
outstanding acquisition indebtedness balance of $100,000, it is
treated in the same manner as a $900,000 property that is not
debt-financed.
The exclusion amount is calculated based on the value of
the property includible in the gross estate, reduced by the
amount of any deduction taken under section 2055(f) with
respect to such land. In general, this value will be equal to
the value of the property after the conservation easement has
been placed on the property. The exclusion from estate taxes
does not extend to the value of any development rights retained
by the decedent or donor, although payment for estate taxes on
retained development rights may be deferred for up to two
years, or until the disposition of the property, whichever is
earlier. For this purpose, retained development rights are any
rights retained to use the land for any commercial purpose
which is not subordinate to and directly supportive of farming
purposes, as defined in section 2032A(e)(5) (e.g., tree
farming, ranching, viticulture, and the raising of other
agricultural or horticultural commodities). De minimis
commercial recreational activity that is consistent with the
conservation purpose, such as the granting of hunting and
fishing licenses, will not cause the property to fail to
qualify for the exclusion. It is anticipated that the Secretary
of the Treasury will provide guidance as to the definition of
``de minimis'' activities.
With respect to land held by a partnership, corporation, or
trust, a look-through rule applies to the extent that the
decedent owns (directly or indirectly) at least 30 percent of
the entity involved.
Maximum benefit allowed
The 40-percent estate tax exclusion for land subject to a
qualified conservation easement is limited to a maximum
exclusion of $100,000 in 1998, $200,000 in 1999, $300,000 in
2000, $400,000 in 2001, and $500,000 in 2002 and thereafter.
If the value of the conservation easement is less than 30
percent of (1) the value of the land without the easement,
reduced by (2) the value of any retained development rights,
then the exclusion percentage is reduced. The reduction in the
exclusion percentage is equal to two percentage points for each
point that the above ratio falls below 30 percent. Thus, for
example, if the value of the easement is 25 percent of the
value of the land before the easement less the value of the
retained development rights, the exclusion percentage is 30
percent (i.e., the 40 percent amount is reduced by twice the
difference between 30 percent and 25 percent). Under this
calculation, if the value of the easement is 10 percent or less
of the value of the land before the easement less the value of
the retained development rights, the exclusion percentage is
equal to zero.
Treatment of land subject to a conservation easement for purposes of
special-use valuation
The granting of a qualified conservation easement (as
defined above) is not treated as a disposition triggering the
recapture provisions of section 2032A. In addition, the
existence of a qualified conservation easement does not prevent
such property from subsequently qualifying for special-use
valuation treatment under section 2032A.
Retained mineral interests
The Act also allows a charitable deduction (for income tax
purposes or estate tax purposes) to taxpayers making a
contribution of a permanent conservation easement on property
where a mineral interest has been retained and surface mining
is possible, but its probability is ``so remote as to be
negligible.'' Prior law provided for a charitable deduction in
such a case if the mineral interests were separated from the
land prior to June 13, 1976. The provision allows such a
charitable deduction to be taken regardless of when the mineral
interests were separated.
Effective Date
The estate tax exclusion applies to decedents dying after
December 31, 1997. The rules with respect to the treatment of
conservation easements under section 2032A and with respect to
retained mineral interests are effective for easements granted
after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $7 million in 1999, $15 million in 2000, $25
million in 2001, $35 million in 2002, $48 million in 2003, $51
million in 2004, $56 million in 2005, $60 million in 2006, and
$64 million in 2007.
B. Generation-Skipping Tax Provision
1. Modification of generation-skipping transfer tax for transfers to
individuals with deceased parents (sec. 511 of the Act and sec.
2651 of the Code)
Present and Prior Law
Under the ``predeceased parent exception,'' a direct skip
transfer to a transferor's grandchild is not subject to the
generation-skipping transfer (``GST'') tax if the child of the
transferor who was the grandchild's parent is deceased at the
time of the transfer (sec. 2612(c)(2)). Under prior law, this
``predeceased parent exception'' to the GST tax was not
applicable to (1) transfers to collateral heirs, e.g.,
grandnieces or grandnephews, or (2) taxable terminations or
taxable distributions.
Reasons for Change
The Congress believed that a transfer to a collateral
relative whose parent is dead should qualify for the
predeceased parent exception in situations where the transferor
decedent has no lineal heirs, because no motive or opportunity
to avoid transfer tax exists. For similar reasons, the Congress
believed that transfers to trusts should be permitted to
qualify for the predeceased parent exclusion where the parent
of the beneficiary is dead at the time that the transfer is
first subject to estate or gift tax. The Congress also
understood that this treatment would remove a present law
impediment to the establishment of charitable lead trusts.
Explanation of Provision
The Act extends the predeceased parent exception to
transfers to collateral heirs, provided that the decedent has
no living lineal descendants at the time of the transfer. For
example, the exception applies to a transfer made by an
individual (with no living lineal heirs) to a grandniece where
the transferor's nephew or niece who is the parent of the
grandniece is deceased at the time of the transfer.
In addition, the Act extends the predeceased parent
exception (as modified by the change in the preceding
paragraph) to taxable terminations and taxable distributions,
provided that the parent of the relevant beneficiary was dead
at the earliest time that the transfer (from which the
beneficiary's interest in the property was established) was
subject to estate or gift tax. For example, where a trust was
established to pay an annuity to a charity for a term for years
with a remainder interest granted to a grandson, the
termination of the term for years would not be a taxable
termination subject to the GST tax if the grandson's parent
(who is the son or daughter of the transferor) is deceased at
the time the trust was created and the transfer creating the
trust was subject to estate or gift tax.
Effective Date
The provision is effective for generation skipping
transfers occurring after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $4 million per year in 1999-2003, $5 million
per year in 2004-2006, and $6 million in 2007.
TITLE VI. EXTENSION OF CERTAIN EXPIRING TAX PROVISIONS
A. Research Tax Credit (sec. 601 of the Act and sec. 41 of the Code)
Prior Law
General rule
Prior to May 31, 1997, section 41 provided for a research
tax credit equal to 20 percent of the amount by which a
taxpayer's qualified research expenditures for a taxable year
exceeded its base amount for that year. The research tax credit
expired and generally did not apply to amounts paid or incurred
after May 31, 1997.\100\
---------------------------------------------------------------------------
\100\ When originally enacted, the research tax credit applied to
qualified expenses incurred after June 30, 1981. The credit was
modified several times and was extended through June 30, 1995. The
credit later was extended for the period July 1, 1996, through May 31,
1997 (with a special 11-month extension for taxpayers that elect to be
subject to the alternative incremental research credit regime).
---------------------------------------------------------------------------
A 20-percent research tax credit also applied to the excess
of (1) 100 percent of corporate cash expenditures (including
grants or contributions) paid for basic research conducted by
universities (and certain nonprofit scientific research
organizations) over (2) the sum of (a) the greater of two
minimum basic research floors plus (b) an amount reflecting any
decrease in nonresearch giving to universities by the
corporation as compared to such giving during a fixed-base
period, as adjusted for inflation. This separate credit
computation is commonly referred to as the ``university basic
research credit'' (see sec. 41(e)).
Computation of allowable credit
Except for certain university basic research payments made
by corporations, the research tax credit applies only to the
extent that the taxpayer's qualified research expenditures for
the current taxable year exceed its base amount. The base
amount for the current year generally is computed by
multiplying the taxpayer's ``fixed-base percentage'' by the
average amount of the taxpayer's gross receipts for the four
preceding years. If a taxpayer both incurred qualified research
expenditures and had gross receipts during each of at least
three years from 1984 through 1988, then its ``fixed-base
percentage'' is the ratio that its total qualified research
expenditures for the 1984-1988 period bears to its total gross
receipts for that period (subject to a maximum ratio of .16).
All other taxpayers (so-called ``start-up firms'') are assigned
a fixed-base percentage of 3 percent.\101\
---------------------------------------------------------------------------
\101\ The Small Business Job Protection Act of 1996 expanded the
definition of ``start-up firms'' under section 41(c)(3)(B)(i) to
include any firm if the first taxable year in which such firm had both
gross receipts and qualified research expenses began after 1983.
A special rule (enacted in 1993) is designed to gradually recompute
a start-up firm's fixed-base percentage based on its actual research
experience. Under this special rule, a start-up firm will be assigned a
fixed-base percentage of 3 percent for each of its first five taxable
years after 1993 in which it incurs qualified research expenditures. In
the event that the research credit is extended beyond the scheduled
expiration date, a start-up firm's fixed-based percentage for its sixth
through tenth taxable years after 1993 in which it incurs qualified
research expenditures will be a phased-in ratio based on its actual
research experience. For all subsequent taxable years, the taxpayer's
fixed-based percentage will be its actual ratio of qualified research
expenditures to gross receipts for any five years selected by the
taxpayer from its fifth through tenth taxable years after 1993 (sec.
41(c)(3)(B)).
---------------------------------------------------------------------------
In computing the credit, a taxpayer's base amount may not
be less than 50 percent of its current-year qualified research
expenditures.
To prevent artificial increases in research expenditures by
shifting expenditures among commonly controlled or otherwise
related entities, a special aggregation rule provides that all
members of the same controlled group of corporations are
treated as a single taxpayer (sec. 41(f)(1)). Special rules
apply for computing the credit when a major portion of a
business changes hands, under which qualified research
expenditures and gross receipts for periods prior to the change
of ownership of a trade or business are treated as transferred
with the trade or business that gave rise to those expenditures
and receipts for purposes of recomputing a taxpayer's fixed-
base percentage (sec. 41(f)(3)).
Alternative incremental research credit regime
As part of the Small Business Job Protection Act of 1996,
taxpayers are allowed to elect an alternative incremental
research credit regime. If a taxpayer elects to be subject to
this alternative regime, the taxpayer is assigned a three-
tiered fixed-base percentage (that is lower than the fixed-base
percentage otherwise applicable under present law) and the
credit rate likewise is reduced. Under the alternative credit
regime, a credit rate of 1.65 percent applies to the extent
that a taxpayer's current-year research expenses exceed a base
amount computed by using a fixed-base percentage of 1 percent
(i.e., the base amount equals 1 percent of the taxpayer's
average gross receipts for the four preceding years) but do not
exceed a base amount computed by using a fixed-base percentage
of 1.5 percent. A credit rate of 2.2 percent applies to the
extent that a taxpayer's current-year research expenses exceed
a base amount computed by using a fixed-base percentage of 1.5
percent but do not exceed a base amount computed by using a
fixed-base percentage of 2 percent. A credit rate of 2.75
percent applies to the extent that a taxpayer's current-year
research expenses exceed a base amount computed by using a
fixed-base percentage of 2 percent. An election to be subject
to this alternative incremental credit regime may be made only
for a taxpayer's first taxable year beginning after June 30,
1996, and before July 1, 1997, and such an election applies to
that taxable year and all subsequent years (in the event that
the credit subsequently is extended by Congress) unless revoked
with the consent of the Secretary of the Treasury. If a
taxpayer elects the alternative incremental research credit
regime for its first taxable year beginning after June 30,
1996, and before July 1, 1997, then all qualified research
expenses paid or incurred during the first 11 months of such
taxable year are treated as qualified research expenses for
purposes of computing the taxpayer's credit.
Eligible expenditures
Qualified research expenditures eligible for the research
tax credit consist of: (1) ``in-house'' expenses of the
taxpayer for wages and supplies attributable to qualified
research; (2) certain time-sharing costs for computer use in
qualified research; and (3) 65 percent of amounts paid by the
taxpayer for qualified research conducted on the taxpayer's
behalf (so-called ``contract research expenses''). \102\
---------------------------------------------------------------------------
\102\ Under a special rule enacted as part of the Small Business
Job Protection Act of 1996, 75 percent of amounts paid to a research
consortium for qualified research is treated as qualified research
expenses eligible for the research credit (rather than 65 percent under
the general rule under section 41(b)(3) governing contract research
expenses) if (1) such research consortium is a tax-exempt organization
that is described in section 501(c)(3) (other than a private
foundation) or section 501(c)(6) and is organized and operated
primarily to conduct scientific research, and (2) such qualified
research is conducted by the consortium on behalf of the taxpayer and
one or more persons not related to the taxpayer.
---------------------------------------------------------------------------
To be eligible for the credit, the research must not only
satisfy the requirements of present-law section 174 (described
below) but must be undertaken for the purpose of discovering
information that is technological in nature, the application of
which is intended to be useful in the development of a new or
improved business component of the taxpayer, and must pertain
to functional aspects, performance, reliability, or quality of
a business component. Research does not qualify for the credit
if substantially all of the activities relate to style, taste,
cosmetic, or seasonal design factors (sec. 41(d)(3)). In
addition, research does not qualify for the credit if conducted
after the beginning of commercial production of the business
component, if related to the adaptation of an existing business
component to a particular customer's requirements, if related
to the duplication of an existing business component from a
physical examination of the component itself or certain other
information, or if related to certain efficiency surveys,
market research or development, or routine quality control
(sec. 41(d)(4)).
Expenditures attributable to research that is conducted
outside the United States do not enter into the credit
computation. In addition, the credit is not available for
research in the social sciences, arts, or humanities, nor is it
available for research to the extent funded by any grant,
contract, or otherwise by another person (or governmental
entity).
Relation to deduction
Under section 174, taxpayers may elect to deduct currently
the amount of certain research or experimental expenditures
incurred in connection with a trade or business,
notwithstanding the general rule that business expenses to
develop or create an asset that has a useful life extending
beyond the current year must be capitalized. However,
deductions allowed to a taxpayer under section 174 (or any
other section) are reduced by an amount equal to 100 percent of
the taxpayer's research tax credit determined for the taxable
year. Taxpayers may alternatively elect to claim a reduced
research tax credit amount under section 41 in lieu of reducing
deductions otherwise allowed (sec. 280C(c)(3)).
Reasons for Change
Businesses may not find it profitable to invest in some
research activities because of the difficulty in capturing the
full benefits from the research. Costly technological advances
made by one firm are often cheaply copied by its competitors. A
research tax credit can help promote investment in research, so
that research activities undertaken approach the optimal level
for the overall economy. Therefore, the Congress believed that,
in order to encourage research activities, it is appropriate to
reinstate the research tax credit.
Explanation of Provision
The research tax credit is extended for 13 months--i.e.,
generally for the period June 1, 1997, through June 30, 1998.
Under the provision, taxpayers are permitted to elect the
alternative incremental research credit regime under section
41(c)(4) for any taxable year beginning after June 30, 1996,
and such election will apply to that taxable year and all
subsequent taxable years unless revoked with the consent of the
Secretary of the Treasury.
Effective Date
Extension of the research credit is effective for qualified
research expenditures paid or incurred during the period June
1, 1997, through June 30, 1998. A special rule provides that,
notwithstanding the general termination date for the research
credit of June 30, 1998, if a taxpayer elects to be subject to
the alternative incremental research credit regime for its
first taxable year beginning after June 30, 1996, and before
July 1, 1997, the alternative incremental research credit will
be available during the entire 24-month period beginning with
the first month of such taxable year--i.e., the equivalent of
the 11-month extension provided for by the Small Business Job
Protection Act of 1996 plus an additional 13-month extension
provided for by the conference agreement. However, to prevent
taxpayers from effectively obtaining more than 24-months of
research credits from the Small Business Job Protection Act of
1996 and this bill, the 24-month period for taxpayers electing
the alternative incremental research credit regime is reduced
by the number of months (if any) after June 1996 with respect
to which the taxpayer claimed research credit amounts under the
regular, 20-percent research credit rules.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $161 million in 1997, $820 million in 1998,
$639 million in 1999, $294 million in 2000, $204 million in
2001, $123 million in 2002, and $33 million in 2003.
B. Contributions of Stock to Private Foundations (sec. 602 of the Act
and sec. 170(e)(5) of the Code)
Present and Prior Law
In computing taxable income, a taxpayer who itemizes
deductions generally is allowed to deduct the fair market value
of property contributed to a charitable organization.\103\
However, in the case of a charitable contribution of short-term
gain, inventory, or other ordinary income property, the amount
of the deduction generally is limited to the taxpayer's basis
in the property. In the case of a charitable contribution of
tangible personal property, the deduction is limited to the
taxpayer's basis in such property if the use by the recipient
charitable organization is unrelated to the organization's tax-
exempt purpose.\104\
---------------------------------------------------------------------------
\103\ The amount of the deduction allowable for a taxable year with
respect to a charitable contribution may be reduced depending on the
type of property contributed, the type of charitable organization to
which the property is contributed, and the income of the taxpayer
(secs. 170(b) and 170(e)).
\104\ As part of the Omnibus Budget Reconciliation Act of 1993,
Congress eliminated the treatment of contributions of appreciated
property (real, personal, and intangible) as a tax preference for
alternative minimum tax (AMT) purposes. Thus, if a taxpayer makes a
gift to charity of property (other than short-term gain, inventory, or
other ordinary income property, or gifts to private foundations) that
is real property, intangible property, or tangible personal property
the use of which is related to the donee's tax-exempt purpose, the
taxpayer is allowed to claim the same fair-market-value deduction for
both regular tax and AMT purposes (subject to present-law percentage
limitations).
---------------------------------------------------------------------------
In cases involving contributions to a private foundation
(other than certain private operating foundations), the amount
of the deduction is limited to the taxpayer's basis in the
property. However, under a special rule contained in section
170(e)(5), taxpayers are allowed a deduction equal to the fair
market value of ``qualified appreciated stock'' contributed to
a private foundation prior to May 31, 1997.\105\ Qualified
appreciated stock is defined as publicly traded stock which is
capital gain property. The fair-market-value deduction for
qualified appreciated stock donations applies only to the
extent that total donations made by the donor to private
foundations of stock in a particular corporation do not exceed
10 percent in value of the outstanding stock of that
corporation. For this purpose, an individual is treated as
making all contributions that are made by any member of the
individual's family.
---------------------------------------------------------------------------
\105\ The special rule contained in section 170(e)(5), which was
originally enacted in 1984, expired January 1, 1995. The Small Business
Job Protection Act of 1996 reinstated the rule for 11 months--for
contributions of qualified appreciated stock made to private
foundations during the period July 1, 1996, through May 31, 1997.
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that, to encourage donations to
charitable private foundations, it is appropriate to extend the
rule that allows a fair market value deduction for certain
gifts of appreciated stock to private foundations.
Explanation of Provision
The Act provides that the special rule contained in section
170(e)(5) is extended for the period June 1, 1997, through June
30, 1998.
Effective Date
The provision is effective for contributions of qualified
appreciated stock to private foundations made during the period
June 1, 1997, through June 30, 1998.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $99 million in 1998, $9 million in 1999, and
$4 million in 2000.
C. Work Opportunity Tax Credit (sec. 603 of the Act and sec. 51 of the
Code)
Present Law
In general
The work opportunity tax credit is available on an elective
basis for employers hiring individuals from one or more of
seven targeted groups. The credit generally is equal to 35
percent of qualified wages. Generally, qualified wages consist
of wages attributable to service rendered by a member of a
targeted group during the one-year period beginning with the
day the individual begins work for the employer.
Generally, no more than $6,000 of wages during the first
year of employment is permitted to be taken into account with
respect to any individual. Thus, the maximum credit per
individual is $2,100. With respect to qualified summer youth
employees, the maximum credit is 35 percent of up to $3,000 of
qualified first-year wages, for a maximum credit of $1,050.
The deduction for wages is reduced by the amount of the
credit.
Targeted groups eligible for the credit
(1) Families receiving AFDC
An eligible recipient is an individual certified by the
designated local employment agency as being a member of a
family eligible to receive benefits under AFDC or its successor
program for a period of at least nine months part of which is
during the 9-month period ending on the hiring date. For these
purposes, members of the family are defined to include only
those individuals taken into account for purposes of
determining eligibility for the AFDC or its successor program.
(2) Qualified ex-felon
A qualified ex-felon is an individual certified as: (1)
having been convicted of a felony under any State or Federal
law, (2) being a member of a family that had an income during
the six months before the earlier of the date of determination
or the hiring date which on an annual basis is 70 percent or
less of the Bureau of Labor Statistics lower living standard,
and (3) having a hiring date within one year of release from
prison or date of conviction.
(3) High-risk youth
A high-risk youth is an individual certified as being at
least 18 but not yet 25 on the hiring date and as having a
principal place of abode within an empowerment zone or
enterprise community (as defined under Subchapter U of the
Internal Revenue Code). Qualified wages willnot include wages
paid or incurred for services performed after the individual moves
outside an empowerment zone or enterprise community.
(4) Vocational rehabilitation referral
Vocational rehabilitation referrals are those individuals
who have a physical or mental disability that constitutes a
substantial handicap to employment and who have been referred
to the employer while receiving, or after completing,
vocational rehabilitation services under an individualized,
written rehabilitation plan under a State plan approved under
the Rehabilitation Act of 1973 or under a rehabilitation plan
for veterans carried out under Chapter 31 of Title 38, U.S.
Code. Certification will be provided by the designated local
employment agency upon assurances from the vocational
rehabilitation agency that the employee has met the above
conditions.
(5) Qualified summer youth employee
Qualified summer youth employees are individuals: (1) who
perform services during any 90-day period between May 1 and
September 15, (2) who are certified by the designated local
agency as being 16 or 17 years of age on the hiring date, (3)
who have not been an employee of that employer before, and (4)
who are certified by the designated local agency as having a
principal place of abode within an empowerment zone or
enterprise community (as defined under Subchapter U of the
Internal Revenue Code). As with high-risk youths, no credit is
available on wages paid or incurred for service performed after
the qualified summer youth moves outside of an empowerment zone
or enterprise community. If, after the end of the 90-day
period, the employer continues to employ a youth who was
certified during the 90-day period as a member of another
targeted group, the limit on qualified first-year wages will
take into account wages paid to the youth while a qualified
summer youth employee.
(6) Qualified veteran
A qualified veteran is a veteran who is a member of a
family certified as receiving assistance under: (1) AFDC for a
period of at least nine months part of which is during the 12-
month period ending on the hiring date, or (2) a food stamp
program under the Food Stamp Act of 1977 for a period of at
least three months part of which is during the 12-month period
ending on the hiring date. For these purposes, members of a
family are defined to include only those individuals taken into
account for purposes of determining eligibility for: (I) the
AFDC or its successor program, and (ii) a food stamp program
under the Food Stamp Act of 1977, respectively.
Further, a qualified veteran is an individual who has
served on active duty (other than for training) in the Armed
Forces for more than 180 days or who has been discharged or
released from active duty in the Armed Forces for a service-
connected disability. However, any individual who has served
for a period of more than 90 days during which the individual
was on active duty (other than for training) is not an eligible
employee if any of this active duty occurred during the 60-day
period ending on the date the individual was hired by the
employer. This latter rule is intended to prevent employers who
hire current members of the armed services (or those departed
from service within the last 60 days) from receiving the
credit.
(7) Families receiving food stamps
An eligible recipient is an individual aged 18 but not yet
25 certified by a designated local employment agency as being a
member of a family receiving assistance under a food stamp
program under the Food Stamp Act of 1977 for a period of at
least six months ending on the hiring date. In the case of
families that cease to be eligible for food stamps under
section 6(o) of the Food Stamp Act of 1977, the six-month
requirement is replaced with a requirement that the family has
been receiving food stamps for at least three of the five
months ending on the date of hire. For these purposes, members
of the family are defined to include only those individuals
taken into account for purposes of determining eligibility for
a food stamp program under the Food Stamp Act of 1977.
Minimum employment period
No credit is allowed for wages paid unless the eligible
individual is employed by the employer for at least 180 days
(20 days in the case of a qualified summer youth employee) or
400 hours (120 hours in the case of a qualified summer youth
employee).
Expiration date
The credit is effective for wages paid to, or incurred with
respect to, a qualified individual who begins work for an
employer after September 30, 1996, and before October 1, 1997.
Reasons for Change
The Congress believed that a short-term extension of the
work opportunity tax credit program with modifications will
provide the Congress and the Treasury and Labor Departments an
opportunity to assess fully the operation and effectiveness of
the credit as a hiring incentive. The Act also will extend
application of the credit to a larger group of eligible
individuals pending that evaluation.
Explanation of Provision
Extension
The work opportunity tax credit is extended for nine months
(through June 30, 1998).
Targeted categories
Eligibility is extended to: (1) members of families
receiving AFDC benefits for any nine months during the eighteen
month period ending on the hiring date, and (2) individuals
receiving supplemental security income (``SSI'') benefits under
Title XVI of the Social Security Act.
Minimum employment period
The minimum employment period is reduced from 400 to 120
hours.
Credit percentage
The Act provides a two-tier credit. The credit percentage
is 25 percent for employment of less than 400 hours and 40
percent for employment of 400 or more hours. To illustrate,
assume that two eligible individuals (A and B) begin work for
their employer before July 1, 1998 for a $6 hourly wage.
Assume, further that A completes 300 hours of employment and B
completes 500 hours of employment. The employer will be
entitled to a credit of $450 for A (25 percent of $1,800) and
$1,200 for B (40 percent of $3,000).
Effective Date
Generally, the provision is effective for wages paid to, or
incurred with respect to, qualified individuals who begin work
for the employer after September 30, 1997, and before July 1,
1998.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $140 million in 1998, $131 million in 1999,
$73 million in 2000, $28 million in 2001, $11 million in 2002,
and $2 million in 2003.\106\
---------------------------------------------------------------------------
\106\ The estimate includes interaction with the welfare-to-work
tax credit; see explanation of section 801 of the Act.
---------------------------------------------------------------------------
D. Orphan Drug Tax Credit (sec. 604 of the Act and sec. 45C of the
Code)
Prior Law
Prior to May 31, 1997, a 50-percent nonrefundable tax
credit was allowed for qualified clinical testing expenses
incurred in testing of certain drugs for rare diseases or
conditions, generally referred to as ``orphan drugs.''
Qualified testing expenses are costs incurred to test an orphan
drug after the drug has been approved for human testing by the
Food and Drug Administration (``FDA'') but before the drug has
been approved for sale by the FDA. A rare disease or condition
is defined as one that (1) affects less than 200,000 persons in
the United States, or (2) affects more than 200,000 persons,
but for which there is no reasonable expectation that
businesses could recoup the costs of developing a drug for such
disease or condition from U.S. sales of the drug. These rare
diseases and conditions include Huntington's disease,
myoclonus, ALS (Lou Gehrig's disease), Tourette's syndrome, and
Duchenne's dystrophy (a form of muscular dystrophy).
As with other general business credits (sec. 38), taxpayers
are allowed to carry back unused credits to three years
preceding the year the credit is earned (but not to a taxable
year ending before July 1, 1996) and to carry forward unused
credits to 15 years following the year the credit is earned.
The credit cannot be used to offset a taxpayer's alternative
minimum tax liability.
The orphan drug tax credit expired and did not apply to
expenses paid or incurred after May 31, 1997.\107\
---------------------------------------------------------------------------
\107\ The orphan drug tax credit originally was enacted in 1983 and
was extended on several occasions. The credit expired after December
31, 1994, and later was reinstated for the period July 1, 1996, through
May 31, 1997.
---------------------------------------------------------------------------
Reasons for Change
The Congress believed it appropriate to reinstate the
orphan drug tax credit.
Explanation of Provision
The orphan drug tax credit provided for by section 45C is
permanently extended.
Effective Date
The provision is effective for qualified clinical testing
expenses paid or incurred after May 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $29 million in 1998, $28 million in 1999,
$30 million in 2000, $32 million in 2001, $34 million in 2002,
$35 million in 2003, $37 million in 2004, $39 million in 2005,
$40 million in 2006, and $42 million in 2007.
TITLE VII. DISTRICT OF COLUMBIA TAX INCENTIVES
(sec. 701 of the Act and new secs. 1400-1400C of the Code)
Present and Prior Law
Empowerment zones and enterprise communities
Pursuant to the Omnibus Budget Reconciliation Act of 1993
(OBRA 1993), the Secretaries of the Department of Housing and
Urban Development (HUD) and the Department of Agriculture
designated a total of nine empowerment zones and 95 enterprise
communities on December 21, 1994. The 1997 Act provides for the
designation of 22 additional empowerment zones.\108\ Designated
empowerment zones and enterprise communities were required to
satisfy certain eligibility criteria, including specified
poverty rates and population and geographic size limitations.
Portions of the District of Columbia were designated as an
enterprise community in 1994.
---------------------------------------------------------------------------
\108\ The Act authorizes the designation of two additional urban
empowerment zones that would be eligible for the tax incentives
available in empowerment zones designated under OBRA 1993. The Act also
authorizes the designation of an additional 20 empowerment zones.
Within these additional empowerment zones, qualified enterprise zone
businesses are eligible to receive up to $20,000 of additional section
179 expensing and to utilize special tax-exempt financing benefits.
However, such businesses are not eligible to receive the present-law
wage credit. The 20 additional empowerment zones are described in
detail in Act secs. 951-956, below.
---------------------------------------------------------------------------
The following tax incentives are available for certain
businesses located in empowerment zones designated under OBRA
1993: (1) an annual 20-percent wage credit for the first
$15,000 of wages paid to a zone resident who works in the zone;
(2) an additional $20,000 of expensing under Code section 179
for qualified zone property placed in service by an enterprise
zone business; and (3) special tax-exempt financing for certain
zone facilities. These incentives are described under Act secs.
951-956, below.
The 95 enterprise communities are eligible for the special
tax-exempt financing benefits but not the other tax incentives
available in the empowerment zones. In addition, OBRA 1993
provided that Federal grants would be made to designated
empowerment zones and enterprise communities. Under the Act,
the so-called ``brownfields'' tax incentive (described in Act
sec. 941, below) that allows taxpayers to expense certain
environmental remediation expenditures is available in
enterprise communities, as well as in empowerment zones. In
addition, certain schools located in empowerment zones or
enterprise communities may be able to benefit from the issuance
of so-called ``zone academy bonds'' (described under Act sec.
226, above) under the Act.
The tax incentives for empowerment zones and enterprise
communities generally are available during the 10-year period
that the designation remains in effect.
Taxation of capital gains
In general, gain or loss reflected in the value of an asset
is not recognized for income tax purposes until a taxpayer
disposes of the asset. On the sale or exchange of capital
assets, the net capital gain generally is taxed at the same
rate as ordinary income, except that, for individuals, the
maximum rate of tax is limited to 20 percent of the net capital
gain.\109\ Net capital gain is the excess of the net long-term
capital gain for the taxable year over the net short-term
capital loss for the year. Gain or loss is treated as long-term
if the asset is held for more than one year. The maximum 20-
percent rate generally applies to capital assets held for more
than 18 months.
---------------------------------------------------------------------------
\109\ The Act generally reduces the maximum rate of tax on the net
capital gain of an individual from 28 percent to 20 percent, and makes
certain other modifications to the maximum capital gains rates
applicable to certain assets. These modifications are described in
detail under Act sec. 311, above. In addition, Code section 1202
provides a 50-percent exclusion for gain from the sale of certain small
business stock acquired at original issue and held for at least five
years. However, the lower rates provided by the Act do not apply to the
includable portion of the gain from the qualifying sale of small
business stock. (See Act sec. 313, above, for a detailed description of
the modifications made by the Act to the small business stock rules.)
---------------------------------------------------------------------------
Capital losses generally are deductible in full against
capital gains. In addition, individual taxpayers may deduct
capital losses against up to $3,000 of ordinary income in each
year. Any remaining unused capital losses may be carried
forward indefinitely to another taxable year.
A capital asset generally means any property except (1)
inventory, stock in trade, or property held primarily for sale
to customers in the ordinary course of the taxpayer's trade or
business, (2) depreciable or real property used in the
taxpayer's trade or business, (3) specified literary or
artistic property, (4) business accounts or notes receivable,
and (5) certain publications of the Federal Government.
In addition, the net gain from the disposition of certain
property used in the taxpayer's trade or business is treated as
long-term capital gain. Gain from the disposition of
depreciable personal property is not treated as capital gain to
the extent of all previous depreciation allowances. Gain from
the disposition of depreciable real property generally is not
treated as capital gain to the extent of the depreciation
allowances in excess of the allowances that would have been
available under the straight-line method. Under the Act, gain
from the sale of depreciable real property, to the extent that
it is ``unrecaptured section 1250 gain,'' is subject to a
maximum rate of 25 percent.
Reasons for Change
The Congress believed that the District of Columbia faces
two key problems--inability to attract and retain a stable
residential base and insufficient economic activity. To this
end, the Congress provided certain tax incentives to attract
new homeowners to the District and to encourage economic
development in those areas of the District where development
has been inadequate.
Explanation of Provisions
Designation of D.C. Enterprise Zone
The Act designates certain economically depressed census
tracts within the District of Columbia as the ``D.C. Enterprise
Zone,'' within which businesses and individual residents are
eligible for special tax incentives. The census tracts that
compose the D.C. Enterprise Zone are (1) all census tracts that
presently are part of the D.C. enterprise community designated
under section 1391 (i.e., portions of Anacostia, Mt. Pleasant,
Chinatown, and the easternmost part of the District) and (2)
all additional census tracts within the District of Columbia
where the poverty rate is not less than 20 percent.\110\ The
D.C. Enterprise Zone designation generally will remain in
effect for five years for the period from January 1, 1998,
through December 31, 2002.\111\
---------------------------------------------------------------------------
\110\ A technical correction is necessary to clarify that the
determination of whether a census tract in the District of Columbia
satisfies the applicable poverty criteria for inclusion in the D.C.
Enterprise Zone for purposes of the wage credit, expensing, and special
tax-exempt financing incentives (poverty rate of not less than 20
percent) or for purposes of the zero-percent capital gains rate
(poverty rate of not less than 10 percent), is based on 1990 decennial
census data. A provision to this effect is included in Title VI (sec.
607) of H.R. 2676, the Tax Technical Corrections Act of 1997, as passed
by the House on November 5, 1997. This technical correction would
clarify that data from the 2000 decennial census will not result in the
expansion or other reconfiguration of the D.C. Enterprise Zone.
\111\ The status of certain census tracts within the District as an
enterprise community designated under section 1391 also terminates on
December 31, 2002.
---------------------------------------------------------------------------
Empowerment zone wage credit, expensing, and tax-exempt financing
In general
The following tax incentives that are available under
present law in certain empowerment zones are available in the
D.C. Enterprise Zone (modified as described below): (1) a 20-
percent wage credit for the first $15,000 of wages paid to
District residents who work in the D.C. Enterprise Zone; (2) an
additional $20,000 of expensing under Code section 179 for
qualified zone property; and (3) special tax-exempt financing
for certain zone facilities. In addition, Federal tax
incentives that are generally available in designated
empowerment zones also are available in the D.C. Enterprise
Zone (e.g., expensing of certain environmental remediation
expenditures (the so-called ``brownfields'' provision), and the
tax credit for holders of qualified ``zone academy
bonds'').\112\
---------------------------------------------------------------------------
\112\ Similarly, one category of targeted individuals for purposes
of the work opportunity tax credit is ``high risk youth,'' defined as
individuals certified by the designated local agency as being 18-24
years old, and having a principal place of abode in an empowerment zone
or enterprise community. Accordingly, individuals between the ages of
18 and 24 who live in the portions of the District that are designated
as the D.C. Enterprise Zone may qualify as members of a targeted group
for purposes of the work opportunity tax credit.
---------------------------------------------------------------------------
D.C. employer wage credit
A 20-percent credit against income tax liability is
available to all employers for the first $15,000 of qualified
wages paid to each employee who (1) is a District resident
(i.e., his or her principal place of abode is within the
District), and (2) performs substantially all employment
services within the D.C. Zone in a trade or business of the
employer.\113\ The D.C. wage credit rate remains at 20 percent
for the D.C. Enterprise Zone for the period 1998 through
2002.\114\
---------------------------------------------------------------------------
\113\ Proposed Treasury regulations provide that an employer may
use either each pay period or the entire calendar year as the relevant
period in determining whether a particular employee satisfies the
``location-of-services'' requirement. For each taxable year, the
employer must use the same method for all its employees. Prop. Treas.
Reg. sec. 1.1396-1. Under the proposed regulations, an employee would
not satisfy the ``location of services'' requirement during the
applicable period (either the pay period or the calendar year) unless
substantially all of the services performed by the employee for the
employer during that period are performed within the zone in a trade or
business of the employer. Prop. Treas. Reg. sec. 1.1396-1(b)(1)(ii) and
Prop. Treas. Reg. sec. 1.1396-1(b)(2)(ii).
\114\ Thus, the D.C. wage credit does not phase down to 15 percent
in the year 2002 as does the empowerment zone wage credit under
present-law section 1396(b).
---------------------------------------------------------------------------
The maximum D.C. wage credit per qualified employee is
$3,000 per year (20 percent of $15,000). Wages paid to a
qualified employee continue to be eligible for the D.C. wage
credit if the employee earns more than $15,000, although only
the first $15,000 of wages will be eligible for the D.C. wage
credit.\115\ The D.C. wage credit is available with respect to
a qualified employee, regardless of the number of other
employees who work for the employer. In general, any taxable
business carrying out activities in the D.C. Zone may claim the
D.C. wage credit, regardless of whether the employer meets the
definition of a ``D.C. Zone business'' (which applies for the
increased section 179 expensing, the tax-exempt financing, and
the zero-percent capital gains rate provisions, described
below).
---------------------------------------------------------------------------
\115\ To prevent avoidance of the $15,000 limit, all employers of a
controlled group of corporations (or partnerships or proprietorships
under common control) will be treated as a single employer.
---------------------------------------------------------------------------
Qualified wages include the first $15,000 of ``wages,''
defined to include (1) salary and wages as generally defined
for FUTA purposes, and (2) certain training and educational
expenses paid on behalf of a qualified employee, provided that
(a) the expenses are paid to an unrelated third party and are
excludable from gross income of the employee under section 127,
or (b) in the case of an employee under age 19, the expenses
are incurred by the employer in operating a youth training
program in conjunction with local education officials.
The D.C. wage credit is allowed with respect to full-time
and part-time employees. However, the employee must be employed
by the employer for a minimum period of at least 90 days. Wages
are not eligible for the D.C. wage credit if paid to certain
relatives of the employer or, if the employer is a corporation
or partnership, certain relatives of a person who owns more
than 50 percent of the business. In addition, wages are not
eligible for the D.C. wage credit if paid to a person who owns
more than five percent of the stock (or capital or profits
interests) of the employer. Finally, the wage credit is not
available with respect to any individual employed at any
facility described in present-law section 144(c)(6)(B) (i.e., a
private or commercial golf course, country club, massage
parlor, hot tub facility, suntan facility, racetrack or other
facility used for gambling, or any store the principal business
of which is the sale of alcoholic beverages for consumption off
premises). In addition, the wage credit is not available with
respect to any individual employed by a trade or business the
principal activity of which is farming (within the meaning of
subparagraphs (A) and (B) of section 2032A(e)(5)), but only if,
as of the close of the preceding taxable year, the sum of the
aggregate unadjusted bases (or, if greater, the fair market
value) of assets of the farm exceed $500,000.\116\
---------------------------------------------------------------------------
\116\ Code secs. 1396(d)(2)(D) and (E).
---------------------------------------------------------------------------
An employer's deduction otherwise allowed for wages paid is
reduced by the amount of D.C. wage credit claimed for that
taxable year.\117\ Wages are not to be taken into account for
purposes of the D.C. wage credit if taken into account in
determining the employer's work opportunity tax credit under
section 51 or the welfare-to-work credit under section
51A.\118\ In addition, the $15,000 cap is reduced by any wages
taken into account in computing the work opportunity tax credit
or the welfare-to-work credit.\119\ The D.C. wage credit may be
used to offset up to 25 percent of alternative minimum tax
liability.\120\
---------------------------------------------------------------------------
\117\ Code sec. 280C(a).
\118\ Code sec. 1396(c)(3)(A) and Code sec. 51A(d)(2).
\119\ Code sec. 1396(c)(3)(B) and Code sec. 51A(d)(2).
\120\ Code sec. 38(c)(2).
---------------------------------------------------------------------------
The wage credit is effective for wages paid (or incurred)
to a qualified individual for services performed after December
31, 1997, and before January 1, 2003.
Increased expensing under Code section 179
For a ``qualified D.C. Zone business'' (defined below), the
expensing allowance for certain depreciable business property
provided under section 179 is increased by the lesser of: (1)
$20,000 or (2) the cost of section 179 property that is
``qualified zone property'' and that is placed in service
during the taxable year.
To qualify for the increased expensing, property must be
both section 179 property and ``qualified zone property.''
Section 179 property generally is depreciable tangible personal
property as well as certain other property. Buildings and their
structural components are not section 179 property. ``Qualified
zone property'' is depreciable tangible property that satisfies
three tests: (1) it must be acquired by purchase after December
31, 1997; (2) the original use of the property in the D.C. Zone
must commence with the taxpayer (however, used property that
has been used elsewhere may qualify); and (3) substantially all
of the use of the property must be in the active conduct of a
trade or business by the taxpayer within the D.C. Zone. A
special rule provides that, in the case of property that is
``substantially renovated'' by the taxpayer, such property need
not be acquired by the taxpayer after December 31, 1997, nor
need the original use of such property in the D.C. Enterprise
Zone commence with the taxpayer. Rather, substantially all of
the use of such property during substantially all of the
taxpayer's holding period (after it has been substantially
renovated) must be in the active conduct of a qualified D.C.
Zone business of the taxpayer in the D.C. Enterprise Zone. For
this purpose, property is treated as ``substantially
renovated'' if, prior to January 1, 2003, additions to basis
with respect to such property in the hands of the taxpayer
during any 24-month period beginning after December 31, 1997,
exceed the greater of (1) an amount equal to the adjusted basis
at the beginning of such 24-month period in the hands of the
taxpayer, or (2) $5,000.
As under present law, the section 179 expensing allowance
is phased out for certain taxpayers with investment in
qualified property during the taxable year in excess of
$200,000. However, the present-law phase-out range is applied
by taking into account only one-half of the cost of qualified
zone property that is section 179 property. In applying the
section 179 phaseout, the cost of section 179 property that is
not qualified zone property is not reduced. The amount
permitted to be expensed and deducted under Code section 179
may not exceed the taxable income derived from the active
conduct of a trade or business.
In general, all other provisions of present-law section 179
apply to the increased expensing for qualified D.C. Zone
businesses. Thus, all component members of a controlled group
are treated as one taxpayer for purposes of the expensing
allowance and the application of the phaseout range (sec.
179(d)(6)). The limitations apply at both the partnership (and
S corporation) and partner (and shareholder) levels. The
increased expensing allowance is allowed for purposes of the
alternative minimum tax (i.e., it is not treated as an
adjustment for purposes of the alternative minimum tax). The
section 179 expensing deduction may be recaptured if the
property is not used predominantly in a qualified D.C. Zone
business (under rules similar to present-law section
179(d)(10)).
Accordingly, qualified D.C. Zone businesses with a
sufficiently small amount of annual investment may elect to
deduct currently (as opposed to depreciate over time) up to
$38,500 in 1998 of the cost of qualifying property placed in
service for the taxable year. The maximum will increase as the
base amount permitted to be expensed under Code section 179
increases each year, up to a maximum amount of $44,000 in 2001
and 2002.
The increased expensing under Code section 179 is effective
for qualified D.C. Zone property placed in service periods
beginning after December 31, 1997, and before January 1, 2003.
Qualified D.C. Zone business.--For purposes of the
increased expensing under Code section 179 (as well as
generally for purposes of the tax-exempt financing provisions
and the zero-percent capital gains rate described below), a
qualified D.C. Zone business generally is defined in the same
manner as is an ``enterprise zone business'' under section
1397B.\121\ However, the Act eliminates the requirement that at
least 35 percent of the employees of a qualified D.C. Zone
business must be residents of the D.C. Zone.\122\
---------------------------------------------------------------------------
\121\ The requirements of an ``enterprise zone business'' under
section 1397B were developed as part of OBRA 1993 in the context of
authorizing the designation of nine unspecified empowerment zones
located throughout the nation. Congress may wish to reconsider the
applicability of certain of these requirements in defining a qualified
D.C. Zone business given the nature of the District's economy and the
type of economic activity that Congress intended to encourage.
\122\ Section 1400(e) eliminates this requirement contained in
section 1397B(b)(6) with respect to corporations and partnerships and
in section 1397B(c)(5) with respect to proprietorships.
---------------------------------------------------------------------------
Accordingly, for purposes of the increased expensing under
section 179, a corporation or partnership is a qualified D.C.
Zone business if: (1) the sole trade or business \123\ of the
corporation or partnership is the active conduct of a
``qualified business'' (defined below) within the D.C. Zone;
\124\ (2) at least 50 percent of the total gross income of such
entity is derived from the active conduct of a qualified
business within the D.C. Zone; \125\ (3) a substantial portion
of the use of the entity's tangible property (whether owned or
leased) is within the D.C. Zone; (4) a substantial portion of
the entity's intangible property is used in the active conduct
of such business; (5) a substantial portion of the services
performed for such entity by its employees are performed within
the D.C. Zone; and (6) less than 5 percent of the average of
the aggregate unadjusted bases of the property of such entity
is attributable to (a) certain financial property,\126\ or (b)
collectibles not held primarily for sale to customers in the
ordinary course of an active trade or business. Similar rules
apply to a qualified business carried on by an individual as a
proprietorship.\127\
---------------------------------------------------------------------------
\123\ A technical correction may be necessary to clarify that, for
purposes of this provision, as well as for purposes of defining a
``qualified business'', the term ``trade or business'' encompasses
activities carried out on a not-for-profit, as well as on a for-profit
basis. For example, a trade association could be a qualified D.C. Zone
business if it satisfies all of the requirements enumerated above.
\124\ This requirement does not apply to a business carried on by
an individual as a proprietorship.
\125\ Regulations issued under section 1394 give an example of a
business that would satisfy this test. The regulations describe a mail
order clothing business which is located in an empowerment zone. The
business purchases its supplies from suppliers located both within and
outside of the zone and expects that orders will be received both from
customers who will reside or work within the zone and from others
outside of the zone. All orders are received and filled at, and are
shipped from, the clothing business located in the zone. Under the
regulations, this clothing business meets the requirement that at least
80 percent (as required under prior law) of its gross income is derived
from the active conduct of business within the zone. Treas. Reg. sec.
1.1394-1(p), Example (3).
\126\ Nonqualified financial property is defined in Code section
1397B(e) to mean debt, stock, partnership interest, options, futures
contracts, forward contracts, warrants, notional principal contracts,
annuities, and other similar property. The term does not include
reasonable amounts of working capital held in cash, cash equivalents,
or debt instruments with a term of 18 months or less, or accounts or
notes receivable acquired in the ordinary course of trade or business
for services rendered or from the sale of inventory property.
\127\ For purposes of determining status as a qualified D.C. Zone
business, limited liability companies will be characterized as
corporations or partnerships in accordance with the so-called ``check-
the-box'' regulations (Treas. Reg. sec. 301.7701-3). A single member
limited liability company that is disregarded for Federal income tax
purposes under the check-the-box regulations would be treated as a
proprietorship or branch for purposes of determining its status as a
qualified D.C. Zone business.
---------------------------------------------------------------------------
In general, a ``qualified business'' means any trade or
business. However, a ``qualified business'' does not include
any trade or business that consists predominantly of the
development or holding of intangibles for sale or license. In
addition, a qualified business does not include any private or
commercial golf course, country club, massage parlor, hot tub
facility, suntan facility, racetrack or other facility used for
gambling, liquor store, or certain large farms (so-called
``excluded businesses''). The rental of residential real estate
is not a qualified business. The rental of commercial real
estate is a qualified business only if at least 50 percent of
the gross rental income from the real property is from
qualified D.C. Zone businesses. The rental of tangible personal
property to others also is not a qualified business unless at
least 50 percent of the rental of such property is by qualified
D.C. Zone businesses or by residents of the D.C. Zone.
A special rule applies to businesses located on contiguous
real property that straddles census tract lines. If the amount
of real property located within the D.C. Zone is substantial
compared to the amount of real property that is not within the
D.C. Zone, then all of the services performed by employees, all
business activities, all tangible property and all intangible
propertyof the business entity or proprietorship that occur in
or is located on the real property is treated as occurring or situated
in the D.C. Zone.\128\
---------------------------------------------------------------------------
\128\ Code section 1397B(f).
---------------------------------------------------------------------------
Activities of legally separate (even if related) parties
are not aggregated for purposes of determining whether an
entity qualifies as a D.C. Zone business.
Tax-exempt financing
A qualified D.C. Zone business (as defined below) is
permitted to borrow proceeds from the issuance of qualified
enterprise zone facility bonds (as defined in section 1394) by
the District of Columbia.\129\ Such bonds are subject to the
District's annual private activity bond volume limitation of
$150 million.\130\
---------------------------------------------------------------------------
\129\ Portions of the District of Columbia were designated as an
enterprise community under section 1391 in 1994. Accordingly, the
District was entitled to issue tax-exempt enterprise zone facility
bonds under section 1394. In fact, however, the District did not issue
any such bonds.
\130\ The exception to the volume cap that is available with
respect to new empowerment zone facility bonds (described in section
1394(f)) does not apply to D.C. enterprise zone facility bonds.
---------------------------------------------------------------------------
Generally, qualified enterprise zone facility bonds for the
District are bonds 95 percent or more of the net proceeds of
which are used to finance: (1) qualified D.C. Zone property the
principal user \131\ of which is a qualified D.C. Zone
business, and (2) functionally related and subordinate land
located in the D.C. Enterprise Zone.
---------------------------------------------------------------------------
\131\ In general, the term ``principal user'' means the owner of
the financed property. However, in the case of rental property, if an
owner of real property financed with enterprise zone facility bonds is
not an enterprise zone business, but the rental of the property is a
qualified business (i.e., 50 percent of the gross rental income is
derived from enterprise zone businesses), then the term ``principal
user'' for purposes of sections 1394 (b) and (e) means the lessee(s).
Treas. Reg. sec. 1.1394-1(j). See also Treas. Reg. sec. 1.1394-1(p),
Example (8).
---------------------------------------------------------------------------
``Qualified D.C. Zone property'' for these purposes
generally has the same definition as ``qualified zone
property'' for purposes of the increased expensing under
section 179. Thus, it is depreciable tangible property that
satisfies three tests: (1) it must be acquired by purchase
after December 31, 1997; (2) the original use of the property
in the D.C. Zone must commence with the taxpayer (however,
property that has been used elsewhere may qualify); \132\ and
(3) substantially all of the use of the property must be in the
active conduct of a trade or business by the taxpayer within
the D.C. Zone. A special rule provides that, in the case of
business property that is ``substantially renovated,'' such
property need not be acquired by the taxpayer after December
31, 1997, nor need the original use of such property in the
D.C. Enterprise Zone commence with the taxpayer. Solely for
purposes of the tax-exempt financing provisions, property is
treated as ``substantially renovated'' if, prior to January 1,
2003, additions to basis with respect to such property in the
hands of the taxpayer during any 24-month period beginning
after December 31, 1997, exceed the greater of (1) an amount
equal to 15 percent of the adjusted basis at the beginning of
such 24-month period in the hands of the taxpayer, or (2)
$5,000.\133\
---------------------------------------------------------------------------
\132\ Treas. Reg. sec. 1.1394-1(h) defines the term ``original
use'' to mean the first use to which the property is put within the
zone. Under a special rule, if property is vacant for at least a one-
year period including the date of the zone designation, then use prior
to that period is disregarded for purposes of determining original use.
\133\ Code section 1394(b)(2)(B).
---------------------------------------------------------------------------
Similarly, the term ``D.C. Zone business'' generally is
defined as for purposes of the increased expensing under
section 179. However, a qualified D.C. Zone business for
purposes of the tax-exempt financing provisions includes a
business located in the D.C. Zone that would qualify as a D.C.
Zone business if it were separately incorporated.\134\ In
addition, under a special rule applicable only for purposes of
the tax-exempt financing rules, a business is not required to
satisfy the requirements applicable to a D.C. Zone business
until the end of a startup period if, at the beginning of the
startup period, there is a reasonable expectation that the
business will be a qualified D.C. Zone business at the end of
the startup period and the business makes bona fide efforts to
be such a business. With respect to each property financed by a
bond issue, the startup period ends at the beginning of the
first taxable year beginning more than two years after the
later of (1) the date of the bond issue financing such
property, or (2) the date the property was placed in service
(but in no event more than three years after the date of bond
issuance). In addition, if a business satisfies certain
requirements applicable to a qualified D.C. Zone business for a
three-year testing period following the end of the start-up
period and thereafter continues to satisfy certain business
requirements,\135\ then it will be treated as a qualified D.C.
Zone business for all years after the testing period
irrespective of whether it satisfies all of the requirements of
a qualified D.C. Zone business.\136\
---------------------------------------------------------------------------
\134\ For example, an establishment that is part of a national
chain could qualify as a D.C. Zone business for purposes of the tax-
exempt financing incentive, provided that such establishment would
satisfy the definition of a D.C. Zone business if it were separately
incorporated.
\135\ To be eligible for this special rule after the end of the 3-
year testing period, a business must remain a trade or business that
does not (1) consist predominantly of the development or holding of
intangibles for sale or license, (2) involve the operation of a private
or commercial golf course, country club, massage parlor, hot tub
facility, suntan facility, racetrack or other facility used for
gambling, or liquor store, and (3) have as its principal activity
farming with respect to certain large farms.
\136\ Section 1394(b)(3)(B)(iii) waives all of the requirements of
an enterprise zone business described in sections 1397B(b) or (c) for
certain businesses after the prescribed testing period except the
requirement that at least 35 percent of the employees of such business
be residents of the empowerment zone or enterprise community. However,
the 35-percent zone resident requirement does not apply with respect to
qualified D.C. Zone businesses (sec. 1400(e)). Accordingly, a technical
correction is necessary to clarify that qualified D.C. Zone businesses
that take advantage of the special tax-exempt financing incentives do
not become subject to a 35-percent zone resident requirement after the
close of the testing period.
---------------------------------------------------------------------------
The aggregate face amount of all outstanding qualified
enterprise zone bonds per qualified D.C. Zone business may not
exceed $15 million. However, the $15 million-per-D.C. Zone
business requirement should not limit issuance of a single
issue of bonds (in excess of $15 million) for more than one
qualified facility, provided that the $15 million limit is
satisfied with respect to each qualified D.C. Zone business. In
addition, total outstanding qualified enterprise zone bond
financing for each principal user of these bonds may not exceed
$20 million for all empowerment zones and enterprise
communities, including the D.C. Enterprise Zone. For purposes
of these determinations, the aggregate amount of outstanding
enterprise zone facility bonds allocable to any business shall
be determined under rules similar to rules contained in section
144(a)(10).
Qualified enterprise zone facility bonds are exempt from
the general restrictions on financing the acquisition of
existing property set forth in section 147(d). Additionally,
these bonds are exempted from the general restriction in
section 147(c)(1)(A) on financing land (or an interest therein)
with 25 percent or more of the net proceeds of a bond issue.
Unless otherwise noted, all other tax-exempt bond rules
relating to exempt facility bonds (including the restrictions
on bank deductibility of interest allocable to tax-exempt
bonds) apply to qualified enterprise zone facility bonds.
Certain so-called ``change-in-use'' rules apply to
qualified enterprise zone facility bonds. Accordingly, interest
on all bond-financed loans to a business that no longer
qualifies as a D.C. Zone business, or on loans to finance
property that ceases to be used by the business in the D.C.
Zone, becomes nondeductible, effective from the first day of
the taxable year in which the disqualification or cessation of
use occurs. This penalty is waived if: (1) the issuer and
principal user in good faith attempted to meet these
requirements and (2) any failure to meet such requirements is
corrected within a reasonable period after such failure is
first discovered. This penalty does not apply solely by reason
of the termination or revocation of the District's designation
as the D.C. Enterprise Zone. The good faith rule described
above also applies to certain other requirements of qualified
enterprise zone facility bonds.
These bonds may only be issued while the D.C. Enterprise
Zone designation is in effect. Thus, the special tax-exempt
bond provisions apply to bonds issued after December 31, 1997,
and prior to January 1, 2003.
Zero-percent capital gains rate
The Act provides a zero-percent capital gains rate for
capital gains from the sale of certain qualified D.C. Zone
assets held for more than five years. In general, qualified
``D.C. Zone assets'' mean stock or partnership interests held
in, or tangible property held by, a D.C. Zone business. For
purposes of the zero-percent capital gains rate, the D.C.
Enterprise Zone is defined to include all census tracts within
the District of Columbia where the poverty rate is not less
than 10 percent.
For purposes of the zero-percent capital gains rate, the
definition of qualified D.C. Zone business generally is the
same as the definition applicable for purposes of the increased
expensing under section 179, described above.\137\ However,
solely for purposes of the zero-percent capital gains rate, a
qualified D.C. Zone business must derive at least 80 percent
(as opposed to 50 percent) of its total gross income from the
active conduct of a qualified business within the D.C.
Enterprise Zone.
---------------------------------------------------------------------------
\137\ A technical correction to section 1400B(c) is necessary to
clarify that a proprietorship can constitute a D.C. Zone business for
purposes of the zero-percent capital gains rate.
---------------------------------------------------------------------------
``D.C. Zone business stock'' is stock in a domestic
corporation originally issued after December 31, 1997, that, at
the time of issuance\138\ and during substantially all of the
taxpayer's holding period, was a qualified D.C. Zone business,
provided that such stock was acquired by the taxpayer on
original issue from the corporation solely in exchange for cash
before January 1, 2003.\139\ A ``D.C. Zone partnership
interest'' is a domestic partnership interest originally issued
after December 31, 1997, that is acquired by the taxpayer from
the partnership solely in exchange for cash before January 1,
2003, provided that, at the time such interest was
acquired\140\ and during substantially all of the taxpayer's
holding period, the partnership was a qualified D.C. Zone
business.
---------------------------------------------------------------------------
\138\ In the case of a new corporation, it is sufficient if the
corporation is being organized for purposes of being a qualified D.C.
Zone business.
\139\ D.C. Zone business stock does not include any stock acquired
from a corporation which made substantial stock redemption of
distribution (without a bona fide business purpose therefor) in an
attempt to avoid the purposes of the provision. A similar rule applies
with respect to D.C. Zone partnership interests.
\140\ In the case of a new partnership, it is sufficient if the
partnership is being formed for purposes of being a qualified D.C. Zone
business.
---------------------------------------------------------------------------
Finally, ``D.C. Zone business property'' is tangible
property\141\ acquired by the taxpayer by purchase (within the
meaning of present law section 179(d)(2)) after December 31,
1997, and before January 1, 2003, provided that the original
use of such property in the D.C. Enterprise Zone commences with
the taxpayer and substantially all of the use of such property
during substantially all of the taxpayer's holding period was
in a qualified D.C. Zone business of the taxpayer. A special
rule provides that, in the case of a building that is
``substantially renovated'' (including any land on which such
building is located), such property need not be acquired by the
taxpayer after December 31, 1997, nor need the original use of
such property in the D.C. Enterprise Zone commence with the
taxpayer. Rather, substantially all of the use of such property
during substantially all of the taxpayer's holding period
(after it has been substantially renovated) must be in a
qualified D.C. Zone business of the taxpayer. For these
purposes, property is treated as ``substantially renovated''
if, prior to January 1, 2003, additions to basis with respect
to such property in the hands of the taxpayer during any 24-
month period beginning after December 31, 1997, exceed the
greater of (1) an amount equal to the adjusted basis at the
beginning of such 24-month period in the hands of the taxpayer,
or (2) $5,000.
---------------------------------------------------------------------------
\141\ D.C. Zone business property is limited to tangible property.
Thus, for example, D.C. Zone businesses that are qualified
proprietorships cannot claim the zero-percent rate on capital gain from
the sale of any intangible property. Similarly, corporations or
partnerships cannot claim the zero-percent rate on capital gain from
the direct sale of intangible property. However, the zero-percent rate
does apply to qualified gain from the sale of D.C. Zone business stock
or a D.C. Zone partnership interest that is attributable to the value
of intangible assets held by the entity, provided such assets are an
integral part of a D.C. Zone business.
---------------------------------------------------------------------------
In addition, qualified D.C. Zone assets include property
that was a qualified D.C. Zone asset in the hands of a prior
owner,\142\ provided that at the time of acquisition, and
during substantially all of the subsequent purchaser's holding
period, either (1) substantially all of the use of the property
is in a qualified D.C. Zone business, or (2) the property is an
ownership interest in a qualified D.C. Zone business.\143\
---------------------------------------------------------------------------
\142\ A technical correction is necessary to clarify that there is
no requirement that D.C. Zone business property be acquired by a
subsequent purchaser prior to January 1, 2003, to be eligible for this
special rule.
\143\ The termination of the D.C. Zone designation will not, by
itself, result in property failing to be treated as a qualified D.C.
Zone asset. However, capital gain eligible for the zero-percent capital
gains rate does not include any gain attributable to periods after
December 31, 2007.
---------------------------------------------------------------------------
In general, gain eligible for the zero-percent tax rate
means gain from the sale or exchange of a qualified D.C. Zone
asset that is (1) a capital asset or (2) property used in the
trade or business as defined in section 1231(b). Gain that is
attributable to real property, or to intangible assets,
qualifies for the zero-percent rate, provided that such real
property or intangible asset is an integral part of a qualified
D.C. Zone business.\144\ However, no gain attributable to
periods before January 1, 1998, and after December 31, 2007, is
qualified capital gain. In addition, no gain that is
attributable, directly or indirectly, to a transaction with a
related person is eligible for the zero-percent rate.
---------------------------------------------------------------------------
\144\ However, as described above, sole proprietorships and other
taxpayers selling assets directly cannot claim the zero-percent rate on
capital gain from the sale of any intangible property (i.e., the
integrally related test does not apply).
---------------------------------------------------------------------------
The Act provides that property that ceases to be a
qualified D.C. Zone asset because the property is no longer
used in (or no longer represents an ownership interest in) a
qualified D.C. Zone business after the five-year period
beginning on the date the taxpayer acquired such property
continues to be treated as a qualified D.C. Zone asset. Under
this rule, the amount of gain eligible for the zero-percent
capital gains rate cannot exceed the amount which would be
qualified capital gain had the property been sold on the date
of such cessation.
Under a special rule, the zero-percent capital gains rate
applies to any amount that is included in a taxpayer's gross
income by reason of holding an interest in a pass-thru entity
(i.e., a partnership, S corporation, regulated investment
company, and common trust fund) if the amount is attributable
to qualified capital gain recognized on the sale or exchange of
a qualified D.C. Zone asset by the pass-thru entity. This flow-
through of the zero-percent capital gains rate applies only to
qualified D.C. Zone assets that were held by the pass-thru
entity for more than five years and were acquired and disposed
of by the pass-thru entity while the taxpayer held an interest
in the pass-thru entity. In addition, the amount of gain to
which this rule applies is limited based on the interest of the
taxpayer in the pass-thru entity on the date that the qualified
D.C. Zone asset was acquired.\145\
---------------------------------------------------------------------------
\145\ Code secs. 1400B(f) and 1202(g). The legislative history of
the Act incorrectly describes the operation of this special rule.
---------------------------------------------------------------------------
The Act also provides that in the case of a transfer of a
qualified D.C. Zone asset by gift, at death, or from a
partnership to a partner that held an interest in the
partnership at the time that the qualified D.C. Zone asset was
acquired, (1) the transferee is to be treated as having
acquired the asset in the same manner as the transferor, and
(2) the transferee's holding period includes that of the
transferor. In addition, rules similar to those contained in
section 1202(i)(2) regarding treatment of contributions to
capital after the original issuance date and section 1202(j)
regarding treatment of certain short positions apply.
First-time home buyer tax credit
The Act provides first-time homebuyers of a principal
residence in the District a tax credit of up to $5,000 of the
amount of the purchase price.\146\ The $5,000 maximum credit
amount applies both to individuals and married couples. Married
individuals filing separately can claim a maximum credit of
$2,500 each. The credit phases out for individual taxpayers
with adjusted gross income between $70,000 and $90,000
($110,000-$130,000 for joint filers). The Secretary of Treasury
may prescribe regulations allocating the credit among unmarried
purchasers of a residence.\147\
---------------------------------------------------------------------------
\146\ A technical correction is necessary to clarify that the term
``purchase price'' means the adjusted basis of the principal residence
on the date the residence is purchased. A newly constructed residence
is treated as purchased by the taxpayer on the date the taxpayer first
occupies such residence. Provisions to this effect are included in
Title VI (sec. 607) of H.R. 2676, the Tax Technical Corrections Act of
1997, as passed by the House on November 5, 1997.
\147\ The provision of the Act that excludes sales of certain
personal residences from the real estate transaction reporting
requirement (see Act sec. 312, above) may not apply to sales of
personal residences in the District of Columbia. In this regard, the
Congress anticipated that the Secretary of Treasury will require such
information as may be necessary to verify eligibility for the D.C.
first-time homebuyer credit.
---------------------------------------------------------------------------
A ``first-time homebuyer'' means any individual if such
individual (and, if married, such individual's spouse) did not
have a present ownership interest in a principal residence in
the District of Columbia during the one-year period ending on
the date of the purchase of the principal residence to which
the credit applies.\148\
---------------------------------------------------------------------------
\148\ A technical correction is required to clarify the statute in
this regard. A provision to this effect is included in Title VI (sec.
607) of H.R. 2676, the Tax Technical Corrections Act of 1997, as passed
by the House on November 5, 1997.
---------------------------------------------------------------------------
A taxpayer will be treated as a first-time homebuyer with
respect to only one residence--i.e., the credit may be claimed
one time only. The credit is available with respect to
purchases of existing property as well as new construction. A
taxpayer's basis in a property is reduced by the amount of any
homebuyer tax credit claimed with respect to such property.
The first-time homebuyer credit is a nonrefundable personal
credit that is claimed after the credits described in Code
sections 25 (credit for interest on certain home mortgages) and
23 (adoption credit).\149\ The credit cannot be used to offset
an alternative minimum tax liability. Any excess credit may be
carried forward indefinitely to succeeding taxable years.
---------------------------------------------------------------------------
\149\ A technical correction is required to clarify the statute in
this regard. A provision to this effect is included in Title VI (sec.
607) of H.R. 2676, the Tax Technical Corrections Act of 1997, as passed
by the House on November 5, 1997.
---------------------------------------------------------------------------
The first-time homebuyer credit is available only for
property purchased after August 4, 1997, and before January 1,
2001. Thus, the credit is available to first-time home
purchasers who acquire title to a qualifying principal
residence on or after August 5, 1997, and on or before December
31, 2000, irrespective of the date the purchase contract was
entered into.\150\
---------------------------------------------------------------------------
\150\ A technical correction is required to clarify the statute in
this regard. A provision to this effect is included in Title VI (sec.
607) of H.R. 2676, the Tax Technical Corrections Act of 1997, as passed
by the House on November 5, 1997.
---------------------------------------------------------------------------
Effective Date
The D.C. wage credit is effective for wages paid (or
incurred) to a qualified individual for services performed
after December 31, 1997, and before January 1, 2003. The
increased expensing under Code section 179 is effective for
qualified D.C. Zone property placed in service in periods
beginning after December 31, 1997, and before January 1, 2003.
The special tax-exempt bond provisions apply to bonds issued
after December 31, 1997, and prior to January 1, 2003. The
zero-percent capital gains rate generally is effective for
acquisitions of qualified D.C. Zone assets after December 31,
1997, and before January 1, 2003. The first-time homebuyer
credit applies to purchases after the date of enactment (August
5, 1997) and before January 1, 2001.
Revenue Effect
The provision designating the D.C. Enterprise Zone (wage
credit, increased expensing under section 179, and expanded
tax-exempt financing) is estimated to reduce Federal fiscal
year budget receipts by $71 million in 1998, $110 million in
1999, $113 million in 2000, $118 million in 2001, $127 million
in 2002, and $45 million in 2003; to increase Federal fiscal
year budget receipts by $3 million in 2004 and by $2 million in
2005; and to reduce Federal fiscal year budget receipts by less
than $500,000 in 2006 and by $2 million in 2007.
The provision providing a zero-percent capital gains rate
for certain property is estimated to reduce Federal fiscal year
budget receipts by $1 million in 1998, $5 million in 1999, $12
million in 2000, $21 million in 2001, $33 million in 2002, $48
million in 2003, $85 million in 2004, $90 million in 2005, $99
million in 2006, and $107 million in 2007.
The first-time homebuyer tax credit provision is estimated
to reduce Federal fiscal year budget receipts by $10 million in
1998, $21 million in 1999, $27 million in 2000, $16 million in
2001, and by less than $500,000 per year in each of 2002
through 2007.
TITLE VIII. WELFARE-TO-WORK TAX CREDIT
(sec. 801 of the Act and new sec. 51A of the Code)
Present Law
The work opportunity tax credit is available on an elective
basis for employers hiring individuals from one or more of
seven targeted groups. The credit generally is equal to 35
percent of qualified wages. Generally, qualified wages consist
of wages attributable to service rendered by a member of a
targeted group during the one-year period beginning with the
day the individual begins work for the employer.
For purposes of the work opportunity tax credit, the
targeted groups for which the credit is available include: (1)
families receiving Aid to Families with Dependent Children
(``AFDC''); (2) qualified ex-felons; (3) high-risk youth; (4)
vocational rehabilitation referrals; (5) qualified summer youth
employees; (6) qualified veterans; and (7) families receiving
food stamps.
Generally, no more than $6,000 of wages during the first
year of employment is permitted to be taken into account with
respect to any individual. Thus, the maximum credit per
individual is $2,100. With respect to qualified summer youth
employees, the maximum credit is 35 percent of up to $3,000 of
qualified first-year wages, for a maximum credit of $1,050.
The deduction for wages is reduced by the amount of the
credit.
The work opportunity tax credit is effective for wages paid
or incurred to a qualified individual who begins work for an
employer after September 30, 1996, and before October 1, 1997.
Reasons for Change
One goal of the Personal Responsibility and Work
Opportunity Reform Act of 1996 (Public Law 104-193) was to move
individuals from welfare to work. The Congress believed that
the welfare-to-work credit will provide to employers an
additional incentive to hire these categories of individuals.
This incentive is intended to ease the transition from welfare
to work for the targeted categories of individuals by
increasing access to employment. It is also intended to provide
certain employee benefits to these individuals to encourage
training, health coverage, dependent care and ultimately better
job attachment.
Explanation of Provision
The Act provides to employers a tax credit on the first
$20,000 of eligible wages paid to qualified long-term family
assistance (AFDC or its successor program) recipients during
the first two years of employment. The credit is 35 percent of
the first $10,000 of eligible wages in the first year of
employment and 50 percent of the first $10,000 of eligible
wages in the second year of employment. The maximum credit is
$8,500 per qualified employee.
Qualified long-term family assistance recipients are: (1)
members of a family that has received family assistance for at
least 18 consecutive months ending on the hiring date; (2)
members of a family that has received family assistance for a
total of at least 18 months (whether or not consecutive) after
the date of enactment of this credit if they are hired within 2
years after the date that the 18-month total is reached; and
(3) members of a family who are no longer eligible for family
assistance because of either Federal or State time limits, if
they are hired within 2 years after the Federal or State time
limits made the family ineligible for family assistance.
Eligible wages include cash wages paid to an employee plus
amounts paid by the employer for the following: (1) educational
assistance excludable under a section 127 program (or that
would be excludable but for the expiration of sec. 127); (2)
health plan coverage for the employee, but not more than the
applicable premium defined under section 4980B(f)(4); and (3)
dependent care assistance excludable under section 129.
Effective Date
The provision is effective for wages paid or incurred to a
qualified individual who begins work for an employer on or
after January 1, 1998, and before May 1, 1999.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $13 million in 1998, $31 million in 1999,
$29 million in 2000, $15 million in 2001, $10 million in 2002,
$4 million in 2003, $2 million in 2004, and $1 million in
2005.\151\
---------------------------------------------------------------------------
\151\ The estimate includes interaction with the work opportunity
tax credit; see explanation of section 603 of the Act.
TITLE IX. MISCELLANEOUS PROVISIONS
A. Excise Tax Provisions
1. Transfer of General Fund highway fuels tax revenues to the Highway
Trust Fund (sec. 901 of the bill and sec. 9503 of the Code)
Present and Prior Law
Federal excise taxes are imposed on highway motor fuels to
finance the Highway Trust Fund (currently, through September
30, 1999). Prior to October 1, 1997, the Highway Trust Fund
motor fuels tax rates were 14 cents per gallon on highway
gasoline and special motor fuels, 20 cents per gallon on
highway diesel fuel, and 3 cents per gallon on diesel fuel used
by intercity buses. Reduced tax rates apply to ethanol and
methanol fuels. Excise taxes of 14 cents per gallon also apply
to gasoline and special motor fuels used in motorboats, which
goes first into the Highway Trust Fund. In addition, prior to
October 1, 1997, a permanent General Fund tax of 4.3 cents per
gallon was imposed on highway and other motor fuels (other than
intercity bus gasoline and recreational motorboat diesel fuel,
which were and are not subject to the tax, and rail diesel
fuel, which paid a General Fund tax of 5.55 cents per gallon).
Under prior law, amounts equivalent to 2 cents per gallon
of the Highway Trust Fund motor fuels tax revenues were
credited to the Mass Transit Account of the Highway Trust Fund
for capital-related expenditures on mass transit programs; the
balance of the highway motor fuels tax revenues were and are
credited to the Highway Account of the Trust Fund for highway-
related programs generally.
Under prior law, transfers were made from the Highway Trust
Fund of $1 million per fiscal year to the Land and Water
Conservation Fund, plus up to $70 million per fiscal year
(through September 30, 1997) to the Boat Safety Account of the
Aquatic Resources Trust Fund of amounts equivalent to 11.5
cents per gallon from recreational motorboat gasoline and
special motor fuels tax revenues. Any excess revenues
attributable to the tax on motorboat fuels were and are
transferred from the Highway Trust Fund to the Sport Fish
Restoration Account in the Aquatic Resources Trust Fund.
Excise taxes imposed on gasoline, diesel and special motor
fuels generally must be paid to the Treasury in semi-monthly
deposits, which are credited to tax liability reported on
quarterly excise tax returns. Subject to special rules for
deposits attributable to taxes for the period September 16-26,
deposits generally must be made 9 days after the end of each
semi-monthly period (14 days for gasoline and diesel fuel taxes
deposited by an independent refiner or small producer).
Reasons for Change
The Congress determined that, consistent with the
historical user tax principle of the highway motor fuels taxes,
the existing 4.3-cents-per-gallon General Fund excise tax on
highway fuels should be transferred to the Highway Trust Fund.
These monies will be available for needed Highway Trust Fund
programs in the future, to the extent consistent with overall
budgetary spending levels.
Explanation of Provision
Transfer of revenues to Highway Trust Fund
The Act transfers the prior-law General Fund excise tax of
4.3 cents per gallon on all highway motor fuels to the Highway
Trust Fund, beginning on October 1, 1997. Under the Act, 0.85
cents per gallon of the 4.3 cents per gallon motor fuels tax
revenues are to be credited to the Mass Transit Account of the
Highway Trust Fund (for a total of 2.85 cents per gallon).\152\
---------------------------------------------------------------------------
\152\ Historically, the Mass Transit Account has received 20
percent of the increase in motor fuels tax. 20 percent of 4.3 cents is
0.86 cents. To effectuate this, a technical correction to credit 2.86
cents per gallon to the Mass Transit Account is included in Title VI
(sec. 608(b)) the Tax Technical Corrections Act of 1997, as passed by
the House on November 5, 1997.
---------------------------------------------------------------------------
Deposit rules for highway motor fuels
The Act provides that the excise taxes on gasoline, diesel
fuel, special motor fuels, and kerosene that otherwise would be
required to be deposited with the Treasury after July 31, 1998,
and before October 1, 1998, are not required to be deposited
until October 5, 1998.
The changes to the deposits to the Highway Trust Fund may
not be used to cause an increase in the allocations under
section 157 of Title 23 of the U.S. Code or any other spending
increase in direct spending other than by enactment of future
legislation in compliance with the Budget Enforcement Act.
Effective Date
The provision was effective on October 1, 1997.
Revenue Effect
This provision has no net effect on Federal fiscal year
budget receipts.
2. Repeal excise tax on diesel fuel used in recreational motorboats
(sec. 902 of the Act and secs. 4041 and 6427 of the Code)
Present and Prior Law
Before a temporary suspension through December 31, 1997 was
enacted in 1996, diesel fuel used in recreational motorboats
was subject to a generally applicable 24.4-cents-per-gallon
diesel fuel excise tax. Revenues from this tax were retained in
the General Fund. The tax was enacted by the Omnibus Budget
Reconciliation Act of 1993 as a revenue offset for repeal of
the excise tax on certain luxury boats.
Reasons for Change
The Congress was informed that many marinas had found it
uneconomical to carry both undyed (taxed) and dyed (untaxed)
diesel fuel because the majority of their market is for uses
not subject to tax. As a result, some recreational boaters had
experienced difficulty finding fuel. In 1996, the Congress
suspended imposition of the tax on recreational boating while
alternative collection methods were evaluated. No satisfactory
alternative was found; therefore, the Congress determined that
competing needs for boat fuel availability and preservation of
the integrity of the diesel fuel tax compliance structure are
best served by repealing the diesel fuel tax on recreational
motorboat use.
Explanation of Provision
The Act repeals the application of the diesel fuel tax to
fuel used in recreational motorboats.
Effective Date
The provision is effective for fuel sold after December 31,
1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $4 million in 1998, $5 million per year in
1999 and 2000, and $1 million per year in 2001 through 2007.
3. Continued application of tax on imported recycled halon-1211 (sec.
903 of the Act and sec. 4682 of the Code)
Present and Prior Law
An excise tax is imposed on the sale or use by the
manufacturer or importer of certain ozone-depleting chemicals
(Code sec. 4681). The amount of tax generally is determined by
multiplying the base tax amount applicable for the calendar
year by an ozone-depleting factor assigned to each taxable
chemical. The base tax amount is $6.25 per pound in 1997, and
is scheduled to increase by 45 cents per pound per year
thereafter. The ozone-depleting factors for taxable halons are
3 for halon-1211, 10 for halon-1301, and 6 for halon-2402.
Taxable chemicals that are recovered and recycled within
the United States are exempt from tax. In addition, exemption
is provided for imported recycled halon-1301 and halon-2402 if
such chemicals are imported from countries that are signatories
to the Montreal Protocol onSubstances that Deplete the Ozone
Layer. Present law further provides that exemption is to be provided
for imported recycled halon-1211, for such chemicals imported from
countries that are signatories to the Montreal Protocol on Substances
that Deplete the Ozone Layer after December 31, 1997.
Reasons for Change
The Congress understood that in response to the profit
incentive created by the higher price for ozone-depleting
chemicals that has resulted from the tax on these chemicals,
entrepreneurs have developed and are marketing a substitute for
halon-1211 that is not ozone depleting. The Congress believed
permitting imported recycled halon-1211 to compete in the
market tax free may destroy this entrepreneurial and
environmental success story.
Explanation of Provision
The Act repeals the prior-law exemption for imported
recycled halon-1211.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by less than $500,000 in each fiscal year from
1997 through 2007. The aggregate increase in Federal fiscal
year budget receipts for the period 1997-2007 is estimated to
be $1 million.
4. Uniform rate of excise tax on vaccines (sec. 904 of the Act and
secs. 4131 and 4132 of the Code)
Present and Prior Law
A manufacturer's excise tax is imposed on certain vaccines
routinely recommended for administration to children. Under
prior law the rates of tax were as follows: DPT (diphtheria,
pertussis, tetanus,), $4.56 per dose; DT (diphtheria, tetanus),
$0.06 per dose; MMR (measles, mumps, or rubella), $4.44 per
dose; and polio, $0.29 per dose. In general, if any vaccine was
administered by combining more than one of the listed taxable
vaccines, the amount of tax imposed was the sum of the amounts
of tax imposed for each taxable vaccine. However, in the case
of MMR and its components, any component vaccine of MMR was
taxed at the same rate as the MMR-combined vaccine.
Amounts equal to net revenues from this excise tax are
deposited in the Vaccine Injury Compensation Trust Fund to
finance compensation awards under the Federal Vaccine Injury
Compensation Program for individuals who suffer certain
injuries following administration of the taxable vaccines.
Reasons for Change
The Congress understood that the prior-law tax rates
applicable to taxable vaccines were chosen to reflect estimated
probabilities of adverse reactions and the severity of the
injury that might result from such reactions. The Congress
understood that medical researchers believe that there is
insufficient data to support fine gradations of estimates of
potential harm from the various different childhood vaccines.
In the light of this scientific assessment, the Congress
believed some simplicity can be achieved by taxing such
vaccines at the same rate per dose.
The Congress further believed it was appropriate to review
the list of taxable vaccines from time to time as medical
science advances. The Center for Disease Control has
recommended that the vaccines for HIB (haemophilus influenza
type B), Hepatitis B, and varicella (chicken pox) be widely
administered among the nation's children. In light of the
growing number of immunizations using these vaccines, the
Congress added these vaccines to the list of taxable vaccines.
Explanation of Provision
The Act replaces the prior-law excise tax rates, that
differed by vaccine, with a single rate tax of $0.75 per dose
on any listed vaccine component. Under the Act, the tax applies
to any vaccine that is a combination of vaccine components is
75 cents times the number of components in the combined
vaccine. For example, the MMR vaccine is taxed at a rate of
$2.25 per dose and the DT vaccine is taxed at rate of $1.50 per
dose.
In addition, the Act adds three new taxable vaccines to the
present-law taxable vaccines: (1) HIB (haemophilus influenza
type B); (2) Hepatitis B; and (3) varicella (chickenpox). The
three newly listed vaccines also are subject to the 75-cents
per dose excise tax.
Effective Date
The provision was effective for sales after the date of
enactment (August 5, 1997). No floor stocks tax was imposed, or
floor stocks refunds permitted, for vaccines held on the
effective date. For the purpose of determining the amount of
refund of tax on a vaccine returned to the manufacturer or
importer, for vaccines returned after the date of enactment and
before January 1, 1999, the amount of tax assumed to have been
paid on the initial purchase of the returned vaccine is not to
exceed $0.75 per dose.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $16 million in 1998, $15 million in 1999,
$15 million in 2000, $15 million in 2001, $14 million in 2002,
$14 million in 2003, $14 million in 2004, $14 million in 2005,
$14 million in 2006, and $14 million in 2007.
5. Treat certain gasoline ``chain retailers'' as wholesale distributors
under the gasoline excise tax refund rules (sec. 905 of the Act
and sec. 6416 of the Code)
Present and Prior Law
Gasoline is taxed at 18.4 cents per gallon upon removal
from a registered pipeline or barge terminal facility. Before
reinstatement of a 0.1-cent-per-gallon tax rate (dedicated to
the Leaking Underground Storage Tank Trust Fund) by the Act,
gasoline was taxed at 18.3 cents per gallon. The position
holder in the terminal at the time of removal is liable for
payment of the tax. Certain uses of gasoline, including use by
States and local governments, are exempt from tax. In general,
these exemptions are realized by refunds to the exempt users of
tax paid by the party that removed the gasoline from a terminal
facility. Present law includes an exception to the general rule
that refunds are made to consumers in the case of gasoline sold
to States and local governments and certain other exempt users.
In those cases, wholesale distributors sell the gasoline net of
tax previously paid and receive the refunds. The term wholesale
distributor includes only persons that sell gasoline to
producers, retailers, or to users in bulk quantities.
Reasons for Change
During recent years, States and local governments
increasingly have purchased gasoline for their fleets by credit
card purchases from retail outlets. Previously, these purchases
were through bulk deliveries to tanks supplying private pumps
at government installations. Currently, wholesale distributors
are eligible to claim gasoline tax refunds on behalf of these
customers. The Congress determined that allowing refunds to
retail businesses of comparable size would adapt the gasoline
tax rules to current market conditions without creating new
opportunities for tax evasion.
Explanation of Provision
The definition of wholesale distributor is expanded to
include certain ``chain retailers''--retailers that make retail
sales from 10 or more retail gasoline outlets. This
modification conforms the definition of wholesale distributor
to that which existed before 1987 when the point of collection
of the gasoline tax was moved from the wholesale distribution
level to removal from a terminal facility.
Effective Date
The provision was effective after the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
6. Exemption of electric and other clean-fuel motor vehicles from
luxury automobile classification (sec. 906 of the Act and secs.
4001 and 4003 of the Code)
Present and Prior Law
Present law imposes an excise tax on the sale of
automobiles whose price exceeds a designated threshold,
currently $36,000. The excise tax is imposed at a rate of 8
percent for 1997 on the excess of the sales price above the
designated threshold. The 8-percent rate declines by one
percentage point per year until reaching 3 percent in 2002, and
no tax thereafter. The $36,000 threshold is indexed for
inflation. The present-law indexed threshold of $36,000 is the
result of adjusting a $30,000 threshold specified in the Code
for inflation occurring after 1990 (sec. 4001(e)).
The tax generally applies only to the first retail sale
after manufacture, production, or importation of an automobile.
It does not apply to subsequent sales of taxable automobiles. A
tax, at the same rate, is imposed on the separate purchase of
parts and accessories for a vehicle within six months of the
first retail sale when the sum of the separate purchases of the
vehicle, parts, and accessories exceeds the luxury tax
threshold (sec. 4003).
The tax applies to sales before January 1, 2003.
Reasons for Change
The Congress believed that the price of a clean-burning
fuel vehicle or an electric vehicle does not necessarily
represent the consumer's purchase of a luxury good in the sense
intended with the enactment of the luxury excise tax on
automobiles in the Omnibus Budget Reconciliation Act of 1990.
Rather, the higher price of such vehicles often represents the
cost of the technology required to produce an automobile
designed to provide certain environmental benefits. The
Congress believed the cost of this technology should not be
considered a luxury for the purpose of the luxury excise tax on
automobiles. Therefore, the Congress determined it appropriate
to modify the threshold above which the luxury automobile
excise tax applies in the case of certain clean-burning fuel
vehicles and electric vehicles.
Explanation of Provision
The Act modifies the threshold above which the luxury
excise tax on automobiles will apply for each of two identified
classes of automobiles both in the case of a purchase of a
vehicle and in the case of the separate purchase of a vehicle
and parts and accessories therefor. First, for an automobile
that is not a clean-burning fuel vehicle to which retrofit
parts and components are installed to make the vehicle a clean-
burning vehicle, the threshold would be $30,000, as adjusted
for inflation under present law, plus an amount equal to the
increment to the retail value of the automobile attributable to
the retrofit parts and components installed.
In the case of a passenger vehicle designed to be propelled
primarily by electricity and built by an original equipment
manufacturer, the threshold applicable for any year is modified
to equal 150 percent of $30,000, with the result increased for
inflation occurring after 1990 and rounded to next lowest
multiple of $2,000.
Effective Date
The provision was effective for sales and installations
occurring after the date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $500,000 for the 1997 fiscal year,
by $1 million for the 1998 fiscal year, by $1 million for the
1999 fiscal year, by less than $500,000 for each fiscal year
from 2000 through 2003, and to have no effect on Federal
receipts thereafter (provision expires December 31, 2002). The
aggregate reduction in Federal fiscal year budget receipts for
fiscal year 1997 through fiscal year 2007 is estimated to be $2
million.
7. Tax certain alternative fuels based on energy equivalency to
gasoline (sec. 907 of the Act and secs. 4041 and 9503 of the
Code)
Present and Prior Law
Excise taxes are imposed on gasoline, diesel fuel, and
special motor fuels used in highway vehicles. Before enactment
of the Act, 4.3 cents per gallon of each of these taxes was
retained in the General Fund, with the balance of the revenues
being dedicated to one or more Trust Funds.\153\ The tax on
gasoline is 18.4 cents per gallon; the tax on diesel fuel is
24.4 cents per gallon; and the tax on special motor fuels
generally is 18.4 cents per gallon. Taxable special motor fuels
include liquefied petroleum gas (``propane''), liquefied
natural gas (``LNG''), and methanol from natural gas.
Compressed natural gas (``CNG'') also is taxed when used as a
fuel in highway vehicles. Special rates apply to methanol from
natural gas (exempt from 7 cents of the prior-law 14-cents-per-
gallon Highway Trust Fund component of the special motor fuels
tax), and compressed natural gas (exempt from the entire prior-
law Highway Trust Fund component of the tax).
---------------------------------------------------------------------------
\153\ Section 901 of the Act provides that revenues from all but
0.1-cent-per gallon of the taxes on highway fuels is to be deposited in
the Highway Trust Fund; the remaining 0.1-cent-per gallon (which was
reinstated by sec. 1033 of the Act) is dedicated to the Leaking
Underground Storage Tank Trust Fund.
---------------------------------------------------------------------------
In general, these four special fuels contain less energy
(i.e., fewer Btu's) per gallon than does gasoline.
Reasons for Change
Under prior law, the largest portion of the excise tax on
propane, LNG, and methanol from natural gas was imposed to
finance Federal highway programs through the Highway Trust
Fund. Under the Act, these revenues are dedicated exclusively
to the Highway Trust Fund. A basic principle of the highway
taxes is that users of the highway system should be taxed in
relation to their use of the system. The Congress believed that
adjusting the tax rates on these three special fuels is
consistent with that principle because consumers must purchase
more gallons of these lower-energy-content fuels than gallons
of gasoline to travel the same number of miles.
Explanation of Provision
The Act adjusts the tax rates on propane, LNG, and methanol
from natural gas to reflect the respective energy equivalence
of the fuels to gasoline. The revised Highway Trust Fund tax
rates on these fuels are: propane, 13.6 cents per gallon; LNG
11.9 cents per gallon, and methanol from natural gas, 9.15
cents per gallon.
The Act provides that revenues from the Highway Trust Fund
portion of these taxes and the tax on CNG will be divided
between the Highway and Mass Transit Accounts of that Trust
Fund in the same proportion as applies to the Highway Trust
Fund tax on gasoline.\154\
---------------------------------------------------------------------------
\154\ A technical correction may be necessary to implement this
provision. Such a correction is included in Title VI of H.R. 2676, the
Tax Technical Corrections Act of 1997, as passed by the House November
5, 1997.
---------------------------------------------------------------------------
Effective Date
The provision was effective for fuels sold or used after
September 30, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $2 million in 1997, $15 million in 1998, $16
million per year in 1999 and 2000, $17 million in 2001, $18
million in 2002, $19 million in 2003, $20 million in 2004, $21
million in 2005, $22 million in 2006, and $23 million in 2007.
8. Reduced rate of alcohol excise tax on certain hard ciders (sec. 908
of the Act and sec. 5041 of the Code)
Present and Prior Law
Distilled spirits are taxed at a rate of $13.50 per proof
gallon; beer is taxed at a rate of $18 per barrel
(approximately 58 cents per gallon); and still wines of 14
percent alcohol or less are taxed at a rate of $1.07 per wine
gallon. The Code defines still wines as wines containing not
more than 0.392 gram of carbon dioxide per hundred milliliters
of wine. Higher rates of tax are applied to wines with greater
alcohol content, to sparkling wines (e.g., champagne), and to
artificially carbonated wines.
Certain small wineries may claim a credit against the
excise tax on wine of 90 cents per wine gallon on the first
100,000 gallons of wine produced annually (i.e., net tax rate
of 17 cents per wine gallon). Certain small breweries pay a
reduced tax of $7.00 per barrel (approximately 22.6 cents per
gallon) on the first 60,000 barrels of beer produced annually.
Apple cider containing alcohol (``hard cider'') is
classified as wine, and was taxed as wine under prior law.
Reasons for Change
The Congress understood that as an alcoholic beverage, hard
cider competes more as a substitute for beer than as a
substitute for still, or table, wine. If most consumers of
alcoholic beverages choose between hard cider and beer, rather
than between hard cider and wine, taxing hard cider at tax
rates imposed on other wine products may distort consumer
choice and unfairly disadvantage producers of hard cider in the
market place. The Congress also understood that producers of
hard cider generally are small businesses and concluded that it
would improve market efficiency and fairness to tax this
beverage at a rate equivalent to the tax imposed on the
production of beer by small brewers.
Explanation of Provision
The Act adjusts the tax rate on ``hard cider'' that was
taxed as a still wine under prior law (i.e., a cider containing
not more than 0.392 gram of carbon dioxide per hundred
milliliters),\155\ to 22.6 cents per gallon for those persons
who produce more than 100,000 gallons of ``hard cider'' during
a calendar year. The provision defines ``hard cider'' as being
fermented solely from apples or apple concentrate and water,
containing no other fruit product and containing at least one-
half of 1 percent and less than 7 percent alcohol by volume.
Once fermented, eligible hard cider may not be altered by the
addition of other fruit juices, flavor, or other ingredient
that alters the flavor that results from the fermentation
process. Thus, for example, cider fermented from apples, but
which has raspberry flavor added to it prior to bottling and
marketing to the public, will not be eligible for the 22.6
cents-per-gallon tax rate.
---------------------------------------------------------------------------
\155\ A technical correction may be required to clarify that the
reduced rate of tax provided by this provision applies only to apple
cider taxable as a still wine under prior law.
---------------------------------------------------------------------------
Qualifying small producers that produce 250,000 gallons or
less of hard cider and other wines in a calendar year may claim
a credit of 5.6 cents per wine gallon on the first 100,000
gallons of hard cider produced. This credit produces an
effective tax rate of 17 cents per gallon, the same effective
rate as under prior law that applied to small producers who
were permitted to claim the 90 cents-per-gallon credit for
small wineries. Hard cider production will continue to be
counted in determining whether other production of a producer
qualifies for the tax credit for small producers of wine. The
Act does not change the classification of qualifying hard cider
as wine.
Effective Date
The provision was effective for hard cider removed after
September 30, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by approximately $1 million in each fiscal year
from 1998 through fiscal year 2007, and an estimated total
reduction in Federal receipts of $7 million for the period
1998-2007.
9. Study feasibility of moving collection point for distilled spirits
excise tax (sec. 909 of the Act)
Present and Prior Law
Distilled spirits are subject to tax at $13.50 per proof
gallon. (A proof gallon is a liquid gallon consisting of 50
percent alcohol.) In the case of domestically produced
distilled spirits and distilled spirits imported in to the
United States in bulk containers for domestic bottling, the tax
is collected on removal of the beverage from the distillery
(without regard to whether a sale occurs at that time). Bottled
distilled spirits that are imported into the United States
comprise approximately 15 percent of the current market for
these beverages; tax is collected on these imports when the
distilled spirits are removed from the first customs bonded
warehouse in which they are deposited upon entry into the
United States.
In the case of certain distilled spirits products, a tax
credit for alcohol derived from fruit is allowed. This credit
reduces the effective tax paid on those beverages. The credit
is determined when the tax is paid (i.e., at the distillery or
on importation).
Explanation of Provision
The Act directs the Treasury Department to study options
for changing the point at which the distilled spirits excise
tax is collected. One of the options evaluated should be
collecting the tax at the point at which the distilled spirits
are removed from registered wholesale warehouses. As part of
this study, the Treasury is to focus on administrative issues
associated with identified options, including the effects on
tax compliance. For example, the Treasury is to evaluate the
actual compliance record of wholesale dealers that currently
pay the excise tax on imported bottled distilled spirits and
the compliance effects of allowing additional wholesale dealers
to be distilled spirts taxpayers. The study also is to address
the number of taxpayers involved, the types of financial
responsibility requirements that might be needed, and any
special requirements regarding segregation of non-tax-paid
distilled spirits from other products carried by the potential
new taxpayers. The study further is to review the effects of
the options on Treasury staffing and other budgetary resources
as well as projections of the time between when tax currently
is collected and the time when tax otherwise would be
collected.
The study is required to be completed and transmitted to
the Senate Committee on Finance and the House Committee on Ways
and Means no later than March 31, 1998.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to have no effect on Federal
fiscal year budget receipts.
10. Codify Treasury Department regulations regulating wine labels (sec.
910 of the Act and sec. 5388 of the Code)
Present and Prior Law
The Code includes provisions regulating the labeling of
wine when it is removed from a winery for marketing. In
general, the regulations under these provisions allow the use
of semi-generic names for wine that reflect geographic
identifications understood in the industry, provided that the
labels include clear indication of any deviation from that
which is generally understood as to the source of the grapes or
the process by which the wine is produced.
Reasons for Change
The Congress determined that the Treasury Department
regulations governing the use of semi-generic designations such
as ``Chablis'' and ``burgundy'' in wine labeling should be
codified to add clarity to the existing Code provisions.
Explanation of Provision
The Act codifies the Treasury Department regulations
governing the use of semi-generic wine designations which
reflect geographic origin into the Code's wine labeling
provisions.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to have no effect on Federal
fiscal year budget receipts.
B. Disaster Relief Provisions
1. Authority to postpone certain tax-related deadlines by reason of
presidentially declared disaster (sec. 911 of the Act and sec.
7508A of the Code)
Present and Prior Law
In the case of a Presidentially declared disaster, the
Secretary of the Treasury has the authority to postpone some
(but not all) tax-related deadlines.
Reasons for Change
The Congress believed that the Secretary should have the
authority to postpone additional tax-related deadlines.
Explanation of Provision
The Secretary of the Treasury may specify that certain
deadlines are postponed for a period of up to 90 days in the
case of a taxpayer determined to be affected by a
Presidentially declared disaster. The deadlines that may be
postponed are the same as are postponed by reason of service in
a combat zone. The provision does not apply for purposes of
determining interest on any overpayment or underpayment.
However, section 915 of the Act provides for the abatement of
interest in the case of individuals living in an area that has
been declared a disaster area by the President during 1997.
Effective Date
The provision was effective for any period for performing
an act that had not expired before the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by a negligible amount.
2. Use of certain appraisals to establish amount of disaster loss (sec.
912 of the Act and sec. 165 of the Code)
Present and Prior Law
In order to claim a disaster loss, a taxpayer must
establish the amount of the loss. This may, for example, be
done through the use of an appraisal.
Reasons for Change
The Congress believed that no impediment should exist to
utilizing alternate types of acceptable appraisals as proof to
establish the amount of loss.
Explanation of Provision
Nothing in the Code will be construed to prohibit Treasury
from issuing guidance providing that an appraisal for the
purpose of obtaining a Federal loan or Federal loan guarantee
as the result of a Presidentially declared disaster may be used
to establish the amount of a disaster loss.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by a negligible amount.
3. Treatment of livestock sold on account of weather-related conditions
(sec. 913 of the bill and secs. 451 and 1033 of the Code)
Present and Prior Law
In general, cash-method taxpayers report income in the year
it is actually or constructively received. However, present law
contains two special rules applicable to livestock sold on
account of drought conditions. Code section 451(e) provides
that a cash-method taxpayer whose principal trade or business
is farming who is forced to sell livestock due to drought
conditions may elect to include income from the sale of the
livestock in the taxable year following the taxable year of the
sale. This elective deferral of income is available only if the
taxpayer establishes that, under the taxpayer's usual business
practices, the sale would not have occurred but for drought
conditions that resulted in the area being designated as
eligible for Federal assistance. This exception is generally
intended to put taxpayers who receive an unusually high amount
of income in one year in the position they would have been in
absent the drought.
In addition, the sale of livestock (other than poultry)
that is held for draft, breeding, or dairy purposes in excess
of the number of livestock that would have been sold but for
drought conditions is treated as an involuntary conversion
under section 1033(e). Consequently, gain from the sale of such
livestock could be deferred by reinvesting the proceeds of the
sale in similar property within a two-year period.
Reasons for Change
The Congress believed that the present-law exceptions to
gain recognition for livestock sold on account of drought
should apply to livestock sold on account of floods and other
weather-related conditions as well.
Explanation of Provision
The Act amends Code section 451(e) to provide that a cash-
method taxpayer whose principal trade or business is farming
and who is forced to sell livestock due not only to drought (as
under present law), but also to floods or other weather-related
conditions, may elect to include income from the sale of the
livestock in the taxable year following the taxable year of the
sale. This elective deferral of income is available only if the
taxpayer establishes that, under the taxpayer's usual business
practices, the sale would not have occurred but for the
drought, flood or other weather-related conditions that
resulted in the area being designated as eligible for Federal
assistance.
In addition, the Act amends Code section 1033(e) to provide
that the sale of livestock (other than poultry) that are held
for draft, breeding, or dairy purposes in excess of the number
of livestock that would have been sold but for drought (as
under present law), flood or other weather-related conditions
is treated as an involuntary conversion.
Effective Date
The provision applies to sales and exchanges after December
31, 1996.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $12 million in 1998, $2 million in 1999, $2
million in 2000, $2 million in 2001, $1 million in 2002, $1
million in 2003, $1 million in 2004, $1 million in 2005, $1
million in 2006, and $1 million in 2007.
4. Mortgage bond financing for residences located in Presidentially
declared disaster areas (sec. 914 of the Act and sec. 143 of
the Code)
Present and Prior Law
Qualified mortgage bonds are private activity tax-exempt
bonds issued by States and local governments acting as conduits
to provide mortgage loans to first-time home buyers who satisfy
specified income limits and who purchase homes that cost less
than statutory maximums.
Present and prior law waives these three buyer targeting
requirements for a portion of the loans made with proceeds of a
qualified mortgage bond issue if the loans are made to finance
homes in statutorily prescribed economically distressed areas.
Reasons for Change
The Congress believed that qualified mortgage bond
financing is an appropriate tool to assist persons experiencing
losses in Presidentially declared disasters to repair or
replace their homes.
Explanation of Provision
The Act waives the first-time homebuyer requirement, and
treats the affected areas as economically distressed areas for
purposes of applying the income limits, and the purchase price
limits in the case of loans to finance homes damaged as a
result of certain Presidentially declared disasters.\156\ The
waiver applies only during the two-year period following the
date of the disaster declaration.
---------------------------------------------------------------------------
\156\ A technical correction may be necessary to clarify the
circumstances in which homebuyers qualify for these exceptions from the
qualified mortgage bond financing rules.
---------------------------------------------------------------------------
Effective Date
The provision applies to loans financed with bonds issued
after December 31, 1996, and before January 1, 1999.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $3 million in 1998, $7 million in 1999, $8
million in 2000, $8 million in 2001, $7 million in 2002, $6
million in 2003, $6 million in 2004, $5 million in 2005, $4
million in 2006, and $4 million in 2007.
5. Requirement to abate interest by reason of Presidentially declared
disaster (sec. 915 of the Act)
Present and Prior Law
In the case of a Presidentially declared disaster, the
Secretary of the Treasury has the authority to postpone some
tax-related deadlines, but there is no authority to abate
interest.
Reasons for Change
The Congress believed that the abatement of interest should
accompany the Secretary's authority to postpone the filing and
payment deadlines, in the case of certain Presidentially
declared disasters.
Explanation of Provision
If the Secretary of the Treasury extends the filing date of
an individual tax return for individuals living in an area that
has been declared a disaster area by the President during 1997,
no interest shall be charged as a result of the failure of an
individual taxpayer to file an individual tax return, or pay
the taxes shown on such return, during the extension. For this
purpose, an individual tax return does not include the return
of a trust or estate.
Effective Date
The provision is effective with respect to declarations
during 1997 that an area warrants assistance by the Federal
Government under the Robert T. Stafford Disaster Relief and
Emergency Assistance Act.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $5 million in 1997.
C. Provisions Relating to Employment Taxes
1. Clarification of standard to be used in determining tax status of
retail securities brokers (sec. 921 of the Act)
Present and Prior Law
Under present and prior law, whether a worker is an
employee or independent contractor is generally determined
under a common-law facts and circumstances test. An employer-
employee relationship is generally found to exist if the
service recipient has not only the right to control the result
to be accomplished by the work, but also the means by which the
result is to be accomplished. The Internal Revenue Service
(``IRS'') generally takes the position that the presence and
extent of instructions is important in reaching a conclusion as
to whether a business retains the right to direct and control
the methods by which a worker performs a job, but that it is
also important to consider the weight to be given those
instructions if they are imposed by the business only in
compliance with governmental or governing body regulations. The
IRS training manual provides that if a business requires its
workers to comply with rules established by a third party
(e.g., municipal building codes related to construction), the
fact that such rules are imposed should be given little weight
in determining the worker's status.
Reasons for Change
Broker-dealers are required to supervise the activities of
their affiliated registered representatives in order to comply
with certain investor protection laws. The Congress believed
that such supervision should not be taken into account in
determining the status of a broker for Federal tax purposes.
Explanation of Provision
Under the Act, in determining the status of a registered
representative of a broker-dealer for Federal tax purposes, no
weight may be given to instructions from the service recipient
which are imposed only in compliance with governmental investor
protection standards or investor protection standards imposed
by a governing body pursuant to a delegation by a Federal or
State agency.
Effective Date
The provision is effective with respect to services
performed after December 31, 1997. No inference is intended
that the treatment under the proposal is not present law.
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
2. Clarification of exemption from self-employment tax for certain
termination payments received by former insurance salesmen
(sec. 922 of the Act and sec. 1402 of the Code)
Present Law and Prior Law
Under present and prior law, as part of the Federal
Insurance Contributions Act (``FICA'') a tax is imposed on
employees and employers. The tax consists of two parts: old-
age, survivor, and disability insurance (``OASDI'') and
Medicare Hospital Insurance (``HI''). For wages paid in 1997,
the OASDI tax rate is 6.2 percent of wages up to $65,400
(indexed for inflation) on both the employer and employee. The
HI tax rate on both the employer and the employee is 1.45
percent of wages (with no wage cap).
Similarly, under the self-employment contributions act
(``SECA''), taxes are imposed on an individual's net earnings
from self employment. In general, net earnings from self
employment means the gross income derived by an individual from
any trade or business carried on by such individual, less the
deductions allowed which are attributable to such trade or
business. The SECA tax rate is the same as the combined
employer and employee FICA rates (i.e., 12.4 percent for OASDI
and 2.9 percent for HI) and the maximum amount of earnings
subject to the OASDI portion of SECA taxes is coordinated with
and is set at the same level as the maximum level of wages and
salaries subject to the OASDI portion of FICA taxes. There is
no limit on the amount of self-employment income subject to the
HI portion of the tax.
Certain insurance salesmen are independent contractors and
therefore subject to tax under SECA.
Under case law, certain payments received by former
insurance salesmen who had sold insurance as independent
contractors are not net earnings from self employment and
therefore are not subject to SECA. See, e.g., Jackson v.
Comm'r, 108 TC ____ No. 10 (1997); Gump v. U.S., 86 F. 3d 1126
(CA FC 1996); Milligan v. Comm'r, 38 F. 3d 1094 (9th Cir.
1994).
Reasons for Change
The Congress believed that clarifying the SECA tax
treatment of certain payments would provide greater certainty
to taxpayers and would reduce the need for further litigation.
Explanation of Provision
The Act codifies case law by providing that net earnings
from self employment do not include any amount received during
the taxable year from an insurance company on account of
services performed by such individual as an insurance salesman
for such company if (1) such amount is received after
termination of the individual's agreement to perform services
for the company, (2) the individual performs no services for
the company after such termination and before the close of the
taxable year, (3) the amount of the payment depends primarily
on policies sold by or credited to the account of the
individual during the last year of the service agreement and/or
the extent to which such policies remain in force for some
period after such termination, and does not depend on the
length of service or overall earnings from services performed
for the company, and (4) the payments are conditioned upon the
salesman agreeing not to compete with the company for at least
one year following such termination. Eligibility for the
payments can be based on length of service or overall earnings.
The Act also amends the Social Security Act to provide that
such termination payments are not treated as earnings for
purposes of determining social security benefits.
No inference is intended with respect to the SECA tax
treatment of payments that are not described in the proposal.
Effective Date
The provision is effective with respect to payments after
December 31, 1997. No inference is intended that the proposal
is not present law.
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
D. Provisions Relating to Small Businesses
1. Delay imposition of penalties for failure to make payments
electronically through EFTPS (sec. 931 of the Act and sec. 6302
of the Code)
Present and Prior Law
Employers are required to withhold income taxes and FICA
taxes from wages paid to their employees. Employers also are
liable for their portion of FICA taxes, excise taxes, and
estimated payments of their corporate income tax liability.
The Code requires the development and implementation of an
electronic fund transfer system to remit these taxes and convey
deposit information directly to the Treasury (Code sec. 6302(h)
\157\). The Electronic Federal Tax Payment System (``EFTPS'')
was developed by Treasury in response to this requirement.\158\
Employers must enroll with one of two private contractors hired
by the Treasury. After enrollment, employers generally initiate
deposits either by telephone or by computer.
---------------------------------------------------------------------------
\157\ This requirement was enacted in 1993 (sec. 523 of P.L. 103-
182).
\158\ Treasury had earlier developed TAXLINK as the prototype for
EFTPS. TAXLINK has been operational for several years; EFTPS is
currently operational. Employers currently using TAXLINK will
ultimately be required to participate in EFTPS.
---------------------------------------------------------------------------
The new system is phased in over a period of years by
increasing each year the percentage of total taxes subject to
the new EFTPS system. For fiscal year 1994, 3 percent of the
total taxes are required to be made by electronic fund
transfer. These percentages increased gradually for fiscal
years 1995 and 1996. For fiscal year 1996, the percentage was
20.1 percent (30 percent for excise taxes and corporate
estimated tax payments). For fiscal year 1997, these
percentages increased significantly, to 58.3 percent (60
percent for excise taxes and corporate estimated tax payments).
The specific implementation method required to achieve the
target percentages is set forth in Treasury regulations.
Implementation began with the largest depositors.
Treasury originally implemented the 1997 percentages by
requiring that all employers who deposit more than $50,000 in
1995 must begin using EFTPS by January 1, 1997. The Small
Business Job Protection Act of 1996 provided that the increase
in the required percentages for fiscal year 1997 (which,
pursuant to Treasury regulations, was to take effect on January
1, 1997) will not take effect until July 1, 1997.\159\ This was
done to provide additional time prior to implementation of the
1997 requirements so that employers could be better informed
about their responsibilities.
---------------------------------------------------------------------------
\159\ Section 1809 of P.L. 104-188.
---------------------------------------------------------------------------
On June 2, 1997, the IRS announced \160\ that it will not
impose penalties through December 31, 1997, on businesses that
make timely deposits using paper federal tax deposit coupons
while converting to the EFTPS system.
---------------------------------------------------------------------------
\160\ IR-97-32.
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that it is necessary to provide small
businesses with additional time prior to implementation of the
requirements so that these employers may be better informed
about their responsibilities.
Explanation of Provision
The Act provides that no penalty shall be imposed solely by
reason of a failure to use EFTPS prior to July 1, 1998, if the
taxpayer was first required to use the EFTPS system on or after
July 1, 1997.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to have no effect on Federal
fiscal year budget receipts.
2. Home office deduction: clarification of definition of principal
place of business (sec. 932 of the Act and sec. 280A of the
Code)
Present and Prior Law
A taxpayer's business use of his or her home may give rise
to a deduction for the business portion of expenses related to
operating the home (e.g., a portion of rent or depreciation and
repairs). Code section 280A(c)(1) provides, however, that
business deductions generally are allowed only with respect to
a portion of a home that is used exclusively and regularly in
one of the following ways: (1) as the principal place of
business for a trade or business; (2) as a place of business
used to meet with patients, clients, or customers in the normal
course of the taxpayer's trade or business; or (3) in
connection with the taxpayer's trade or business, if the
portion so used constitutes a separate structure not attached
to the dwelling unit. In the case of an employee, the Code
further requires that the business use of the home must be for
the convenience of the employer (sec. 280A(c)(1)).\161\ These
rules apply to houses, apartments, condominiums, mobile homes,
boats, and other similar property used as the taxpayer's home
(sec. 280A(f)(1)). Under Internal Revenue Service (IRS)
rulings, the deductibility of expenses incurred for local
transportation between a taxpayer's home and a work location
sometimes depends on whether the taxpayer's home office
qualifies under section 280A(c)(1) as a principal place of
business (see Rev. Rul. 94-47, 1994-29 I.R.B. 6).
---------------------------------------------------------------------------
\161\ If an employer provides access to suitable space on the
employer's premises for the conduct by an employee of particular
duties, then, if the employee opts to conduct such duties at home as a
matter of personal preference, the employee's use of the home office is
not ``for the convenience of the employer.'' See, e.g., W. Michael
Mathes, T.C. Memo 1990-483.
---------------------------------------------------------------------------
Prior to 1976, expenses attributable to the business use of
a residence were deductible whenever they were ``appropriate
and helpful'' to the taxpayer's business. In 1976, Congress
adopted section 280A, in order to provide a narrower scope for
the home office deduction, but did not define the term
``principal place of business.'' In Commissioner v. Soliman,
113 S.Ct. 701 (1993), the Supreme Court reversed lower court
rulings and upheld an IRS interpretation of section 280A that
disallowed a home office deduction for a self-employed
anesthesiologist who practiced at several hospitals but was not
provided office space at the hospitals. Although the
anesthesiologist used a room in his home exclusively to perform
administrative and management activities for his profession
(i.e., he spent two or three hours a day in his home office on
bookkeeping, correspondence, reading medical journals, and
communicating with surgeons, patients, and insurance
companies), the Supreme Court upheld the IRS position that the
``principal place of business'' for the taxpayer was not the
home office, because the taxpayer performed the ``essence of
the professional service'' at the hospitals.\162\ Because the
taxpayer did not meet with patients at his home office and the
room was not a separate structure, a deduction was not
available under the second or third exception under section
280A(c)(1) (described above).
---------------------------------------------------------------------------
\162\ In response to the Supreme Court's decision in Soliman, the
IRS revised its Publication 587, Business Use of Your Home, to more
closely follow the comparative analysis used in Soliman by focusing on
the following two primary factors in determining whether a home office
is a taxpayer's principal place of business: (1) the relative
importance of the activities performed at each business location; and
(2) the amount of time spent at each location.
---------------------------------------------------------------------------
Section 280A(c)(2) contains a special rule that allows a
home office deduction for business expenses related to a space
within a home that is used on a regular (even if not exclusive)
basis as a storage unit for the inventory or product samples of
the taxpayer's trade or business of selling products at retail
or wholesale, but only if the home is the sole fixed location
of such trade or business.
Home office deductions may not be claimed if they create
(or increase) a net loss from a business activity, although
such deductions may be carried over to subsequent taxable years
(sec. 280A(c)(5)).
Reasons for Change
The Congress believed that the Supreme Court's decision in
Soliman unfairly denied a home office deduction to a growing
number of taxpayers who manage their business activities from
their homes. Thus, the statutory modification adopted by the
Congress will reduce the prior-law bias in favor of taxpayers
who manage their business activities from outside their homes,
thereby enabling more taxpayers to work efficiently at home,
save commuting time and expenses, and spend additional time
with their families. Moreover, the statutory modification is an
appropriate response to the computer and information
revolution, which has made it more practical for taxpayers to
manage trade or business activities from a home office.
Explanation of Provision
Section 280A is amended to specifically provide that a home
office qualifies as the ``principal place of business'' if (1)
the office is used by the taxpayer to conduct administrative or
management activities of a trade or business and (2) there is
no other fixed location of the trade or business where the
taxpayer conducts substantial administrative or management
activities of the trade or business. As under present law,
deductions will be allowed for a home office meeting the above
two-part test only if the office is exclusively used on a
regular basis as a place of business by the taxpayer and, in
the case of an employee, only if such exclusive use is for the
convenience of the employer.
Thus, under the provision, a home office deduction is
allowed (subject to the present-law ``convenience of the
employer'' rule governing employees) if a portion of a
taxpayer's home is exclusively and regularly used to conduct
administrative or management activities for a trade or business
of the taxpayer, who does not conduct substantial
administrative or management activities at any other fixed
location of the trade or business, regardless of whether
administrative or management activities connected with his
trade or business (e.g., billing activities) are performed by
others at other locations. The fact that a taxpayer also
carries out administrative or management activities at sites
that are not fixed locations of the business, such as a car or
hotel room, will not affect the taxpayer's ability to claim a
home office deduction under the provision. Moreover, if a
taxpayer conducts some administrative or management activities
at a fixed location of the business outside the home, the
taxpayer still is eligible to claim a deduction so long as the
administrative or management activities conducted at any fixed
location of the business outside the home are not substantial
(e.g., the taxpayer occasionally does minimal paperwork at
another fixed location of the business). In addition, a
taxpayer's eligibility to claim a home office deduction under
the provision will not be affected by the fact that the
taxpayer conducts substantial non-administrative or non-
management business activities at a fixed location of the
business outside the home (e.g., meeting with, or providing
services to, customers, clients, or patients at a fixed
location of the business away from home).
If a taxpayer in fact does not perform substantial
administrative or management activities at any fixed location
of the business away from home, then the second part of the
test will be satisfied, regardless of whether or not the
taxpayer opted not to use an office away from home that was
available for the conduct of such activities. However, in the
case of an employee, the question whether an employee chose not
to use suitable space made available by the employer for
administrative activities is relevant to determining whether
the present-law ``convenience of the employer'' test is
satisfied. In cases where a taxpayer's use of a home office
does not satisfy the provision's two-part test, the taxpayer
nonetheless may be able to claim a home office deduction under
the present-law ``principal place of business'' exception or
any other provision of section 280A.
Effective Date
The provision applies to taxable years beginning after
December 31, 1998.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $119 million in 1999, $244 million in 2000,
$253 million in 2001, $263 million in 2002, $274 million in
2003, $285 million in 2004, $295 million in 2005, $306 million
in 2006, and $318 million in 2007.
3. Income averaging for farmers (sec. 933 of the Act and sec. 1301 of
the Code)
Prior Law
The ability of an individual taxpayer to reduce his or her
tax liability by averaging his or her income over a number of
years was repealed by the Tax Reform Act of 1986.
Explanation of Provision
In general, an individual taxpayer is allowed to elect to
compute his or her current year tax liability by averaging,
over the prior three-year period, all or a portion of his or
her taxable income from the trade or business of farming.
The provision operates such that an electing eligible
taxpayer (1) designates all or a portion of his or her taxable
income attributable to any farming business \163\ of the
taxpayer from the current year as ``elected farm income;''
\164\ (2) allocates one-third of such ``elected farm income''
to each of the prior three taxable years; and (3) determines
his or her current year section 1 tax liability by determining
the sum of (a) his or her current year section 1 liability
without the elected farm income allocated to the three prior
taxable years plus (b) the increases in the section 1 tax for
each of the three prior taxable years by taking into account
the allocable share of the elected farm income for such years.
If a taxpayer elects the operation of the provision for a
taxable year, the allocation of elected farm income among
taxable years pursuant to the election shall apply for purposes
of any election in a subsequent taxable year.
---------------------------------------------------------------------------
\163\ The term ``farming business'' has the same meaning given such
term by sec. 263A(e)(4).
\164\ The amount of elected farm income of a taxpayer for a taxable
year may not exceed the taxable income attributable to any farming
business for the year.
---------------------------------------------------------------------------
Taxable income attributable to any farming business may
include gain from the sale or other disposition of property
(other than land) regularly used by the taxpayer in his or her
farming business for a substantial period.
The provision does not apply for employment tax purposes,
or to an estate or a trust. Further, the provision does not
apply for purposes of the alternative minimum tax under section
55. Finally, the provision does not require the recalculation
of the tax liability of any other taxpayer, including a minor
child required to use the tax rates of his or her parents under
section 1(g).
The election shall be made in the manner prescribed by the
Secretary of the Treasury and, except as provided by the
Secretary, shall be irrevocable. In addition, the Secretary of
the Treasury shall prescribe such regulations as are necessary
to carry out the purposes of the provision, including
regulations regarding the order and manner in which items of
income, gain, deduction, loss, and credits (and any limitations
thereon) are to be taken into account for purposes of the
provision and the application of the provision to any short
taxable year. It is expected that such regulations will deny
the multiple application of items that carry over from one
taxable year to the next (e.g., net operating loss or tax
credit carryovers).
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997, and before January 1, 2001.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $1 million in 1997, $10 million in 1998, $53
million in 1999, $54 million in 2000, and $50 million in 2001.
4. Increase deduction for health insurance costs of self-employed
individuals (sec. 934 of the Act and sec. 162(l) of the Code)
Present and Prior Law
Under present and prior law, self-employed individuals are
entitled to deduct a portion of the amount paid for health
insurance for the self-employed individual and the individual's
spouse and dependents. Under prior law, the deduction was 40
percent in 1997; 45 percent in 1998 through 2002; 50 percent in
2003; 60 percent in 2004; 70 percent in 2005; and 80 percent in
2006 and thereafter. Under present and prior law, the deduction
for health insurance expenses of self-employed individuals is
not available for any month in which the taxpayer is eligible
to participate in a subsidized health plan maintained by the
employer of the taxpayer or the taxpayer's spouse.
Under present and prior law employees can exclude from
income 100 percent of employer-provided health insurance.
Reasons for Change
The Congress believed that it was appropriate to continue
to increase the amount self-employed individuals are entitled
to deduct for their health insurance expenses.
Explanation of Provision
The Act permits self-employed individuals to deduct a
higher percentage of the amount paid for health insurance is as
follows: the deduction is 40 percent in 1997, 45 percent in
1998 and 1999, 50 percent in 2000 and 2001, 60 percent in 2002,
80 percent in 2003 through 2005, 90 percent in 2006, and 100
percent in 2007 and all years thereafter.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1996.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $39 million in 2000, $120 million in 2001,
$224 million in 2002, $605 million in 2003, $882 million in
2004, $601 million in 2005, $404 million in 2006, and $604
million in 2007.
5. Moratorium on regulations regarding employment taxes of limited
partners (sec. 935 of the Act and sec. 1402 of the Code)
Present and Prior Law
Under the Self-Employment Contributions Act, taxes are
imposed on an individual's net earnings from self employment. A
limited partner's net earnings from self employment include
guaranteed payments made to the individual for services
actually rendered and do not include a limited partner's
distributive share of the income or loss of the partnership.
The Department of the Treasury issued proposed regulations
defining a limited partner for this purpose. These regulations
provided, among other things, that an individual is not a
limited partner if the individual participates in the
partnership business for more than 500 hours during the taxable
year. The regulations were proposed to be effective with the
individual's first taxable year beginning on or after the date
the regulations are published in the Federal Register.
Explanation of Provision
Any regulations relating to the definition of a limited
partner for self-employment tax purposes cannot be issued or
effective before July 1, 1998.
Revenue Effect
The provision is estimated to have no effect on Federal
fiscal year budget receipts.
E. Expensing of Environmental Remediation Costs
(``Brownfields'') (sec. 941 of the Act and new sec. 198
of the Code)
Present and Prior Law
Code section 162 allows a deduction for ordinary and
necessary expenses paid or incurred in carrying on any trade or
business. Treasury Regulations provide that the cost of
incidental repairs which neither materially add to the value of
property nor appreciably prolong its life, but keep it in an
ordinarily efficient operating condition, may be deducted
currently as a business expense. Section 263(a)(1) limits the
scope of section 162 by prohibiting a current deduction for
certain capital expenditures. Treasury Regulations define
``capital expenditures'' as amounts paid or incurred to
materially add to the value, or substantially prolong the
useful life, of property owned by the taxpayer, or to adapt
property to a new or different use. Amounts paid for repairs
and maintenance do not constitute capital expenditures. The
determination of whether an expense is deductible or
capitalizable is based on the facts and circumstances of each
case.
Treasury regulations provide that capital expenditures
include the costs of acquiring or substantially improving
buildings, machinery, equipment, furniture, fixtures and
similar property having a useful life substantially beyond the
current year. In INDOPCO, Inc. v. Commissioner, 503 U.S. 79
(1992), the Supreme Court required the capitalization of legal
fees incurred by a taxpayer in connection with a friendly
takeover by one of its customers on the grounds that the merger
would produce significant economic benefits to the taxpayer
extending beyond the current year; capitalization of the costs
thus would match the expenditures with the income produced.
Similarly, the amount paid for the construction of a filtration
plant, with a life extending beyond the year of completion, and
as a permanent addition to the taxpayer's mill property, was a
capital expenditure rather than an ordinary and necessary
current business expense. Woolrich Woolen Mills v. United
States, 289 F.2d 444 (3d Cir. 1961) .
Although Treasury regulations provide that expenditures
that materially increase the value of property must be
capitalized, they do not set forth a method of determining how
and when value has been increased. In Plainfield-Union Water
Co. v. Commissioner, 39 T.C. 333 (1962), nonacq., 1964-2 C.B.
8, the U.S. Tax Court held that increased value was determined
by comparing the value of an asset after the expenditure with
its value before the condition necessitating the expenditure.
The Tax Court stated that ``an expenditure which returns
property to the state it was in before the situation prompting
the expenditure arose, and which does not make the relevant
property more valuable, more useful, or longer-lived, is
usually deemed a deductible repair.''
In several Technical Advice Memoranda (TAM), the Internal
Revenue Service (IRS) declined to apply the Plainfield-Union
valuation analysis, indicating that the analysis represents
just one of several alternative methods of determining
increases in the value of an asset. In TAM 9240004 (June 29,
1992), the IRS required certain asbestos removal costs to be
capitalized rather than expensed. In that instance, the
taxpayer owned equipment that was manufactured with insulation
containing asbestos; the taxpayer replaced the asbestos
insulation with less thermally efficient, non-asbestos
insulation. The IRS concluded that the expenditures resulted in
a material increase in the value of the equipment because the
asbestos removal eliminated human health risks, reduced the
risk of liability to employees resulting from the
contamination, and made the property more marketable.
Similarly, in TAM 9411002 (November 19, 1993), the IRS required
the capitalization of expenditures to remove and replace
asbestos in connection with the conversion of a boiler room to
garage and office space. However, the IRS permitted deduction
of costs of encapsulating exposed asbestos in an adjacent
warehouse.
In 1994, the IRS issued Rev. Rul. 94-38, 1994-1 C.B. 35,
holding that soil remediation expenditures and ongoing water
treatment expenditures incurred to clean up land and water that
a taxpayer contaminated with hazardous waste are deductible. In
this ruling, the IRS explicitly accepted the Plainfield-Union
valuation analysis.\165\ However, the IRS also held that costs
allocable to constructing a groundwater treatment facility are
capital expenditures.
---------------------------------------------------------------------------
\165\ Rev. Rul. 94-38 generally rendered moot the holding in TAM
9315004 (December 17, 1992) requiring a taxpayer to capitalize certain
costs associated with the remediation of soil contaminated with
polychlorinated biphenyls (PCBs).
---------------------------------------------------------------------------
In 1995, the IRS issued TAM 9541005 (October 13, 1995)
requiring a taxpayer to capitalize certain environmental study
costs, as well as associated consulting and legal fees. The
taxpayer acquired the land and conducted activities causing
hazardous waste contamination. After the contamination, but
before it was discovered, the company donated the land to the
county to be developed into a recreational park. After the
county discovered the contamination, it reconveyed the land to
the company for $1. The company incurred the costs in
developing a remediation strategy. The IRS held that the costs
were not deductible under section 162 because the company
acquired the land in a contaminated state when it purchased the
land from the county. In January, 1996, the IRS revoked and
superseded TAM 9541005 (TAM 9627002). Noting that the company's
contamination of the land and liability for remediation were
unchanged during the break in ownership by the county, the IRS
concluded that the break in ownership should not, in and of
itself, operate to disallow a deduction under section 162.
Reasons for Change
To encourage the cleanup of contaminated sites, as well as
to eliminate uncertainty regarding the appropriate treatment of
environmental remediation expenditures for Federal tax law
purposes, the Congress believed that it is appropriate to
provide clear and consistent rules regarding the Federal tax
treatment of certain environmental remediation expenses.
Explanation of Provision
The Act provides that taxpayers can elect to treat certain
environmental remediation expenditures that would otherwise be
chargeable to capital account as deductible in the year paid or
incurred. The deduction applies for both regular and
alternative minimum tax purposes. The expenditure must be
incurred in connection with the abatement or control of
hazardous substances at a qualified contaminated site. In
general, any expenditure for the acquisition of depreciable
property used in connection with the abatement or control of
hazardous substances at a qualified contaminated site does not
constitute a qualified environmental remediation expenditure.
However, depreciation deductions allowable for such property,
which would otherwise be allocated to the site under the
principles set forth in Commissioner v. Idaho Power Co.\166\
and section 263A, are treated as qualified environmental
remediation expenditures.
---------------------------------------------------------------------------
\166\ Commissioner v. Idaho Power Co., 418 U.S. 1 (1974) (holding
that equipment depreciation allocable to the taxpayer's construction of
capital facilities must be capitalized under section 263(a)(1)).
---------------------------------------------------------------------------
A ``qualified contaminated site'' generally is any property
that (1) is held for use in a trade or business, for the
production of income, or as inventory; (2) is certified by the
appropriate State environmental agency to be located within a
targeted area; and (3) contains (or potentially contains) a
hazardous substance (so-called ``brownfields''). Targeted areas
are defined as: (1) empowerment zones and enterprise
communities as designated under present law and under the Act
\167\ (including any supplemental empowerment zone designated
on December 21, 1994); (2) sites announced before February,
1997, as being subject to one of the 76 Environmental
Protection Agency (``EPA'') Brownfields Pilots; (3) any
population census tract with a poverty rate of 20 percent or
more; and (4) certain industrial and commercial areas that are
adjacent to tracts described in (3) above.
---------------------------------------------------------------------------
\167\ Thus, the 22 additional empowerment zones authorized to be
designated under the Act, as well as the D.C. Enterprise Zone
established under Title VII of the Act, are ``targeted areas'' for
purposes of this provision.
---------------------------------------------------------------------------
Both urban and rural sites qualify. However, sites that are
identified on the national priorities list under the
Comprehensive Environmental Response, Compensation, and
Liability Act of 1980 (``CERCLA'') cannot qualify as targeted
areas. The chief executive officer of a State, in consultation
with the Administrator of the EPA, could designate an
appropriate State environmental agency. If no State
environmental agency was so designated within 60 days of the
date of enactment, the appropriate environmental agency for
such State shall be designated by the Administrator of the EPA.
Hazardous substances generally are defined by reference to
sections 101(14) and 102 of CERCLA, subject to additional
limitations applicable to asbestos and similar substances
within buildings, certain naturally occurring substances such
as radon, and certain other substances released into drinking
water supplies due to deterioration through ordinary use.
The Act further provides that, in the case of property to
which a qualified environmental remediation expenditure
otherwise would have been capitalized, any deduction allowed
under the Act is treated as a depreciation deduction and the
property is treated as section 1245 property. Thus, deductions
for qualified environmental remediation expenditures are
subject to recapture as ordinary income upon sale or other
disposition of the property. The Act also provides that
sections 280B (demolition of structures) and 468 (special rules
for mining and solid waste reclamation and closing costs) shall
not apply to amounts which are treated as expenses under this
provision.
Finally, the Congress clarified that providing current
deductions for certain environmental remediation expenditures
under the Act creates no inference as to the proper treatment
of other remediation expenditures not described in the Act.
Effective Date
The provision applies only to eligible expenditures paid or
incurred in taxable years ending after August 5, 1997 (the date
of enactment), and before January 1, 2001.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $57 million in 1998, $132 million in 1999,
$165 million in 2000, and $63 million in 2001. The provision is
estimated to increase Federal fiscal year budget receipts by
less than $500,000 in 2002, $2 million in 2003, $9 million in
2004, $17 million in 2005, $19 million in 2006, and $18 million
in 2007.
F. Empowerment Zones and Enterprise Communities
(secs. 951-956 of the Act and secs. 1391, 1392, 1394, 1396,
1397A, 1397B, and 1397C of the Code)
Present and Prior Law
In general
Pursuant to the Omnibus Budget Reconciliation Act of 1993
(OBRA 1993), the Secretaries of the Department of Housing and
Urban Development (HUD) and the Department of Agriculture
designated a total of nine empowerment zones and 95 enterprise
communities on December 21, 1994. As required by law, six
empowerment zones are located in urban areas (with aggregate
population for the six designated urban empowerment zones
limited to 750,000) and three empowerment zones are located in
rural areas.\168\ Of the enterprise communities, 65 are located
in urban areas and 30 are located in rural areas (sec. 1391).
Designated empowerment zones and enterprise communities were
required to satisfy certain eligibility criteria, including
specified poverty rates and population and geographic size
limitations (sec. 1392).
---------------------------------------------------------------------------
\168\ The six designated urban empowerment zones are located in New
York City, Chicago, Atlanta, Detroit, Baltimore, and Philadelphia-
Camden (New Jersey). The three designated rural empowerment zones are
located in Kentucky Highlands (Clinton, Jackson, and Wayne counties,
Kentucky), Mid-Delta Mississippi (Bolivar, Holmes, Humphreys, Leflore
counties, Mississippi), and Rio Grande Valley Texas (Cameron, Hidalgo,
Starr, and Willacy counties, Texas).
---------------------------------------------------------------------------
The following tax incentives are available for certain
businesses located in empowerment zones: (1) a 20-percent wage
credit for the first $15,000 of wages paid to a zone resident
who works in the zone;\169\ (2) an additional $20,000 of
section 179 expensing for ``qualified zone property'' placed in
service by an ``enterprise zone business'' (accordingly,
certain businesses operating in empowerment zones are allowed
up to $38,000 of expensing for section 179 property placed in
service in 1997); and (3) special tax-exempt financing for
certain zone facilities (described in more detail below).
---------------------------------------------------------------------------
\169\ For wages paid in calendar years during the period 1994
through 2001, the credit rate is 20 percent. The credit rate will be
reduced to 15 percent for calendar year 2002, 10 percent for calendar
year 2003, and 5 percent for calendar year 2004. No wage credit will be
available after 2004.
---------------------------------------------------------------------------
The 95 enterprise communities are eligible for the special
tax-exempt financing benefits but not the other tax incentives
available in the nine empowerment zones. In addition to these
tax incentives, OBRA 1993 provided that Federal grants would be
made to designated empowerment zones and enterprise
communities.
The tax incentives for empowerment zones and enterprise
communities generally are available during the period that the
designation remains in effect--i.e., the 10-year period of 1995
through 2004.
Definition of ``qualified zone property''
Section 1397C defines ``qualified zone property'' as
depreciable tangible property provided that: (1) the property
is acquired by the taxpayer (from an unrelated party) after the
zone or community designation took effect; (2) the original use
of the property in the zone or community commences with the
taxpayer; and (3) substantially all of the use of the property
is in the zone or community in the active conduct of a trade or
business by the taxpayer in the zone or community. In the case
of property which is substantially renovated by the taxpayer,
however, the property need not be acquired by the taxpayer
after zone or community designation or originally used by the
taxpayer within the zone or community if, during any 24-month
period after zone or community designation, the additions to
the taxpayer's basis in the property exceed 100 percent of the
taxpayer's basis in the property at the beginning of the
period, or $5,000 (whichever is greater).
Definition of ``enterprise zone business''
Prior to enactment of the Taxpayer Relief Act of 1997 (the
Act), section 1397B defined the term ``enterprise zone
business'' as a corporation or partnership (or proprietorship)
if for the taxable year: (1) every trade or business of the
corporation or partnership is the active conduct of a qualified
business within an empowerment zone or enterprise
community;\170\ (2) at least 80 percent of the total gross
income is derived from the active conduct of a ``qualified
business'' within a zone or community; (3) substantially all of
the business's tangible property is used within a zone or
community; (4) substantially all of the business's intangible
property is used in, and exclusively related to, the active
conduct of such business; (5) substantially all of the services
performed by employees are performed within a zone or
community; (6) at least 35 percent of the employees are
residents of the zone or community; and (7) no more than 5
percent of the average of the aggregate unadjusted bases of the
property owned by the business is attributable to (a) certain
financial property, or (b) collectibles not held primarily for
sale to customers in the ordinary course of an active trade or
business.
---------------------------------------------------------------------------
\170\ A qualified proprietorship is not required to meet a
requirement that every trade or business of the proprietor is the
active conduct of a qualified business within the empowerment zone or
enterprise community.
---------------------------------------------------------------------------
A ``qualified business'' is defined as any trade or
business other than a trade or business that consists
predominantly of the development or holding of intangibles for
sale or license.\171\ In addition, the leasing of real property
that is located within the empowerment zone or community to
others is treated as a qualified business only if (1) the
leased property is not residential property, and (2) at least
50 percent of the gross rental income from the real property is
from enterprise zone businesses. Prior to enactment of the Act,
the rental of tangible personal property to others was not a
qualified business unless substantially all of the rental of
such property was by enterprise zone businesses or by residents
of an empowerment zone or enterprise community.
---------------------------------------------------------------------------
\171\ Also, a qualified business does not include certain
facilities described in section 144(c)(6)(B)(i.e., a private or
commercial golf course, country club, massage parlor, hot tub facility,
suntan facility, racetrack or other facility used for gambling, or any
store the principal business of which is the sale of alcoholic
beverages for consumption off premises) or certain large farms.
---------------------------------------------------------------------------
Tax-exempt financing rules
Tax-exempt private activity bonds may be issued to finance
certain facilities in empowerment zones and enterprise
communities. These bonds, along with most private activity
bonds, are subject to an annual private activity bond State
volume cap equal to $50 per resident of each State, or (if
greater) $150 million per State.
Qualified enterprise zone facility bonds are bonds 95
percent or more of the net proceeds of which are used to
finance (1) ``qualified zone property'' (as defined
above),\172\ the principal user of which is an ``enterprise
zone business'' (also defined above), or (2) functionally
related and subordinate land located in the empowerment zone or
enterprise community. These bonds may only be issued while an
empowerment zone or enterprise community designation is in
effect.
---------------------------------------------------------------------------
\172\ For purposes of the tax-exempt financing rules, an
``enterprise zone business'' also includes a business located in a zone
or community which would qualify as an enterprise zone business if it
were separately incorporated.
---------------------------------------------------------------------------
The aggregate face amount of all qualified enterprise zone
bonds for each qualified enterprise zone business may not
exceed $3 million per zone or community. In addition, total
qualified enterprise zone bond financing for each principal
user of these bonds may not exceed $20 million for all zones
and communities.
Reasons for Change
The Congress believed that it is appropriate to provide for
the designation of additional empowerment zones and to
liberalize the definition of ``enterprise zone business'' and
tax-exempt financing rules that apply for purposes of all
empowerment zones and enterprise communities. In addition, in
view of the unique characteristics of the States of Alaska and
Hawaii, and the economically depressed areas within those
States, the Congress believed that the generally applicable
criteria for designation of empowerment zones and enterprise
communities should be modified in the event of future
designations of such zones or communities in those States.
Explanation of Provision
Two additional empowerment zones with same tax incentives as previously
designated empowerment zones
The Act authorizes the Secretary of HUD to designate two
additional empowerment zones located in urban areas (thereby
increasing to eight the total number of empowerment zones
located in urban areas) with respect to which apply the same
tax incentives (i.e., the wage credit, additional expensing,
and special tax-exempt financing) as are available within the
empowerment zones authorized by OBRA 1993.\173\ The two
additional empowerment zones are subject to the same
eligibility criteria under present-law section 1392 that
applied to the original six urban empowerment zones. In order
to permit designation of these two additional empowerment
zones, the aggregate population cap applicable to empowerment
zones located in urban areas is increased from 750,000 to a cap
of one million aggregate population for the eight urban
empowerment zones.
---------------------------------------------------------------------------
\173\ The wage credit available in the two new urban empowerment
zones is modified slightly to provide that the credit rate will be 20
percent for calendar years 2000-2004, 15 percent for calendar year
2005, 10 percent for calendar year 2006, and 5 percent for calendar
year 2007. No wage credit will be available in the two new urban
empowerment zones after 2007.
---------------------------------------------------------------------------
The two additional empowerment zones must be designated
within 180 days after enactment (i.e., the designations must be
made by February 1, 1998). However, a special rule provides
that the designations of these two additional empowerment zones
will not take effect until January 1, 2000 (and generally will
remain in effect for 10 years).
Designation of additional 20 empowerment zones
The Act also authorizes the Secretaries of HUD and
Agriculture to designate an additional 20 empowerment zones (no
more than 15 in urban areas and no more than five in rural
areas).\174\ With respect to these additional empowerment
zones, the present-law eligibility criteria are expanded
slightly in comparison to the eligibility criteria provided for
by OBRA 1993. First, the general square mileage limitations
(i.e., 20 square miles for urban areas and 1,000 square miles
for rural areas) are expanded to allow the empowerment zones to
include an additional 2,000 acres. This additional acreage,
which could be developed for commercial or industrial purposes,
is not subject to the poverty rate criteria and may be divided
among up to three noncontiguous parcels. In addition, the
general requirement that at least half of the nominated area
consist of census tracts with poverty rates of 35 percent or
more does not apply to the 20 additional empowerment zones.
However, under present-law section 1392(a)(4), at least 90
percent of the census tracts within a nominated area must have
a poverty rate of 25 percent or more, and the remaining census
tracts must have a poverty rate of 20 percent or more.\175\ For
this purpose, census tracts with populations under 2,000 are
treated as satisfying the 25-percent poverty rate criteria if
(1) at least 75 percent of the tract was zoned for commercial
or industrial use, and (2) the tract is contiguous to one or
more other tracts that actually have a poverty rate of 25
percent or more.\176\
---------------------------------------------------------------------------
\174\ In contrast to OBRA 1993, areas located within Indian
reservations are eligible for designation as one or more of the
additional 20 empowerment zones under the Act.
\175\ In lieu of the poverty criteria, out migration may be taken
into account in designating one rural empowerment zone.
\176\ A special rule enacted as part of the Act modifies the
present-law empowerment zone and enterprise community designation
criteria so that any zones or communities designated in the future in
the States of Alaska or Hawaii will not be subject to the general size
limitations, nor will such zones or communities be subject to the
general poverty-rate criteria. Instead, nominated areas in either State
will be eligible for designation as an empowerment zone or enterprise
community if, for each census tract or block group within such area, at
least 20 percent of the families have incomes which are 50 percent or
less of the State-wide median family income. Such zones and communities
will be subject to the population limitations under present-law section
1392(a)(1).
---------------------------------------------------------------------------
Within the 20 additional empowerment zones, qualified
``enterprise zone businesses'' are eligible to receive up to
$20,000 of additional section 179 expensing \177\ and to
utilize special tax-exempt financing benefits. In addition the
so-called ``brownfields'' tax incentive (provided for by the
Act, see E., above) is available. This incentive allows
taxpayers to expense (rather than capitalize) certain
environmental remediation expenditures incurred before January
1, 2001, at contaminated sites located within new or previously
designated empowerment zones or enterprise communities, as well
as certain other targeted areas. However, businesses within the
20 additional empowerment zones are not eligible to receive the
present-law wage credit available within the 11 other
designated empowerment zones (i.e., the wage credit is
available only within in the nine zones designated under OBRA
1993 and the two urban zones designated under the Act that are
eligible for the same tax incentives as are available in the
nine zones designated under OBRA 1993).
---------------------------------------------------------------------------
\177\ However, the additional section 179 expensing is not
available for any property substantially all the use of which is within
the additional 2,000 acres allowed to be included under the Act within
an empowerment zone.
---------------------------------------------------------------------------
The 20 additional empowerment zones are required to be
designated before 1999, and the designations generally will
remain in effect for 10 years.
Modification of definition of enterprise zone business
The Act modifies the prior-law requirement of section 1397B
that an entity may qualify as an ``enterprise zone business''
only if (in addition to the other criteria) at least 80 percent
of the total gross income of such entity is derived from the
active conduct of a qualified business within an empowerment
zone or enterprise community. The Act liberalizes this
requirement by reducing the percentage threshold so that an
entity may qualify as an enterprise zone business if at least
50 percent of the total gross income of such entity is derived
from the active conduct of a qualified business within an
empowerment zone or enterprise community (assuming that the
other criteria of section 1397B are satisfied). In addition,
section 1397B is modified so that rather than requiring that
``substantially all'' tangible and intangible property (and
employee services) of an enterprise zone business be used (and
performed) within a designated empowerment zone or enterprise
community, a ``substantial portion'' of tangible and intangible
property (and employee services) of an enterprise zone business
must be used (and performed) within a designated zone or
community. Moreover, the Act further amends the section 1397B
rule governing intangible assets so that a substantial portion
of an entity's intangible property must be used in the active
conduct of a qualified business within an empowerment zone or
enterprise community, but there is no need (as under prior law)
to determine whether the use of such assets is ``exclusively
related to'' such business.
Thus, as a result of the modifications made by the Act,
section 1397B defines the term ``enterprise zone business'' as
a corporation or partnership (or proprietorship) if for the
taxable year: (1) every trade or business \178\ of the
corporation or partnership is the active conduct of a qualified
business within an empowerment zone or enterprise community;
(2) at least 50 percent of the total gross income is derived
from the active conduct of a ``qualified business'' within a
zone or community; (3) a substantial portion of the business's
tangible property is used within a zone or community; (4) a
substantial portion of the business's intangible property is
used in the active conduct of such business; (5) a substantial
portion of the services performed by employees are performed
within a zone or community; (6) at least 35 percent of the
employees are residents of the zone or community; and (7) less
than five percent of the average of the aggregate unadjusted
bases of the property owned by the business is attributable to
(a) certain financial property, or (b) collectibles not held
primarily for sale to customers in the ordinary course of an
active trade or business.
---------------------------------------------------------------------------
\178\ A technical correction may be necessary to clarify that, for
purposes of this provision, as well as for purposes of defining the
term ``qualified business,'' the term ``trade or business'' encompasses
activities carried on a not-for-profit, as well as a for-profit basis.
For example, a trade association could be an ``enterprise zone
business'' if all the requirements of section 1397B were satisfied.
---------------------------------------------------------------------------
As under prior law, section 1397B(d)(4) continues to
provide that a ``qualified business'' does not include any
trade or business consisting predominantly of the development
or holding of intangibles for sale or license. The Act also
clarifies that an enterprise zone business that leases to
others commercial real property within a zone or community may
rely on a lessee's certification that the lessee is an
enterprise zone business. Finally, the Act provides that the
rental to others of tangible personal property shall be treated
as a qualified business if and only if at least 50 percent of
the rental of such property is by enterprise zone businesses or
by residents of a zone or community (rather than the prior-law
requirement that ``substantially all'' tangible personal
property rentals of an enterprise zone business satisfy this
test).
This modified ``enterprise zone business'' definition is
effective for taxable years beginning on or after August 5,
1997, with respect to all previously designated empowerment
zones and enterprise communities, the two urban empowerment
zones to be designated under theAct with the same tax
incentives as the previously designated empowerment zones, and the 20
additional empowerment zones to be designated under the Act.\179\
---------------------------------------------------------------------------
\179\ In addition, the modifications to the enterprise zone
business definition generally apply (with certain exceptions) for
purposes of defining a ``D.C. Zone business'' under certain provisions
of the Act that provide tax incentives for the District of Columbia (as
described in Title VII, above).
---------------------------------------------------------------------------
Tax-exempt financing rules
Exceptions to volume cap and issue size
So-called ``new empowerment zone facility bonds'' are
allowed to be issued for qualified enterprise zone businesses
in the 20 additional empowerment zones authorized to be
designated under the Act. These ``new empowerment zone facility
bonds'' are not subject to the State private activity bond
volume caps or the special limits on issue size generally
applicable to qualified enterprise zone facility bonds under
section 1394(c).\180\ The maximum amount of these bonds that
may be issued is limited to $60 million per rural zone, $130
million per urban zone with a population of less than 100,000,
and $230 million per urban zone with a population of 100,000 or
more.
---------------------------------------------------------------------------
\180\ ``New empowerment zone facility bonds'' may not be issued
with respect to the two urban empowerment zones to be designated under
the Act with the same tax incentives as the previously designated
empowerment zones.
---------------------------------------------------------------------------
Changes to certain rules applicable to both empowerment
zone facility bonds and qualified enterprise
community facility bonds
Qualified enterprise zone businesses located in newly
designated empowerment zones and enterprise communities--as
well as qualified enterprise zone businesses located in
previously designated empowerment zones and enterprise
communities--are eligible for special tax-exempt bond financing
under prior-law rules, subject to the modifications described
below (and the exceptions to the volume cap and issue size
described above for the 20 additional empowerment zones
authorized to be designated under the Act).
The Act waives until the end of a ``startup period'' the
requirement that 95 percent or more of the proceeds of bond
issue be used by a qualified enterprise zone business. With
respect to each property, the startup period ends at the
beginning of the first taxable year beginning more than two
years after the later of (1) the date of the bond issue
financing such property, or (2) the date the property was
placed in service (but in no event more than three years after
the date of bond issuance). This waiver is available only if,
at the beginning of the startup period, there is a reasonable
expectation that the use by a qualified enterprise zone
business would be satisfied at the end of the startup period
and the business makes bona fide efforts to satisfy the
enterprise zone business definition.
The Act also waives the requirements of an enterprise zone
business (other than the requirement that at least 35 percent
of the business' employees be residents of the zone or
community) for all years after a prescribed testing period
equal to first three taxable years after the startup period.
Finally, the Act relaxes the rehabilitation requirement for
financing existing property with qualified enterprise zone
facility bonds. In the case of property which is substantially
renovated by the taxpayer, the property need not be acquired by
the taxpayer after empowerment zone or enterprise community
designation or originally used by the taxpayer within the zone
if, during any 24-month period after empowerment zone or
enterprise community designation, the additions to the
taxpayer's basis in the property exceed 15 percent of the
taxpayer's basis at the beginning of the period, or $5,000
(whichever is greater).
Effective Date
The two additional urban empowerment zones (within which
would be available the same tax incentives as are available in
the empowerment zones designated pursuant to OBRA 1993) must be
designated by February 1, 1998, but the designation will not
take effect until January 1, 2000. The 20 additional
empowerment zones (within which the wage credit will not be
available) are to be designated after enactment of the Act but
prior to January 1, 1999. For purposes of the additional
section 179 expensing available within empowerment zones, the
modifications to the definition of ``enterprise zone business''
are effective for taxable years beginning on or after the date
of enactment of the Act (i.e., August 5, 1997).
The modifications to the tax-exempt financing rules are
effective for qualified enterprise zone facility bonds and the
new empowerment zone facility bonds issued after August 5,
1997.
Revenue Effect
The provisions are estimated to reduce Federal fiscal year
budget receipts by $82 million in 1998, $121 million in 1999,
$159 million in 2000, $185 million in 2001, $171 million in
2002, $154 million in 2003, $122 million in 2004, $94 million
in 2005, $64 million in 2006, and $38 million in 2007.
G. Other Provisions
1. Shrinkage estimates for inventory accounting (sec. 961 of the Act
and sec. 471 of the Code)
Present and Prior Law
Section 471(a) provides that ``(w)henever in the opinion of
the Secretary the use of inventories is necessary in order
clearly to determine the income of any taxpayer, inventories
shall be taken by such taxpayer on such basis as the Secretary
may prescribe as conforming as nearly as may be to the best
accounting practice in the trade or business and as most
clearly reflecting income.'' Where a taxpayer maintains book
inventories in accordance with a sound accounting system, the
net value of the inventory will be deemed to be the cost basis
of the inventory, provided that such book inventories are
verified by physical inventories at reasonable intervals and
adjusted to conform therewith.\181\ The physical count is used
to determine and adjust for certain items, such as undetected
theft, breakage, and bookkeeping errors, collectively referred
to as ``shrinkage.''
---------------------------------------------------------------------------
\181\ Treas. Reg. sec. 1.471-2(d).
---------------------------------------------------------------------------
Some taxpayers verify and adjust their book inventories by
a physical count taken on the last day of the taxable year.
Other taxpayers may verify and adjust their inventories by
physical counts taken at other times during the year. Still
other taxpayers take physical counts at different locations at
different times during the taxable year (cycle counting).
If a physical inventory is taken at year-end, the amount of
shrinkage for the year is known. If a physical inventory is not
taken at year-end, shrinkage through year-end will have to be
based on an estimate, or not taken into account until the
following year. In the first decision in Dayton Hudson v.
Commissioner,\182\ the U.S. Tax Court held that a taxpayer's
method of accounting may include the use of an estimate of
shrinkage occurring through year-end, provided the method is
sound and clearly reflects income. In the second decision in
Dayton Hudson v. Commissioner,\183\ the U.S. Tax Court adhered
to this holding. However, the U.S. Tax Court in the second
decision determined that this taxpayer had not established that
its method of accounting clearly reflected income. Other cases
decided by the U.S. Tax Court \184\ have held that taxpayers'
methods of accounting that included shrinkage estimates do
clearly reflect income.
---------------------------------------------------------------------------
\182\ 101 T.C. 462 (1993).
\183\ T.C. Memo 1997-260.
\184\ Wal-Mart v. Commissioner, T.C. Memo 1997-1 and Kroger v.
Commissioner, T.C. Memo 1997-2.
---------------------------------------------------------------------------
The U.S. Tax Court in the second Dayton Hudson opinion
noted that ``(i)n most cases, generally accepted accounting
principles (GAAP), consistently applied, will pass muster for
tax purposes. The Supreme Court has made clear, however, that
GAAP does not enjoy a presumption of accuracy that must be
rebutted by the Commissioner.''
Reasons for Change
The Congress believed that inventories should be kept in a
manner that clearly reflects income. The Congress also believed
that it is inappropriate to require a physical count of a
taxpayer's entire inventory to be taken exactly at year-end,
provided that physical counts are taken on a regular and
consistent basis. Where physical inventories are not taken at
year-end, the Congress believed that income will be more
clearly reflected if the taxpayer makes a reasonable estimate
of the shrinkage occurring through year-end. In the case of
retail trade inventories, the Congress believed that the
availability of a safe harbor shrinkage calculation would
facilitate the clear reflection of income.
The Congress believed that a taxpayer should have the
opportunity to change its method of accounting to a method that
keeps inventories using shrinkage estimates, so long as such
method is sound and clearly reflects income.
Explanation of Provision
The Act provides that a method of keeping inventories will
not be considered unsound, or to fail to clearly reflect
income, solely because it includes an adjustment for the
shrinkage estimated to occur through year-end, based on
inventories taken other than at year-end. Such an estimate must
be based on actual physical counts. Where such an estimate is
used in determining ending inventory balances, the taxpayer is
required to take a physical count of inventories at each
location on a regular and consistent basis. A taxpayer is
required to adjust its ending inventory to take into account
all physical counts performed through the end of its taxable
year.
The Secretary of the Treasury is expected to issue guidance
establishing one or more safe harbor methods for the estimation
of inventory shrinkage that will be deemed to result in a clear
reflection of income, provided such safe harbor method is
consistently applied and the taxpayer's inventory methods
otherwise satisfy the clear reflection of income standard.
For taxpayers primarily engaged in retail trade (the resale
of personal property to the general public), Congress
anticipates that a safe harbor method that will use a
historical ratio of shrinkage to sales, multiplied by total
sales between the date of the last physical inventory and year-
end will be available, provided physical inventories are
normally taken at each location at least annually. The Congress
anticipates that this historical ratio will be based on the
actual shrinkage established by all physical inventories taken
during the most recent three taxable years and the sales for
related periods. The historical ratio should be separately
determined for each store or department in a store of the
taxpayer. The historical ratio, or estimated shrinkage
determined using the historical ratio, cannot be adjusted by
judgmental or other factors (e.g., floors or caps). The
Congress expects that estimated shrinkage determined in
accordance with the consistent application of the safe harbor
method will not be required to be recalculated, through a
lookback adjustment or otherwise, to reflect the results of
physical inventories taken after year-end.
In the case of a new store or department in a store that
has not verified shrinkage by a physical inventory in each of
the most recent three taxable years, it is anticipated that the
historical ratio for that store or department will be the
average of the historical ratios of the retailer's other stores
or departments. Retailers using last in, first out (LIFO)
methods of inventory are expected to be required to allocate
shrinkage among their various inventory pools in a reasonable
and consistent manner.
The Congress expects that the Secretary of the Treasury
should provide procedures to allow an automatic election of
such method of accounting for a taxpayer's first taxable year
ending after the date of enactment. It is expected that any
adjustment required by section 481 as a result of the change in
method of accounting generally will be taken into account over
a period of four years.
Effective Date
The provision was effective for taxable years ending after
the date of enactment (August 5, 1997).
A taxpayer is permitted to change its method of accounting
by this section if the taxpayer is currently using a method
that does not utilize estimates of inventory shrinkage and
wishes to change to a method for inventories that includes
shrinkage estimates based on physical inventories taken other
than at year-end. Congress also anticipates that a taxpayer
primarily engaged in retail trade will be permitted to change
its method of accounting to the safe harbor method described
herein, without regard to whether the taxpayer is currently
using a method that utilizes estimates of inventory shrinkage.
Changes made pursuant to this provision are treated as
voluntary changes in method of accounting, initiated by the
taxpayer with the consent of the Secretary of the Treasury,
provided the taxpayer changes to a permissible method of
accounting (including the described safe harbor method, if the
taxpayer is eligible). The period for taking into account any
adjustment required under section 481 as a result of such a
change in method is 4 years.
No inference is intended with regard to whether any
particular method of accounting for inventories is permissible
under prior law.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $7 million in 1998, $21 million in 1999, $23
million in 2000, $25 million in 2001, $27 million in 2002, $29
million in 2003, $31 million in 2004, $33 million in 2005, $35
million in 2006 and $37 million in 2007.
2. Treatment of workmen's compensation liability under rules for
certain personal injury liability assignments (sec. 962 of the
Act and sec. 130 of the Code)
Present and Prior Law
Under present law, an exclusion from gross income is
provided for amounts received for agreeing to a qualified
assignment to the extent that the amount received does not
exceed the aggregate cost of any qualified funding asset (sec.
130). A qualified assignment means any assignment of a
liability to make periodic payments as damages (whether by suit
or agreement) on account of a personal injury or sickness (in a
case involving physical injury or physical sickness), provided
the liability is assumed from a person who is a party to the
suit or agreement, and the terms of the assignment satisfy
certain requirements. Generally, these requirements are that
(1) the periodic payments are fixed as to amount and time; (2)
the payments cannot be accelerated, deferred, increased, or
decreased by the recipient; (3) the assignee's obligation is no
greater than that of the assignor; and (4) the payments are
excludable by the recipient under section 104(a)(2) as damages
on account of personal injuries or sickness. Present and prior
law provide a separate exclusion under section 104(a)(1) for
the recipient of amounts received under workmen's compensation
acts as compensation for personal injuries or sickness, but
under prior law, a qualified assignment under section 130 did
not include the assignment of a liability to make such
payments.
Reasons for Change
Structured settlement arrangements are essentially conduit
arrangements in which the assignor of a liability, the assignee
(the structured settlement company) and the claimant (recipient
of benefits) share the economic benefit of the exclusion from
income provided under present law. The Congress understood that
some workmen's compensation payments involve periodic payments
(rather than lump sum payments). The Congress was persuaded
that additional economic security would be provided to
workmen's compensation claimants who receive periodic payments
if the payments are made through a structured settlement
arrangement, where the payor is generally subject to State
insurance company regulation that is aimed at maintaining
solvency of the company, in lieu of being made directly by
self-insuring employers that may not be subject to comparable
solvency-related regulation.
Explanation of Provision
The Act extends the exclusion for qualified assignments
under Code section 130 to amounts assigned for assuming a
liability to pay compensation under any workmen's compensation
act. The provision requires that the assignee assume the
liability from a person who is a party to the workmen's
compensation claim, and requires that the periodic payment be
excludable from the recipient's gross income under section
104(a)(1), in addition to the requirements of present law.
Effective Date
The provision is effective for workmen's compensation
claims filed after the date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $1 million in 1998, $2 million in 1999, $5
million in 2000, $8 million in 2001, $12 million in 2002, $17
million in 2003, $23 million in 2004, $29 million in 2005, $32
million in 2006, and $36 million in 2007.
3. Tax-exempt status for certain State workmen's compensation act
companies (sec. 963 of the Act and sec. 501(c)(27) of the Code)
Present and Prior Law
In general, the Internal Revenue Service (``IRS'') takes
the position that organizations that provide insurance for
their members or other individuals are not considered to be
engaged in a tax-exempt activity. The IRS maintains that such
insurance activity is either (1) a regular business of a kind
ordinarily carried on for profit, or (2) an economy or
convenience in the conduct of members' businesses because it
relieves the members from obtaining insurance on an individual
basis.
Certain insurance risk pools have qualified for tax
exemption under Code section 501(c)(6). In general, these
organizations (1) assign any insurance policies and
administrative functions to their member organizations
(although they may reimburse their members for amounts paid and
expenses); (2) serve an important common business interest of
their members; and (3) must be membership organizations
financed, at least in part, by membership dues.
State insurance risk pools may also qualify for tax exempt
status under section 501(c)(4) as a social welfare organization
or under section 115 as serving an essential governmental
function of a State. In seeking qualification under section
501(c)(4), insurance organizations generally are constrained by
the restrictions on the provision of ``commercial-type
insurance'' contained in section 501(m). Section 115 generally
provides that gross income does not include income derived from
the exercise of any essential governmental function and
accruing to a State or any political subdivision thereof.
Reasons for Change
The Congress believed that eliminating uncertainty
concerning the eligibility of certain State workmen's
compensation act companies for tax-exempt status would assist
States in ensuring workmen's compensation coverage for
uninsured employers with respect to employees in the State.
While tax exemption may have been available under prior law for
many of these entities, the Congress believed that it was
appropriate to clarify standards for tax-exempt status.
Explanation of Provision
The Act clarifies the tax-exempt status of any organization
that is created by State law, and organized and operated
exclusively to provide workmen's compensation insurance and
related coverage that is incidental to workmen's compensation
insurance,\185\ and that meets certain additional requirements.
The workmen's compensation insurance must be required by State
law, or be insurance with respect to which State law provides
significant disincentives if it is not purchased by an employer
(such as loss of exclusive remedy or forfeiture of affirmative
defenses such as contributory negligence). The organization
must provide workmen's compensation to any employer in the
State (for employees in the State or temporarily assigned out-
of-State) seeking such insurance and meeting other reasonable
requirements. The State must either extend its full faith and
credit to the initial debt of the organization or provide the
initial operating capital of such organization. For this
purpose, the initial operating capital can be provided by
providing the proceeds of bonds issued by a State authority;
the bonds may be repaid through exercise of the State's taxing
authority, for example. For periods after the date of
enactment, either the assets of the organization must revert to
the State upon dissolution, or State law must not permit the
dissolution of the organization absent an act of the State
legislature. Should dissolution of the organization become
permissible under applicable State law, then the requirement
that the assets of the organization revert to the State upon
dissolution applies. Finally, the majority of the board of
directors (or comparable oversight body) of the organization
must be appointed by an official of the executive branch of the
State or by the State legislature, or by both.
---------------------------------------------------------------------------
\185\ Related coverage that is incidental to workmen's compensation
insurance includes liability under Federal workmen's compensation laws,
the Jones Act, and the Longshore and Harbor Workers Compensation Act,
for example.
---------------------------------------------------------------------------
No inference is intended that the benefit plans of
organizations described in the provision are not properly
maintained by the organization. It is anticipated that Federal
regulatory agencies will take appropriate action to address
transition issues faced by organizations to conform their
benefit plans under the provision. For example, it is intended
that an organization that has been maintaining a section 457
plan as an agency or instrumentality of a State could (without
creating any inference with respect to prior-law treatment)
freeze future contributions to the section 457 plan and
establish a retirement arrangement (e.g., a section 401(k)
plan) that is consistent with the treatment of the organization
as a tax-exempt employer under the provision.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997. Many organizations described in the
provision have been operating as tax-exempt organizations. No
inference is intended that organizations described in the
provision are not tax-exempt under prior law.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $500,000 in each of 1998 and 1999,
and by $1 million per year in each of 2000 through 2007.
4. Election for 1987 partnerships to continue exception from treatment
of publicly traded partnerships as corporations (sec. 964 of
the Act and sec. 7704 of the Code)
Present and Prior Law
A publicly traded partnership generally is treated as a
corporation for Federal tax purposes (sec. 7704). An exception
to the rule treating the partnership as a corporation applies
if 90 percent of the partnership's gross income consists of
``passive-type income,'' which includes (1) interest (other
than interest derived in a financial or insurance business, or
certain amounts determined on the basis of income or profits),
(2) dividends, (3) real property rents (as defined for purposes
of the provision), (4) gain from the sale or other disposition
of real property, (5) income and gains relating to minerals and
natural resources (as defined for purposes of the provision),
and (6) gain from the sale or disposition of a capital asset
(or certain trade or business property) held for the production
of income of the foregoing types (subject to an exception for
certain commodities income).
The exception for publicly traded partnerships with
``passive-type income'' does not apply to any partnership that
would be described in section 851(a) of the Code (relating to
regulated investment companies, or ``RICs''), if that
partnership were a domestic corporation. Thus, a publicly
traded partnership that is registered under the Investment
Company Act of 1940 generally is treated as a corporation under
the provision. Nevertheless, if a principal activity of the
partnership consists of buying and selling of commodities
(other than inventory or property held primarily for sale to
customers) or futures, forwards and options with respect to
commodities, and 90 percent of the partnership's income is such
income, then the partnership is not treated as a corporation.
A publicly traded partnership is a partnership whose
interests are (1) traded on an established securities market,
or (2) readily tradable on a secondary market (or the
substantial equivalent thereof).
Treasury regulations provide detailed guidance as to when
an interest is treated as readily tradable on a secondary
market or the substantial equivalent. Generally, an interest is
so treated ``if, taking into account all of the facts and
circumstances, the partners are readily able to buy, sell, or
exchange their partnership interests in a manner that is
comparable, economically, to trading on an established
securities market'' (Treas. Reg. sec. 1.7704-1(c)(1)).
When the publicly traded partnership rules were enacted in
1987, a 10-year grandfather rule provided that the provisions
apply to certain existing partnerships only for taxable years
beginning after December 31, 1997.\186\ An existing publicly
traded partnership is any partnership, if (1) it was a publicly
traded partnership on December 17, 1987, (2) a registration
statement indicating that the partnership was to be a publicly
traded partnership was filed with the Securities and Exchange
Commission with respect to the partnership on or before
December 17, 1987, or (3) with respect to the partnership, an
application was filed with a State regulatory commission on or
before December 17, 1987, seeking permission to restructure a
portion of a corporation as a publicly traded partnership. A
partnership that otherwise would be treated as an existing
publicly traded partnership ceases to be so treated as of the
first day after December 17, 1987, on which there has been an
addition of a substantial new line of business with respect to
such partnership. A rule is provided to coordinate this
grandfather rule with the exception to the rule treating the
partnership as a corporation that applies if 90 percent of the
partnership's gross income consists of passive-type income. The
coordination rule provides that passive-type income exception
applies only after the grandfather rule ceases to apply
(whether by passage of time or because the partnership ceases
to qualify for the grandfather rule).
---------------------------------------------------------------------------
\186\ Omnibus Budget Reconciliation Act of 1987 (P.L. 100-203),
sec. 10211(c).
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that, in important respects, publicly
traded partnerships generally resemble corporations and should
be subject to tax as corporations, so long as the current
corporate income tax applies to corporate entities.
Nevertheless, in the case of certain publicly traded
partnerships that were existing on December 17, 1987, and that
are treated as partnerships under the grandfather rule until
December 31, 1997, it is appropriate to permit the continuation
of their status as partnerships, so long as they elect to be
subject to a tax that is intended to approximate the corporate
tax they would pay if they were treated as corporations for
Federal tax purposes.
Explanation of Provision
In the case of an electing 1987 partnership that elects to
be subject to a tax on gross income from the active conduct of
a trade or business, the rule of present law treating a
publicly traded partnership as a corporation does not apply. An
electing 1987 partnership means any publicly traded
partnership, if (1) it is an existing partnership within the
meaning of section 10211(c)(2) of the 1987 Act, (2) it has not
been treated as a corporation for taxable years beginning after
December 31, 1987, and before January 1, 1998 (and would not
have been treated as a corporation even without regard to
section 7704(c), the exception for partnerships with ``passive-
type'' income), and (3) the partnership elects under the
provision to be subject to a tax on gross income from the
active conduct of a trade or business. An electing 1987
partnership ceases to be treated as such as of the first day
after December 31, 1997, on which there has been the addition
of a substantial new line of business with respect to the
partnership. The election to be subject to the tax on gross
trade or business income, once made, remains in effect until
revoked by the partnership, and cannot be reinstated.
The tax is 3.5 percent of the partnership's gross income
from the active conduct of a trade or business. The
partnership's gross trade or business income includes its share
of gross trade or business income of any lower-tier
partnership. The tax imposed under the provision may not be
offset by tax credits, by either the partnership or the
partners; nor is the tax deductible by the partnership or the
partners (sec. 275).
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated neither to increase nor reduce
Federal fiscal year budget receipts for the years 1998 through
2007.
5. Exclusion from UBIT for certain corporate sponsorship payments (sec.
965 of the Act and new sec. 513(i) of the Code)
Present and Prior Law
Although generally exempt from Federal income tax, tax-
exempt organizations are subject to the unrelated business
income tax (``UBIT'') on income derived from a trade or
business regularly carried on that is not substantially related
to the performance of the organization's tax-exempt functions
(secs. 511-514). Contributions or gifts received by tax-exempt
organizations generally are not subject to the UBIT. However,
present-law section 513(c) provides that an activity (such as
advertising) does not lose its identity as a separate trade or
business merely because it is carried on within a larger
complex of other endeavors.\187\ If a tax-exempt organization
receives sponsorship payments in connection with an event or
other activity, the solicitation and receipt of such
sponsorship payments may be treated as a separate activity. The
Internal Revenue Service (IRS) has taken the position that,
under some circumstances, such sponsorship payments are subject
to the UBIT.\188\
---------------------------------------------------------------------------
\187\ See United States v. American College of Physicians, 475 U.S.
834 (1986) (holding that the activity of selling advertising in a
medical journal was not substantially related to the organization's
exempt purposes and, as a separate business under section 513(c), was
subject to tax).
\188\ See Prop. Treas. Reg. sec. 1.513-4 (issued January 19, 1993,
EE-74-92, IRB 1993-7, 71). These proposed regulations generally exclude
from the UBIT financial arrangements under which the tax-exempt
organization provides so-called ``institutional'' or ``good will''
advertising.
---------------------------------------------------------------------------
Reasons for Change
In order to reduce the uncertainty regarding the treatment
for UBIT purposes of corporate sponsorship payments received by
tax-exempt organizations, the Congress believed that it is
appropriate to distinguish sponsorship payments for which the
donor receives no substantial return benefit other than the use
or acknowledgment of the donor's name or logo as part of a
sponsored event (which should not be subject to the UBIT) from
payments made in exchange for advertising provided by the
recipient organization (which should be subject to the UBIT).
Explanation of Provision
Under the Act, qualified sponsorship payments received by a
tax-exempt organization (or State college or university
described in section 511(a)(2)(B)) are exempt from the UBIT.
``Qualified sponsorship payments'' are defined as any
payment made by a person engaged in a trade or business with
respect to which the person will receive no substantial return
benefit other than the use or acknowledgment of the name or
logo (or product lines) of the person's trade or business in
connection with the organization's activities.\189\ Such a use
or acknowledgment does not include advertising of such person's
products or services--meaning qualitative or comparative
language, price information or other indications of savings or
value, or an endorsement or other inducement to purchase, sell,
or use such products or services. Thus, for example, if, in
return for receiving a sponsorship payment, an organization
promises to use the sponsor's name or logo in acknowledging the
sponsor's support for an educational or fundraising event
conducted by the organization, such payment will not be subject
to the UBIT. In contrast, if the organization provides
advertising of a sponsor's products, the payment made to the
organization by the sponsor in order to receive such
advertising will be subject to the UBIT (provided that the
other, present-law requirements for UBIT liability are
satisfied).\190\
---------------------------------------------------------------------------
\189\ In determining whether a payment is a qualified sponsorship
payment, it is irrelevant whether the sponsored activity is related or
unrelated to the organization's exempt purpose.
\190\ As provided under Prop. Treas. Reg. sec. 1.513-4, the use of
promotional logos or slogans that are an established part of the
sponsor's identity would not, by itself, constitute advertising for
purposes of determining whether a payment is a qualified sponsorship
payment.
---------------------------------------------------------------------------
The term ``qualified sponsorship payment'' does not include
any payment where the amount of such payment is contingent, by
contract or otherwise, upon the level of attendance at an
event, broadcast ratings, or other factors indicating the
degree of public exposure to an activity. However, the fact
that a sponsorship payment is contingent upon an event actually
taking place or being broadcast, in and of itself, will not
cause the payment to fail to be a qualified sponsorship
payment. Moreover, mere distribution or display of a sponsor's
products by the sponsor or the tax-exempt organization to the
general public at a sponsored event, whether for free or for
remuneration, will be considered to be ``use or
acknowledgment'' of the sponsor's product lines (as opposed to
advertising), and thus will not affect the determination of
whether a payment made by the sponsor is a qualified
sponsorship payment.
The provision does not apply to payments that entitle the
payor to the use or acknowledgment of the payor's trade or
business name or logo (or product lines) in tax-exempt
organization periodicals. Such payments are outside the
qualified sponsorship payment provision's safe-harbor
exclusion, and, therefore, will be governed by present-law
rules that determine whether the payment is subject to the
UBIT. Thus, for example, payments that entitle the payor to a
depiction of the payor's name or logo in a tax-exempt
organization periodical may or may not be subject to the UBIT
depending on the application of present-law rules regarding
periodical advertising and nontaxable donor recognition.\191\
For this purpose, the term ``periodical'' means regularly
scheduled and printed material published by (or on behalf of)
the payee organization that is not related to and primarily
distributed in connection with a specific event conducted by
the payee organization.\192\ In addition, the safe-harbor
exclusion provided for by the provision does not apply to
payments made in connection with ``qualified convention or
trade show activities,'' as defined in present-law section
513(d)(3).
---------------------------------------------------------------------------
\191\ For guidance regarding the treatment of periodical
advertising under the UBIT, see section 513(c), United States v.
American College of Physicians, 475 U.S. 834 (1986); Treas. Reg. 1.513-
1(d)(4)(iv), Example 7; Rev. Rul. 82-139, 1982-2 C.B. 108; Rev. Rul.
74-38, 1974-1 C.B. 144; PLR 9137049; and PLR 9234002. For guidance
regarding the treatment of donor acknowledgments under the UBIT, see
Rev. Rul. 76-93, 1976-1 C.B. 170; PLR 8749085; and PLR 9044071. In the
interest of administrative convenience, the Treasury Department is
encouraged to permit tax-exempt entities to provide combined reporting
of payments that are both qualified sponsorship payments and nontaxable
payments made in exchange for donor acknowledgments in a periodical or
in connection with a qualified convention or trade show. In addition,
to the extent tax-exempt entities are required to allocate portions of
payments, the Treasury Department is encouraged to minimize the
reporting burden associated with any such allocation.
\192\ For example, the provision will not apply to payments that
lead to acknowledgments in a monthly journal, but will apply if a
sponsor receives an acknowledgment in a program or brochure distributed
at a sponsored event.
---------------------------------------------------------------------------
The provision specifically provides that, to the extent
that a portion of a payment would (if made as a separate
payment) be a qualified sponsorship payment, such portion of
the payment will be treated as a separate payment. Thus, if a
sponsorship payment made to a tax-exempt organization entitles
the sponsor to both product advertising and use or
acknowledgment of the sponsor's name or logo by the
organization, then the UBIT will not apply to the amount of
such payment that exceeds the fair market value of the product
advertising provided to the sponsor. Moreover, the provision of
facilities, services or other privileges by an exempt
organization to a sponsor or the sponsor's designees (e.g.,
complimentary tickets, pro-am playing spots in golf
tournaments, or receptions for major donors) in connection with
a sponsorship payment will not affect the determination of
whether the payment is a qualified sponsorship payment. Rather,
the provision of such goods or services will be evaluated as a
separate transaction in determining whether the organization
has unrelated business taxable income from the event. In
general, if such services or facilities do not constitute a
substantial return benefit or if the provision of such services
or facilities is a related business activity, then the payments
attributable to such services or facilities will not be subject
to the UBIT. Moreover, just as the provision of facilities,
services or other privileges by a tax-exempt organization to a
sponsor or the sponsor's designees (complimentary tickets, pro-
am playing spots in golf tournaments, or receptions for major
donors) will be treated as a separate transaction that does not
affect the determination of whether a sponsorship payment is a
qualified sponsorship payment, a sponsor's receipt of a license
to use an intangible asset (e.g., trademark, logo, or
designation) of the tax-exempt organization likewise will be
treated as separate from the qualified sponsorship transaction
in determining whether the organization has unrelated business
taxable income.
The exemption provided by the provision will be in addition
to other present-law exceptions from the UBIT (e.g., the
exceptions for activities substantially all the work for which
is performed by volunteers and for activities not regularly
carried on). No inference is intended as to whether any
sponsorship payment received prior to 1998 was subject to the
UBIT.
Effective Date
The provision applies to qualified sponsorship payments
solicited or received after December 31, 1997.
Revenue Effect
The provision is estimated to have a negligible revenue
effect on Federal fiscal year budget receipts.
6. Timeshare associations (sec. 966 of the Act and sec 528 of the Code)
Present and Prior Law
Taxation of homeowners associations making the section 528 election
Under present law (sec. 528), condominium management
associations and residential real estate management
associations may elect to be taxed at a 30-percent rate on
their ``homeowners association income'' if they meet certain
income, expenditure, and organizational requirements.
``Homeowners association income'' is the excess of the
association's gross income, excluding ``exempt function
income,'' over allowable deductions directly connected with
non-exempt function gross income. ``Exempt function income''
includes membership dues, fees, and assessments for a common
activity undertaken by association members or owners of
residential units in the condominium or subdivision. Homeowners
association income includes passive income (e.g., interest and
dividends) earned on reserves and fees for use of association
property (e.g., swimming pools, meeting rooms, etc.).
For an association to qualify for this treatment: (1) at
least 60 percent of the association's gross income must consist
of membership dues, fees, or assessments on owners; (2) at
least 90 percent of its expenditures must be for the
acquisition, management, maintenance, or care of ``association
property;'' and (3) no part of its net earnings can inure to
the benefit of any private shareholder. ``Association
property'' means: (1) property held by the association; (2)
property commonly held by association members; (3) property
within the association privately held by association members;
and (4) property held by a governmental unit for the benefit of
association members. In addition to these statutory
requirements, Treasury regulations require that the units of
the association be used for residential purposes. Use is not a
residential use if the unit is occupied by a person or series
of persons less than 30 days for more than half of the
association's taxable year. Treas. Reg. sec. 1.528-4(d).
Taxation of homeowners associations not making the section 528 election
Homeowners associations that do not (or cannot) make the
section 528 election are taxed either as tax-exempt social
welfare organizations under section 501(c)(4) or as regular C
corporations. In order for an organization to qualify as a tax-
exempt social welfare organization, the organization must meet
the following three requirements: (1) the association must
serve a ``community'' which bears a reasonable, recognizable
relationship to an area ordinarily identified as a governmental
subdivision or unit; (2) the association may not conduct
activities directed to exterior maintenance of any private
residence, and (3) common areas of association facilities must
be for the use and enjoyment of the general public (Rev. Rul.
74-99, 1974-1 C.B. 131).
Non-exempt homeowners associations are taxed as C
corporations, except that: (1) the association may exclude
excess assessments that it refunds to its members or applies to
the subsequent year's assessments (Rev. Rul. 70-604, 1970-2
C.B. 9); (2) gross income does not include special assessments
held in a special bank account (Rev. Rul. 75-370, 75-2 C.B.
25); and (3) assessments for capital improvements are treated
as non-taxable contributions to capital (Rev. Rul. 75-370,
1975-2 C.B. 25).
Taxation of timeshare associations
Under prior law, timeshare associations are taxed as
regular C corporations because (1) they cannot meet the
requirement of the Treasury regulations for the section 528
election that the units be used for residential purposes (i.e.,
the 30-day rule) and they have relatively large amount of
services performed for its owners (e.g., maid and janitorial
services) and (2) they cannot meet any of requirements of Rev.
Rul. 74-99 for tax-exempt status under section 501(c)(4).
Reasons for Change
The Congress understood that the IRS recently had
challenged the exclusions from gross income of timeshare
associations of refunds of excess assessments, special
assessments held in a segregated account, and capital
assessments as contributions to capital. See P.L.R. 9539001
(June 8, 1995). The Congress believed that the activities of
timeshare associations are sufficiently similar to those of
homeowners associations that they should be similarly taxed.
Accordingly, the Act extends the rules for the taxation of
homeowners associations to timeshare associations, except that
the rate of tax on timeshare associations is 32 percent,
instead of the 30-percent rate that applies to homeowner's
associations.
Explanation of Provision
In general
The Act amends section 528 to permit timeshare associations
to qualify for taxation under that section. Timeshare
associations will have to meet the requirements of section 528
(e.g., the 60-percent gross income, 90-percent expenditure, and
the non-profit organizational and operational requirements).
Timeshare associations electing to be taxed under section 528
are subject to a tax on their ``timeshare association income''
at a rate of 32 percent.
60-percent test
A qualified timeshare association must receive at least 60
percent of its income from membership dues, fees and
assessments from owners of either (a) timeshare rights to use
of, or (b) timeshare ownership in, property of the timeshare
association.
90-percent test
At least 90 percent of the expenditures of the timeshare
association must be for the acquisition, management,
maintenance, or care of ``association property,'' and
activities provided by the association to, or on behalf of,
members of the timeshare association. ``Activities provided to
or on behalf of members of the [timeshare] association''
include events located on association property (e.g., members'
meetings at the association's meeting room, parties at the
association's swimming pool, golf lessons on association's golf
range, transportation to and from association property, etc.).
Association property includes property in which a timeshare
association or members of the association have rights arising
out of recorded easements, covenants, and other recorded
instruments to use property related to the timeshare project.
Organizational and operational tests
No part of the net earnings of the timeshare association
can inure to the benefit (other than by acquiring,
constructing, or providing management, maintenance, and care of
property of the timeshare association or rebate of excess
membership dues, fees, or assessments) of any private
shareholder or individual. A member of a qualified timeshare
association must hold a timeshare right to use (or timeshare
ownership in) real property of the association. A qualified
timeshare association cannot be a condominium management
association. Lastly, the timeshare association must elect to be
taxed under section 528.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1996.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $1 million in each of the years 1998 through
2001 and by $2 million for each of the years 2002 through 2007.
7. Modification of advance refunding rules for certain tax-exempt bonds
issued by the Virgin Islands (sec. 967 of the Act and sec. 149
of the Code)
Present and Prior Law
In general
Interest on State and local government bonds generally is
excluded from gross income for purposes of the regular
individual and corporate income taxes if the proceeds of the
bonds are used to finance direct activities of these
governmental units (Code sec. 103).
Unlike the interest on governmental bonds, described
above, interest on private activity bonds generally is taxable.
A private activity bond is a bond issued by a State or local
governmental unit acting as a conduit to provide financing for
private parties in a manner violating either (1) a private
business use and payment test or (2) a private loan
restriction. However, interest on private activity bonds is not
taxable if (1) the financed activity is specified in the Code
and (2) at least 95 percent of the net proceeds of the bond
issue is used to finance the specified activity.
Issuers of State and local government bonds must satisfy
numerous other requirements, including arbitrage restrictions
(for all such bonds) and annual State volume limitations (for
most private activity bonds) for the interest on these bonds to
be excluded from gross income.
Advance refundings
Generally, a governmental bond originally issued after
December 31, 1985, may be advance refunded one time. An advance
refunding is any refunding where all of the refunded bonds are
not redeemed within 90 days after the refunding bonds are
issued. Private activity bonds may not be advance refunded.
Virgin Island bonds
Under prior law, the Virgin Islands was required to secure
its bonds with a priority first lien claim on specified revenue
streams rather than being permitted to issue multiple bond
issues secured on a parity basis by a common pool of revenues.
Under a recent non-tax law change, the priority lien
requirement was repealed.
Reasons for Change
The Congress believed that allowing an additional advance
refunding is appropriate to accommodate made changes to other,
nontax Federal restrictions on these bonds.
Explanation of Provision
Under the Act, one additional advance refunding is allowed
for governmental bonds issued by the Virgin Islands that were
advance refunded before June 9, 1997.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $2 million in 1998, $4 million in 1999, $5
million in 2000, $5 million in 2001, $5 million in 2002, $3
million in 2003, $1 million in 2004, $3 million in 2005, $4
million in 2006, and $4 million in 2007.
8. Deferral of gain on certain sales of farm product refiners and
processors (sec. 968 of the Act (canceled pursuant to Line Item
Veto Act) and sec. 1042 of the Code)
Present and Prior Law
Under present law, if certain requirements are satisfied,
a taxpayer may defer recognition of gain on the sale of
qualified securities to an employee stock ownership plan
(``ESOP'') or an eligible worker-owned cooperative to the
extent that the taxpayer reinvests the proceeds in qualified
replacement property (sec. 1042). Gain is recognized when the
taxpayer disposes of the qualified replacement property. One of
the requirements that must be satisfied for deferral to apply
is that, immediately after the sale, the ESOP must own at least
30 percent of the stock of the corporation issuing the
qualified securities. In general, qualified securities are
securities issued by a domestic C corporation that has no stock
outstanding that is readily tradeable on an established
securities market. Deferral treatment does not apply to gain on
the sale of qualified securities by a C corporation.
Reasons for Change
The Congress understood that much of the final value of
farm products often is generated not in their production on the
farm, but during the processing or refining of farm products
after those products leave the farm. The Congress believed
that, in order for farmers to share more of that final value,
farmers must directly or indirectly own some of the processing
or refining facilities. The Congress believed it appropriate to
facilitate the transfer of refiners and processors to farmers'
cooperatives by providing for the tax-free rollover of gain on
the sale of stock of a corporation that owns farm product
processing or refining facilities if the stock was sold to a
cooperative which was selling farm produce for refining or
processing in those facilities.
Explanation of Canceled Provision
As passed by Congress, the Act extended the deferral
provided under section 1042 to the sale of stock of a qualified
refiner or processor to an eligible farmers' cooperative. A
qualified refiner or processor is a domestic corporation
substantially all of the activities of which consist of the
active conduct of the trade or business of refining or
processing agricultural or horticultural products and which
purchases more than one-half of the products to be refined or
processed from farmers who make up the cooperative (or the
cooperative itself) which is purchasing the stock for at least
one year prior to the sale. An eligible farmers' cooperative is
an organization which is treated as a cooperative for Federal
income tax purposes and which is engaged in the marketing of
agricultural or horticultural products.
The deferral of gain is available only if, immediately
after the sale, the eligible farmers' cooperative owns 100
percent of the qualified refiner or processor. The provision
applies even if the stock of the qualified refiner or processor
is publicly traded. In addition, the provision applies to gain
on the sale of stock by a C corporation.
Effective Date
The provision would have applied to sales after December
31, 1997.
Revenue Effect
The provision was estimated to reduce Federal fiscal year
budget receipts by $2 million in 1998, $68 million in 1999, $5
million per year in 2000 and 2001, and $4 million per year in
each of the years 2002 through 2007.
Effect of Line Item Veto
This provision was identified by the Joint Committee on
Taxation as a limited tax benefit within the meaning of the
Line Item Veto Act. The President canceled this provision
pursuant to the Line Item Veto Act.\193\
---------------------------------------------------------------------------
\193\ A modified version of this provision is included in H.R. 2513
as passed by the House on November 8, 1997. (See report of the House
Committee on Ways and Means; H. Rept. 105-318, Part I, October 9,
1997).
---------------------------------------------------------------------------
9. Increased deduction for business meals while operating under
Department of Transportation hours of service limitations (sec.
969 of the Act and sec. 274 of the Code)
Present and Prior Law
Ordinary and necessary business expenses, as well as
expenses incurred for the production of income, are generally
deductible, subject to a number of restrictions and
limitations. Generally, the amount allowable as a deduction for
food and beverage is limited to 50 percent of the otherwise
deductible amount. Exceptions to this 50 percent rule are
provided for food and beverages provided to crew members of
certain vessels and offshore oil or gas platforms or drilling
rigs.
Reasons for Change
Individuals subject to the hours of service limitations of
the Department of Transportation are frequently forced to eat
meals away from home in circumstances where their choice is
limited, prices comparatively high and the opportunity for
lavish meals remote. The Congress believed that it is
appropriate to allow a higher percentage of the cost of food
and beverages consumed while away from home on business by
these individuals to be deducted than is allowed under the
general rule.
Explanation of Provision
The Act increased to 80 percent the deductible percentage
of the cost of food and beverages consumed while away from home
by an individual during, or incident to, a period of duty
subject to the hours of service limitations of the Department
of Transportation.
Individuals subject to the hours of service limitations of
the Department of Transportation include:
(1) certain air transportation employees such as pilots,
crew, dispatchers, mechanics, and control tower operators
pursuant to Federal Aviation Administration regulations,
(2) interstate truck operators and interstate bus drivers
pursuant to Department of Transportation regulations,
(3) certain railroad employees such as engineers,
conductors, train crews, dispatchers and control operations
personnel pursuant to Federal Railroad Administration
regulations, and
(4) certain merchant mariners pursuant to Coast Guard
regulations.
The increase in the deductible percentage is phased in
according to the following schedule:
Deductible
Taxable years beginning in-- percentage
1998, 1999................................................. 55
2000, 2001................................................. 60
2002, 2003................................................. 65
2004, 2005................................................. 70
2006, 2007................................................. 75
2008 and thereafter........................................ 80
Effective Date
The provision is effective for taxable years beginning
after 1997.
Revenue Effect
This provision and Act sec. 970 (described following) are
estimated to reduce Federal fiscal year budget receipts by $8
million in 1998, $17 million in 1999, $27 million in 2000, $37
million in 2001, $49 million in 2002, $62 million in 2003, $76
million in 2004, $91 million in 2005, $108 million in 2006 and
$125 million in 2007.
10. Deductibility of meals provided for the convenience of the employer
(sec. 970 of the Act and sec. 132 of the Code)
Present and Prior Law
In general, subject to several exceptions, only 50 percent
of business meal and entertainment expenses are allowed as a
deduction (sec. 274(n)). Under one exception, the value of
meals that are excludable from employees' incomes as a de
minimis fringe benefit (sec. 132) are fully deductible by the
employer.
In addition, the courts that have considered the issue have
held that if meals are provided for the convenience of the
employer pursuant to section 119 they are fully deductible
pursuant to sec. 274(n)(2)(B), provided they satisfy the
relevant section 132 requirements (Boyd Gaming Corp. v.
Commissioner \194\ and Gold Coast Hotel & Casino v. I.R.S.
\195\).
---------------------------------------------------------------------------
\194\ 106 T.C. 343 (1996).
\195\ U.S. D.C. Nev. CV-5-94-1146-HDM (LRL) (September 26, 1996).
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that it is consistent with the case
law to provide for full deductibility of business meals that
are excludible from employees' incomes because they are
provided for the convenience of the employer.
Explanation of Provision
The Act provides that meals that are excludable from
employees' incomes because they are provided for the
convenience of the employer pursuant to section 119 of the
Code, provided they satisfy the relevant section 132
requirements, are excludable as a de minimis fringe benefit and
therefore are fully deductible by the employer. No inference is
intended as to whether such meals are fully deductible under
present law.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The effect of this provision on Federal fiscal year budget
receipts is included in the estimate of the effect of the
provision allowing an increased deduction for business meals
while operating under Department of Transportation hours of
service limitations (Act sec. 969, above).
11. Modify limits on depreciation of luxury automobiles for certain
clean-burning fuel and electric vehicles (sec. 971 of the Act
and sec. 280F of the Code)
Present and Prior Law
The amount the taxpayer may claim as a depreciation
deduction for any passenger automobile is limited to: $2,560
for the first taxable year in the recovery period; $4,100 for
the second taxable year in the recovery period; $2,450 for the
third taxable year in the recovery period; and $1,475 for each
succeeding taxable year in the recovery period. Each of the
dollar limitations is indexed for inflation after October 1987
by the automobile component of the Consumer Price Index.
Consequently, the depreciation deduction limitations applicable
for 1997 are $3,160, $5,000, $3,050, and $1,775.
Reasons for Change
The Congress believed that the price of a clean-burning
fuel vehicle or an electric vehicle does not necessarily
represent the consumer's purchase of a luxury automobile.
Rather, the higher price of such vehicles often represents the
cost of the technology required to produce an automobile
designed to provide certain environmental benefits. The
Congress believed the cost of this technology should not be
considered a luxury for the purpose of the limitation on
depreciation that may be claimed on passenger automobiles.
Therefore, the Congress believed it is appropriate to modify
the limitation on depreciation that may be claimed on passenger
automobiles in the case of certain clean-burning fuel vehicles
and electric vehicles.
Explanation of Provision
The Act modifies the limitation on depreciation in the case
of qualified clean-burning fuel vehicles and certain electric
vehicles. With respect to qualified clean-burning fuel
vehicles, those that are modified to permit such vehicles to be
propelled by a clean burning fuel, the Act generally applies
the limitation to that portion of the vehicles' cost not
represented by the installed qualified clean-burning fuel
property. The taxpayer may claim an amount otherwise allowable
as a depreciation deduction on the installed qualified clean-
burning fuel property, without regard to the limitation.
Generally, this has the same effect as only subjecting the cost
of the vehicle before modification to the limitations.
In the case of a passenger vehicle designed to be propelled
primarily by electricity and built by an original equipment
manufacturer, the base-year limitation amounts of $2,560 for
the first taxable year in the recovery period, $4,100 for the
second taxable year in the recovery period, $2,450 for the
third taxable year in the recovery period, and $1,475 for each
succeeding taxable year in the recovery period are tripled to
$7,680, $12,300, $7,350, and $4,425, respectively, and then
adjusted for inflation after October 1987 by the automobile
component of the Consumer Price Index.
Effective Date
The provision is effective for property placed in service
after the date of enactment (August 5, 1997) and before January
1, 2005.
Revenue Effect
The provision is estimated to result in a negligible
reduction in Federal fiscal year budget receipts for years 1997
through 2007.
12. Temporary suspension of income limitations on percentage depletion
for production from marginal wells (sec. 972 of the Act and
sec. 613A of the Code)
Present and Prior Law
The Code permits taxpayers to recover their investments in
oil and gas wells through depletion deductions. In the case of
certain properties, the deductions may be determined using the
percentage depletion method. Among the limitations that apply
in calculating percentage depletion deductions is a restriction
that, for oil and gas properties, the amount deducted may not
exceed 100 percent of the net income from that property in any
year (sec. 613(a)).
Specific percentage depletion rules apply to oil and gas
production from ``marginal'' properties (sec. 613A(c)(6)).
Marginal production is defined as domestic crude oil and
natural gas production from stripper well property or from
property substantially all of the production from which during
the calendar year is heavy oil. Stripper well property is
property from which the average daily production is 15 barrel
equivalents or less, determined by dividing the average daily
production of domestic crude oil and domestic natural gas from
producing wells on theproperty for the calendar year by the
number of wells. Heavy oil is domestic crude oil with a weighted
average gravity of 20 degrees API or less (corrected to 60 degrees
Fahrenheit).
Reasons for Change
The Congress believed that a temporary suspension of the
net income property limitation for marginal oil and gas
production was an appropriate part of overall national energy
security policy.
Explanation of Provision
The 100-percent-of-net-income property limitation is
suspended for domestic oil and gas production from marginal
properties during taxable years beginning after December 31,
1997, and before January 1, 2000.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $21 million in 1998, $35 million in 1999,
and $14 million in 2000.
13. Increase in standard mileage rate for purposes of computing
charitable deduction (sec. 973 of the Act and sec. 170(I) of
the Code)
Present and Prior Law
In computing taxable income, individuals who do not elect
the standard deduction may claim itemized deductions, including
a deduction (subject to certain limitations) for charitable
contributions or gifts made during the taxable year to a
qualified charitable organization or governmental entity (sec.
170). Individuals who elect the standard deduction may not
claim a deduction for charitable contributions made during the
taxable year.
No charitable contribution deduction is allowed for a
contribution of services. However, unreimbursed expenditures
made incident to the rendition of donated services to a
qualified charitable organization--such as out-of-pocket
transportation expenses necessarily incurred in performing
donated services--may constitute a deductible contribution
(Treas. Reg. sec. 1.170A-1(g)).\196\ However, no charitable
contribution deduction is allowed for traveling expenses
(including expenses for meals and lodging) while away from
home, whether paid directly or by reimbursement, unless there
is no significant element of personal pleasure, recreation, or
vacation in such travel (sec. 170(j)). Moreover, a taxpayer may
not deduct as a charitable contribution out-of-pocket
expenditures incurred on behalf of a charity if such
expenditures are made for the purposes of influencing
legislation (sec. 170(f)(6)).
---------------------------------------------------------------------------
\196\ Treasury Regulation section 1.170A-1(g) allows taxpayers to
deduct only their own unreimbursed expenses incurred in performing
services for a qualified charitable organization, and not expenses
incident to a third party's performance of services. See Davis v.
United States, 495 U.S. 472 (1990).
---------------------------------------------------------------------------
Under prior law, for purposes of computing the charitable
contribution deduction for the use of a passenger automobile
(including vans, pickups, and panel trucks) in connection with
rendering donated services to a qualified charitable
organization, the standard mileage rate was 12 cents per mile
(sec. 170(i)).
Reasons for Change
The Congress believed that it is appropriate to increase
the standard mileage rate for purposes of the charitable
contribution deduction.
Explanation of Provision
For purposes of computing the charitable contribution
deduction for the use of a passenger automobile in connection
with rendering donated services to a qualified charitable
organization, the standard mileage rate is increased to 14
cents per mile.
As an alternative to claiming the standard mileage rate,
taxpayers will continue to have the option of claiming a
deduction for actual out-of-pocket transportation expenses
necessarily incurred in performing donated services (i.e.,
operating expenses for use of an automobile, but not general
maintenance, depreciation, or insurance costs), provided that
the taxpayer maintains adequate records or other evidence for
substantiation. See Rev. Proc. 96-63, 1996-2 C.B. 420. Parking
fees and tolls attributable to the use of an automobile for
charitable purposes may be deducted as separate items. Id.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $8 million in 1998, $56 million in 1999, $58
million in 2000, $61 million in 2001, $64 million in 2002, $68
million in 2003, $71 million in 2004, $75 million in 2005, $78
million in 2006, and $82 million in 2007.
14. Purchases of receivables by tax-exempt hospital cooperative service
organizations (sec. 974 of the Act and sec. 501(e) of the Code)
Present and Prior Law
Section 501(e) provides that an organization organized on a
cooperative basis by tax-exempt hospitals will itself be tax-
exempt if the organization is operated solely to perform, on a
centralized basis, one or more of certain enumerated services
for its members. These services are: data processing,
purchasing (including the purchase of insurance on a group
basis), warehousing, billing and collection, food, clinical,
industrial engineering, laboratory, printing, communications,
record center, and personnel services. An organization does not
qualify under section 501(e) if it performs services other than
the enumerated services. (Treas. Reg. sec. 1.501(e)-1(c)).
Reasons for Change
The Congress believed that it is important to clarify that
permissible billing and collection services that can be carried
out by hospital cooperative service organizations under section
501(e) include the purchase of patron accounts receivable on a
recourse basis.
Explanation of Provision
The Act clarifies that, for purposes of section 501(e),
billing and collection services include the purchase of patron
accounts receivable on a recourse basis. Thus, hospital
cooperative service organizations are permitted to advance cash
on the basis of member accounts receivable, provided that each
member hospital retains the risk of non-payment with respect to
its accounts receivable.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1996. No inference is intended with respect
to taxable years prior to the effective date.
Revenue Effect
The provision is estimated to have a negligible revenue
effect on Federal fiscal year budget receipts in each of 1997
through 2007.
15. Provide above-the-line deduction for certain business expenses in
connection with service performed by certain officials (sec.
975 of the Act and sec. 62 of the Code)
Present and Prior Law
Under present and prior law, individuals may generally
deduct ordinary and necessary business expenses in determining
adjusted gross income (``AGI''). Under prior law, this
deduction did not apply in the case of any individual
performing services as an employee. Employee business expenses
generally were deductible only as a miscellaneous itemized
deduction, i.e., only to the extent all the taxpayer's
miscellaneous itemized deductions exceed 2 percent of the
taxpayer's AGI. Employee business expenses were not allowed as
a deduction for alternative minimum tax purposes.
Reasons for Change
The Congress was aware that certain State and local
government officials are compensated (in whole or in part) on a
fee basis to provide certain services to the government. These
officials hire employees and incur expenses in connection with
their official duties. These expenses may be subject, under
prior law, to the 2-percent floor on itemized deductions. The
Congress believed these expenses should be deductible.
Explanation of Provision
Under the Act, employee business expenses relating to
service as an official of a State or local government (or
political subdivision thereof) are deductible in computing AGI
(``above the line''), provided the official is compensated in
whole or in part on a fee basis. Consequently, such expenses
are also deductible for minimum tax purposes.
Effective Date
The provision applies to expenses paid or incurred in
taxable years beginning after December 31, 1986.
Revenue Effect
The provision is estimated to reduce fiscal year budget
receipts by $10 million in 1998, $4 million in 1999, $4 million
in 2000, $4 million in 2001, $5 million in 2002, $5 million in
2003, $6 million in 2004, $6 million in 2005, $7 million in
2006, and $7 million in 2007.
16. Combined employment tax reporting demonstration project (sec. 976
of the Act)
Present and Prior Law
Traditionally, Federal tax forms are filed with the Federal
government and State tax forms are filed with individual
states. This necessitates duplication of items common to both
returns. Some States have recently been working with the IRS to
implement combined State and Federal reporting of certain types
of items on one form as a way of reducing the burdens on
taxpayers. The State of Montana and the IRS have cooperatively
developed a system to combine State and Federal employment tax
reporting on one form. The one form would contain exclusively
Federal data, exclusively State data, and information common to
both: the taxpayer's name, address, TIN, and signature.
The Internal Revenue Code prohibits disclosure of tax
returns and return information, except to the extent
specifically authorized by the Internal Revenue Code (sec.
6103). Unauthorized disclosure is a felony punishable by a fine
not exceeding $5,000 or imprisonment of not more than five
years, or both (sec. 7213). An action for civil damages also
may be brought for unauthorized disclosure (sec. 7431). No tax
information may be furnished by the Internal Revenue Service
(``IRS'') to another agency unless the other agency establishes
procedures satisfactory to the IRS for safeguarding the tax
information it receives (sec. 6103(p)).
Implementation of the combined Montana-Federal employment
tax reporting project has been hindered because section 6103
can be interpreted to apply that provision's restrictions on
disclosure to information common to both the State and Federal
portions of the combined form, although these restrictions
would not apply to the State with respect to the State's use of
State-requested information if that information were supplied
separately to both the State and the IRS.
Reasons for Change
The Congress believed that it is appropriate to permit a
demonstration project to assess the feasibility and
desirability of expanding combined reporting in the future.
Explanation of Provision
The Act permits implementation of a demonstration project
to assess the feasibility and desirability of expanding
combined reporting in the future. There are several limitations
on the demonstration project. First, it is limited to the State
of Montana and the IRS. Second, it is limited to employment tax
reporting. Third, it is limited to disclosure of the name,
address, TIN, and signature of the taxpayer, which is
information common to both the Montana and Federal portions of
the combined form. Fourth, it is limited to a period of five
years.
The Congress intended that the State of Montana be allowed
to use the data collected through the demonstration project as
if it had collected it separately.\197\
---------------------------------------------------------------------------
\197\ A technical correction may be needed so that the statute
reflects this intent. See Title VI (sec. 608(c)) of H.R. 2676, the Tax
Technical Corrections Act of 1997, as passed by the House on November
5, 1997.
---------------------------------------------------------------------------
Effective Date
The provision was effective on the date of enactment
(August 5, 1997), and will expire on the date five years after
the date of enactment (August 5, 2002).
Revenue Effect
The provision is estimated to have no effect on Federal
fiscal year budget receipts.
17. Elective carryback of existing net operating losses of the National
Railroad Passenger Corporation (Amtrak) (sec. 977 of the Act)
Present and Prior Law
Generally, under prior law, net operating losses could be
carried back to the three taxable years of the taxpayer that
precede the year of loss (10 taxable years in certain
circumstances). Section 1082 of the Act limits this carryback
period to two years for losses arising in taxable years
beginning after August 5, 1997.
Reasons for Change
The Congress believed that the provision of viable
intercity passenger rail service by Amtrak is an important
national objective. At present, that objective is threatened by
capital needs of Amtrak, the principal passenger rail service
provider.
Explanation of Provision
The Act provides elective procedures that allow Amtrak to
consider the tax attributes of its predecessors, those
railroads that were relieved of their responsibility to provide
intercity rail passenger service as a result of the Rail
Passenger Service Act of 1970, in the use of Amtrak's net
operating losses. The benefit allowable under these procedures
is limited to the least of: (1) 35 percent of Amtrak's existing
qualified carryovers, (2) the net tax liability for the
carryback period, or (3) $2,323,000,000. One half of the amount
so calculated will be treated as a payment of the tax imposed
by chapter 1 of the Internal Revenue Code of 1986 for the
Amtrak's taxable year ending December 31, 1997, and a similar
amount for Amtrak's taxable year ending December 31, 1998.
The existing qualified carryovers are the net operating
loss carryovers that are available under section 172(b) in
Amtrak's first taxable year ending after September 30, 1997.
The net tax liability for the carryback period is the aggregate
of the net tax liability of Amtrak's railroad predecessors for
all taxable years beginning before January 1, 1971, for which
there is a net Federal tax liability. Amtrak's railroad
predecessors are those railroads that were relieved of their
responsibility to provide intercity rail passenger service as a
result of the Rail Passenger Service Act of 1970, and their
predecessors. In the case of a railroad predecessor who joined
in the filing of a consolidated tax return, the net tax
liability of the predecessor will be the net tax liability of
the consolidated group.
The net operating losses of Amtrak are required to be
reduced by an amount equal to the amount obtained by Amtrak
under this provision, divided by 0.35. The Secretary of the
Treasury is to adjust, as he deems appropriate, the tax account
of each predecessor railroad for the carryback period to
reflect the utilization of the net operating losses. The amount
of the adjustment is equal to the amount of the benefit and is
to be taken into consideration on the tax accounts of the
predecessor railroads on a first-in, first-out basis, starting
with balances for the earliest year for which any predecessor
railroad has a net tax liability. No additional refund to any
taxpayer other than Amtrak is to be allowed as a result of
these adjustments.
The availability of the elective procedures is conditioned
on Amtrak (1) agreeing to make payments of one percent of the
amount it receives to each of the non-Amtrak States to offset
certain transportation related expenditures and (2) using the
balance for certain qualified expenses. Non-Amtrak States are
those States that are not receiving Amtrak service at any time
during the period beginning on the date of enactment and ending
on the date of payment.
No deduction is allowed with respect to any qualified
expense whose payment is attributable to the proceeds made
available as a result of this provision. The basis of any
property must be reduced by the portion of its cost that is
attributable to such proceeds. An item of cost or expense is
attributable to such proceeds if it is (1) paid from the
proceeds of the refund or (2) to the extent the principal and
interest of any borrowings are paid from the proceeds of the
refund, from the proceeds of such borrowings.
Amtrak's earnings and profits will be increased by the
amount of the refund. However, Congress expects that this
amount will not be included in adjusted current earnings for
alternative minimum tax purposes, consistent with Treas. Reg.
sec. 1.56(g)-1(c)(4) (ii).
Effective Date
The provision was effective on the date of enactment
(August 5, 1997). However, no refund shall be made as a result
of this provision earlier than the date of enactment of Federal
legislation which authorizes reforms of Amtrak.\198\ No
interest shall accrue with respect to the payment of any refund
due as a result of this provision until 45 days after the
latest of (1) the enactment of such reform legislation, (2) the
filing by Amtrak of a Federal income tax return which includes
the election to use the procedures described in this provision,
or (3) the original due date of such return.
---------------------------------------------------------------------------
\198\ Section 301(b) of the Amtrak Reform and Accountability Act of
1997 (P.L. 105-134), passed by the House and Senate on November 13,
1997 and signed by the President on December 2, 1997, states that such
Act constitutes Amtrak reform legislation within the meaning of this
provision.
---------------------------------------------------------------------------
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $1,162 million in 1998 and $1,162 million in
1999.
H. Extension of Duty-Free Treatment Under Generalized
System of Preferences (sec. 981 of the Act and sec. 505
of the Trade Act of 1974)
Prior Law
Title V of the Trade Act of 1974, as amended (Generalized
System of Preferences) (``GSP''), grants authority to the
President to provide duty-free treatment on imports of eligible
articles from designated beneficiary developing countries,
subject to specific conditions and limitations. To qualify for
GSP privileges each beneficiary country is subject to various
mandatory and discretionary eligibility criteria. Import
sensitive products are ineligible for GSP. The President's
authority to grant GSP benefits expired after May 31, 1997.
Reasons for Change
The GSP program promotes three broad policy goals: (1) to
foster economic development in developing economies and
economies in transition through increased trade, rather than
foreign aid; (2) to promote U.S. trade interests by encouraging
beneficiaries to open their markets and comply more fully with
international trading rules; and (3) to help maintain U.S.
international competitiveness by lowering costs for U.S.
business, as well as lowering prices for American consumers.
Recent short-term extensions of the program have been highly
disruptive to U.S. companies who rely on GSP products, and to
the economic development of beneficiary countries. Budgetary
effects of the program, however, precluded a longer term
extension. So that there will be no gap in duty-free treatment,
the provision provides for an extension that is retroactive to
May 31, 1997, through a refund procedure upon request of an
importer.
Explanation of Provision
The Act reauthorizes the GSP program for 13 months, to
expire after June 30, 1998. The provision provides for refunds,
upon request of the importer, of any duty paid between May 31,
1997 and the date of enactment.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $378 million in 1998, and to have no revenue
effect in fiscal years 1999 through 2007.
TITLE X. REVENUE-INCREASE PROVISIONS
A. Financial Products
1. Require recognition of gain on certain appreciated financial
positions in personal property (sec. 1001(a) of the Act and
sec. 1259 of the Code)
Present and Prior Law
In general, gain or loss is taken into account for tax
purposes when realized. Gain or loss generally is realized with
respect to a capital asset at the time the asset is sold,
exchanged, or otherwise disposed of. Gain or loss is determined
by comparing the amount realized with the adjusted basis of the
particular property sold. In the case of corporate stock, the
basis of shares purchased at different dates or different
prices generally is determined by reference to the actual lot
sold if it can be identified. Special rules under the Code can
defer or accelerate recognition in certain situations.
The recognition of gain or loss is postponed for open
transactions. For example, in the case of a ``short sale''
(i.e., when a taxpayer sells borrowed property such as stock
and closes the sale by returning identical property to the
lender), no gain or loss on the transaction is recognized until
the closing of the borrowing.
Under prior law, transactions designed to reduce or
eliminate risk of loss on financial assets generally did not
cause realization. For example, a taxpayer could lock in gain
on securities by entering into a ``short sale against the
box,'' i.e., when the taxpayer owned securities that were the
same as, or substantially identical to, the securities borrowed
and sold short. The form of the transaction was respected for
income tax purposes and gain on the substantially identical
property was not recognized at the time of the short sale.
Pursuant to rules that allow specific identification of
securities delivered on a sale, the taxpayer could obtain open
transaction treatment by identifying the borrowed securities as
the securities delivered. When it was time to close out the
borrowing, the taxpayer could choose to deliver either the
securities held or newly-purchased securities. The Code
provided rules only to prevent taxpayers from using short sales
against the box to accelerate loss or to convert short-term
capital gain into long-term capital gain or long-term capital
loss into short-term capital loss (sec. 1233(b)).
Taxpayers also can lock in gain on certain property by
entering into offsetting positions in the same or similar
property. Under the straddle rules, when a taxpayer realizes a
loss on one offsetting position in actively-traded personal
property, the taxpayer generally can deduct this loss only to
the extent the loss exceeds the unrecognized gain in the other
positions in the straddle. In addition, rules similar to the
short sale rules prevent taxpayers from changing the tax
character of gains and losses recognized on the offsetting
positions in a straddle (sec. 1092).
Taxpayers may engage in other arrangements, such as
``futures contracts,'' ``forward contracts,'' ``equity swaps''
and other ``notional principal contracts'' where the risk of
loss and opportunity for gain with respect to property are
shifted to another party (the ``counterparty''). Under prior
law, these arrangements did not result in the recognition of
gain by the taxpayer.
The Code accelerates the recognition of gains and losses in
certain cases. For example, taxpayers are required each year to
mark to market certain regulated futures contracts, foreign
currency contracts, non-equity options, and dealer equity
options, and to take any capital gain or loss thereon into
account as 40 percent short-term gain and 60 percent long-term
gain (sec. 1256).
Reasons for Change
In general, a taxpayer cannot completely eliminate risk of
loss (and opportunity for gain) with respect to property
without disposing of the property in a taxable transaction. In
recent years, however, several financial transactions have been
developed or popularized which allow taxpayers to substantially
reduce or eliminate their risk of loss (and opportunity for
gain). Like most taxable dispositions, many of these
transactions also provide the taxpayer with cash or other
property in return for the interest that the taxpayer has given
up.
One of these transactions is the ``short sale against the
box.'' In such a transaction, a taxpayer borrows and sells
shares identical to the shares the taxpayer holds. By holding
two precisely offsetting positions, the taxpayer is insulated
from economic fluctuations in the value of the stock. While the
short against the box is in place, the taxpayer generally can
borrow a substantial portion of the value of the appreciated
stock so that, economically, the transaction strongly resembles
a sale of the long stock.
Other transactions that have been used by taxpayers to
transfer risk of loss (and opportunity for gain) involve
entering into notional principal contracts or futures or
forward contracts to deliver the same stock. For example, a
taxpayer holding appreciated stock may enter into an ``equity
swap'' which requires the taxpayer to make payments equal to
the dividends and any increase in the stock's value for a
specified period, and entitles the taxpayer to receive payments
equal to any depreciation in value. The terms of such swaps
also frequently entitle the shareholder to receive payments
during the swap period of a market rate of return (e.g., the
Treasury-bill rate) on a notional principal amount equal to the
value of the shareholder's appreciated stock, making the
transaction strongly resemble a taxable exchange of the
appreciated stock for an interest-bearing asset.
Explanation of Provision
General rules
The Act requires a taxpayer to recognize gain (but not
loss) upon entering into a constructive sale of any appreciated
position in stock, a partnership interest or certain debt
instruments as if such position were sold, assigned or
otherwise terminated at its fair market value on the date of
the constructive sale.
If the requirements for a constructive sale are met, the
taxpayer recognizes gain in a constructive sale as if the
position were sold at its fair market value on the date of the
sale and immediately repurchased. Except as provided in
Treasury regulations, a constructive sale generally is not
treated as a sale for other Code purposes; an appropriate
adjustment in the basis of the appreciated financial position
is made in the amount of any gain recognized on a constructive
sale, and a new holding period of such position begins as if
the taxpayer had acquired the position on the date of the
constructive sale.
A taxpayer is treated as making a constructive sale of an
appreciated position when the taxpayer (or, in certain
circumstances, a person related to the taxpayer) does one of
the following: (1) enters into a short sale of the same
property, (2) enters into an offsetting notional principal
contract with respect to the same property, or (3) enters into
a futures or forward contract to deliver the same property. A
constructive sale under any part of the definition occurs if
the two positions are in property that, although not the same,
is substantially identical. In addition, in the case of an
appreciated financial position that is a short sale, a notional
principal contract or a futures or forward contract, the holder
is treated as making a constructive sale when it acquires the
same property as the underlying property for the position.
Finally, to the extent provided in Treasury regulations, a
taxpayer is treated as making a constructive sale when it
enters into one or more other transactions, or acquires one or
more other positions, that have substantially the same effect
as any of the transactions described.
Whether any part of the constructive sale definition is met
by one or more appreciated financial positions and offsetting
transactions generally will be determined as of the date the
last of such positions or transactions is entered into. The
positions of two related persons are treated as together
resulting in a constructive sale if the relationship is one
described in section 267 or section 707(b) and the transaction
is entered into with a view toward avoiding the purposes of the
provision.
The Act provides an exception from constructive sale
treatment for any transaction that is closed before the end of
the 30th day after the close of the taxable year in which it
was entered into (the ``extended taxable year''). The exception
is available only if (1) the taxpayer holds the appreciated
financial position to which the transaction relates (e.g., the
stock where the offsetting transaction is a short sale)
throughout the 60-day period beginning on the date the
transaction is closed and (2) at no time during such 60-day
period is the taxpayer's risk of loss reduced (under the
principles of section 246(c)(4)) by holding positions with
respect to substantially similar or related property. These
requirements do not apply to a transaction that is closed
during the extended taxable year where a substantially similar
transaction is reopened during the 60-day period beginning on
the closing date, so long as the reopened transaction is closed
during the extended taxable year and the requirements of the
previous sentence are met after such closing.
A transaction that has resulted in a constructive sale of
an appreciated financial position (e.g., a short sale) is not
treated as resulting in a constructive sale of another
appreciated financial position so long as the taxpayer holds
the position which was treated as constructively sold. However,
when that position is assigned, terminated or disposed of by
the taxpayer, the taxpayer immediately thereafter is treated as
entering into the transaction that resulted in the constructive
sale (e.g., the short sale) if it remains open at that time.
Thus, the transaction can cause a constructive sale of another
appreciated financial position at any time thereafter. For
example, assume a taxpayer holds two appreciated stock
positions and one offsetting short sale, and the taxpayer
identifies the short sale as offsetting one of the stock
positions. If the taxpayer then sells the stock position that
was identified, the identified short position would cause a
constructive sale of the taxpayer's other stock position at
that time.
Definitions
An appreciated financial position is defined as any
position with respect to any stock, debt instrument, or
partnership interest, if there would be gain upon a taxable
disposition of the position for its fair market value. A
``position'' is defined as an interest, including a futures or
forward contract, short sale, or option. The Congress intended
that a ``position'' include a notional principal contract or
other derivative instrument that provides that a taxpayer make
or receive payments (or contractual credits) that approximate
the economic effect of ownership of stock, a debt instrument or
a partnership interest. For example, a contract that provides a
right to receive payments (or contractual credits) based on a
calculation having the effect of interest on a notional
principal amount will be treated as a position with respect to
a debt instrument.
An appreciated financial position does not include a
position with respect to a debt instrument that has an
unconditionally payable principal amount, that is not
convertible into the stock of the issuer or a related person,
and the interest on which is either fixed, payable at certain
variable rates (Treas. reg. sec. 1.860G-1(a)(3)) or based on
certain interest payments on a pool of mortgages. A position
that is a hedge of a position that meets these requirements
also qualifies for this exception.\199\ A hedge for this
purpose includes any position that reduces the taxpayer's risk
of interest rate or price changes or currency fluctuation with
respect to another position. Other debt positions, including
those identified as part of a hedging or straddle transaction,
can be appreciated financial positions.
---------------------------------------------------------------------------
\199\ A technical correction may be needed so that the statute
reflects this intent. See Title VI (sec. 609(a)(1)) of H.R. 2676, the
Tax Technical Corrections Act of 1997, passed by the House on November
5, 1997.
---------------------------------------------------------------------------
A trust instrument that is actively traded is generally
treated as stock for purposes of determining whether the
instrument is an appreciated financial position. However, an
exception provides that a trust instrument will not be treated
as stock if substantially all (by value) of the property held
by the trust is debt that qualifies for the exception for
certain debt positions described above.
A notional principal contract is treated as an offsetting
notional principal contract, and thus results in a constructive
sale of an appreciated financial position, if it requires the
holder of the appreciated financial position to pay (or provide
a contractual credit for) all or substantially all of the
investment yield and appreciation on the position for a
specified period and also gives the holder a right to be
reimbursed for (or receive credit for) all or substantially all
of any decline in value of the position.
A forward contract results in a constructive sale of an
appreciated financial position only if the forward contract
provides for delivery, or for cash settlement, of a
substantially fixed amount of property and a substantially
fixed price.\200\ Thus, a forward contract providing for
delivery of property, such as shares of stock, the amount of
which is subject to significant variation under the contract
terms does not result in a constructive sale. The Congress did
not intend that an agreement that is not a contract for
purposes of applicable contract law, or which is subject to
very substantial contingencies, will be treated as a forward
contract.
---------------------------------------------------------------------------
\200\ A technical correction may be needed so that the statute
reflects this intent. See Title VI (sec. 609(a)(2)) of H.R. 2676, the
Tax Technical Corrections Act of 1997, passed by the House on November
5, 1997.
---------------------------------------------------------------------------
Special rules
A constructive sale does not include a transaction
involving an appreciated financial position that is marked to
market, including positions governed by section 475 (mark to
market for securities and commodities dealers and traders) or
section 1256 (mark to market for futures contracts, options and
currency contracts). Nor does a constructive sale include any
contract for sale of an appreciated financial position which is
not a ``marketable security'' (as defined in section 453(f)) if
the contract settles within one year after the date it is
entered into.
More than one appreciated financial position or more than
one offsetting transaction can be aggregated to determine
whether a constructive sale has occurred. For example, it is
possible that no constructive sale would result if one
appreciated financial position and one offsetting transaction
were considered in isolation, but that a constructive sale
would result if the appreciated financial position were
considered in combination with two transactions. Where the
standard for a constructive sale is met with respect to only a
pro rata portion of a taxpayer's appreciated financial position
(e.g., some, but not all, shares of stock), that portion will
be treated as constructively sold under the provision. If there
is a constructive sale of less than all of any type of property
held by the taxpayer, the specific property deemed sold will be
determined under the rules governing actual sales, after
adjusting for previous constructive sales under the Act. Under
the regulations to be issued by the Treasury, either a
taxpayer's appreciated financial position or an offsetting
transaction might in some circumstances be treated as
disaggregated on a non-pro rata basis for purposes of the
constructive sale determination. The Congress intended that
this authority be used only where such disaggregated treatment
reflects the economic reality of the transaction and is
administratively feasible. For example, one transaction for
which disaggregated treatment might be appropriate is an equity
swap that references a small group of stocks, where the
transaction is entered into by a taxpayer owning only one of
the stocks.\201\
---------------------------------------------------------------------------
\201\ A standard similar to that of Treas. reg. sec. 1.246-5 would
be appropriate for determining whether the relationship between the
stock held and the group of stocks shorted is sufficient for
constructive sale purposes.
---------------------------------------------------------------------------
The Congress intended that the constructive sale provision
generally will apply to transactions that are identified
hedging or straddle transactions under other Code provisions
(secs. 1092 (a)(2), (b)(2) and (e), 1221 and 1256(e)). Where
either position in such an identified transaction is an
appreciated financial position and a constructive sale of such
position results from acquiring the other position, the
Congress intended that the constructive sale will be treated as
having occurred immediately before the identified transaction.
The constructive sale will not, however, prevent qualification
of the transaction as an identified hedging or straddle
transaction. Where, after the establishment of such an
identified transaction, there is a constructive sale of either
position in the transaction, gain will generally be recognized
and accounted for under the relevant hedging or straddle
provision. However, the Congress intended that future Treasury
regulations may except certain transactions from the
constructive sale provision where the gain recognized would be
deferred under an identified hedging or straddle provision
(e.g. Treas. reg. sec. 1.446-4(b)).
Treasury guidance
The Act provides regulatory authority to the Treasury to
treat as constructive sales certain transactions that have
substantially the same effect as those specified (i.e., short
sales, offsetting notional principal contracts and futures or
forward contracts to deliver the same or substantially similar
property).
The Congress anticipated that future Treasury regulations
will treat as constructive sales other financial transactions
that, like those specified in the provision, have the effect of
eliminating substantially all of the taxpayer's risk of loss
and opportunity for income and gain with respect to the
appreciated financial position. Because this standard requires
reduction of both risk of loss and opportunity for gain, the
Congress intended that transactions that reduce only risk of
loss or only opportunity for gain will not be covered. Thus,
for example, the Congress did not intend that a taxpayer who
holds an appreciated financial position in stock will be
treated as having made a constructive sale when the taxpayer
enters into a put option with an exercise price equal to the
current market price (an ``at the money'' option). Because such
an option reduces only the taxpayer's risk of loss, and not its
opportunity for gain, the above standard would not be met.
The Congress did not intend that risk of loss and
opportunity for gain be considered separately for purposes of
the provision. Thus, if a transaction has the effect of
eliminating a portion of the taxpayer's risk of loss and a
portion of the taxpayer's opportunity for gain with respect to
an appreciated financial position which, taken together, are
substantially all of the taxpayer's risk of loss and
opportunity for gain, the Congress intended that Treasury
regulations will treat this transaction as a constructive sale
of the position.
The Congress anticipated that the Treasury regulations,
when issued, will provide specific standards for determining
whether several common transactions will be treated as
constructive sales. One such transaction is a ``collar.'' In a
collar, a taxpayer commits to an option requiring him to sell a
financial position at a fixed price (the ``call strike price'')
and has the right to have his position purchased at a lower
fixed price (the ``put strike price''). For example, a
shareholder may enter into a collar for a stock currently
trading at $100 with a put strike price of $95 and a call
strike price of $110. The effect of the transaction is that the
seller has transferred the rights to all gain above the $110
call strike price and all loss below the $95 put strike price;
the seller has retained all risk of loss and opportunity for
gain in the price range between $95 and $110. A collar can be a
single contract or can be effected by using a combination of
put and call options.
In order to determine whether collars have substantially
the same effect as the transactions specified in the provision,
the Congress anticipated that Treasury regulations will provide
specific standards that take into account various factors with
respect to the appreciated financial position, including its
volatility. It is expected that several aspects of the collar
transaction will be relevant, including the spread between the
put and call prices, the period of the transaction, and the
extent to which the taxpayer retains the right to periodic
payments on the appreciated financial position (e.g., the
dividends on collared stock). The Congress intended that the
Treasury regulations with respect to collars will be applied
prospectively, except in cases to prevent abuse.
Another common transaction for which a specific regulatory
standard may be appropriate is a so-called ``in-the-money''
option, i.e., a put option where the strike price is
significantly above the current market price or a call option
where the strike price is significantly below the current
market price. For example, if a shareholder purchases a put
option with a strike price of $120 with respect to stock
currently trading at $100, the shareholder has eliminated all
risk of loss on the position for the option period. The
shareholder may also effectively have transferred substantially
all of the potential gain on the stock because only if its
value rises above $120 can there be any gain to the
shareholder. In determining whether such a transaction will be
treated as a constructive sale, the Congress anticipated that
Treasury regulations will provide a specific standard that
takes into account many of the factors described above with
respect to collars, including the yield and volatility of the
stock and the period and other terms of the option.
For collars, options and some other transactions, one
approach that Treasury might take in issuing regulations is to
rely on option prices and option pricing models. The price of
an option represents the payment the market requires to
eliminate risk of loss (for a put option) and to purchase the
right to receive yield and gain (for a call option). Thus,
option pricing offers one model for quantifying both the total
risk of loss and opportunity for gain with respect to an
appreciated financial position, as well as the proportions of
these total amounts that the taxpayer has retained.
In addition to setting specific standards for treatment of
these and other transactions, it may be appropriate for
Treasury regulations to establish ``safe harbor'' rules for
common financial transactions that do not result in
constructive sale treatment. An example might be a collar with
a sufficient spread between the put and call prices, a
sufficiently limited period and other relevant terms such that,
regardless of the particular characteristics of the stock, the
collar probably would not transfer substantially all risk of
loss and opportunity for gain.
Effective Date
The provision is effective for constructive sales entered
into after June 8, 1997. A special rule is provided for
transactions before this date which would have been
constructive sales under the provision. The positions in such a
transaction will not be taken into account in determining
whether a constructive sale after June 8, 1997, has occurred,
provided that the taxpayer identified the offsetting positions
of the earlier transaction before the close of the 30-day
period beginning on the date of enactment (or a later date
provided in Treasury regulations). The special rule will cease
to apply on the date the taxpayer ceases to hold any of the
offsetting positions so identified.
In the case of a decedent dying after June 8, 1997, if (1)
a constructive sale of an appreciated financial position (as
defined in the provision) occurred before such date, (2) the
transaction remains open (a) for not less than two years and
(b) at some time during the three-year period ending on the
decedent's death and (3) the transaction was not closed in a
taxable transaction within 30 days after the date of
enactment,\202\ each of the appreciated financial position and
the transaction resulting in the constructive sale will, if
held at the time of the taxpayer's death, be treated as
property constituting rights to receive income in respect of a
decedent (``IRD'') under section 691. However, where a
constructive sale transaction that is subject to this rule is
closed prior to death, gain that accrues after the transaction
is closed will not be treated as IRD. The effect of these rules
is generally to preserve the unrealized gain at the time the
constructive sale transaction is entered into and to tax a net
amount equal to such gain to the taxpayer and/or his heirs or
legatees under the IRD rules (sec. 691).
---------------------------------------------------------------------------
\202\ ``A technical correction may be needed so that the statute
reflects this intent. See Title VI (sec. 609(a)(4)) of H.R. 2676, of
the Tax Technical Corrections Act of 1997, passed by the House on
November 5, 1997.
---------------------------------------------------------------------------
For example, consider a ``short against the box''
transaction involving stock with a basis of $10 that was
entered into when the stock was worth $100. Assume first that
the taxpayer does not close the transaction and dies when the
stock is worth $1,000, and assume for simplicity no changes in
the stock value after the taxpayer's death. Under the IRD
rules, the taxpayer's heirs will receive no step up in the
stock's basis. When the heirs close the transaction by
delivering the stock, they will recognize $990 of gain on the
stock and a loss on the short position of $900, for a net
recognized gain of $90, which is the same as the unrealized
gain when the ``short against the box'' was entered into ($100
minus $10). As a second example, assume the taxpayer in the
first example closed the ``short against the box'' (three years
or less prior to his death) when the stock was worth $500 by
delivering additional stock purchased in the market. The
taxpayer would recognize a loss of $400 on the short position.
If, at the time of taxpayer's death, he owns the stock that was
the long position in the transaction, $490 of the gain on the
stock would be treated as IRD. The taxpayer's heirs would
receive no step up in basis for this amount and thus would
recognize gain of $490 when they sell the stock. On a combined
basis, the decedent and his heirs are taxed on gain of $90
($490 minus $400), which is equal to the unrealized gain when
the transaction was entered into.
Revenue Effect
Sections 1001 and 1002 of the Act are estimated on a
combined basis to increase Federal fiscal year budget receipts
by $367 million in 1998, $121 million in 1999, $68 million in
2000, $73 million in 2001, $79 million in 2002, $85 million in
2003, $94 million in 2004, $111 million in 2005, $118 million
in 2006 and $127 million in 2007.
2. Election of mark to market for securities traders and for traders
and dealers in commodities (sec. 1001(b) of the Act and secs.
475(e) and (f) of the Code)
Present and Prior Law
A dealer in securities must compute its income pursuant to
a mark-to-market method of accounting (sec. 475). Any security
that is inventory must be included in inventory at its fair
market value, and any security that is not inventory and that
is held at year end is treated as sold for its fair market
value. There is an exception to mark-to-market treatment for
any security identified as held for investment or not held for
sale to customers (or a hedge of such a security). For this
purpose, a ``dealer in securities'' is a person who (1)
regularly purchases securities from or sells securities to
customers in the ordinary course of a trade or business, or (2)
regularly offers to enter into, assume, offset, assign or
otherwise terminate positions in securities with customers in
the ordinary course of a trade or business. For this purpose,
``security'' means any stock in a corporation; any partnership
or beneficial ownership interest in a widely-held or publicly-
traded partnership or trust; any note, bond, debenture, or
other evidence of indebtedness; an interest rate, currency or
equity notional principal contract; any evidence of an interest
in, or a derivative financial instrument of any security
described above; and certain positions identified as hedges of
any of the above. Any gain or loss taken into account under
these provisions generally is treated as ordinary gain or loss.
Traders in securities generally are taxpayers who engage in
a trade or business involving active sales or exchanges of
securities on the market, rather than to customers. Under prior
law, the mark-to-market treatment applicable to securities
dealers did not apply to traders in securities or to dealers in
other property.
Reasons for Change
Mark-to-market accounting generally provides a clear
reflection of income with respect to assets that are traded in
established markets. For market-valued assets, mark-to-market
accounting imposes few burdens and offers few opportunities for
manipulation. Securities and exchange-traded commodities have
determinable market values, and securities traders and
commodities traders and dealers regularly calculate year-end
values of their assets in determining their income for
financial statement purposes. Many commodities dealers also
utilize year-end values in adjusting their inventory using the
lower-of-cost-or-market method for Federal income tax purposes.
Explanation of Provision
The Act allows securities traders and commodities traders
and dealers to elect application of the mark-to-market
accounting rules, which applied only to securities dealers
under prior law. All securities held by an electing taxpayer in
connection with a trade or business as a securities trader, and
all commodities held by an electing taxpayer in connection with
a trade or business as a commodities trader, are subject to
mark-to-market treatment. The taxpayer is allowed to identify
property not held in connection with its trade or business as
not subject to the election. Gain or loss recognized by an
electing taxpayer under the provision generally is ordinary
gain or loss. The Congress intended that gain or loss that is
treated as ordinary solely by reason of the election would not
be treated as other than gain or loss from a capital asset for
purposes of determining an individual's net earnings from self-
employment under the Self-Employment Contributions Act (sec.
1402) or determining whether the passive-type income exception
to the publicly-traded partnership rules is met (sec.
7704(c)).\203\
---------------------------------------------------------------------------
\203\ A technical correction may be needed so that the statute
reflects this intent. See Title VI (sec. 609(a)(3)) the Tax Technical
Corrections Act of 1997, as passed by the House on November 5, 1997.
---------------------------------------------------------------------------
With respect to a commodities dealer, all of the rules of
prior law section 475 apply as if commodities were securities.
A commodity for purposes of the provision includes any
commodity that is actively traded (within the meaning of
section 1092(d)(1)), any option, forward contract, futures
contract, short position, notional principal contract or
derivative instrument that references such a commodity, and any
other evidence of an interest in such a commodity. Also
included are positions that hedge one of the items listed and
that are identified by the taxpayer under rules similar to the
rules for securities.
The Congress anticipated that Treasury regulations applying
section 475(b)(4), which prevents a dealer from treating
certain notional principal contracts and other derivative
financial instruments as held for investment, will in the case
of a commodities trader or dealer apply only to contracts and
instruments referenced to commodities.
For a securities trader that elects application of the
provision, all securities held in connection with its trade or
business will be subject to mark-to-market accounting. An
exception is provided for securities that have no connection
with activities as a trader and that are identified on the day
acquired (or at such other times as provided in Treasury
regulations). The Congress did not intend that an electing
taxpayer would be entitled to mark-to-market loans made to
customers or receivables or debt instruments acquired from
customers that are not received or acquired in connection with
a trade or business as a securities trader. Any position that
is properly subject to the mark-to-market regime will not be
taken into account for purposes of the constructive sale rules
of section 1259. Similar rules apply to commodities traders.
Because the Congress was concerned about issues of taxpayer
selectivity, it was intended that an electing taxpayer must be
able to demonstrate by clear and convincing evidence that a
security bears no relation to activities as a trader in order
to be identified as not subject to the mark-to-market regime.
Any security that hedges another security that is held in
connection with the taxpayer's trade or business as a trader
will be treated as so held. The Congress also intended that the
Secretary of the Treasury use his regulatory authority under
section 475(g)(1) to prevent electing traders from effectively
selecting the securities that are subject to mark-to-market
treatment through use of related entities or other
arrangements. Similar rules should apply to commodities
traders.
The election is to be made separately with respect to the
taxpayer's entire business as (1) a securities trader, (2) a
commodities trader, or (3) a commodities dealer. Thus, a
taxpayer that is both a commodities dealer and a securities
trader may make the election with respect to one business, but
not the other. The election will be made in the time and manner
prescribed by the Secretary of the Treasury and will be
effective for the taxable year for which it is made and all
subsequent taxable years, unless revoked with the consent of
the Secretary.
Effective Date
The provision applies to taxable years of traders or
dealers ending after the date of enactment (August 5, 1997).
For a taxpayer making the election for a taxable year that
includes the date of enactment, the taxpayer must have
identified the securities or commodities to which the election
applies within 30 days of the date of enactment. For elections
for taxable years including the date of enactment, the
adjustments required under section 481 as a result of the
change in accounting method are required to be taken into
account ratably over the four-year period beginning in the
first taxable year for which the election is in effect.
Any elections made for taxable years beginning after the
date of enactment will be governed by rules and procedures
established by the Secretary of the Treasury.
Revenue Effect
The combined revenue effect of sections 1001 and 1002 of
the Act is presented in the discussion of section 1001(a) of
the Act above.
3. Limitation on exception for investment companies under section 351
(sec. 1002 of the Act and sec. 351(e) of the Code)
Present and Prior Law
A contribution of property to a corporation does not result
in gain or loss to the contributing shareholder if the
contributor is part of a group of contributors who have 80
percent control (as defined in sec. 368(c)). A contribution of
property to a partnership generally does not result in
recognition of gain or loss to the contributing partner.
Certain Code sections provide exceptions to the general
rule for deferral of pre-contribution gain and loss. Gain or
loss is recognized upon a contribution by a shareholder to a
corporation that is an investment company (sec. 351(e)(1)).
Gain, but not loss, is recognized upon a contribution by a
partner to a partnership that would be treated as an investment
company if the partnership were a corporation (sec. 721(b)).
Under Treasury regulations, a contribution of property by a
shareholder to a corporation, or by a partner to a partnership,
is treated as a transfer to an investment company only if (1)
the contribution results, directly or indirectly, in a
diversification of the transferor's interests, and (2) the
transferee is (a) a regulated investment company (``RIC''), (b)
a real estate investment trust (``REIT''), or (c) a corporation
more than 80 percent of the assets of which by value (excluding
cash and non-convertible debt instruments) are readily
marketable stocks or securities or interests in RICs or REITs
that are held for investment (Treas. reg. sec. 1.351-1(c)(1)).
Reasons for Change
Under prior law and regulations, a partnership or a
corporation was not treated as an investment company even
though more than 80 percent of its assets were a combination of
stock and securities and other high-quality investment assets
of determinable values, such as non-convertible debt
instruments, notional principal contracts, foreign currency and
interests in metals. Thus, under prior law, a partner could
contribute stock, securities or other assets to an investment
partnership, and a shareholder could contribute such assets to
a corporation (e.g., a RIC) and, without current taxation,
receive an interest in an entity that was essentially a pool of
high-quality investment assets. Where, as a result of such a
transaction, the partner or shareholder diversified or
otherwise changed the nature of the financial assets in which
it had an interest, the transaction had the effect of a taxable
exchange. Of particular concern to the Congress was the
reappearance of so-called ``swap funds,'' which are
partnerships or RICs that are structured to fall outside the
definition of an investment company, and thereby allow
contributors to make tax-free contributions of stock and
securities in exchange for an interest in an entity that holds
similar assets.
Explanation of Provision
The Act modified the definition of an investment company
for purposes of determining whether a transfer of property to a
partnership or corporation results in gain recognition (secs.
351(e) and 721(b)) by requiring that certain assets be taken
into account for purposes of the definition, in addition to
readily marketable stock and securities as under prior law.
Under the Act, an investment company includes a RIC or REIT
as under prior law. In addition, under the Act, an investment
company includes any corporation or partnership if more than 80
percent of its assets by value consist of money, stocks and
other equity interests in a corporation (whether or not readily
marketable), evidences of indebtedness, options, forward or
futures contracts, notional principal contracts or derivatives,
foreign currency, certain interests in precious metals,
interests in REITs, RICs, common trust funds and publicly-
traded partnerships or other interests in non-corporate
entities that are convertible into or exchangeable for any of
the assets listed. Other assets that count toward the 80-
percent test are an interest in an entity substantially all of
the assets of which are assets listed above, and to the extent
provided in Treasury regulations, interests in other entities,
but only to the extent of the value of the interest that is
attributable to listed assets.\204\ Finally, the Act granted
regulatory authority to the Treasury Department to add other
assets to the list set out in the provision, or, under
appropriate circumstances, to remove items from the list.
---------------------------------------------------------------------------
\204\ Until such regulations are issued, it is intended that the
Treasury regulations promulgated under the similar provisions of
section 731(c)(2) generally will apply. Specifically, it is intended
that an entity will meet the ``substantially all'' requirement if 90
percent or more of its assets are listed assets (Treas. Reg. sec.
1.731-2(c)(3)(i)). Similarly, with respect to partnerships and other
non-corporate entities, it is intended that, where 20 percent or more
(but less than 90 percent) of the entity's assets consist of listed
assets, a pro rata portion of the interest in the entity will be
treated as a listed asset (Treas. Reg. sec. 1.731-2(c)(3)(ii)).
---------------------------------------------------------------------------
The Congress intended that the Act would change only the
types of assets considered in the definition of an investment
company in the present Treasury regulations (Treas. Reg. sec.
1.351-1(c)(1)(ii)) and not to override the other provisions of
those regulations. For example, the Act did not override the
requirement that only assets held for investment are considered
for purposes of the definition (Treas. Reg. sec. 1.351-
1(c)(1)(ii)). Thus, stock, securities or other listed assets
held primarily for sale to customers in the ordinary course of
business or used in a trade or business of banking, insurance,
brokerage or a similar trade or business are not counted toward
the 80-percent test (Treas. Reg. sec. 1.351-1(c)(3)).
Similarly, the Act did not override the rule that, for purposes
of determining whether a corporation or partnership is an
investment company, the assets of a corporation are treated as
owned proportionally by any shareholder (whether a corporation
or other entity) owning 50 percent or more of its stock (Treas.
Reg. sec. 1.351-1(c)(4)). The Act also did not override the
requirement that the investment company determination consider
any plan with regard to an entity's assets in existence at the
time of transfer (Treas. Reg. sec. 1.351-1(c)(2)). For example,
although under the Act, money is counted toward the 80-percent
test, where money is contributed to a corporation or
partnership and, pursuant to a plan, either (1) assets not
counted toward the 80-percent test are purchased or contributed
to the entity or (2) the entity makes expenditures not
resulting in the acquisition of an asset (e.g. salaries), the
investment company determination would be made on the basis of
the entity's assets after such events. Finally, the Act did not
override the requirement that a contribution of property to an
investment company result in diversification in order for gain
to be recognized (Treas. Reg. sec. 1.351-1(c)(1)(i)).
Effective Date
The provision applies to all transfers after June 8, 1997,
in taxable years ending after such date. An exception is
provided for transfers of a fixed amount of securities made
pursuant to a binding written contract in effect on June 8,
1997, and at all times thereafter until the transfer.
Revenue Effect
The combined revenue effect of sections 1001 and 1002 of
the Act is presented in the discussion of section 1001(a) of
the Act above.
4. Gains and losses from certain terminations with respect to property
(sec. 1003 of the Act and secs. 1233(h), 1234A, 1271(b) of the
Code)
Present and Prior Law
Extinguishment treated as exchange
Treatment of gains and losses.--Gain from the ``sale or
other disposition'' of property is the excess of the amount
realized therefrom over its adjusted basis; loss is the excess
of adjusted basis over the amount realized.
Definition of capital gain or loss.--The definition of
capital gains and losses in section 1222 requires that there be
a ``sale or exchange'' of a capital asset.\205\ The U.S.
Supreme Court has held that the term ``sale or exchange'' is a
narrower term than ``sale or other disposition.'' \206\ Thus,
it is possible for there to be taxable income from a sale or
other disposition of an asset without that income being treated
as a capital gain.
---------------------------------------------------------------------------
\205\ Code section 1221 defines a capital asset to mean property
held by the taxpayer other than (1) property properly includible in
inventory of the taxpayer or primarily held for sale to customers in
the ordinary course of the taxpayer's trade or business, (2)
depreciable and real property used in the taxpayer's trade or business,
(3) a copyright, a literary musical, or artistic composition, letter or
memorandum, or similar property that was created by the taxpayer (or
whose basis is determined, in whole or in part, by reference to the
basis of the creator), (4) accounts or notes receivable acquired in the
ordinary course of the taxpayer's trade or business, and (5) a
publication of the United States Government which was received from the
Government other than by sale.
\206\ Helvering v. William Flaccus Oak Leather Co., 313 U.S. 247
(1941).
---------------------------------------------------------------------------
Court decisions interpreting the ``sale or exchange''
requirement.--There has been a considerable amount of
litigation dealing with whether a modification of the legal
relationship between taxpayers is treated as a ``sale or
exchange.'' For example, in Douglass Fairbanks v. U.S., 306
U.S. 436 (1939), the U.S. Supreme Court held that gain realized
on the redemption of bonds before their maturity is not
entitled to capital gain treatment because the redemption was
not a ``sale or exchange''.\207\ Several court decisions
interpreted the ``sale or exchange'' requirement to mean that a
disposition that occurs as a result of a lapse, cancellation,
or abandonment is not a sale or exchange of a capital asset,
but produces ordinary income or loss. For example, in
Commissioner v. Pittston Co., 252 F. 2d 344 (2d Cir), cert.
denied, 357 U.S. 919 (1958), a payment received by the taxpayer
for terminating a long-term right to purchase the coal output
from another company's mine was treated as ordinary income on
the grounds that the payment was in lieu of subsequent profits
that would have been taxed as ordinary income. Similarly, in
Commissioner v. Starr Brothers, 205 F. 2d 673 (1953), the
Second Circuit held that a payment received by a retail
distributor from a manufacturer in exchange for waiving a
contract provision prohibiting the manufacturer from selling to
the distributor's competition was not a sale or exchange.
Likewise, in General Artists Corp. v. Commissioner, 205 F. 2d
360, cert. denied 346 U.S. 866 (1953), the Second Circuit held
that amounts received by a booking agent for cancellation of a
contract to be the exclusive agent of a singer were not from a
sale or exchange. In National-Standard Company v. Commissioner,
749 F. 2d 369, the Sixth Circuit held that a loss incurred on
the transfer of foreign currency to discharge the taxpayer's
liability was an ordinary loss, since the transfer was not a
``sale or exchange'' of that currency. More recently, in
Stoller v. Commissioner, 994 F. 2d 855 (1993), the Court of
Appeals for the District of Columbia held, in a transaction
that preceded the effective date of section 1234A, that losses
incurred on the cancellation of forward contracts to buy and
sell short-term Government securities that formed a straddle
were ordinary because the cancellation of the contracts was not
a ``sale or exchange.''
---------------------------------------------------------------------------
\207\ The result in this case was overturned by enactment in 1934
of the predecessor of present law section 1271(a); see below. See
section 117 of the Revenue Act of 1934, 28 Stat. 680, 714-715.
---------------------------------------------------------------------------
The U.S. Tax Court has held that the abandonment of
property subject to non-recourse indebtedness is a ``sale''
and, therefore, any resulting loss is a capital loss. Freeland
v. Commissioner, 74 T.C. 970 (1980); Middleton v. Commissioner,
77 T.C. 310 (1981), aff'd per curiam 693 F.2d 124 (11th Cir.
1982); and Yarbro v. Commissioner, 45 T.C.M. 170, aff'd. 737
F.2d 479 (5th Cir. 1984), cert. denied, 469 U.S. 1189 (1985).
Extinguishment treated as sale or exchange.--The Internal
Revenue Code contains provisions that deem certain transactions
to be a sale or exchange and, therefore, any resulting gain or
loss is to be treated as a capital gain or loss. These rules
generally provide for ``sale or exchange'' treatment as a way
of extending capital gain or loss treatment to those
transactions.
Under one special provision, gains and losses attributable
to the cancellation, lapse, expiration, or other termination of
a right or obligation with respect to certain personal property
are treated as gains or losses from the sale of a capital asset
(sec. 1234A). Personal property subject to this rule is (1)
personal property of a type which is actively traded \208\ and
which is, or would be on acquisition, a capital asset in the
hands of the taxpayer (other than stock that is not part of
straddle or of a corporation that is not formed or availed of
to take positions which offset positions in personal property
of its shareholders) and (2) a ``section 1256 contract'' \209\
which is a capital asset in the hands of the taxpayer.\210\
Section 1234A does not apply to the retirement of a debt
instrument.
---------------------------------------------------------------------------
\208\ Treasury Regulations generally define ``actively traded'' as
any personal property for which there is an established financial
market. In addition, those regulations provide that a ``notional
principal contract constitutes personal property of a type that is
actively traded if contracts based on the same or substantially similar
specified indices are purchased, sold, or entered into on an
established financial market'' and that ``rights and obligations of a
party to a notional principal contract are rights and obligations with
respect to personal property and constitute an interest in personal
property.'' Treas. Reg. sec. 1.1092(d)-1(c).
\209\ A ``section 1256 contract'' means any (1) regulated futures
contract, (2) foreign currency contract, (3) nonequity option, or (4)
dealer equity option.
\210\ The present-law provision (sec. 1234A) which treats
cancellation, lapse, expiration, or other termination of a right or
obligation with respect to personal property as a sale of a capital
asset was added by Congress in 1981 when Congress adopted a number of
provisions dealing with tax straddles. These are two components or
``legs'' to a straddle, where the value of one leg changes inversely
with the value of the other leg. Without a special rule, taxpayers were
able to ``leg-out'' of the loss leg of the straddle, while retaining
the gain leg, resulting in the creation of an ordinary loss. In 1981,
Congress believed that the effective ability of taxpayers to elect the
character of a gain or loss leg of a straddle was unwarranted and
provided the present law rule. However, since straddles were the focus
of the 1981 legislation, that legislation was limited to types of
property which were the subject of straddles, i.e., personal property
(other than stock) of a type which is actively traded which is, or
would be on acquisition, a capital asset in the hands of the taxpayer.
The provision subsequently was extended to section 1256 contracts.
---------------------------------------------------------------------------
Treatment of capital gains and losses.--Under prior law,
long-term capital gains of individuals are subject to a maximum
rate of tax of 28 percent. Capital losses of individuals are
allowed to the extent of capital gains or the lower of those
gains or $3,000.
Long-term capital gains of corporations are subject to the
same rate of tax as ordinary income. Capital losses of
corporations are allowed only to the extent of the
corporation's capital gains; excess capital losses may be
carried back to the 3 preceding years and carried forward for 5
succeeding years.
In the case of gains and losses from the sale or exchange
of property used in a trade or business, net gains generally
are treated as capital gain while net losses are treated as
ordinary losses (sec. 1231).
Short positions that become substantially worthless
In the case of a ``short sale'' (i.e., where the taxpayer
sells borrowed property (such as stock) and later closes the
sale by repaying the lender with identical property), any gain
or loss on the closing transaction is considered gain or loss
from the sale or exchange of a capital asset if the property
used to close the short sale is a capital asset in the hands of
the taxpayer (sec. 1233(a)), but the gain ordinarily is treated
as short-term gain (sec. 1233(b)(1)). Entering into a contract
to sell generally is treated as a short sale for purposes of
these rules.
Character of gain on retirement of debt obligations
Amounts received on the retirement of any debt instrument
are treated as amounts received in exchange therefor (sec.
1271(a)(1)). In addition, gain on the sale or exchange of a
debt instrument with original issue discount (OID) \211\
generally is treated as ordinary income to the extent of its
OID if there was an intention at the time of its issuance to
call the debt instrument before maturity (sec. 1271(a)(2)).
These rules do not apply to (1) debt issued by a natural person
or (2) debt issued before July 2, 1982, by a noncorporate or
nongovernment issuer. As a result of this exemption, the
character of gain or loss realized on retirement of an
obligation issued by a natural person under prior law was
governed by case law.
---------------------------------------------------------------------------
\211\ The issuer of a debt instrument with OID generally accrues
and deducts the discount, as interest, over the life of the obligations
even though the amount of such interest is not paid until the debt
matures. The holder of such a debt instrument also generally includes
the OID in income as it accrues as interest. The mandatory inclusion of
OID in income does not apply, among other exceptions, to obligations
issued by a natural person before March 2, 1984, and loans of less than
$10,000 between natural persons if such loan is not made in the
ordinary course of business of the lender (secs. 1272(a)(2)(D) and
(E)).
---------------------------------------------------------------------------
Reasons for Change
Extinguishment treated as sale or exchange.--In general,
the Congress believed that prior law was deficient since (1) it
taxed similar economic transactions differently and (2) it
effectively provided some, but not all, taxpayers with an
election. Its lack of certainty made the tax laws unnecessarily
difficult to administer.
The Congress believed that some transactions, such as
settlements of contracts to deliver a capital asset, are
economically equivalent to a sale or exchange of such contracts
since the value of any asset is the present value of the future
income that such asset will produce. In addition, to the extent
that prior law treated modifications of property rights as not
being a sale or exchange, prior law effectively provided
taxpayers with an election to treat a transaction as giving
rise to capital gain, subject to more favorable rates than
ordinary income, or an ordinary loss that could offset higher-
taxed ordinary income and not be subject to limitations on use
of capital losses. The effect of an election could be achieved
by selling the property right if the resulting transaction
resulted in a gain or by providing for the extinguishment of
the property right if the resulting transaction resulted in a
loss.
Courts have given different answers as to whether
transactions which terminate contractual interests are treated
as a ``sale or exchange.'' This lack of uniformity caused
uncertainty to both taxpayers and the Internal Revenue Service
in the administration of the tax laws.
Accordingly, the Act treats the cancellation, lapse,
expiration, or other termination of a right or obligation with
respect to any type of property which is (or on acquisition
would be) a capital asset in the hands of the taxpayer as a
``sale or exchange.'' A major effect of the Act would be to
remove the effective ability of a taxpayer to elect the
character of gains and losses from certain transactions.
Another significant effect of the Act would be to reduce the
uncertainty concerning the tax treatment of modifications of
property rights.
Short positions that become substantially worthless.--
Congress also was concerned with the ability to postpone
indefinitely gain on short positions where the underlying
property becomes substantially worthless by simply not closing
out the short position. The Congress believed that gain on the
short position has been realized when the underlying property
becomes substantially worthless and should be recognized at
that time.
Character of gain on retirement of debt obligations issued
by natural persons.--Similar objections can be raised about the
prior law rule which exempts debt of natural persons from the
deemed sale or exchange rule applicable to debt of other
taxpayers. The Congress believed that the debt of natural
persons and other taxpayers is sufficiently economically
similar to be similarly taxed upon their retirement.
Accordingly, the Congress believed that the exception to the
deemed sale or exchange rule on retirement of debt of a natural
person should be repealed.
Explanation of Provision
Extension of relinquishment rule to all types of
property.--The Act extends to all types of property that is a
capital asset in the hands of the taxpayer the rule of present
law that treats gain or loss from the cancellation, lapse,
expiration, or other termination of a right or obligation with
respect to personal property or section 1256 contracts which is
(or on acquisition would be) a capital asset in the hands of
the taxpayer, as gain or loss from the sale of a capital asset.
Thus, the extension of the ``sale or exchange rule'' of
prior law section 1234A to all property that is a capital asset
in the hands of the taxpayer affects capital assets that are
(1) interests in real property and (2) non-actively traded
personal property. An example of the first type of property
interest that will be affected by the Act is the tax treatment
of amounts received to release a lessee from a requirement that
the premises be restored on termination of the lease.\212\ An
example of the second type of property interest that is
affected by the Act is the forfeiture of a down payment under a
contract to purchase stock.\213\ The Act does not affect
whether a right is property or whether property is a capital
asset.
---------------------------------------------------------------------------
\212\ See Billy Rose Diamond Horseshoe, Inc. v. Commissioner, 448
F.2d 549 (1971), where the Second Circuit held that payments were not
entitled to capital gain treatment because there was no sale or
exchange. See also, Sirbo Holdings, Inc. v. Commissioner, 509 F.2d 1220
(2d Cir. 1975).
\213\ See U.S. Freight Co. v. U.S., 422 F.2d 887 (Ct. Cl. 1970),
holding that forfeiture was an ordinary loss.
---------------------------------------------------------------------------
Short positions that become substantially worthless.--In
addition, the Act provides that if a taxpayer enters into a
short sale of property and such property becomes substantially
worthless, the taxpayer shall recognize gain as if the short
sale were closed when the property becomes substantially
worthless. The Act also extends the statute of limitations with
respect to such gain recognition to the earlier of: (1) three
years after the Treasury Secretary is notified that the
position has become substantially worthless; or (2) six years
after the date of filing of the income tax return for the
taxable year during which the position became substantially
worthless. To the extent provided in Treasury regulations,
similar gain recognition rules apply to any option with respect
to property, any offsetting notional principal contract with
respect to property, any futures or forward contract to deliver
property, or with respect to any similar transaction or
position that becomes substantially worthless.
Character of gain on retirement of debt obligations issued
by natural persons.--The Act repeals the provision that exempts
debt obligations issued by natural persons effective for
obligations issued after June 8, 1997, from the rule which
treats retirement as an exchange. In addition, the Act
terminates the grandfather of debt issued before July 2, 1982,
by noncorporations or nongovernments from the rule that treats
gain or loss realized on retirement of such debt as gain or
loss realized on an exchange, effective for obligations
acquired by purchase (within the meaning of section 1272(d)(1))
after June 8, 1997. Thus, under the Act, gain or loss on the
retirement of such debt will be capital gain or loss.
Effective Date
Extension of relinquishment rule to all types of
property.--The extension of the extinguishment rule applies to
terminations occurring more than 30 days after the date of
enactment of the Act (August 5, 1997).
Short positions that become substantially worthless.--The
provision applies to property that becomes substantially
worthless after the date of enactment of the Act (August 5,
1997). No inference is intended as to the proper treatment of
these or similar transactions or positions under prior law.
Character of gain on retirement of debt obligations issued
by natural persons.--The provision applies to sales, exchanges
and retirements after date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $15 million in 1998, $27 million in 1999,
and $25 million per year in each of the years 2000 through
2007.
5. Determination of original issue discount where pooled debt
obligations subject to acceleration (sec. 1004 of the Act and
sec. 1272 of the Code)
Present and Prior Law
Inclusion of interest income, in general
A taxpayer generally must include in gross income the
amount of interest received or accrued within the taxable year
on indebtedness held by the taxpayer. If the principal amount
of an indebtedness may be paid without interest by a specified
date (as is the case with certain credit card balances), under
present law, the holder of the indebtedness is not required to
accrue interest until after the specified date has passed.
Original issue discount
The holder of a debt instrument with original issue
discount (``OID'') generally accrues and includes in gross
income, as interest, the OID over the life of the obligation,
even though the amount of the interest may not be received
until the maturity of the instrument.
The amount of OID with respect to a debt instrument is the
excess of the stated redemption price at maturity over the
issue price of the debt instrument. The stated redemption price
at maturity includes all amounts payable at maturity. The
amount of OID in a debt instrument is allocated over the life
of the instrument through a series of adjustments to the issue
price for each accrual period. The adjustment to the issue
price is determined by multiplying the adjusted issue price
(i.e., the issue price increased by adjustments prior to the
accrual period) by the instrument's yield to maturity, and then
subtracting the interest payable during the accrual period.
Thus, in order to compute the amount of OID and the portion of
OID allocable to a period, the stated redemption price at
maturity and the time of maturity must be known. Issuers of OID
instruments accrue and deduct the amount of OID as interest
expense in the same manner as the holder.
Special rules for determining the amount of OID allocated
to a period apply to certain instruments that may be subject to
prepayment. First, if a borrower can reduce the yield on a debt
by exercising a prepayment option, the OID rules assume that
the borrower will prepay the debt. In addition, in the case of
(1) any regular interest in a REMIC, (2) qualified mortgages
held by a REMIC, or (3) any other debt instrument if payments
under the instrument may be accelerated by reason of
prepayments of other obligations securing the instrument, the
daily portions of the OID on such debt instruments are
determined by taking into account an assumption regarding the
prepayment of principal for such instruments.
Reasons for Change
Interest income generally accrues over the period an amount
is borrowed and repaid. Certain debt instruments, such as
credit card receivables, do not require the debtors to pay
interest if they pay their accounts by a specified date. The
operation of the OID and interest accrual rules of prior law
provided that, in such instances, the holder of the debt could
assume that the debtors would remit their balances in a timely
manner and thus avoid the interest charges. In the case of a
large pool of such debt instruments, this prepayment
assumption, as applied to all debtors in the pool, was
unrealistic and may have resulted in the mismeasurement of
income with respect to the interest charged to those debtors
that did not prepay their account balances.
Explanation of Provision
The Act applies the special OID rule applicable to any
regular interest in a REMIC, qualified mortgages held by a
REMIC, or certain other debt instruments to any pool of debt
instruments the payments on which may be affected by reason of
prepayments. Thus, under the Act, if a taxpayer holds a pool of
credit card receivables that require interest to be paid if the
borrowers do not pay their accounts by a specified date, the
taxpayer would be required to accrue interest or OID on such
pool based upon a reasonable assumption regarding the timing of
the payments of the accounts in the pool. In cases where the
payments in the pool occur soon after year end and before the
taxpayer files its tax return for the taxable year that
includes such year end, the taxpayer may accrue interest based
on its actual experience rather than based upon reasonable
assumptions.
The Act operates as follows: Assume that a calendar year
taxpayer issues credit cards, the terms of which provide that
if the cardholder pays his or her balance in full within 25
days after the close of the monthly billing cycle, no interest
will accrue with respect to such charges. However, if the
balances are not paid within this 25-day grace period, interest
will accrue from the date of the charge until the balance is
paid. Further assume that the taxpayer issues a significant
number of such credit cards and the cardholders incur charges
of $10 million during the billing cycle that runs from December
16, 1998 to January 15, 1999. Under prior law (depending upon
the taxpayer's accounting method), the taxpayer was not
required to include any interest income in 1998 with respect to
the billing cycle that includes December 31, 1998, because it
is possible each credit cardholder will pay his or her balance
in full before the end of the 25-day grace period (i.e., by
February 10, 1998), and therefore no one will any incur any
related finance charges. Under the Act, the taxpayer, in
computing its 1998 taxable income, is required to make a
reasonable assumption as to what portion of the $10 million
cumulative balance attributable to 1998 will not be paid off
within the 25-day grace period and is required to accrue
interest income through December 31, 1998, with respect to such
portion. The taxpayer would then adjust such accrual in 1999 to
reflect the extent to which such prepayment assumption
reflected the actual payments received during the grace period.
In addition, the Secretary of the Treasury is authorized to
provide appropriate exemptions from the provision, including
exemptions for taxpayers that hold a limited amount of debt
instruments, such as small retailers.
Effective Date
The provision is effective for taxable years beginning
after the date of enactment (i.e., after August 5, 1997). If a
taxpayer is required to change its method of accounting under
the Act, such change is treated as initiated by the taxpayer
with the consent of the Secretary of the Treasury and any
section 481 adjustment is included in income ratably over a
four-year period. It is understood that some taxpayers
presently use a method of accounting similar to the method
required to be used under the Act and have asked the Secretary
of the Treasury for permission to change to a different method
for pre-effective date years. It is within the discretion of
the Secretary whether or not to grant these pending
requests.\214\
---------------------------------------------------------------------------
\214\ See, IRS Notice 97-67, issued November 14, 1997, advising of
upcoming guidance providing procedures for automatically changing
methods of accounting with respect to grace period interest.
---------------------------------------------------------------------------
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $76 million in 1998, $275 million in 1999,
$358 million in 2000, $319 million in 2001, $283 million in
2002, $100 million in 2003, $105 million in 2004, $109 million
in 2005, $114 million in 2006, and $118 million in 2007.
6. Deny interest deduction on certain debt instruments (sec. 1005 of
the Act and sec. 163 of the Code)
Prior Law
Whether an instrument qualifies for tax purposes as debt or
equity is determined under all the facts and circumstances
based on principles developed in case law. If an instrument
qualifies as equity, the issuer generally does not receive a
deduction for dividends paid and the holder generally includes
such dividends in income (although corporate holders generally
may obtain a dividends-received deduction of at least 70
percent of the amount of the dividend). If an instrument
qualifies as debt, the issuer may receive a deduction for
accrued interest and the holder generally includes interest in
income, subject to certain limitations.
Original issue discount (``OID'') on a debt instrument is
the excess of the stated redemption price at maturity over the
issue price of the instrument. An issuer of a debt instrument
with OID generally accrues and deducts the discount as interest
over the life of the instrument even though interest may not be
paid until the instrument matures. The holder of such a debt
instrument also generally includes the OID in income on an
accrual basis.
Reasons for Change
The Congress was concerned that corporate taxpayers may
issue instruments denominated as debt but that more closely
resemble equity transactions for which an interest deduction is
not appropriate.
Explanation of Provision
Under the Act, no deduction is allowed for interest or OID
on an instrument issued by a corporation (or issued by a
partnership to the extent of its corporate partners) that is
payable in stock of the issuer or a related party (within the
meaning of sections 267(b) and 707(b)), including an instrument
a substantial portion of which is mandatorily convertible or
convertible at the issuer's option into stock of the issuer or
a related party. In addition, an instrument is to be treated as
payable in stock if a substantial portion of the principal or
interest is required to be determined, or may be determined at
the option of the issuer or related party, by reference to the
value of stock of the issuer or related party. An instrument
also is treated as payable in stock if it is part of an
arrangement that is reasonably expected to result in such
payment of the instrument with or by reference to such stock,
such as in the case of certain issuances of a forward contract
in connection with the issuance of debt, nonrecourse debt that
is secured principally by such stock, or certain debt
instruments that are convertible at the holder's option when it
is substantially certain that the right will be exercised. For
example, it is not expected that the provision will affect debt
with a conversion feature where the conversion price is
significantly higher than the market price of the stock on the
issue date of the debt. The Act does not affect the treatment
of a holder of an instrument.
For purposes of the provision, principal or interest shall
be treated as required to be paid in, converted to, or
determined with reference to the value of equity if it may be
so required at the option of the holder or a related party and
there is a substantial certainty that the option will be
exercised.
The Act is not intended to affect the characterization of
instruments as debt or equity under present or prior law; and
no inference is intended as to the treatment of any instrument
under prior law.
Effective Date
The provision is effective for instruments issued after
June 8, 1997, but will not apply to such instruments (1) issued
pursuant to a written agreement which was binding on such date
and at all times thereafter, (2) described in a ruling request
submitted to the Internal Revenue Service on or before such
date, or (3) described in a public announcement or filing with
the Securities and Exchange Commission on or before such date.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $5 million in 1998, $16 million in 1999, $29
million in 2000, $43 million in 2001, $55 million in 2002, $62
million in 2003, $63 million in 2004, $64 million in 2005, $65
million in 2006, and $67 million in 2007.
B. Corporate Organizations and Reorganizations
1. Require gain recognition for certain extraordinary dividends (sec.
1011 of the Act and sec. 1059 of the Code)
Prior Law
A corporate shareholder generally can deduct at least 70
percent of a dividend received from another corporation. This
dividends received deduction is 80 percent if the corporate
shareholder owns at least 20 percent of the distributing
corporation and generally 100 percent if the shareholder owns
at least 80 percent of the distributing corporation.
Section 1059 of the Code requires a corporate shareholder
that receives an ``extraordinary dividend'' to reduce the basis
of the stock with respect to which the dividend was received by
the nontaxed portion of the dividend. Whether a dividend is
``extraordinary'' is determined, among other things, by
reference to the size of the dividend in relation to the
adjusted basis of the shareholder's stock. Also, a dividend
resulting from a non pro rata redemption or a partial
liquidation is an extraordinary dividend. If the reduction in
basis of stock exceeds the basis in the stock with respect to
which an extraordinary dividend is received, the excess is
taxed as gain on the sale or disposition of such stock, but not
until that time (sec. 1059(a)(2)). The reduction in basis for
this purpose occurs immediately before any sale or disposition
of the stock (sec. 1059(d)(1)(A)). The Treasury Department has
general regulatory authority to carry out the purposes of the
section.
Except as provided in regulations, the extraordinary
dividend provisions do not apply to result in a double
reduction in basis in the case of distributions between members
of an affiliated group filing consolidated returns, where the
dividend is eliminated or excluded under the consolidated
return regulations. Double inclusion of earnings and profits
(i.e., from both the dividend and from gain on the disposition
of stock with a reduced basis) also should generally be
prevented.\215\ Treasury regulations provide for application of
the provision when a corporation is a partner in a partnership
that receives a distribution.\216\
---------------------------------------------------------------------------
\215\ See H. Rept. 99-841, II-166, 99th Cong. 2d Sess. (September
18, 1986).
\216\ See Treas. Reg. sec. 1.701-2(f), Example (2).
---------------------------------------------------------------------------
In general, a distribution in redemption of stock is
treated as a dividend, rather than as a sale of the stock, if
it is essentially equivalent to a dividend (sec. 302). A
redemption of the stock of a shareholder generally is
essentially equivalent to a dividend if it does not result in a
meaningful reduction in the shareholder's proportionate
interest in the distributing corporation. Section 302(b) also
contains several specific tests (e.g., a substantial reduction
computation and a termination test) to identify redemptions
that are not essentially equivalent to dividends. The
determination whether a redemption is essentially equivalent to
a dividend includes reference to the constructive ownership
rules of section 318, including the option attribution rules of
section 318(a)(4). The rules relating to treatment of cash or
other property received in a reorganization contain a similar
reference (sec. 356(a)(2)).
Reasons for Change
Corporate taxpayers have attempted to dispose of stock of
other corporations in transactions structured as redemptions,
where the redeemed corporate shareholder apparently expects to
take the position that the transactions are dividends that
qualify for the dividends received deduction. Thus, the
redeemed corporate shareholder attempts to exclude from income
a substantial portion of the amount received. In some cases, it
appears that the taxpayers' interpretations of the option
attribution rules of section 318(a)(4) are important to the
taxpayers' contentions that their interests in the distributing
corporation are not meaningfully reduced, and are, therefore,
dividends.\217\ Some taxpayers may argue that certain options
have sufficient economic reality that they should be recognized
as stock ownership for purposes of determining whether a
taxpayer has substantially reduced its ownership.
---------------------------------------------------------------------------
\217\ For example, it has been reported that Seagram Corporation
intends to take the position that the corporate dividends-received
deduction will eliminate tax on significant distributions received from
DuPont Corporation in a redemption of almost all the DuPont stock held
by Seagram, coupled with the issuance of certain rights to reacquire
DuPont stock. See e.g., Landro and Shapiro, ``Hollywood Shuffle,'' Wall
Street Journal, pp. A1 and A11 (April 7, 1995); Sloan, ``For Seagram
and DuPont, a Tax Deal that No One Wants to Brandy About,'' Washington
Post, p. D3 (April 11, 1995); Sheppard, ``Can Seagram Bail Out of
DuPont without Capital Gain Tax,'' Tax Notes Today, (April 10, 1995, 95
TNT 75-4).
---------------------------------------------------------------------------
Even in the absence of options, the present law rules
dealing with extraordinary dividends may permit inappropriate
deferral of gain recognition when the portion of the
distribution that is excluded due to the dividends received
deduction exceeds the basis of the stock with respect to which
the extraordinary dividend is received.
Explanation of Provision
Under the Act, except as provided in regulations, a
corporate shareholder recognizes gain immediately with respect
to any redemption treated as a dividend (in whole or in part)
when the nontaxed portion of the dividend exceeds the basis of
the shares surrendered, if the redemption is treated as a
dividend due to options being counted as stock ownership.\218\
---------------------------------------------------------------------------
\218\ Thus, for example, where a portion of such a distribution
would not have been treated as a dividend due to insufficient earnings
and profits, the rule applies to the portion treated as a dividend.
---------------------------------------------------------------------------
In addition, the Act requires immediate gain recognition
whenever the basis of stock with respect to which any
extraordinary dividend was received is reduced below zero. The
reduction in basis of stock is treated as occurring at the
beginning of the ex-dividend date of the extraordinary dividend
to which the reduction relates.\219\ Except as provided in
regulations, it is not expected that the provision will cause
current gain recognition in consolidated return situations to
the extent that the consolidated return regulations require the
creation or increase of an excess loss account.
---------------------------------------------------------------------------
\219\ For redemptions, the reduction in basis of stock is treated
as occurring at the beginning of the date holders of the stock become
entitled to receive the redemption proceeds.
---------------------------------------------------------------------------
Reorganizations or other exchanges involving amounts that
are treated as dividends under section 356 of the Code are
treated as redemptions for purposes of applying the rules
relating to redemptions under section 1059(e). For example, if
a recapitalization or other transaction that involves a
dividend under section 356 has the effect of a non pro rata
redemption or is treated as a dividend due to options being
counted as stock, the rules of section 1059 apply. Redemptions
of shares, or other extraordinary dividends on shares, held by
a partnership will be subject to section 1059 to the extent
there are corporate partners (e.g., appropriate adjustments to
the basis of the shares held by the partnership and to the
basis of the corporate partner's partnership interest will be
required).
Under continuing section 1059(g) of present law, the
Treasury Department is authorized to issue regulations where
necessary to carry out the purposes and prevent the avoidance
of the provision.
Effective Date
The provision generally is effective for distributions
after May 3, 1995, unless made pursuant to the terms of a
written binding contract in effect on May 3, 1995, and at all
times thereafter before such distribution, or a tender offer
outstanding on May 3, 1995.\220\ However, in applying the new
gain recognition rules to any distribution that is not a
partial liquidation, a non pro rata redemption, or a redemption
that is treated as a dividend by reason of options, September
13, 1995 is substituted for May 3, 1995 in applying the
transition rules.
---------------------------------------------------------------------------
\220\ Thus, for example, in the case of a distribution prior to the
effective date, the provisions of present law would continue to apply,
including the provisions of present-law sections 1059(a) and
1059(d)(1), requiring reduction in basis immediately before any sale or
disposition of the stock, and requiring recognition of gain at the time
of such sale or disposition.
---------------------------------------------------------------------------
No inference is intended regarding the tax treatment under
prior law of any transaction within the scope of the provision,
including transactions utilizing options.
In addition, no inference is intended regarding the rules
under prior law (or in any case where the treatment is not
specified in the provision) for determining the shares of stock
with respect to which a dividend is received or that experience
a basis reduction.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $44 million in 1998, to decrease Federal
fiscal year budget receipts by $93 million in 1999, $54 million
in 2000, and $10 million in 2001, and to increase Federal
fiscal year budget receipts by $45 million in 2002, $77 million
in 2003, $81 million in 2004, $89 million in 2005, $95 million
in 2006, and $101 million in 2007.
2. Require gain recognition on certain distributions of controlled
corporation stock (sec. 1012 of the Act and secs. 355, 358,
351(c), and 368(a)(2)(H) of the Code)
Prior Law
A corporation generally is required to recognize gain on
the distribution of property (including stock of a subsidiary)
as if such property had been sold for its fair market value.
The shareholders generally treat the receipt of property as a
taxable event as well. Section 355 of the Internal Revenue Code
provides an exception to this rule for certain ``spin-off''
type distributions of stock of a controlled corporation,
provided that various requirements are met, including certain
restrictions relating to acquisitions and dispositions of stock
of the distributing corporation (``distributing'') or the
controlled corporation (``controlled'') prior and subsequent to
a distribution.
In cases where the form of the transaction involves a
contribution of assets to the particular controlled corporation
that is distributed in connection with the distribution, there
are specific Code requirements that distributing corporation's
shareholders own ``control'' of the distributed corporation
immediately after the distribution. Control is defined for this
purpose as 80 percent of the voting power of all classes of
stock entitled to vote and 80 percent of each other class of
stock (secs. 368(a)(1)(D), 368(c), and 351(a) and (c)). In
addition, it is a requirement for qualification of any section
355 distribution that the distributing corporation distribute
control of the controlled corporation (defined by reference to
the same 80-percent test).\221\ Present law has the effect of
imposing more restrictive requirements on certain types of
acquisitions or other transfers following a distribution if the
company acquired is the controlled corporation rather than the
distributing corporation.
---------------------------------------------------------------------------
\221\ If a controlled corporation is acquired after a distribution,
an issue may arise whether the acquisition can be viewed under step-
transaction concepts as having occurred before the distribution, with
the result that the distributing corporation would not be viewed as
having distributed the necessary 80 percent control. The Internal
Revenue Service had indicated that it would not rule on requests for
section 355 treatment in cases in which there have been negotiations,
agreements, or arrangements with respect to transactions or events
which, if consummated before the distribution, would result in the
distribution of stock or securities of a corporation which is not
``controlled'' by the distributing corporation. Rev. Proc. 96-39, 1996-
33 I.R.B. 11, as incorporated in Rev. Proc. 97-3, 1997-1 I.R.B. 85 at
sec. 5.17, modified by Rev. Proc. 97-53, 1997-47 I.R.B. 10 to delete
sec. 5.17; see also Rev. Rul. 96-30, 1996-1 C.B. 36; Rev. Rul. 70-225,
1970-1 C.B. 80.
---------------------------------------------------------------------------
After a spin-off transaction, the amount of a stockholder's
basis in the stock of the distributing corporation is generally
allocated between the stock of distributing and controlled
received by that shareholder, in proportion to their relative
fair market values (sec. 358(c); see Treas. reg. sec. 1.358-2).
In the case of an affiliated group of corporations filing a
consolidated return, this basis allocation rule generally
eliminates any excess loss account in the stock of a controlled
corporation that is distributed within the group, and its basis
is generally determined with reference to the basis of the
distributing corporation.\222\
---------------------------------------------------------------------------
\222\ Excess loss accounts in consolidation generally are created
when a subsidiary corporation makes a distribution (or has a loss that
is used by other members of the group) that exceeds the parent's basis
in the stock of the subsidiary. In general, such excess loss accounts
in consolidation are permitted to be deferred rather than causing
immediate taxable gain. Nevertheless, they are recaptured when a
subsidiary leaves the group or in certain other situations. However,
such excess loss accounts are not recaptured in certain cases where
there is an internal spin-off prior to the subsidiary leaving the
group. See, Treas. Reg. sec. 1.1502-19(g). In addition, an excess loss
account may not be created at all in certain cases that are similar
economically to a distribution that would reduce the stock basis of the
distributing subsidiary corporation, if the distribution from the
subsidiary is structured to meet the form of a section 355
distribution.
---------------------------------------------------------------------------
The treatment of basis of the distributing and controlled
corporations in a section 355 distribution differs from a
distribution of stock that is not a qualified section 355 spin-
off. In a non-qualified distribution within an affiliated group
of corporations filing a consolidated return, not only is gain
generally recognized (though deferred) on the excess of value
over basis at the distributing corporation level, the basis of
the distributing corporation's stock is increased by any gain
recognized in the distribution (when that gain is taken into
account under the relevant regulations), and reduced by the
fair market value of the distribution if the distribution is
within an affiliated group filing a consolidated return. The
basis of the stock of the distributed corporation within the
group is a fair market value basis. In the case of a
nonqualified distribution between members of an affiliated
group that is not filing a consolidated return, the
distribution causes a reduction of basis of the distributing
corporation only to the extent it exceeds the earnings and
profits of the distributing corporation or it is an
extraordinary dividend.
Reasons for Change
The Congress believed that section 355 was intended to
permit the tax-free division of existing business arrangements
among existing shareholders. In cases in which it is intended
that new shareholders will acquire ownership of a business in
connection with a spin-off, the transaction more closely
resembles a corporate level disposition of the portion of the
business that is acquired.
The Congress also believed that the difference in treatment
of certain transactions following a spin-off, depending upon
whether the distributing or controlled corporation engages in
the transaction, should be minimized.
The Congress also was concerned that spin-off transactions
within a single corporate group can have the effect of avoiding
other present law rules that create or recapture excess loss
accounts in affiliated groups filing consolidated returns. Some
intra-group distributions may have the effect of permitting
inappropriate basis increases (or preventing basis decreases)
following a distribution, due to the differences between the
basis allocation rules that govern spin-offs and those that
apply to other distributions. In the case of an affiliated
group not filing a consolidated return, it is also possible
that section 355 distributions could in effect permit similar
inappropriate basis results.
Explanation of Provision
The Act adopts additional restrictions under section 355 on
acquisitions and dispositions of the stock of the distributing
or controlled corporation.
Under the Act, if either the controlled or distributing
corporation is acquired pursuant to a plan or arrangement in
existence on the date of distribution, gain is recognized as of
the date of the distribution.
In the case of an acquisition of either the distributing
corporation or the controlled corporation, the amount of gain
recognized is the amount that the distributing corporation
would have recognized had the stock of the controlled
corporation been sold for fair market value on the date of the
distribution. Such gain is recognized immediately before the
distribution and is treated as long-term capital gain. No
adjustment to the basis of the stock or assets of either
corporation is allowed by reason of the recognition of the
gain.\223\
---------------------------------------------------------------------------
\223\ There is no intention to limit the otherwise applicable
Treasury regulatory authority under section 336(e) of the Code. There
is also no intention to limit the otherwise applicable provisions of
section 1367 with respect to the effect on shareholder stock basis of
gain recognized by an S corporation under this provision.
---------------------------------------------------------------------------
Whether a corporation is acquired is determined under rules
similar to those of present law section 355(d), except that
acquisitions would not be restricted to ``purchase''
transactions. Thus, an acquisition occurs if one or more
persons acquire 50 percent or more of the vote or value of the
stock of the controlled or distributing corporation pursuant to
a plan or arrangement. For example, assume a corporation
(``P'') distributes the stock of its wholly owned subsidiary
(``S'') to its shareholders in a transaction that otherwise
qualifies as a section 355 spin-off. If, pursuant to a plan or
arrangement, 50 percent or more of the vote or value of either
P or S is acquired by one or more persons, the Act requires
gain recognition by the distributing corporation. Except as
provided in Treasury regulations, if the assets of the
distributing or controlled corporation are acquired by a
successor in a merger or other transaction under section
368(a)(1)(A), (C) or (D) of the Code, the shareholders
(immediately before the acquisition) of the corporation
acquiring such assets are treated as acquiring stock in the
corporation from which the assets were acquired. Under Treasury
regulations, other asset transfers also could be subject to
this rule.
Under the Act, certain aggregation and attribution rules
apply for determining whether one or more persons has acquired
a 50-percent or greater interest in distributing or controlled.
The aggregation rules of section 355(d)(7)(A) apply. In
addition, except as provided in regulations, section
318(a)(2)(C) applies without regard to the amount of stock
ownership of the corporation.
A public offering of sufficient size can result in an
acquisition that causes gain recognition under the provision.
Acquisitions occurring within the four-year period
beginning two years before the date of distribution are
presumed to have occurred pursuant to a plan or arrangement.
Taxpayers can avoid gain recognition by showing that an
acquisition occurring during this four-year period was
unrelated to the distribution.
The Treasury Department is authorized to prescribe
regulations as necessary to carry out the purposes of the Act,
including regulations to provide for the application of the
changes made by the Act in the case of multiple transactions.
Certain transactions not considered acquisitions
Under the Act, certain specific types of transactions do
not cause gain recognition or are not counted as acquisitions
for purposes of determining whether there has been an
acquisition of a 50-percent or greater interest in the
distributing or the controlled corporation.
Single affiliated group
Under the Act, a plan (or series of related transactions)
is not one that will cause gain recognition if, immediately
after the completion of such plan or transactions, the
distributing corporation and all controlled corporations are
members of a single affiliated group of corporations (as
defined in section 1504 without regard to subsection (b)
thereof).
Example 1: P corporation is a member of an affiliated group
of corporations that includes subsidiary corporation S and
subsidiary corporation S1. P owns all the stock of S. S owns
all the stock of S1. P corporation is merged into unrelated X
corporation in a transaction in which the former shareholders
of X corporation will own 50 percent or more of the vote or
value of the stock of surviving X corporation after the merger.
As part of the plan of merger, S1 will be distributed by S to
X, in a transaction that otherwise qualifies under section 355.
After this distribution, S, S1, and X will remain members of a
single affiliated group of corporations under section 1504
(without regard to whether any of the corporations is a foreign
corporation, an insurance company, a tax exempt organization,
or an electing section 936 company). Even though there has been
an acquisition of P, S, and S1 by X, and a distribution of S1
by S that is part of a plan or series of related transactions,
the plan is not treated as one that requires gain recognition
on the distribution of S1 to X. This is because the
distributing corporation S and the controlled corporation S1
remain within a single affiliated group after the distribution
(even though the P group has changed ownership).
Continuing direct or indirect ownership
Under the Act, except as provided in Treasury regulations,
certain acquisitions are not taken into account in determining
whether a 50-percent or greater interest in distributing or
controlled has been acquired. Generally, in any transaction,
stock received directly or indirectly by former shareholders of
distributing or controlled, in a successor or new controlling
corporation of either, is not treated as acquired stock if it
is attributable to such shareholders' stock in distributing or
controlled that was not acquired as part of a plan or
arrangement to acquire 50 percent or more of such successor or
other corporation.
Section 355(e)(3)(A)(iv) of the Act, as originally enacted,
provided that an acquisition does not require gain recognition
if the same persons own 50 percent or more of both
corporations, directly or indirectly (rather than merely
indirectly, as in the House bill and Senate amendment), before
and after the acquisition and distribution, provided the stock
owned before the acquisition was not acquired as part of a plan
(or series of related transactions) to acquire a 50-percent or
greater interest in either distributing or controlled. The
intention of Congress, however, was that the acquisition of
stock in the distributing corporation or any controlled
corporation is disregarded to the extent that the percentage of
stock owned directly or indirectly in such corporation by each
person owning stock in such corporation immediately before the
acquisition does not decrease.\224\
---------------------------------------------------------------------------
\224\ A technical correction may be needed so that the statute
reflects this result. See Title VI (sec. 609(b)(2)) of H.R. 2676, the
Tax Technical Corrections Act of 1997, as passed by the House on
November 5, 1997.
---------------------------------------------------------------------------
Example 2: Individual A owns all the stock of P
corporation. P owns all the stock of a subsidiary corporation,
S. Subsidiary S is distributed to individual A in a transaction
that otherwise qualifies under section 355. As part of a plan,
P then merges with corporation X, alsoowned entirely by
individual A. There is not an acquisition that requires gain
recognition under the provision, because individual A owns directly or
indirectly 100 percent of all the stock of both X, the successor to P,
and S before and after the transaction.\225\ The same result would
occur if P were contributed to a holding company, all the stock of
which is owned by A.
---------------------------------------------------------------------------
\225\ The example assumes that A did not acquire his or her stock
in P as part of a plan or series of related transactions that results
in the direct or indirect ownership of 50 percent or more of S or P
separately by A. If A's stock in P was acquired as part of such a plan,
the transaction would be one requiring gain recognition on the spin-off
of S.
---------------------------------------------------------------------------
Example 3: Assume the facts are the same as in Example 2
except that corporations P and X are each owned by the same 20
individual 5-percent shareholders (rather than wholly by
individual A). The transaction described in Example 2, in which
S is spun off by P to P's shareholders and P is acquired by X,
would not cause gain recognition, because each shareholder that
owned stock of distributing and controlled before the
transaction continues to own the same percentage of stock of
each corporation after the transaction.
Example 4: Shareholder A owns 10 percent of the vote and
value of the stock of corporation D (which owns all of
corporation C). There are nine other equal shareholders of D. A
also owns 100 percent of the vote and value of the stock of
unrelated corporation P. D distributes C pro rata to all the
shareholders of D. Thereafter, pursuant to a plan or series of
related transactions, D (worth 100x) merges with corporation P
(worth 900x). After the merger, each of the former shareholders
of corporation D owns stock of the merged entity reflecting the
vote and value attributable to that shareholder's respective 10
percent former stock ownership in D. Each of the former
shareholders of D owns 1 percent of the stock of the merged
corporation, except that shareholder A (who owned 100 percent
of corporation P and 10 percent of corporation D before the
merger) now owns 91 percent of the stock of the merged
corporation. In determining whether a 50-percent or greater
interest in D has been acquired, the interest of each of the
continuing shareholders is disregarded only to the extent there
has been no decrease in such shareholder's direct or indirect
ownership. Thus, the 10-percent interest of A, and the 1-
percent interest of each of the nine other former shareholders
of D, is not counted. The remaining 81-percent ownership of the
merged corporation, representing a decrease of nine percent in
the interests of each of the nine former shareholders other
than A, is counted in determining the extent of an acquisition.
Therefore, a 50-percent or greater interest in D has been
acquired.\226\
---------------------------------------------------------------------------
\226\ This example reflects the technical correction contained in
Title VI (sec. 609(b)(2)) of H.R. 2676, the Tax Technical Corrections
Act of 1997, as passed by the House on November 5, 1997.
---------------------------------------------------------------------------
Except as provided in Treasury regulations, certain other
acquisitions also are not taken into account. For example,
under section 355(e)(3)(A), the following other types of
acquisitions of stock are not subject to the provision,
provided that the stock owned before the acquisition was not
acquired pursuant to a plan or series of related transactions
to acquire a 50-percent or greater ownership interest in either
distributing or controlled:
First, the acquisition of stock in the controlled
corporation by the distributing corporation (as one example, in
the case of a contribution of property by the distributing
corporation to the controlled corporation in exchange for the
stock of the controlled corporation);
Second, the acquisition by a person of stock in any
controlled corporation by reason of holding stock or securities
in the distributing corporation (as one example, the receipt by
a distributing corporation shareholder of controlled
corporation stock in a distribution--including a split-off
distribution in which a shareholder that did not own 50 percent
of the stock of distributing owns 50 percent or more of the
stock of controlled); and
Third, the acquisition by a person of stock in any
successor corporation of the distributing corporation or any
controlled corporation by reason of holding stock or securities
in such distributing or controlled corporation (for example,
the receipt by former shareholders of distributing of 50
percent or more of the stock of a successor corporation in a
merger of distributing).
The Act does not apply to distributions that would
otherwise be subject to section 355(d) of present law, which
imposes corporate level tax on certain disqualified
distributions.
The Act does not apply to a distribution pursuant to a
title 11 or similar case.
Section 355(f)
The Act provides that, except as provided in Treasury
regulations, section 355 (or so much of section 356 as relates
to section 355) shall not apply to the distribution of stock
from one member of an affiliated group of corporations (as
defined in section 1504(a)) to another member of such group (an
``intragroup spin-off'') if such distribution is part of a plan
(or series of related transactions) described in subsection
(e)(2)(A)(ii), pursuant to which one or more persons acquire
directly or indirectly stock representing a 50-percent or
greater interest in the distributing corporation or any
controlled corporation.
Example 5: P corporation owns all the stock of subsidiary
corporation S. S owns all the stock of subsidiary corporation
T. S distributes the stock of T corporation to P as part of a
plan or series of related transactions in which P then
distributes S to its shareholders and then P is merged into
unrelated X corporation. After the merger, former shareholders
of X corporation own 50 percent or more of the voting power or
value of the stock of the merged corporation. Because the
distribution of T by S is part of a plan or series of related
transactions in which S is distributed by P outside the P
affiliated group and P is then acquired under section 355(e),
section 355 in its entirety does not apply to the intragroup
spin-off of T to P, under section 355(f). Also, the
distribution of S by P is subject to section 355(e).
In determining whether an acquisition described in
subsection (e)(2)(A)(ii) occurs, all the provisions of new
subsection 355(e) are applied. For example, an intragroup spin-
off in connection with an overall transaction that does not
cause gain recognition under section 355(e) because it is
described in section 355(e)(2)(C), or because of section
355(e)(3), or because of the effective date of section 355(e),
is not subject to the rule of section 355(f).
The Treasury Department has regulatory authority to vary
the result that the intragroup distribution under section
355(f) does not qualify for section 355 treatment. In this
connection, the Treasury Department could by regulation
eliminate some or all of the gain recognition required under
section 355(f) in connection with the issuance of regulations
that would cause appropriate basis results with respect to the
stock of S and T in the above example so that concerns
regarding present law section 355 basis rules (described below
in connection with section 358(c)) would be eliminated.\227\
---------------------------------------------------------------------------
\227\ Examples of approaches that the Treasury Department may
consider are discussed in connection with section 358(g), infra.
---------------------------------------------------------------------------
Treasury regulatory authority under section 358(g)
The Act provides that in the case of any distribution of
stock of one member of an affiliated group of corporations to
another member under section 355 (``intragroup spin-off''), the
Secretary of the Treasury is authorized under section 358(g) to
provide adjustments to the basis of any stock in a corporation
which is a member of such group, to reflect appropriately the
proper treatment of such distribution. It is understood that
the approach of any such regulations applied to intragroup
spin-offs that do not involve an acquisition may also be
applied under the Treasury regulatory authority to modify the
rule of section 355(f) as may be appropriate.
Congress believed that the concerns relating to basis
adjustments in the case of intragroup spin offs are essentially
similar, whether or not an acquisition is currently intended as
part of a plan or series of related transactions. The concerns
include the following. First, under present law consolidated
return regulations, it is possible that an excess loss account
of a lower tier subsidiary may be eliminated. This creates the
potential for the subsidiary to leave the group without
recapture of the excess loss account, even though the group has
benefitted from the losses or distributions in excess of basis
that led to the existence of the excess loss account.
Second, under present law, a shareholder's stock basis in
its stock of the distributing corporation is allocated after a
spin-off between the stock of the distributing and controlled
corporations, in proportion to the relative fair market values
of the stock of those companies. If a disproportionate amount
of asset basis (as compared to value) is in one of the
companies (including but not limited to a shift of value and
basis through a borrowing by one company and contribution of
the borrowed cash to the other), present law rules under
section 358(c) can produce an increase in stock basis relative
to asset basis in one corporation, and a correspondingdecrease
in stock basis relative to asset basis in the other company. Because
the spin-off has occurred within the corporate group, the group can
continue to benefit from high inside asset basis either for purposes of
sale or depreciation, while also choosing to benefit from the
disproportionately high stock basis in the other corporation. If, for
example, both corporations were sold at a later date, a prior
distribution can result in a significant decrease in the amount of gain
recognized than would have occurred if the two corporations had been
sold together without a prior spin off (or separately, without a prior
spin-off).
Example 6: P owns all the stock of S1 and S1 owns all the
stock of S2. P's basis in the stock of S1 is 50; the inside
asset basis of S1's assets is 50; and the total value of S1's
stock and assets (including the value of S2) is 150. S1's basis
in the stock of S2 is 0; the inside basis of S2's assets is 0;
and the value of S2's stock and assets is 100. If S1 were sold,
holding S2, the total gain would be 100. S1 distributes S2 to P
in a section 355 transaction. After this spin-off, under
present law, P's basis in the stock of S1 is approximately 17
(50/150 times the total 50 stock basis in S1 prior to the spin-
off) and the inside asset basis of S1 is 50. P's basis in the
stock of S2 is 33 (100/150 times the total 50 stock basis in S1
prior to the spin-off) and the inside asset basis of S2 is 0.
After a period of time, S2 can be sold for its value of 100,
with a gain of 67 rather than 100. Also, since S1 remains in
the corporate group, the full 50 inside asset basis can
continue to be used. S1's assets could be sold for 50 with no
gain or loss. Thus, S1 and S2 can be sold later at a total gain
of 67, rather than the total gain of 100 that would have
occurred had they been sold without the spin-off.
As one variation on the foregoing concern, taxpayers have
attempted to utilize spin-offs to extract significant amounts
of asset value and basis, (including but not limited to
transactions in which one corporation decreases its value by
incurring debt, and increases the asset basis and value of the
other corporation by contributing the proceeds of the debt to
the other corporation) without creation of an excess loss
account or triggering of gain, even when the extraction is in
excess of the basis in the distributing corporation's stock.
The Treasury Department may promulgate any regulations
necessary to address these concerns and other collateral
issues. As one example, the Treasury Department may consider
providing rules that require a carryover basis within the group
(or stock basis conforming to asset basis as appropriate) for
the distributed corporation (including a carryover of an excess
loss account, if any, in a consolidated return). Similarly, the
Treasury Department may provide a reduction in the basis of the
stock of the distributing corporation to reflect the change in
the value and basis of the distributing corporation's assets.
The Treasury Department may determine that the aggregate stock
basis of distributing and controlled after the distribution may
be adjusted to an amount that is less than the aggregate basis
of the stock of the distributing corporation before the
distribution, to prevent inappropriate potential for artificial
losses or diminishment of gain on disposition of any of the
corporations involved in the spin-off. The Treasury Department
may provide separate regulations for corporations in affiliated
groups filing a consolidated return and for affiliated groups
not filing a consolidated return, as appropriate to each
situation.
Control requirement for certain transactions
The Act also modifies certain rules for determining control
immediately after a distribution in the case of certain
divisive transactions in which a controlled corporation is
distributed and the transaction meets the requirements of
section 355. In such cases, under section 351 and modified
section 368(a)(2)(H) with respect to certain reorganizations
under section 368(a)(1)(D), those shareholders receiving stock
in the distributed corporation are treated as in control of the
distributed corporation immediately after the distribution if
they hold stock representing a greater than 50 percent interest
in the vote and value of stock of the distributed corporation.
The Act does not change the present-law requirement under
section 355 that the distributing corporation must distribute
80 percent of the voting power and 80 percent of each other
class of stock of the controlled corporation. It is expected
that this requirement will be applied by the Internal Revenue
Service taking account of the provisions of the Act regarding
plans that permit certain types of planned restructuring of the
distributing corporation following the distribution, and to
treat similar restructurings of the controlled corporation in a
similar manner. Thus, the 80-percent control requirement is
expected to be administered in a manner that would prevent the
tax-free spin-off of a less-than-80-percent controlled
subsidiary, but generally would not impose additional
restrictions on post-distribution restructurings of the
controlled corporation if such restrictions would not apply to
the distributing corporation.
Effective Date
The provision is generally effective for distributions
after April 16, 1997. However, the part of the provision
providing a greater-than-50-percent control requirement
immediately after certain section 351 and 368(a)(1)(D)
distributions is effective for transfers after August 5, 1997.
The provision does not apply to a distribution after April
16, 1997 that is part of an acquisition that would otherwise
cause gain recognition to the distributing or controlled
corporation under new section 355(e) or (f), if such
acquisition is (1) made pursuant to a written agreement which
was binding on April 16, 1997 and at all times thereafter; (2)
described in a ruling request submitted to the Internal Revenue
Service on or before such date; or (3) described on or before
such date in a public announcement or in a filing with the
Securities and Exchange Commission (``SEC'') required solely by
reason of the distribution or acquisition. Any written
agreement, ruling request, or public announcement or SEC filing
is not within the scope of these transition provisions unless
it identifies the acquiror of the distributing corporation or
of any controlled corporation, whichever is applicable.
The part of the provision providing a greater-than-50-
percent control provision for certain transfers after the date
of enactment will not apply if such transfer meets the
requirements of (1), (2), or (3) of the preceding paragraph.
An acquisition of stock that occurs on or before April 16,
1997, will not cause gain recognition under the provision, even
if there is a distribution after that date that is part of a
plan or series of related transactions that would otherwise be
subject to the provision.
Any contract that is, in fact, binding under State law as
of April 16, 1997, even though not written, is eligible for
transition relief. It would be expected, in such a case, that
some form of contemporaneous written evidence of such contract
would be in existence. As one example, if under State law
acceptance of the terms and conditions of a contract by a
corporate board of directors creates a binding contract with an
acquiror, then such contract, and the terms and conditions
presented to the board, could satisfy the requirement for
binding contract transitional relief under the conference
agreement. If there was such an offer and acceptance on or
before April 16, 1997, and a ruling request filed on or before
April 16, 1997, with respect to a proposed spin-off and
acquisition, which identifies the acquiror as one of a list of
prospective acquirors, then the transaction may be eligible for
relief under the transition rules.
Finally, with respect to the Treasury Department regulatory
authority under section 358(g) as applied to intragroup spin-
off transactions that are not part of a plan or series of
related transactions under new section 355(f), the provision
applies to distributions after April 16, 1997.\228\ However,
Congress expects that any Treasury regulations will be applied
prospectively, except in cases to prevent abuse.
---------------------------------------------------------------------------
\228\ A technical correction may be needed so that the statute
reflects this result. See Title VI (sec. 609(b)(1)) of H.R. 2676, the
Tax Technical Corrections Act of 1997, as passed by the House on
November 5, 1997.
---------------------------------------------------------------------------
Revenue Effect
The provision is estimated to increase fiscal year budget
receipts by $301 million in 1998, $243 million in 1999, $216
million in 2000, $187 million in 2001, $158 million in 2002,
$130 million in 2003, $101 million in 2004, $73 million in
2005, $46 million in 2006, and $10 million in 2007.
3. Reform tax treatment of certain corporate stock transfers (sec. 1013
of the Act and secs. 304 and 1059 of the Code)
Prior Law
Under section 304, if one corporation purchases stock of a
related corporation, the transaction generally is
recharacterized as a redemption. In determining whether a
transaction so recharacterized is treated as a sale or a
dividend, reference is made to the changes in the selling
corporation's ownership of stock in the issuing corporation
(applying the constructive ownership rules of section 318(a)
with modifications under section 304(c)). Sales proceeds
received by a corporate transferor that are characterized as a
dividend may qualify for the dividends received deduction under
section 243, and such dividend may bring with it foreign tax
credits under section 902. Section 304 does not apply to
transfers of stock between members of a consolidated group.
Section 1059 applies to ``extraordinary dividends,''
including certain redemption transactions treated as dividends
qualifying for the dividends received deduction. If a
redemption results in an extraordinary dividend, section 1059
generally requires the shareholder to reduce its basis in the
stock of the redeeming corporation by the nontaxed portion of
such dividend.
Reasons for Change
Section 304 is directed primarily at preventing a
controlling shareholder from claiming basis recovery and
capital gain treatment on transactions that result in a
withdrawal of earnings from corporate solution. These concerns
are most relevant where the shareholder is an individual.
Different concerns may be present if the shareholder is a
corporation, due in part to the availability of the dividends
received deduction. A corporation often may prefer a
transaction to be characterized as a dividend, as opposed to a
sale or exchange. Accordingly, a corporation may intentionally
seek to apply section 304 to a transaction which is in
substance a sale or exchange. Corporations that are related for
purposes of section 304 need not be 80-percent controlled by a
common parent. The separate rules for corporations filing a
consolidated return, that would generally reduce basis for
untaxed dividends received, do not apply. Furthermore, in some
situations where the selling corporation does not in fact own
any stock of the acquiring corporation before or after the
transaction (except by attribution), it is possible that
current law may lead to inappropriate results.
As one example, in certain related-party sales the selling
corporation may take the position that its basis in any shares
of stock it may have retained (or possibly in any shares of the
acquiring corporation that it may own) need not be reduced by
the amount of its dividends received deduction. This could
result in an inappropriate shifting of basis. The result can be
artificial reduction of gain or creation of loss on disposition
of any such retained shares.
For example, assume that domestic corporation X owns 70
percent of the shares of domestic corporation S and all the
shares of domestic corporation B. S owns all the shares of
domestic corporation T with a basis of $100. Assume that
corporation B has sufficient earnings and profits so that any
distribution of property would be treated as a dividend. Assume
that S sells all but one of its shares in T to B for $99, their
fair market value. The transfer is treated as a redemption of
shares of B, which redemption is treated as a dividend to S
because, even though S in fact owns no shares of B, it is
deemed to own all the shares of B before and after the
transaction through attribution from X. In such a case,
taxpayers may have contended that the one share of T retained
(worth $1) retains the entire original basis of $100. Although
S has received $99 from B for its other shares of T, and has
not paid full tax on that receipt due to the dividends received
deduction, S may now attempt to claim a $99 loss on disposing
of the remaining share of T.
In international cases, a U.S. corporation owned by a
foreign corporation may inappropriately claim foreign tax
credits from a section 304 transaction. For example, if a
foreign-controlled domestic corporation sells the stock of a
subsidiary to a foreign sister corporation, the domestic
corporation may have taken the position that it is entitled to
credit foreign taxes that were paid by the foreign sister
corporation. See Rev. Rul. 92-86, 1992-2 C.B. 199; Rev. Rul.
91-5, 1991-1 C.B. 114. However, if the foreign sister
corporation had actually distributed its earnings and profits
to the common foreign parent, no foreign tax credits would have
been available to the domestic corporation.
Explanation of Provision
Under the Act, to the extent that a section 304 transaction
is treated as a distribution under section 301, the transferor
and the acquiring corporation are treated as if (1) the
transferor had transferred the stock involved in the
transaction to the acquiring corporation in exchange for stock
of the acquiring corporation in a transaction to which section
351(a) applies,\229\ and (2) the acquiring corporation had then
redeemed the stock it is treated as having issued. Thus, the
acquiring corporation is treated for all purposes as having
redeemed the stock it is treated as having issued to the
transferor. In addition, the Act amends section 1059 so that,
if the section 304 transaction is treated as a dividend to
which the dividends received deduction applies, the dividend is
treated as an extraordinary dividend in which only the basis of
the transferred shares would be taken into account under
section 1059.
---------------------------------------------------------------------------
\229\ In determining the holding period of stock deemed to have
been contributed and redeemed under the provision, the tacking of
holding period rules applicable under section 351 apply for purposes of
the provision.
---------------------------------------------------------------------------
Under the Act, a special rule applies to section 304
transactions involving acquisitions by foreign corporations.
The Act limits the earnings and profits of the acquiring
foreign corporation that are taken into account in applying
section 304. The earnings and profits of the acquiring foreign
corporation to be taken into account will not exceed the
portion of such earnings and profits that (1) is attributable
to stock of such acquiring corporation held by a corporation or
individual who is the transferor (or a person related thereto)
and who is a U.S. shareholder (within the meaning of sec,
951(b)) of such corporation, and (2) was accumulated during
periods in which such stock was owned by such person while such
acquiring corporation was a controlled foreign corporation. For
purposes of this rule, except as otherwise provided by the
Secretary of the Treasury, the rules of section 1248(d)
(relating to certain exclusions from earnings and profits)
would apply. The Secretary of the Treasury is to prescribe
regulations as appropriate, including regulations determining
the earnings and profits that are attributable to particular
stock of the acquiring corporation.
No inference is intended as to the treatment of any
transaction under prior law.
Effective Date
The provision is effective for distributions or
acquisitions after June 8, 1997, except that the provision will
not apply to any such distribution or acquisition (1) made
pursuant to a written agreement which was binding on such date
and at all times thereafter, (2) described in a ruling request
submitted to the Internal Revenue Service on or before such
date, or (3) described in a public announcement or filing with
the Securities and Exchange Commission on or before such date.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $10 million in 1998, $10 million in 1999,
and $5 million in each of the years 2000 through 2007.
4. Treat certain preferred stock as ``boot'' (sec. 1014 of the Act and
secs. 351, 354, 355, 356, and 1036 of the Code)
Prior Law
In reorganization transactions within the meaning of
section 368 and certain other restructurings, no gain or loss
is recognized except to the extent ``other property'' (often
called ``boot'') is received, that is, property other than
certain stock, including preferred stock. Thus, preferred stock
would be received tax-free in a reorganization. Upon the
receipt of ``other property,'' gain (or, in some situations,
loss) is recognized. A special rule permits debt securities to
be received tax-free, but only to the extent debt securities of
no lesser principal amount are surrendered in the exchange.
Other than this securities-for-securities rule, similar rules
generally apply to transactions under section 351.
Reasons for Change
Certain preferred stocks have been widely used in corporate
transactions to afford taxpayers non-recognition treatment,
even though the taxpayer may receive relatively secure
instruments in exchange for relatively risky instruments.
As one example, a shareholder of a corporation that is to
be acquired for cash may not wish to recognize gain on a sale
of his or her stock at that time. Transactions are structured
so that a new holding company is formed, to which the
shareholder contributes common stock of the company to be
acquired, and receives in exchange preferred stock. The
acquiring corporation contributes cash to a holding company,
which uses the cash to acquire the stock of the other
shareholders. Similar results might also be obtained if the
corporation to be acquired recapitalized by issuing the
preferred stock in exchange for the common stock of the
shareholder. Features such as puts and calls may effectively
determine the period within which total payment is to occur. In
the case of an individual shareholder, the preferred stock may
be puttable or redeemable only at death, in which case the
shareholder would obtain a basis step-up and never recognize
gain on the transaction.
Similarly, as another type of example, so called ``auction
rate'' preferred stock has a mechanism to reset the dividend
rate on preferred stock so that it tracks changes in interest
ratesover the term of the instrument, thus diminishing any risk
that the ``principal'' amount of stock would change if interest rates
changed.
The Congress believed that when such preferred stock
instruments are received in certain exchange transactions, it
is appropriate to view such instruments as taxable
consideration since the investor has often obtained a more
secure form of investment.
Explanation of Provision
The Act amends the relevant provisions (secs. 351, 354,
355, 356 and 1036) to treat certain preferred stock as ``other
property'' (i.e., ``boot'') subject to certain exceptions.
Thus, when a taxpayer exchanges property for this preferred
stock in a transaction that qualifies under either section 351,
355, 368, or 1036, gain (or in some instances loss) is
recognized.
For purposes of section 351, nonqualified preferred stock
is treated as ``boot'' under section 351(b). The transferor
receiving such stock thus is not treated as receiving
nonrecognition treatment under section 351(a). However, the
nonqualified preferred stock continues to be treated as stock
received by a transferor for purposes of qualification of a
transaction under section 351(a), unless and until regulations
may provide otherwise.
Section 351(b) applies to a transferor who transfers
property in a section 351 exchange and receives nonqualified
preferred stock in addition to stock that is not treated as
``other property'' under that section. Thus, if a transferor of
loss property received only nonqualified preferred stock but
the transaction in the aggregate otherwise qualified as a
section 351 exchange, such a transferor would recognize loss
under section 1001 of the Code and the basis of the
nonqualified preferred stock and of the property in the hands
of the transferee corporation would reflect the transaction in
the same manner as if that particular taxpayer had received
solely ``other property'' of any other type.\230\ However, as
with any other loss, this loss could be disallowed by the
application of section 267 or by the application of any other
provision that would disallow or defer the recognition of a
loss.
---------------------------------------------------------------------------
\230\ A technical correction may be needed so that the statute
reflects this intent. See Title VI (sec. 609(c)(1)) of H.R. 2676, the
Tax Technical Corrections Act of 1997, as passed by the House on
November 5, 1997.
---------------------------------------------------------------------------
For example, if A contributes appreciated property to new
corporation X for all the common stock (representing 90 percent
of the value and all the voting power) of X stock and B
contributes appreciated property for nonqualified preferred
stock representing 10 percent of the value of X stock, B has
received ``boot,'' but the preferred stock is still treated as
stock for purposes of sections 351(a) and 368(c), unless and
until Treasury Regulations are issued requiring a different
result. Thus, the transaction as a whole (apart from B's
treatment with respect to nonqualified preferred stock)
qualifies for non-recognition under section 351 and A does not
recognize gain. If B had received other stock in addition to
nonqualified preferred stock, B would be required to recognize
gain only to the extent of the fair market value of the
nonqualified preferred stock B receives.
The Act applies to preferred stock (i.e., stock that is
limited and preferred as to dividends and does not participate
in corporate growth to any significant extent), where (1) the
holder has the right to require the issuer or a related person
(within the meaning of secs. 267(b) and 707(b)) to redeem or
purchase the stock, (2) the issuer or a related person is
required to redeem or purchase the stock, (3) the issuer (or a
related person) has the right to redeem or purchase the stock
and, as of the issue date, it is more likely than not that such
right will be exercised, or (4) the dividend rate on the stock
varies in whole or in part (directly or indirectly) with
reference to interest rates, commodity prices, or other similar
indices, regardless of whether such varying rate is provided as
an express term of the stock (for example, in the case of an
adjustable rate stock) or as a practical result of other
aspects of the stock (for example, in the case of auction rate
stock). Factors (1), (2) or (3) above will cause an instrument
to be nonqualified preferred stock only if the right or
obligation may be exercised within 20 years of the date the
instrument is issued and such right or obligation is not
subject to a contingency which, as of the issue date, makes
remote the likelihood of the redemption or purchase. In
addition, a right or obligation is disregarded if it may be
exercised only upon the death, disability, or mental
incompetency of the holder, but only if neither the stock
surrendered nor the stock received in the exchange is stock of
a corporation any class of stock of which (or of a related
corporation) is readily tradable on an established securities
market or otherwise.\231\ For this purpose, stock of a
corporation is treated as stock that is readily tradable on an
established securities market or otherwise if such exchange is
part of a transaction or series of transactions in which such
corporation is to become a corporation that has, or a related
corporation of which has, readily tradable stock. Also, a right
or obligation is disregarded in the case of stock transferred
in connection with the performance of services if it may be
exercised only upon the holder's separation from service.
---------------------------------------------------------------------------
\231\ Conversely, in a case involving a corporation that has (or
any related corporation of which has) any class of readily tradable
stock, or that is to become such a corporation, suppose a shareholder
(A) exchanges appreciated common stock of corporation X for preferred
stock of corporation Y in a transaction otherwise qualifying as a
section 351 exchange. The preferred stock is limited and preferred as
to dividends, does not participate in corporate growth to any
significant extent, and is redeemable at the end of 21 years from the
date of issuance or upon the death of A. At the time of the exchange, A
is 80 years old (or is in ill health). If, under actuarial tables or
under the facts and circumstances of A's case the contingency of A's
death (which is certain to occur) is likely to occur within 20 years of
the date of the exchange, then the preferred stock is nonqualified
preferred stock if corporation X or Y (or any related corporation of
corporation X or Y) has any class of stock that is readily tradable, or
if X or Y (or any related corporation of X or Y) is to become such a
corporation.
---------------------------------------------------------------------------
In no event will a conversion privilege into stock of the
issuer automatically be considered to constitute participation
in corporate growth to any significant extent. Stock that is
convertible or exchangeable into stock of a corporation other
than the issuer (including, for example, stock of a parent
corporation or other related corporation) is not considered to
be stock that participates in corporate growth to any
significant extent for purposes of the provision.
The following exchanges are excluded from gain recognition
under the provisions of sections 354, 355 and 356: (1) certain
exchanges of preferred stock for comparable preferred stock of
the same or lesser value; (2) an exchange of preferred stock
for common stock; (3) certain exchanges of debt securities for
preferred stock of the same or lesser value; and (4) exchanges
of stock in certain recapitalizations of family-owned
corporations.
Exclusions (1), (2) and (3) result from the fact that
nonqualified preferred stock is treated as ``other property''
under sections 354, 355 and 356 only if received in exchange
for stock (or, under section 355, with respect to stock) that
is not nonqualified preferred stock. Thus, if nonqualified
preferred stock is received for or with respect to other
nonqualified preferred stock, or for debt securities, gain
recognition is not required. The receipt of nonqualified
preferred stock for comparable nonqualified preferred stock of
the same or lesser value, or the exchange of debt securities
for nonqualified preferred stock of the same or lesser value,
are considered to be exchanges ``for'' or ``with respect to''
such stock that are permitted. Similarly, the exchange of
nonqualified preferred stock for common stock would not be
within the scope of the provision because in such a
transaction, nonqualified preferred stock is not received in
the exchange.
For purposes of the exception for exchanges in certain
recapitalizations of family owned corporations, a family-owned
corporation is defined as any corporation if at least 50
percent of the total voting power and value of the stock of
such corporation is owned by members of the same family for
five years preceding the recapitalization. In addition, a
recapitalization does not qualify for the exception if the same
family does not own 50 percent of the total voting power and
value of the stock throughout the three-year period following
the recapitalization. Members of the same family are defined by
reference to the definition in section 447(e). Thus, a family
includes children, parents, brothers, sisters, and spouses,
with a limited attribution for directly and indirectly owned
stock of the corporation. Shares held by a family member are
treated as not held by a family member to the extent a non-
family member had a right, option or agreement to acquire the
shares (directly or indirectly, for example, through
redemptions by the issuer), or with respect to shares as to
which a family member has reduced its risk of loss with respect
to the share, for example, through an equity swap. Even though
the provision excepts certain family recapitalizations, the
special valuation rules of section 2701 for estate and gift tax
consequences continue to apply.
The statutory period for the assessment of any deficiency
attributable to a corporation failing to be a family-owned
corporation shall not expire before the expiration of three
years after the date the Secretary of the Treasury is notified
by the corporation (in such manner as the Secretary may
prescribe) of such failure, and such deficiency may be assessed
before the expiration of such three-year period notwithstanding
the provisions of any other law or rule of law which would
otherwise prevent such assessment.\232\
---------------------------------------------------------------------------
\232\ A technical correction may be needed so that the statute
reflects this intent. See Title VI (sec. 609(c)(2)) of H.R. 2676, the
Tax Technical Corrections Act of 1997, as passed by the House on
November 5, 1997.
---------------------------------------------------------------------------
An exchange of nonqualified preferred stock for
nonqualified preferred stock in an acquiring corporation may
qualify for tax-free treatment under section 354, but not
section 351. In cases in which both sections 354 and 351 may
apply to a transaction, section 354 generally will apply for
purposes of the provision. Thus, in that situation, the
exchange would be tax free.
The Treasury Secretary has regulatory authority under the
provision, including, for example, authority to (1) apply
installment sale-type rules to preferred stock that is subject
to the provision in appropriate cases and (2) prescribe
treatment of preferred stock subject to this provision under
other provisions of the Code (e.g., secs. 304, 306, 318, and
368(c)). Until regulations are issued, preferred stock that is
subject to the proposal shall continue to be treated as stock
under other provisions of the Code.
Effective Date
The provision is effective for transactions after June 8,
1997, but will not apply to such transactions (1) made pursuant
to a written agreement which was binding on such date and at
all times thereafter, (2) described in a ruling request
submitted to the Internal Revenue Service on or before such
date, or (3) described in a public announcement or filing with
the Securities and Exchange Commission on or before such date.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $35 million in 1998, $37 million in 1999,
$39 million in 2000, $41 million in 2001, $43 million in 2002,
$10 million in 2003, $10 million in 2004, $11 million in 2005,
$11 million in 2006, and $12 million in 2007.
5. Modify holding period for dividends-received deduction (sec. 1015 of
the Act and sec. 246(c) of the Code)
Prior Law
If an instrument issued by a U.S. corporation is classified
for tax purposes as stock, a corporate holder of the instrument
generally is entitled to a dividends received deduction for
dividends received on that instrument. This deduction is 70
percent of dividends received if the recipient owns less than
20 percent (by vote and value) of stock of the payor. If the
recipient owns more than 20 percent of the stock the deduction
is increased to 80 percent. If the recipient owns more than 80
percent of the payor's stock, the deduction is further
increased to 100 percent for qualifying dividends.
The dividends-received deduction is allowed to a corporate
shareholder only if the shareholder satisfies a 46-day holding
period for the dividend-paying stock (or a 91-day period for
certain dividends on preferred stock). The 46- or 91-day
holding period generally does not include any time in which the
shareholder is protected from the risk of loss otherwise
inherent in the ownership of an equity interest. The holding
period must be satisfied only once, rather than with respect to
each dividend received.
Reasons for Change
The Congress was concerned that dividend-paying stocks can
be marketed to corporate investors with accompanying attempts
to hedge or relieve the holder from risk for much of the
holding period of the stock, after the initial holding period
has been satisfied. In addition, because of the limited
application of section 1059 of the Code requiring basis
reduction, many investors whose basis includes a price paid
with the expectation of a dividend may be able to sell the
stock after the receipt of a dividend not subject to tax at an
artificial loss, even though the holder may actually have been
relieved of the risk of loss for much of the period it has held
the stock.
The Congress believed that no deduction for a distribution
on stock should be allowed when the owner of stock does not
bear the risk of loss otherwise inherent in the ownership of an
equity interest at a time proximate to the time the
distribution is made.
Explanation of Provision
The Act provides that a taxpayer is not entitled to a
dividends-received deduction if the taxpayer's holding period
for the dividend-paying stock is not satisfied over a period
immediately before or immediately after the taxpayer becomes
entitled to receive the dividend.
Effective Date
The Act is generally effective for dividends paid or
accrued after the 30th day after the date of enactment.
However, the provision does not apply to dividends received
within two years of the date of enactment if: (1) the dividend
is paid with respect to stock held on June 8, 1997, and all
times thereafter until the dividend is received; (2) the stock
is continuously subject to a position described in section
246(c)(4) on June 8, 1997, and all times thereafter until the
dividend is received; and (3) such stock and related position
is identified by the taxpayer within 30 days after enactment of
this Act (i.e., before September 5, 1997). A stock will not be
considered to be continuously subject to a position if such
position is sold, closed or otherwise terminated and is
reestablished.
Revenue Effect
The provision is estimated to increase fiscal year budget
receipts by $11 million in 1998, $13 million in 1999, $15
million in 2000, $16 million in 2001, $16 million in 2002, $16
million in 2003, $17 million in 2004, $17 million in 2005, $17
million in 2006, and $18 million in 2007.
C. Administrative Provisions
1. Reporting of certain payments made to attorneys (sec. 1021 of the
Act and sec. 6045 of the Code)
Present and Prior Law
Information reporting is required by persons engaged in a
trade or business and making payments in the course of that
trade or business of ``rent, salaries, wages, . . . or other
fixed or determinable gains, profits, and income'' (Code sec.
6041(a)). Treas. reg. sec. 1.6041-1(d)(2) provides that
attorney's fees are required to be reported if they are paid by
a person in a trade or business in the course of a trade or
business. Reporting is required to be done on Form 1099-Misc.
If, on the other hand, the payment is a gross amount and it is
not known what portion is the attorney's fee, no reporting is
required on any portion of the payment.
Reasons for Change
The Congress believed that there would be a positive impact
on compliance with the tax laws by requiring additional
information reporting. Although some might consider it
inappropriate to single out payments to one profession for
additional information reporting, requiring reporting was
considered to be appropriate in this instance because attorneys
are generally the only professionals who receive this type of
payment, a portion of which may be income to them and a portion
of which may belong to their client.
Explanation of Provision
The Act requires gross proceeds reporting on all payments
to attorneys made by a trade or business in the course of that
trade or business. It is anticipated that gross proceeds
reporting would be required on Form 1099-B (currently used by
brokers to report gross proceeds). The only exception to this
new reporting requirement would be for any payments reported on
either Form 1099-Misc under section 6041 (reports of payment of
income) or on Form W-2 under section 6051 (payments of wages).
In addition, the present exception in the regulations
exempting from reporting any payments made to corporations will
not apply to payments made to attorneys. Treasury regulation
section 1.6041-3(c) exempts payments to corporations generally
(although payments to most corporations providing medical
services must be reported). Reporting will be required under
both Code sections 6041 and 6045 (as proposed) for payments to
corporations that provide legal services. The exception of
Treasury regulation section 1.6041-3(g) exempting from
reporting payments of salaries or profits paid or distributed
by a partnership to the individual partners would continue to
apply to both sections (since these amounts are required to be
reported on Form K-1).
First, the provision applies to payments made to attorneys
regardless of whether the attorney is the exclusive payee.
Second, payments to law firms are payments to attorneys, and
therefore are subject to this reporting provision. Third,
attorneys are required to promptly supply their TINs to persons
required to file these information reports, pursuant to section
6109. Failure to do so could result in the attorney being
subject to penalty under section 6723 and the payments being
subject to backup withholding under section 3406. Fourth, the
IRS should administer this provision so that there is no
overlap between reporting under section 6041 and reporting
under section 6045. For example, if two payments are
simultaneously made to an attorney, one of which represents the
attorney's fee and the second of which represents the
settlement with the attorney's client, the first payment would
be reported under section 6041 and the second payment would not
be reported under either section 6041 or section 6045, since it
is known that the entire payment represents the settlement with
the client (and therefore no portion of it represents income to
the attorney). Fifth, it is anticipated that the IRS will
administer this provision so that it will not apply to foreign
attorneys who can clearly demonstrate that they are not subject
to U.S. tax.
Effective Date
The provision is effective for payments made after December
31, 1997. Consequently, the first information reports will be
filed with the IRS (and copies will be provided to recipients
of the payments) in 1999, with respect to payments made in
1998.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $3 million in 1999, $3 million in 2000, $3
million in 2001, $3 million in 2002, $3 million in 2003, $4
million in 2004, $4 million in 2005, $4 million in 2006, and $4
million in 2007.
2. Information reporting on persons receiving contract payments from
certain Federal agencies (sec. 1022 of the Act and sec. 6041A
of the Code)
Present and Prior Law
A service recipient (i.e., a person for whom services are
performed) engaged in a trade or business who makes payments of
remuneration in the course of that trade or business to any
person for services performed must file with the IRS an
information return reporting such payments (and the name,
address, and taxpayer identification number of the recipient)
if the remuneration paid to the person during the calendar year
is $600 or more (sec. 6041A(a)). A similar statement must also
be furnished to the person to whom such payments were made
(sec. 6041A(e)). Treasury regulations explicitly exempt from
this reporting requirement payments made to a corporation
(Treas. reg. sec. 1.6041A-1(d)(2)).
The head of each Federal executive agency must file an
information return indicating the name, address, and taxpayer
identification number (TIN) of each person (including
corporations) with which the agency enters into a contract
(sec. 6050M). The Secretary of the Treasury has the authority
to require that the returns be in such form and be made at such
time as is necessary to make the returns useful as a source of
information for collection purposes. The Secretary is given the
authority both to establish minimum amounts for which no
reporting is necessary as well as to extend the reporting
requirements to Federal license grantors and subcontractors of
Federal contracts. Treasury regulations provide that no
reporting is required if the contract is for $25,000 or less
(Treas. reg. sec. 1.6050M-1(c)(1)(i)).
Reasons for Change
The Congress determined that lowering the information
reporting threshold from $25,000 to $600 will improve
compliance because additional, small-dollar value contracts
will be reported.
Explanation of Provision
The Act requires reporting of all payments of $600 or more
made by a Federal executive agency to any person (including a
corporation) for services. In addition, the provision requires
that a copy of the information return be sent by the Federal
agency to the recipient of the payment. An exception is
provided for certain classified or confidential contracts.
Effective Date
The provision is effective for returns the due date for
which (without regard to extensions) is more than 90 days after
the date of enactment.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $7 million in 1999, $8 million in 2000, $9
million in 2001, $10 million in 2002, $11 million in 2003, $11
million in 2004, $12 million in 2005, $12 million in 2006, and
$13 million in 2007.
3. Disclosure of tax return information for administration of certain
veterans programs (sec. 1023 of the Act and sec. 6103 of the
Code)
Present and Prior Law
The Internal Revenue Code prohibits disclosure of tax
returns and return information, except to the extent
specifically authorized by the Internal Revenue Code (sec.
6103). Unauthorized disclosure is a felony punishable by a fine
not exceeding $5,000 or imprisonment of not more than five
years, or both (sec. 7213). An action for civil damages also
may be brought for unauthorized disclosure (sec. 7431). No tax
information may be furnished by the Internal Revenue Service
(``IRS'') to another agency unless the other agency establishes
procedures satisfactory to the IRS for safeguarding the tax
information it receives (sec. 6103(p)).
Among the disclosures permitted under the Code is
disclosure to the Department of Veterans Affairs (``DVA'') of
self-employment tax information and certain tax information
supplied to the IRS and Social Security Administration by third
parties. Disclosure is permitted to assist DVA in determining
eligibility for, and establishing correct benefit amounts
under, certain of its needs-based pension, health care, and
other programs (sec. 6103(1)(7)(D)(viii)). The income tax
returns filed by the veterans themselves are not disclosed to
DVA.
The DVA is required to comply with the safeguards currently
contained in the Code and in section 1137(c) of the Social
Security Act (governing the use of disclosed tax information).
These safeguards include independent verification of tax data,
notification to the individual concerned, and the opportunity
to contest agency findings based on such information.
The DVA disclosure provision is scheduled to expire after
September 30, 1998.
Reasons for Change
The Congress determined that it is appropriate to permit
disclosure of otherwise confidential tax information to ensure
the correctness of government benefits payments.
Explanation of Provision
The Act extends the DVA disclosure provision through
September 30, 2003.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $22 million in 1999, $27 million in 2000,
$31 million in 2001, $36 million in 2002, $36 million in 2003.
The provision is not estimated to change Federal fiscal year
budget receipts in 2004 through 2007.
4. Establish IRS continuous levy and improve debt collection (secs.
1024, 1025, and 1026 of the Act and secs. 6103, 6331, and 6334
of the Code)
a. Continuous levy
Present and Prior Law
If any person is liable for any internal revenue tax and
does not pay it within 10 days after notice and demand \233\ by
the IRS, the IRS may then collect the tax by levy upon all
property and rights to property belonging to the person,\234\
unless there is an explicit statutory restriction on doing so.
A levy is the seizure of the person's property or rights to
property. Property that is not cash is sold pursuant to
statutory requirements.\235\
---------------------------------------------------------------------------
\233\ Notice and demand is the notice given to a person liable for
tax stating that the tax has been assessed and demanding that payment
be made. The notice and demand must be mailed to the person's last
known address or left at the person's dwelling or usual place of
business (Code sec. 6303).
\234\ Code sec. 6331.
\235\ Code sec. 6335-6343.
---------------------------------------------------------------------------
In general, a levy does not apply to property acquired
after the date of the levy,\236\ regardless of whether the
property is held by the taxpayer or by a third party (such as a
bank) on behalf of a taxpayer. Successive seizures may be
necessary if the initial seizure is insufficient to satisfy the
liability.\237\ The only exception to this rule is for salary
and wages.\238\ A levy on salary and wages is continuous from
the date it is first made until the date it is fully paid or
becomes unenforceable.
---------------------------------------------------------------------------
\236\ Code sec. 6331(b).
\237\ Code sec. 6331(c).
\238\ Code sec. 6331(e).
---------------------------------------------------------------------------
A minimum exemption is provided for salary and wages.\239\
It is computed on a weekly basis by adding the value of the
standard deduction plus the aggregate value of personal
exemptions to which the taxpayer is entitled, divided by
52.\240\ For a family of four for taxable year 1996, the weekly
minimum exemption is $325.\241\
---------------------------------------------------------------------------
\239\ Code sec. 6334(a)(9).
\240\ Code sec. 6334(d).
\241\ Standard deduction of $6,700 plus four personal exemptions at
$2,550 each equals $16,900, which when divided by 52 equals $325.
---------------------------------------------------------------------------
Reasons for Change
The Congress determined that the extension of the
continuous levy provisions will substantially ease the
administrative burdens of collecting taxes by levy. The
Congress anticipated that taxpayers who already comply with the
tax laws will have a positive view of increased collections of
taxes owed by taxpayers who have not complied with the tax
laws.
Explanation of Provision
The Act amends the Code to provide that a continuous levy
is also applicable to non-means tested recurring Federal
payments. This is defined as a Federal payment for which
eligibility is not based on the income and/or assets of a
payee. For example, Social Security payments, which are subject
to levy under present law, would become subject to continuous
levy.
In addition, the Act provides that this levy would attach
up to 15 percent of any specified payment due the taxpayer.
This rule explicitly replaces the other specifically enumerated
exemptions from levy in the Code. A continuous levy of up to 15
percent would also apply to unemployment benefits and means-
tested public assistance.
The Act also permits the disclosure of otherwise
confidential tax return information to the Treasury
Department's Financial Management Service only for the purpose
of, and to the extent necessary in, implementing these levy
provisions.
Use of a continuous levy is at the discretion of the
Secretary of the Treasury and its use must be approved by the
Internal Revenue Service before it takes effect.\242\
---------------------------------------------------------------------------
\242\ See Title VI (sec. 609(d)) of H.R. 2676, the Tax Technical
Corrections Act of 1997, as passed by the House on November 5, 1997.
---------------------------------------------------------------------------
Effective Date
The provision was effective for levies issued after the
date of enactment (August 5, 1997).
b. Modifications of levy exemptions
Present and Prior Law
The Code exempts from levy workmen's compensation payments
\243\ and annuity or pension payments under the Railroad
Retirement Act and benefits under the Railroad Unemployment
Insurance Act \244\ described above, unemployment benefits
\245\ and means-tested public assistance.\246\
---------------------------------------------------------------------------
\243\ Code sec. 6334(a)(7).
\244\ Code sec. 6334(a)(6).
\245\ Sec. 6334(a)(4).
\246\ Sec. 6334(a)(11).
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that if wages are subject to levy,
wage replacement payments should also be subject to levy. In
addition, the Congress believed that it is inappropriate to
exempt from levy one type of annuity or pension payment while
most other types of these payments are subject to levy.
Explanation of Provision
The Act provides that the following property is not exempt
from levy if the Secretary of the Treasury (or his delegate)
approves the levy of such property:
(1) workmen's compensation payments;
(2) annuity or pension payments under the Railroad
Retirement Act and benefits under the Railroad Unemployment
Insurance Act;
(3) unemployment benefits; and
(4) means-tested public assistance.
Effective Date
The provision applies to levies issued after the date of
enactment (August 5, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $332 million in 1998, $327 million in 1999,
$256 million in 2000, $213 million in 2001, $157 million in
2002, $117 million in 2003, $102 million in 2004, $86 million
in 2005, $82 million in 2006, and $78 million in 2007.
5. Consistency rule for beneficiaries of trusts and estates (sec. 1027
of the Act and sec. 6034A of the Code)
Present and Prior Law
An S corporation is required to file a return for the
taxable year and is required to furnish to its shareholders a
copy of certain information shown on such return. The
shareholder is required to file its return in a manner that is
consistent with the information received from the S
corporation, unless the shareholder files with the Secretary of
the Treasury a notification of inconsistent treatment (sec.
6037(c)). Similar rules apply in the case of partnerships and
their partners (sec. 6222).
The fiduciary of an estate or trust that is required to
file a return for any taxable year is required to furnish to
beneficiaries certain information shown on such return
(generally via a Schedule K-1) (sec. 6034A). In addition, a
U.S. person that is treated as the owner of any portion of a
foreign trust is required to ensure that the trust files a
return for the taxable year and furnishes certain required
information to each U.S. person who is treated as an owner of a
portion of the trust or who receives any distribution from the
trust (sec. 6048(b)). However, under prior law, rules
comparable to the consistency rules that apply to S corporation
shareholders and partners in partnerships were not specified in
the case of beneficiaries of estates and trusts.
Reasons for Change
Both partners in partnerships and shareholders of S
corporations are required either to file their returns on a
basis that is consistent with the information received from the
partnership or S corporation or to identify any inconsistent
treatment. The Congress believed it appropriate to apply such
requirement also to beneficiaries of estates and trusts.
Explanation of Provision
Under the Act, a beneficiary of an estate or trust is
required to file its return in a manner that is consistent with
the information received from the estate or trust, unless the
beneficiary files with its return a notification of
inconsistent treatment identifying the inconsistency.
Effective Date
The provision is effective for returns filed after the date
of enactment (after August 5, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $3 million per year in each of 1998 through
2003, and $4 million per year in each of 2004 through 2007.
6. Registration of confidential corporate tax shelters and substantial
understatement penalty (sec. 1028 of the Act and secs. 6111,
6662, and 6707 of the Code)
Present and Prior Law
Tax shelter registration
An organizer of a tax shelter is required to register the
shelter with the Internal Revenue Service (IRS) (sec. 6111). If
the principal organizer does not do so, the duty may fall upon
any other participant in the organization of the shelter or any
person participating in its sale or management. The shelter's
identification number must be furnished to each investor who
purchases or acquires an interest in the shelter. Failure to
furnish this number to the tax shelter investors will subject
the organizer to a $100 penalty for each such failure (sec.
6707(b)).
A penalty may be imposed against an organizer who fails
without reasonable cause to timely register the shelter or who
provides false or incomplete information with respect to it.
The penalty is the greater of one percent of the aggregate
amount invested in the shelter or $500. Any person claiming any
tax benefit with respect to a shelter must report its
registration number on her return. Failure to do so without
reasonable cause will subject that person to a $250 penalty
(sec. 6707(b)(2)).
A person who organizes or sells an interest in a tax
shelter subject to the registration rule or in any other
potentially abusive plan or arrangement must maintain a list of
the investors (sec. 6112). A $50 penalty may be assessed for
each name omitted from the list. The maximum penalty per year
is $100,000 (sec. 6708).
For this purpose, a tax shelter is defined as any
investment that meets two requirements. First, the investment
must be (1) required to be registered under a Federal or state
law regulating securities, (2) sold pursuant to an exemption
from registration requiring the filing of a notice with a
Federal or state agency regulating the offering or sale of
securities, or (3) a substantial investment. Second, it must be
reasonable to infer that the ratio of deductions and 350
percent of credits to investment for any investor (i.e., the
tax shelter ratio) may be greater than two to one as of the
close of any of the first five years ending after the date on
which the investment is offered for sale. An investment that
meets these requirements will be considered a tax shelter
regardless of whether it is marketed or customarily designated
as a tax shelter (sec. 6111(c)(1)).
Accuracy-related penalty
The accuracy-related penalty, which is imposed at a rate of
20 percent, applies to the portion of any underpayment that is
attributable to (1) negligence, (2) any substantial
understatement of income tax, (3) any substantial valuation
misstatement, (4) any substantial overstatement of pension
liabilities, or (5) any substantial estate or gift tax
valuation understatement.
The substantial understatement penalty applies in the
following manner. If the correct income tax liability of a
taxpayer for a taxable year exceeds that reported by the
taxpayer by the greater of 10 percent of the correct tax or
$5,000 ($10,000 in the case of most corporations), then a
substantial understatement exists and a penalty may be imposed
equal to 20 percent of the underpayment of tax attributable to
the understatement. In determining whether a substantial
understatement exists, the amount of the understatement is
reduced by any portion attributable to an item if (1) the
treatment of the item on the return is or was supported by
substantial authority, or (2) facts relevant to the tax
treatment of the item were adequately disclosed on the return
or on a statement attached to the return and there was a
reasonable basis for the tax treatment of the item. Special
rules apply to tax shelters.
With respect to tax shelter items of non-corporate
taxpayers, the penalty may be avoided only if the taxpayer
establishes that, in addition to having substantial authority
for his position, he reasonably believed that the treatment
claimed was more likely than not the proper treatment of the
item. This reduction in the penalty is unavailable to corporate
tax shelters. The reduction in the understatement for items
disclosed on the return is inapplicable to both corporate and
non-corporate tax shelters. For this purpose, a tax shelter is
a partnership or other entity, plan, or arrangement the
principal purpose of which is the avoidance or evasion of
Federal income tax.
The Secretary may waive the penalty with respect to any
item if the taxpayer establishes reasonable cause for his
treatment of the item and that he acted in good faith.
Reasons for Change
The Congress concluded that the provision will improve
compliance with the tax laws by giving the Treasury Department
earlier notification than it generally receives under present
law of transactions that may not comport with the tax laws. In
addition, the provision will improve compliance by discouraging
taxpayers from entering into questionable transactions. Also,
the provision will improve economic efficiency, because
investments that are not economically motivated, but that are
instead tax-motivated, may reduce the supply of capital
available for economically motivated activities, which could
cause a loss of economic efficiency.
Explanation of Provision
Tax shelter registration
The Act requires a promoter of a corporate tax shelter to
register the shelter with the Secretary. Registration is
required not later than the next business day after the day
when the tax shelter is first offered to potential users. If
the promoter is not a U.S. person, or if a required
registration is not otherwise made, then any U.S. participant
is required to register the shelter. An exception to this
special rule provides that registration would not be required
if the U.S. participant notifies the promoter in writing not
later than 90 days after discussions began that the U.S.
participant will not participate in the shelter and the U.S.
person does not in fact participate in the shelter.
A corporate tax shelter is any investment, plan,
arrangement or transaction (1) a significant purpose of the
structure of which is tax avoidance or evasion by a corporate
participant, (2) that is offered to any potential participant
under conditions of confidentiality, and (3) for which the tax
shelter promoters may receive total fees in excess of $100,000.
A transaction is offered under conditions of
confidentiality if: (1) an offeree (or any person acting on its
behalf) has an understanding or agreement with or for the
benefit of any promoter to restrict or limit its disclosure of
the transaction or any significant tax features of the
transaction; or (2) the promoter claims, knows or has reason to
know (or the promoter causes another person to claim or
otherwise knows or has reason to know that a party other than
the potential offeree claims) that the transaction (or one or
more aspects of its structure) is proprietary to the promoter
or any party other than the offeree, or is otherwise protected
from disclosure or use. The promoter includes specified related
parties.
Registration will require the submission of information
identifying and describing the tax shelter and the tax benefits
of the tax shelter, as well as such other information as the
Treasury Department may require.
Tax shelter promoters are required to maintain lists of
those who have signed confidentiality agreements, or otherwise
have been subjected to nondisclosure requirements, with respect
to particular tax shelters. In addition, promoters must retain
lists of those paying fees with respect to plans or
arrangements that have previously been registered (even though
the particular party may not have been subject to
confidentiality restrictions).
All registrations will be treated as taxpayer information
under the provisions of section 6103 and will therefore not be
subject to any public disclosure.
The penalty for failing to timely register a corporate tax
shelter is the greater of $10,000 or 50 percent of the fees
payable to any promoter with respect to offerings prior to the
date of late registration (i.e., this part of the penalty does
not apply to fee payments with respect to offerings after late
registration). A similar penalty is applicable to actual
participants in any corporate tax shelter who were required to
register the tax shelter but did not. With respect to
participants, however, the 50-percent penalty is based only on
fees paid by that participant. Intentional disregard of the
requirement to register by either a promoter or a participant
increases the 50-percent penalty to 75 percent of the
applicable fees.
Substantial understatement penalty
The Act makes two modifications to the substantial
understatement penalty. The first modification affects the
reduction in the amount of the understatement which is
attributable to an item if there is a reasonable basis for the
treatment of the item. The provision provides that in no event
would a corporation have a reasonable basis for its tax
treatment of an item attributable to a multi-party financing
transaction if such treatment does not clearly reflect the
income of the corporation. No inference is intended that such a
multi-party financing transaction could not also be a tax
shelter as defined under the modification described below or
under present law.
The second modification affects the special tax shelter
rules, which define a tax shelter as an entity the principal
purpose of which is the avoidance or evasion of Federal income
tax. The provision instead provides that a significant purpose
(rather than the principal purpose) of the entity must be the
avoidance or evasion of Federal income tax for the entity to be
considered a tax shelter. This modification conforms the
definition of tax shelter for purposes of the substantial
understatement penalty to the definition of tax shelter for
purposes of these new confidential corporate tax shelter
registration requirements.
Treasury report
The provision also directs the Treasury Department, in
consultation with the Department of Justice, to issue a report
to the tax-writing committees on the following tax shelter
issues: (1) a description of enforcement efforts under section
7408 of the Code (relating to actions to enjoin promoters of
abusive tax shelters) with respect to corporate tax shelters
and the lawyers, accountants, and others who provide opinions
(whether or not directly addressed to the taxpayer) regarding
aspects of corporate tax shelters; (2) an evaluation of whether
the penalties regarding corporate tax shelters are generally
sufficient; and (3) an evaluation of whether confidential tax
shelter registration should be extended to transactions where
the investor (or potential investor) is not a corporation. The
report is due one year after the date of enactment.
Effective Date
The tax shelter registration provision applies to any tax
shelter offered to potential participants after the date the
Treasury Department issues guidance with respect to the filing
requirements. The modifications to the substantial
understatement penalty apply to items with respect to
transactions entered into after the date of enactment (August
5, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $15 million in 1998, $37 million in 1999,
$38 million in 2000, $39 million in 2001, $41 million in 2002,
$42 million in 2003, $43 million in 2004, $44 million in 2005,
$46 million in 2006, and $47 million in 2007.
D. Excise and Employment Tax Provisions
1. Extension and modification of Airport and Airway Trust Fund excise
taxes (sec. 1031 of the Act and secs. 4081, 4091, and 4261 of
the Code)
Present and Prior Law
A variety of excise taxes have been imposed on air
transportation under present and prior law to finance the
Airport and Airway Trust Fund programs administered by the
Federal Aviation Administration (the ``FAA''). In general, the
full cost of FAA capital programs is financed from the Airport
and Airway Trust Fund, while only a portion of FAA operational
expenses is Trust Fund-financed. Overall, the portion of total
FAA expenditures that has been financed from the Trust Fund
declined from 75 percent through the early 1990s to 62 percent
for the 1997 fiscal year. The balance is financed by general
taxpayers, rather than directly by program users. Under prior
law, each of the Airport and Airway Trust Fund excise taxes was
scheduled to expire after September 30, 1997.
Commercial air passenger transportation taxes
Under prior law, domestic air passenger transportation was
subject to an ad valorem excise tax equal to 10 percent of the
amount paid for the transportation. Under both prior law and
present law, taxable domestic air transportation includes both
travel within the United States, certain travel between the
United States and points in Canada or Mexico that are within
225 miles of the U.S. border (the ``225-mile zone''), and
certain transportation within the 225-mile zone.
International air passenger transportation was subject to a
$6 departure excise tax imposed on passengers departing the
United States for other countries under prior law. No tax was
imposed on passengers arriving in the United States from other
countries. Both present law and prior law define international
transportation to include separate domestic flights from which
passengers connect to international flights, provided that
stopover time at any point within the United States does not
exceed 12 hours. Thus, passengers traveling on these ``domestic
legs'' associated with international transportation (e.g., a
flight from Los Angeles to New York from which the passenger
boards a connecting flight to London) are exempt from the
excise tax otherwise imposed on such transportation between two
domestic points even though other passengers traveling on the
same flights without continuing to a foreign point are subject
to tax.
Because both the domestic and international air passenger
excise taxes have been imposed only on transportation for which
an amount is paid under both present law and prior law, no tax
is imposed on passengers engaged in ``free'' travel (e.g.,
frequent flyer travel and airline industry employee travel for
which the passenger is not directly charged).
The air passenger transportation excise taxes are imposed
on passengers; transportation providers (generally airlines)
are responsible for collecting and remitting the taxes to the
Federal Government. Under prior law, air carriers were not
liable for payment of the tax itself. In general, both the
domestic and international air passenger transportation excise
taxes are imposed without regard to whether the transportation
is purchased in the United States. An exception provides that
travel between the United States and points within the 225-mile
zone and certain transportation within the 225-mile zone is
taxed as domestic transportation only if it is purchased within
the United States.
The Code requires all advertising for taxable air passenger
transportation either (1) to state the fare on a tax-inclusive
basis or (2) if the Federal tax is stated separately, to state
the amount of the tax at least as prominently as the underlying
air fare and to identify that amount as ``user taxes to pay for
airport construction and airway safety and operations'' (sec.
7275(b)).
The amount of air passenger transportation excise tax to be
collected from a passenger must be stated on the ticket.
Commercial air cargo transportation
Under both present law and prior law, domestic air cargo
transportation is subject to a 6.25-percent ad valorem excise
tax. This tax, like the air passenger transportation excise
taxes, is imposed on the consumer, with the transportation
provider being required to collect and remit the tax to the
Federal Government. However, there is no requirement that the
tax be stated separately on shipping invoices.
Noncommercial aviation
Noncommercial aviation, or transportation on private
aircraft which is not ``for hire,'' is subject to excise taxes
imposed on fuel in lieu of the commercial air passenger ticket
and air cargo excise taxes. Under prior law, the Airport and
Airway Trust Fund tax rates on these fuels were 15 cents per
gallon on aviation gasoline and 17.5 cents per gallon on jet
fuel.
The aviation gasoline excise tax is imposed on removal of
the fuel from a registered terminal facility (the same point of
collection as the highway gasoline excise tax). The jet fuel
excise tax is imposed on sale of the fuel by a wholesale
distributor. Many larger airports have dedicated pipeline
facilities that directly service aircraft; in such a case, the
tax effectively is imposed at the retail level. The person
removing the gasoline from a terminal facility or the wholesale
distributor of the jet fuel is liable for these taxes.
General Fund aviation fuels excise tax
Under both present law and prior law, fuels used in air
transportation are subject to a 4.3-cents-per-gallon excise tax
(in addition to any fuels tax described above). Under prior
law, receipts from this tax were retained in the General Fund.
This fuels tax is identical to taxes also imposed on motor
fuels used in other transportation sectors, including highway,
inland waterway, and rail.
Deposit of air transportation excise taxes
Under present law and prior law, the air passenger ticket
and freight excise taxes are collected from passengers and
freight shippers by the commercial air carriers. After
collecting tax, air carriers remit the funds to the Treasury
Department; however, the carriers are not required to remit
monies immediately. Excise tax returns are filed quarterly
(similar to annual income tax returns) with taxes being
deposited on a semi-monthly basis (similar to estimated income
taxes). For air transportation sold during a semi-monthly
period, air carriers may elect to treat the taxes as collected
on the last day of the first week of the second following semi-
monthly period. Under these ``deemed collected'' rules, for
example, the taxes on air transportation sold between August 1
and August 15, are treated as collected by the air carriers on
or before September 7, with the amounts generally being
deposited with the Treasury Department by September 10. A
special rule requires certain taxes on air transportation sold
during the first half of September to be deposited by September
29.
Semi-monthly deposits and quarterly excise tax returns also
are required with respect to the fuels excise taxes imposed on
air transportation.
Overflight user fees
Non-tax user fees are imposed on air transportation (both
commercial and noncommercial aviation) that travels through
airspace for which the United States provides air traffic
control services, but that neither lands in nor takes off from
a point in the United States. These fees are imposed and
collected by the FAA with respect to mileage actually flown,
and apply both to travel within U.S. territorial airspace and
to travel within international oceanic airspace for which the
United States is responsible for providing air traffic control
services.
Reasons for Change
The Congress determined that provisions to ensure a long-
term, stable funding source for the Airport and Airway Trust
Fund should be enacted at this time. Events shortly before
enactment of the Act when a shortfall in fiscal year 1997 FAA
funding was narrowly averted by an emergency extension of the
prior-law excise taxes through September 30, 1997 (H.R. 668),
\247\ illustrated the need for a longer-term resolution of
these funding needs. Therefore, the Act extends (with certain
modifications) the prior-law Airport and Airway Trust Fund
excise taxes for a 10-year period, in order to address for this
period, concerns about the structure of these taxes and the
availability of adequate user tax revenues to fund the portion
of FAA programs to be appropriated from the Airport and Airway
Trust Fund.
---------------------------------------------------------------------------
\247\ See Part One of this pamphlet for a description of H.R. 668
(P.L. 105-2; February 28, 1997).
---------------------------------------------------------------------------
The Congress determined that limited modifications to the
commercial air passenger excise tax structure are warranted as
part of this longer-term resolution of Airport and Airway Trust
Fund financing requirements. First, the structure of the tax is
modified by the Act to include a reducedad valorem rate plus a
fixed dollar amount tax rate applicable to all revenue passengers. The
Act further clarifies that tax is imposed on payments to air carriers
(and related parties) from credit card and other companies in exchange
for the right to frequent flyer or other reduced-cost air travel
rights. In addition, the Congress determined that the perceived
fairness of the passenger air transportation excise taxes will be
improved if certain currently untaxed payments for air transportation
are taxed to help support the FAA programs. In furtherance of this
goal, the Act extends the international air passenger transportation
tax to internationally arriving passengers.
Explanation of Provisions
Extension of Airport and Airway Trust Fund taxes
The Act extends the Airport and Airway Trust Fund excise
taxes, as modified below, for 10 years, for the period October
1, 1997, through September 30, 2007. The taxes that are
extended include the domestic and international air passenger
excise taxes, the air cargo excise tax, and the noncommercial
aviation fuels taxes. Gross receipts from these taxes will
continue to be deposited in the Airport and Airway Trust Fund
throughout this period.
Modification of commercial air passenger transportation taxes
Domestic passenger tax rates.--The prior-law 10-percent
domestic air passenger excise tax is changed to a tax equal to
the total of 7.5 percent of the gross amount paid by the
passenger for the transportation plus a $3 fixed dollar amount
per flight segment. Both the ad valorem rate and fixed-dollar
flight segment tax are phased in, as follows:
October 1, 1997-September 30, 1998: 9 percent of the
fare, plus $1 per domestic flight segment;
October 1, 1998-September 30, 1999: 8 percent of the
fare, plus $2 per domestic flight segment;
October 1, 1999-December 31, 1999: 7.5 percent of the
fare, plus $2.25 per domestic flight segment.
After December 31, 1999, the ad valorem rate will remain at
7.5 percent. The domestic flight segment component of the tax
will increase to $2.50 (January 1, 2000-December 31, 2000), to
$2.75 (January 1, 2001-December 31, 2001), and to $3 (January
1, 2002-December 31, 2002). On January 1, 2003, and on each
January 1 thereafter, the fixed dollar amount per flight
segment will be indexed annually for inflation occurring after
2001, measured by changes in the Consumer Price Index (the
``CPI'') rounded to the nearest 10 cents. Inflation adjustments
will be effective for transportation provided beginning after
December 31, 2002, and in each subsequent calendar year.
The term ``flight segment'' is defined as transportation
involving a single take-off and a single landing.\248\ The Act
provides a rule of administrative convenience that there is no
change in the number of flight segment taxes imposed (increase
or decrease) if a passenger's route between two locations is
changed (with a resulting change in the number of actual flight
segments) and there is no change in the fare charged (including
no imposition of an additional administrative or other fee
associated with the route change). Generally, this rule applies
to flight changes for travel between the same origin and
destination as a result of, e.g., aircraft mechanical problems.
The rule similarly covers itinerary changes such as a diversion
to another intermediate or destination airport as a result of
inclement weather conditions.
---------------------------------------------------------------------------
\248\ For example, travel from New York to San Francisco, with an
intermediate stop in Chicago, would consist of two flights segments
(without regard to whether the passenger changed aircraft in Chicago).
---------------------------------------------------------------------------
All transportation between points within the 48 contiguous
States (and within Hawaii or Alaska), other than domestic
segments associated with uninterrupted international
transportation, is subject to tax at the revised ad valorem and
flight segment rates.
International passenger tax rates.--The prior-law $6
international departure tax is increased to $12 per departure,
and an identical $12 per passenger tax is imposed on arrivals
in the United States from international locations. The
international departure and arrival taxes are indexed for
inflation occurring after 1997, measured by changes in the CPI
rounded to the nearest 10 cents. Inflation adjustments will be
effective for transportation provided beginning after December
31, 1998, and each subsequent calendar year. The Congress
believed that this increased tax level is consistent with the
user tax principles of the Airport and Airway Trust Fund taxes
which include the recovery from international passengers of a
greater percentage of the costs those passengers impose on FAA
programs than were collected by the prior-law international
departure tax, so that purely domestic passengers and the
General Fund will not be required to subsidize the costs
imposed by international travelers to the extent that occurred
under prior law.
Special rules applicable to certain transportation.--As
under prior law, certain air transportation between the United
States and points within the 225-mile zone of Canada or Mexico
or within the 225-mile zone is taxed as domestic transportation
when the transportation is purchased in the United States.
Identical transportation purchased in either Canada or Mexico
is subject to the revised tax on international departures and
arrivals.
Transportation between the 48 contiguous States and Alaska
or Hawaii (or between those States) remains subject to the
special rules provided in prior law. Thus, this transportation
is taxed on apportioned mileage in U.S. territorial airspace
(and a fixed dollar per domestic flight segment tax), plus a
single international passenger tax per one-way flight segment
(despite the fact that the flight both departs into and arrives
from international airspace). In addition, under a special
rule, the applicable international tax rate forthis
transportation is $6 (rather than $12) per passenger. As with the
domestic flight segment tax and the $12 international tax rates, the $6
rate is indexed for inflation using the CPI.
A further special rule is provided for certain flight
segments to or from qualified rural airports. A qualified rural
airport is an airport that (1) in the second preceding calendar
year had fewer than 100,000 commercial passenger enplanements
(i.e., departures), and (2) either (a) is not located within 75
miles of another airport that had more than 100,000 such
passenger enplanements in that year, or (b) is eligible for
payments under the Federal ``essential air services'' program
(as that program was in effect on the date of the Act's
enactment). Flight segments to or from a qualified rural
airport are subject to the fully phased-in 7.5 percent ad
valorem rate effective after September 30, 1997, and the fixed
dollar flight segment component of the domestic passenger
transportation tax does not apply to such segments.\249\ The
otherwise applicable ad valorem rate and the flight segment
component of the tax apply in full to flight segments other
than those departing from or arriving at qualified rural
airports.
---------------------------------------------------------------------------
\249\ The Act directs the Treasury Department to publish an annual
list of qualified rural airports, based on passenger enplanements for
the requisite calendar year.
---------------------------------------------------------------------------
The term flight segment means transportation involving a
single take-off and a single landing. In the case of
transportation involving multiple flight segments, the portion
of the fare allocable to the rural segment for purposes of
applying the reduced ad valorem tax rate is determined based on
the number of Great Circle miles in the rural flight segment as
compared to the aggregate number of such miles in all of the
flight segments.
Extension of tax to certain previously exempt passengers.--
As described above, revenue passengers arriving in the United
States from other countries, who were the only group of
travelers under prior law whose transportation was subject
neither to an excise tax nor a user fee for U.S.-provided
aviation services, are subject to a $12 international passenger
tax on their arriving international flights.
The Act also clarifies that any amounts paid to air
carriers (in cash or in kind) for the right to award or
otherwise distribute free or reduced-rate air transportation
are treated as amounts paid for taxable air transportation,
subject to the 7.5 percent ad valorem tax rate. This tax
applies to payments, whether made within the United States or
elsewhere, if the rights to transportation for which payments
are made can be used in whole or in part for transportation
that, if purchased directly, would be subject to either the
domestic or international passenger taxes. Also, except as
described below, the tax applies without regard to whether
transportation ultimately is provided pursuant to the
transferred rights. Examples of amounts taxable under this
provision include (1) payments for frequent flyer miles
(including other rights to air transportation) purchased by
credit card companies, telephone companies, rental car
companies, television networks, restaurants and hotels, air
carriers (or related parties), mutual funds, and other
businesses, and (2) amounts received by airlines (whether paid
in cash or in kind) pursuant to joint venture credit card or
other air transportation marketing arrangements as compensation
for the right to air transportation. The Act further
specifically authorizes the Treasury Department to disregard
accounting allocations or other arrangements which have the
effect of reducing artificially the base to which the 7.5-
percent tax is applied. The Act includes an exception to this
general rule in the case of payments for air transportation
rights between corporations that are members of a 100-percent
commonly owned controlled group (e.g., transportation purchased
from an air carrier by a 100-percent commonly owned corporation
operating a frequent flyer award program for the air carrier).
The Congress was aware that consumers accrue mileage awards
from numerous sources, including actual air travel as well as
programs giving rise to taxable payments under this provision.
Once awarded to consumers, these miles are commingled in the
consumer's account such that any miles that ultimately may be
used for a specific purpose may not be traceable to the source
which gave rise to them. The Act authorizes the Treasury
Department to develop regulations excluding from the tax base a
portion of otherwise taxable payments, if any, with respect to
awarded frequent flyer miles if the Treasury determines that a
portion properly can be allocated (traced) to miles that are
used by consumers for purposes other than air transportation.
Miles that are unused should not be treated as used for
purposes other than air transportation. As part of any
rulemaking process it undertakes, the Treasury is authorized to
review airline frequent flyer programs and other information
from all available sources, including industry and third-party
data, in determining whether mileage awards can be adequately
traced to support allocations based on the ultimate use of the
awards. The Congress intended that any adjustment to the tax
base will be prescribed only if the Treasury finds a consistent
pattern of non-air transportation usage by consumers at levels
indicating that significant mileage awarded pursuant to
payments taxable under this provision is being used for
purposes other than air transportation. In making any such
adjustment, the Treasury Department should treat mileage used
for otherwise non-taxable air transportation or for non-air
transportation purposes as coming first from mileage awarded to
consumers from actual air travel (and other sources not subject
to tax under this provision).
No inference is intended from this provision as to the
proper treatment of these payments under prior law.
Advertising requirements.--The Act retains the prior-law
Code advertising requirements governing statement of taxes in
advertisements and passenger tickets. These requirements apply
equally to the reduced ad valorem rate and the fixed dollar per
flight segment component of the tax.
Liability for tax.--The prior-law provision imposing
liability for the tax on passengers (with transportation
providers being liable for collecting and remitting revenues to
the Federal Government) is modified to impose liability for
uncollected tax (including tax on sales of frequent flyer miles
and similar rights to reduced-cost air transportation) on air
carriers. In the case of transportation for which payment is
made outside the United States, this liability is imposed on
the air carrier carrying the passenger on the first flight
segment in the United States.
Transfer of 4.3-cents-per-gallon fuels excise tax to Airport and Airway
Trust Fund
The 4.3-cents-per-gallon excise tax on aviation gasoline
and jet fuel will be deposited in the Airport and Airway Trust
Fund, rather than in the General Fund, beginning with fuels
sold or removed after September 30, 1997.
Modify air passenger excise tax deposit rules
The deposit rules with respect to the commercial air
passenger excise taxes are modified to permit taxes that
otherwise would have been required to be deposited during the
period August 15, 1997, through September 30, 1997, to be
deposited on October 10, 1997. Additionally, the Act provides
that deposits of commercial air passenger taxes that otherwise
would be required after August 14, 1998, and before October 1,
1998, will be due on October 5, 1998. Deposits of the
commercial air cargo and aviation fuels taxes that otherwise
would be required to be made after July 31, 1998, and before
October 1, 1998, will be due on October 5, 1998.
Effective Date
These provisions generally are effective on the date of
enactment (August 5, 1997), for air transportation beginning
after September 30, 1997. The modifications to the domestic air
passenger transportation tax did not apply to transportation
purchased before October 1, 1997, and the modifications to the
international passenger tax did not apply to transportation
purchased before eight days after the date of the Act's
enactment (i.e., before August 13, 1997), if the transportation
began after September 30, 1997.
The extension of the general aviation fuels excise taxes is
effective for fuels removed or sold after September 30, 1997.
The provision relating to certain amounts paid for the
right to award air transportation is effective for amounts paid
(or benefits transferred) after September 30, 1997, except
payments (or transfers) between related parties occurring after
June 11, 1997 and before October 1, 1997, are subject to tax if
the payments relate to rights to transportation to be awarded
or otherwise distributed after September 30, 1997.
The provision transferring the 4.3-cents-per-gallon General
Fund fuels tax revenues to the Airport and Airway Trust Fund
was effective for taxes received after September 30, 1997. The
provision modifying the commercial air passenger excise tax
deposit rules was effective on the date of enactment.
Revenue Effect
The provision is estimated to decrease Federal fiscal year
budget receipts by $1,017 million in 1997 and to increase
Federal fiscal year budget receipts by $5,649 million in 1998,
$7,434 million in 1999, $6,498 million in 2000, $7,014 million
in 2001, $7,580 million in 2002,$8,124 million in 2003, $8,676
million in 2004, $9,267 million in 2005, $9,901 million in 2006, and
$10,566 million in 2007.
2. Extend diesel fuel excise tax rules to kerosene (sec. 1032 of the
Act and secs. 4081-4083 of the Code)
Present and Prior Law
Diesel fuel used as a transportation motor fuel generally
is taxed at 24.4 cents per gallon.\250\ This tax is collected
on all diesel fuel upon removal from a pipeline or barge
terminal unless the fuel is indelibly dyed and is destined for
a nontaxable use. Diesel fuel also commonly is used as heating
oil; diesel fuel used as heating oil is not subject to tax.
Certain other uses also are exempt from tax, and some
transportation uses (e.g., rail and intercity buses) are taxed
at reduced rates. Both exemptions and reduced-rates are
realized through credits or refund claims if undyed diesel fuel
is used in a qualifying use.
---------------------------------------------------------------------------
\250\ The tax rate was 24.3 cents per gallon before reinstatement
of the Leaking Underground Storage Tank Trust Fund rate as of October
1, 1997, by section 1033 of the Act. (See item D.3., following.)
---------------------------------------------------------------------------
Before October 1, 1997, aviation gasoline and jet fuel
(both commercial and noncommercial use) were subject to a 4.3-
cents-per-gallon General Fund tax rate. In addition, through
September 30, 1997, gasoline and jet fuel used in noncommercial
aviation were subject to an additional 15-cents-per-gallon rate
(gasoline) and 17.5-cents-per-gallon rate (jet fuel),
respectively, for the Airport and Airway Trust Fund. These
combined rates produced an aggregate tax of 21.8 cents per
gallon on noncommercial aviation jet fuel and 19.3 cents per
gallon on noncommercial aviation gasoline. Separate provisions
of the Act provided for transfer of revenues from the 4.3-
cents-per-gallon fuels tax to the Airport and Airway Trust
Fund, and increased the aggregate tax rate by 0.1-percent per
gallon (reflecting reinstatement of the Leaking Underground
Storage Tank Trust Fund rate). The tax on non-gasoline aviation
fuel is imposed on the sale of the fuel by a ``producer,''
typically a wholesale distributor. Thus, this tax is imposed at
a point in the fuel distribution chain subsequent to removal
from a terminal facility. The tax on aviation gasoline is
imposed on removal of the gasoline from a pipeline or barge
terminal facility.
Kerosene is used both as a transportation fuel and as an
aviation fuel. Kerosene also is blended with diesel fuel
destined both for taxable (highway) and nontaxable (heating
oil) uses to, among other things, prevent gelling of the diesel
fuel in colder temperatures. Under present law, kerosene is not
subject to excise tax unless it is blended with taxable diesel
fuel or is sold for use as aviation fuel. When kerosene is
blended with dyed diesel fuel to be used in a nontaxable use,
the dye concentration of the fuel mixture must be adjusted to
ensure that it meets Treasury Department requirements for
untaxed, dyed diesel fuel. Clear, low-sulphur kerosene (K-1)
also is used in space heaters, and often is sold for this
purpose at retail service stations. As with other heating oil
uses, kerosene used in space heaters is not subject to Federal
excise tax.
Although heating oil often has minor amounts of kerosene
blended with it in colder weather, this blending typically
occurs before removal of the fuel from the terminal facilities
where Federal excise taxes are imposed. However, it may be
necessary during periods of extreme or unseasonably cold
weather to add kerosene to heating oil after its removal from
the terminal. Other nontaxable uses of kerosene include
feedstock use in the petrochemical industry.
Reasons for Change
The Congress was informed that the Internal Revenue Service
has discovered significant evidence that kerosene was being
blended with taxable highway diesel fuel during periods when
the blending is not necessary due to colder weather conditions.
Some wholesale distributors of diesel fuel also suggested that
their competitors were not paying the tax on the kerosene that
they blended with diesel fuel for highway use. These reports of
increased use of kerosene as a taxable highway fuel without
payment of tax coincided with implementation of enhanced diesel
fuel tax compliance measures that significantly reduced
opportunities to evade that tax. The Congress determined,
therefore, that these same compliance measures should be
extended to kerosene.
Explanation of Provision
The Act extends the diesel fuel excise tax collection rules
to kerosene. Thus, kerosene is taxed when it is removed from a
registered terminal unless it is indelibly dyed and destined
for a nontaxable use. However, aviation-grade kerosene that is
removed from the terminal by a registered producer of aviation
fuel (e.g., fuel by such a producer for delivery to a retail
fixed-base operator for use in noncommercial aviation) is not
subject to the dyeing requirement and will continue to be taxed
under the prior- and present-law rules applicable to aviation
fuel. Feedstock kerosene that a registered industrial user
receives by pipeline or vessel also is exempt from the dyeing
requirement. Other feedstock kerosene would be exempt from the
dyeing requirement to the extent and under conditions
(including satisfaction of registration and certification
requirements) prescribed by Treasury Department regulation.
To accommodate State safety regulations that require the
use of clear (K-1) kerosene in certain space heaters, a refund
procedure is provided under which registered ultimate vendors
may claim refunds of the tax paid on kerosene sold for that
use. In addition, the Internal Revenue Service is given
discretion to refund to a registered ultimate vendor the tax
paid on kerosene that is blended with heating oil for use
during periods of extreme or unseasonable cold.
Further, to ensure that registered terminals offer untaxed
dyed kerosene and diesel fuel to customers, the Code provisions
governing eligibility of terminals to receive non-tax-paid fuel
are modified to require that a terminal offer both dyed and
undyed kerosene (if it receives non-tax-paid kerosene
(including kerosene aviation jet fuel and diesel fuel #1) as a
condition of receiving non-tax-paid kerosene and that terminals
offer both dyed and undyed diesel fuel as a condition of
receiving non-tax-paid diesel fuel.
Effective Date
The provision is effective for kerosene removed from
terminal facilities after June 30, 1998. Appropriate floor
stocks taxes will be imposed on kerosene held beyond the point
of taxation on July 1, 1998.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $44 million in 1998, $43 million in 1999,
$49 million in 2000, $46 million in 2001, $44 million in 2002,
$43 million in 2003, $44 million in 2004, $47 million in 2005,
$49 million in 2006, and $52 million in 2007.
3. Reinstate Leaking Underground Storage Tank Trust Fund excise tax
(sec. 1033 of the Act and secs. 4041(d), 4081(a)(2), and
4081(d)(2) of the Code)
Present and Prior Law
Before January 1, 1996, an excise tax of 0.1 cent per
gallon was imposed on gasoline, diesel fuel (including train
diesel fuel), special motor fuels (other than liquefied
petroleum gas), aviation fuels, and inland waterways fuels.
Revenues from the tax were dedicated to the Leaking Underground
Storage Tank Trust Fund to finance cleanups of leaking
underground storage tanks.
Reasons for Change
The Congress determined that the Leaking Underground
Storage Tank Trust Fund excise tax should be reinstated to
ensure the availability of funds to pay cleanup costs of
leaking underground storage tanks.
Explanation of Provision
The Act reinstates the prior-law Leaking Underground
Storage Tank Trust Fund excise tax through March 31, 2005.
Effective Date
The provision was effective on October 1, 1997.
Revenue Effect
This provision is estimated to increase Federal fiscal year
budget receipts by $129 million in 1998 and 1999, $128 million
in 2000, $129 million in 2001, $131 million in 2002, $134
million in 2003, $136 million in 2004, and $67 million in 2005.
4. Application of communications excise tax to prepaid telephone cards
(sec. 1034 of the Act and sec. 4251 of the Code)
Present and Prior Law
A 3-percent excise tax is imposed on amounts paid for local
and toll (long-distance) telephone service and teletypewriter
exchange service. The tax is collected by the provider of the
service from the consumer (business and personal service).
Reasons for Change
The Congress understood that communications service
providers sometimes sell units of telephone service to third
parties who, in turn, resell or distribute these units of
telephone service to the ultimate customer in the form of
prepaid telephone cards or similar arrangements. The Congress
believed that such payments clearly represent payments for
telephone service and clarified that such payments are subject
to the communications excise tax.
Explanation of Provision
Under the Act, any amounts paid to communications service
providers (in cash or in kind) for the right to award or
otherwise distribute telephone service (i.e., local or toll
telephone service) are treated as amounts paid for taxable
communications services, subject to the 3-percent ad valorem
tax rate. Examples of such taxable amounts include (1) prepaid
telephone cards offered through service stations, convenience
stores and other businesses to their customers and others and
(2) amounts received by communications service providers
pursuant to joint venture credit card or other marketing
arrangements.\251\ The Treasury Department is authorized
specifically to disregard accounting allocations or other
arrangements which have the effect of reducing artificially the
base to which the 3-percent tax is applied.
---------------------------------------------------------------------------
\251\ A technical correction may be required to clarify that
payments to a communications service provider from a third party such
as a joint venture credit card company are treated as payments made by
the holder of the credit card to obtain communications services.
---------------------------------------------------------------------------
The Act also clarifies that the base to which the
communications tax applies in the case of prepaid telephone
cards and similar arrangements is the retail value of the
service provided by the use of the card or arrangement. The
Congress understood that at the time the Act was enacted,
prepaid telephone cards were offered to the public in two
forms. The first type of prepaid telephone card can be called a
``dollar value card.'' In this case, the final customer
purchases a card or account which allows him to utilize $X
worth of telephone service provided by an underlying
telecommunications carrier. In this case, the Act provides that
the 3-percent communications excise tax will apply to the value
X at the time the prepaid telephone card is sold by a
telecommunications carrier to a person who is not a
telecommunications carrier.
The second type of prepaid telephone card may be called a
``unit card'' or a ``minute card.'' In this case the final
customer purchases a card or account which allows him to use Y
number of units or minutes of telephone service provided by an
underlying telecommunications carrier. The Congress intended
that the tax applicable to such cards be based on the retail
value of the telephone service offered to a consumer and the
Act grants the Treasury Department regulatory authority to
determine the appropriate retail value. The legislative history
notes that at the time the Act was enacted, the Federal
Communications Commission generally required telecommunications
carriers to file a tariff listing the prices of their various
service offerings including the price of units or minutes
offered via prepaid telephone cards. For this case, the
legislative history provides that the 3-percent communications
excise tax will apply to Y (the number of units or minutes)
multiplied by the tariffed price of those units or minutes at
the time the prepaid telephone card is sold by a
telecommunications carrier to a person who is not a
telecommunications carrier.
The legislative history recognizes that such a tariffed
value may not in all cases correspond to the over-the-counter
price that a final customer may pay for the card. However, the
legislative history states that looking to the tariffed price,
at present, is the best way to achieve neutral treatment of
``dollar cards'' and ``unit'' or ``minute cards.'' The
legislative history provides that, where a prepaid telephone
card does not have an underlying tariff that applies to that
particular card, tariffs for comparable telephone service shall
be applied. The legislative history expresses Congress's
preference that tariffs should continue to be filed for service
offered by prepaid telephone cards, but if, in the future,
tariff filings are not generally filed the Act authorizes the
Treasury Department to develop alternative standards for
determining the appropriate retail value of the units or
minutes of service offered on such cards.
The Act recognizes that sometimes a communications service
provider may require certain customers to prepay for their
service as assurance that payment is made by the customer for
services to be provided. The legislative history accompanying
the Act states that such arrangements do not constitute payment
for communications services for the purposes of this provision
if the customer is entitled to a full refund, in cash, for the
value of any unused service. The legislative history considers
such arrangements to be deposits to assure payment for service
to be provided in the future. However, if such payments are
nonrefundable, or only partially refundable, then such payments
are subject to the communications excise tax at the time they
are made.
No inference is intended from this provision as to the
proper treatment of payments received by communications service
providers for prepaid telephone cards and amounts received by
communications service providers pursuant to joint venture
credit card or other marketing arrangements under prior law.
Effective Date
The provision was effective for cards sold on or after the
first day of the month which commences more than 60 days after
the date of enactment (i.e., effective on November 1, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $19 million in 1998, $28 million in 1999,
$38 million in 2000, $49 million in 2001, $60 million in 2002,
$71 million in 2003, $83 million in 2004, $101 million in 2005,
$113 million in 2006, $124 million in 2007.
5. Extension of temporary Federal unemployment surtax (sec. 1035 of the
Act and sec. 3301 of the Code)
Present Law
The Federal Unemployment Tax Act (FUTA) imposes a 6.2-
percent gross tax rate on the first $7,000 paid annually by
covered employers to each employee. Employers in States with
programs approved by the Federal Government and with no
delinquent Federal loans may credit 5.4-percentage points
against the 6.2-percent tax rate, making the minimum, net
Federal unemployment tax rate 0.8 percent. Since all States
have approved programs, 0.8 percent is the Federal tax rate
that generally applies. This Federal revenue finances
administration of the system, half of the Federal-State
extended benefits program, and a Federal account for State
loans. The States use the revenue turned back to them by the
5.4-percent credit to finance their regular State programs and
half of the Federal-State extended benefits program.
In 1976, Congress passed a temporary surtax of 0.2 percent
of taxable wages to be added to the permanent FUTA tax rate.
Thus, the current 0.8-percent FUTA tax rate has two components:
a permanent tax rate of 0.6 percent, and a temporary surtax
rate of 0.2 percent. The temporary surtax subsequently has been
extended through 1998.
Reasons for Change
The Congress determined that the surtax extension is needed
in order to increase funds for the Federal Unemployment Trust
Fund to provide a cushion against future Trust Fund
expenditures. The monies retained in the Federal Unemployment
Account of the Federal Unemployment Trust Fund can then be used
to make loans to the 53 State Unemployment Compensation benefit
accounts as needed.
Explanation of Provision
The Act extends the temporary surtax rate through December
31, 2007. It also increases the limit from 0.25 percent to 0.50
percent of covered wages on the Federal Unemployment Account
(FUA) in the Federal Unemployment Trust Fund.
Effective Date
The provision is effective for labor performed on or after
January 1, 1999.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $1,063 million in 1999, $1,763 million in
2000, $1,797 million in 2001, $1,733 million in 2002, $661
million in 2003, and to decrease Federal fiscal year budget
recipts by $73 million in 2004, $71 million in 2005, $74
million in 2006, and $73 million in 2007.
E. Provisions Relating to Tax-Exempt Organizations
1. Extend UBIT rules to second-tier subsidiaries and amend control test
(sec. 1041 of the Act and sec. 512(b)(13) of the Code)
Present and Prior Law
In general, interest, rents, royalties and annuities are
excluded from the unrelated business income (``UBI'') of tax-
exempt organizations. However, section 512(b)(13) treats
otherwise excluded rent, royalty, annuity, and interest income
as UBI if such income is received from a taxable or tax-exempt
subsidiary that is 80 percent controlled by the parent tax-
exempt organization.\252\ In the case of a stock subsidiary,
the 80 percent control test is met if the parent organization
owns 80 percent or more of the voting stock and all other
classes of stock of the subsidiary.\253\ In the case of a non-
stock subsidiary, the applicable Treasury regulations look to
factors such as the representation of the parent corporation on
the board of directors of the nonstock subsidiary, or the power
of the parent corporation to appoint or remove the board of
directors of the subsidiary.\254\
---------------------------------------------------------------------------
\252\ For this purpose, a ``controlled organization'' is defined
under section 368(c). Under present law, rent, royalty, annuity, and
interest payments are treated as UBI when received by the parent
organization based on the percentage of the subsidiary's income that is
UBI (either in the hands of the subsidiary if the subsidiary is tax-
exempt, or in the hands of the parent organization if the subsidiary is
taxable).
\253\ Treas. Reg. sec. 1.512(b)-1(l)(4)(I)(a).
\254\ Treas. Reg. sec. 1.512(b)-1(l)(4)(I)(b).
---------------------------------------------------------------------------
The control test under section 512(b)(13) does not,
however, incorporate any indirect ownership rules.\255\
Consequently, rents, royalties, annuities and interest derived
from second-tier subsidiaries generally do not constitute UBI
to the tax-exempt parent organization.\256\
---------------------------------------------------------------------------
\255\ See PLR 9338003 (June 16, 1993) (holding that because no
indirect ownership rules are applicable under section 512(b)(13), rents
paid by a second-tier taxable subsidiary are not UBI to a tax-exempt
parent organization). In contrast, an example of an indirect ownership
rule can be found in Code section 318. Section 318(a)(2)(C) provides
that if 50 percent or more in value of the stock in a corporation is
owned, directly or indirectly, by or for any person, such person shall
be considered as owning the stock owned, directly or indirectly by or
for such corporation, in the proportion the value of the person's stock
ownership bears to the total value of all stock in the corporation.
\256\ See PLR 9542045 (July 28, 1995) (holding that first-tier
holding company and second-tier operating subsidiary were organized
with bona fide business functions and were not agents of the tax-exempt
parent organization; therefore, rents, royalties, and interest received
by tax-exempt parent organization from second-tier subsidiary were not
UBI).
---------------------------------------------------------------------------
Reasons for Change
Section 512(b)(13) was enacted, in part, to prevent
subsidiaries of tax-exempt organizations from reducing their
otherwise taxable income by borrowing, leasing, or licensing
assets from a tax-exempt parent organization at inflated
levels. In addition, however, even if such payments arguably
could satisfy an arm's-length standard, section 512(b)(13) is
intended to prevent a tax-exempt parent from obtaining what is,
in effect, a tax-free return on capital invested in its
subsidiary. Because section 512(b)(13) was narrowly drafted,
organizations were able to circumvent its application through,
for example, the issuance of 21 percent of nonvoting stock with
nominal value to a separate friendly party or through the use
of tiered or brother/sister subsidiaries. The Congress believed
that modifications to the control requirement and inclusion of
attribution rules will ensure that section 512(b)(13) operates
consistent with its intended purposes.
Explanation of Provision
The Act modifies the test for determining control for
purposes of section 512(b)(13). Under the Act, ``control''
means (in the case of a stock corporation) ownership by vote or
value of more than 50 percent of the stock. In the case of a
partnership or other entity, control means ownership of more
than 50 percent of the profits, capital or beneficial
interests.
In addition, the Act applies the constructive ownership
rules of section 318 for purposes of section 512(b)(13). Thus,
a parent exempt organization is deemed to control any
subsidiary in which it holds more than 50 percent of the voting
power or value, directly (as in the case of a first-tier
subsidiary) or indirectly (as in the case of a second-tier
subsidiary).
The Act also makes technical modifications to the method
provided in section 512(b)(13) for determining how much of an
interest, rent, annuity, or royalty payment made by a
controlled entity to a tax-exempt organization is includable in
the latter organization's UBI.\257\ Such payments are subject
to the unrelated business income tax to the extent the payment
reduces the net unrelated income (or increases any net
unrelated loss) of the controlled entity.
---------------------------------------------------------------------------
\257\ In this regard, a technical correction is required to
correctly cross reference section 513(a) in the parenthetical contained
in section 512(b)(13)(B)(i)(I).
---------------------------------------------------------------------------
Effective Date
The provision generally applies to taxable years beginning
after the date of enactment. The provision does not apply to
any amount paid or accrued during the first two taxable years
beginning on or after the date of enactment if such amount is
paid or accrued pursuant to a binding written contract in
effect on June 8, 1997, and at all times thereafter before such
amount is paid or accrued.\258\
---------------------------------------------------------------------------
\258\ A technical correction is required to clarify the statute in
this regard.
---------------------------------------------------------------------------
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by less than $500,000 in each of 1998 through
2000, $3 million in 2001, $5 million in 2002, $5 million in
2003, and $4 million per year in each of 2004 through 2007.
2. Repeal grandfather rule with respect to pension business of certain
insurers (sec. 1042 of the 1997 Act and sec. 1012(c) of the Tax
Reform Act of 1986)
Present and Prior Law
Present law provides that an organization described in
sections 501(c)(3) or (4) of the Code is exempt from tax only
if no substantial part of its activities consists of providing
commercial-type insurance. When this rule was enacted in 1986,
certain treatment (described below) applied to Blue Cross and
Blue Shield organizations providing health insurance that (1)
were in existence on August 16, 1986; (2) were determined at
any time to be tax-exempt under a determination that had not
been revoked; and (3) were tax-exempt for the last taxable year
beginning before January 1, 1987 (when the present-law rule
became effective), provided that no material change occurred in
the structure or operations of the organizations after August
16, 1986, and before the close of 1986 or any subsequent
taxable year.
The treatment applicable to such Blue Cross and Blue Shield
organizations, which became taxable organizations under the
provision, is as follows. A special deduction applies with
respect to health business equal to 25 percent of the claims
and expenses\259\ incurred during the taxable year less the
adjusted surplus at the beginning of the year. An exception is
provided for such organizations from the application of the 20-
percent reduction in the deduction for increases in unearned
premiums that applies generally to property and casualty
insurance companies. A fresh start was provided with respect to
changes in accounting methods resulting from the change from
tax-exempt to taxable status. Thus, no adjustment was made
under section 481 on account of an accounting method change.
Such an organization was required to compute its ending 1986
loss reserves without artificial changes that would reduce 1987
income. Thus, any reserve weakening after August 16, 1986 was
treated as occurring in the organization's first taxable year
beginning after December 31, 1986. The basis of such an
organization's assets was deemed to be equal to the amount of
the assets' fair market value on the first day of the
organization's taxable year beginning after December 31, 1986,
for purposes of determining gain or loss (but not for
determining depreciation or for other purposes).
---------------------------------------------------------------------------
\259\ Section 1604(d) of the 1997 Act clarifies this rule to
provide that, for purposes of the section 833 deduction, liabilities
incurred during the taxable year under cost-plus contracts are added to
claims incurred, and expenses incurred under cost-plus contracts are
added to expenses incurred.
---------------------------------------------------------------------------
Grandfather rules were provided in the 1986 Act relating to
the provision. It was provided that the provision does not
apply to that portion of the business of the Teachers Insurance
Annuity Association-College Retirement Equities Fund which is
attributable to pension business, nor did the provision apply
with respect to that portion of the business of Mutual of
America which is attributable to pension business. Pension
business means the administration of any plan described in
section 401(a) of the Code which includes a trust exempt from
tax under section 501(a), and plan under which amounts are
contributed by an individual's employer for an annuity contract
described in section 403(b) of the Code, any individual
retirement plan described in section 408 of the Code, and any
eligible deferred compensation plan to which section 457(a) of
the Code applies.
Reasons for Change
The Congress was concerned that the continued tax-exempt
status of certain organizations that engage in insurance
activities gives such organizations an unfair competitive
advantage. The Congress believed that the provision of
insurance at a price sufficient to cover the costs of insurance
generally constitutes an activity that is commercial. Thus, the
Congress believed it no longer appropriate to continue the
grandfather rule that permits certain organizations to retain
tax-exempt status with respect to pension business that
constitutes commercial-type insurance.
Explanation of Provision
The Act repeals the grandfather rules applicable to that
portion of the business of the Teachers Insurance Annuity
Association and College Retirement Equities Fund which is
attributable to pension business and to that portion of the
business of Mutual of America which is attributable to pension
business. The Teachers Insurance Annuity Association and
College Retirement Equities Fund and Mutual of America are to
be treated for Federal tax purposes as life insurance
companies.
A fresh start is provided with respect to changes in
accounting methods resulting from the change from tax-exempt to
taxable status. Thus, no adjustment is made under section 481
on account of an accounting method change. The Teachers
Insurance Annuity Association and College Retirement Equities
Fund and Mutual of America are required to compute ending 1997
loss reserves without artificial changes that would reduce 1998
income. Thus, any reserve weakening after June 8, 1997, is
treated as occurring in the organization's first taxable year
beginning after December 31, 1997. The basis of assets of
Teachers Insurance Annuity Association and College Retirement
Equities Fund and Mutual of America is deemed to be equal to
the amount of the assets' fair market value on the first day of
the organization's taxable year beginning after December 31,
1997, for purposes of determining gain or loss (but not for
determining depreciation, amortization, or for other purposes).
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by less than $500,000 in 1998, $82 million in
1999, $116 million in 2000, $124 million in 2001, $128 million
in 2002, $133 million in 2003, $140 million in 2004, $149
million in 2005, $160 million in 2006, and $174 million in
2007.
F. Foreign Provisions
1. Inclusion of income from notional principal contracts and stock
lending transactions under subpart F (sec. 1051 of the Act and
sec. 954 of the Code)
Present and Prior Law
Under the subpart F rules, the U.S. 10-percent shareholders
of a controlled foreign corporation (``CFC'') are subject to
U.S. tax currently on certain income earned by the CFC, whether
or not such income is distributed to the shareholders. The
income subject to current inclusion under the subpart F rules
includes, among other things, ``foreign personal holding
company income.''
Foreign personal holding company income generally consisted
of the following: dividends, interest, royalties, rents and
annuities; net gains from sales or exchanges of (1) property
that gives rise to the foregoing types of income, (2) property
that does not give rise to income, and (3) interests in trusts,
partnerships, and REMICs; net gains from commodities
transactions; net gains from foreign currency transactions; and
income that is equivalent to interest. Income from notional
principal contracts referenced to commodities, foreign
currency, interest rates, or indices thereon was treated as
foreign personal holding company income; under prior law,
income from equity swaps or other types of notional principal
contracts was not treated as foreign personal holding company
income. Under prior law, income derived from transfers of debt
securities (but not equity securities) pursuant to the rules
governing securities lending transactions (sec. 1058) was
treated as foreign personal holding company income.
Income earned by a CFC that is a regular dealer in the
property sold or exchanged generally was excluded from the
definition of foreign personal holding company income. However,
under prior law, no exception was available for a CFC that is a
regular dealer in financial instruments referenced to
commodities.
A U.S. shareholder of a passive foreign investment company
(``PFIC'') is subject to U.S. tax and an interest charge with
respect to certain distributions from the PFIC and gains on
dispositions of the stock of the PFIC, unless the shareholder
elects to include in income currently for U.S. tax purposes its
share of the earnings of the PFIC. A foreign corporation is a
PFIC if it satisfies either a passive income test or a passive
assets test. For this purpose, passive income is defined by
reference to foreign personal holding company income.
Reasons for Change
The Congress understood that income from notional principal
contracts and stock-lending transactions is economically
equivalent to types of income that were treated as foreign
personal holding company income under prior law. Accordingly,
the Congress believed that the categories of foreign personal
holding company income should be expanded to cover such income.
In addition, the Congress believed that an exception from the
foreign personal holding company income rules should be
available for dealers in financial instruments referenced to
commodities.
Explanation of Provision
The Act treats net income from all types of notional
principal contracts as a new category of foreign personal
holding company income. However, income, gain, deduction or
loss from a notional principal contract entered into to hedge
an item of income in another category of foreign personal
holding company income is included in that other category.
Although net income from notional principal contracts is added
as a new category of foreign personal holding company income,
amounts with respect to a notional principal contract entered
into to hedge an item described in another category of foreign
personal holding company income are taken into account under
the rules of such other category. In this regard, gains and
losses from transactions in inventory property are covered by
an exclusion from the category of personal holding company
income for net gains from property transactions; income from a
notional principal contract entered into to hedge inventory
property is taken into account under such category and thus
similarly is excluded from foreign personal holding company
income.
The Act treats payments in lieu of dividends derived from
equity securities lending transactions pursuant to section 1058
as another new category of foreign personal holding company
income.
The Act provides an exception from foreign personal holding
company income for certain income, gain, deduction, or loss
from transactions (including hedging transactions) entered into
in the ordinary course of a CFC's business as a regular dealer
in property, forward contracts, options, notional principal
contracts, or similar financial instruments (including
instruments referenced to commodities).
These modifications to the definition of foreign personal
holding company income apply for purposes of determining a
foreign corporation's status as a PFIC.
Effective Date
The provision applies to taxable years beginning after the
date of enactment (after August 5, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $9 million in 1998, $20 million in 1999, $21
million in 2000, $21 million in 2001, $21 million in 2002, $21
million in 2003, $22 million in 2004, $22 million in 2005, $22
million in 2006, and $23 million in 2007.
2. Restrict like-kind exchange rules for certain personal property
(sec. 1052 of the Act and sec. 1031 of the Code)
Present and Prior Law
Like-kind exchanges
An exchange of property, like a sale, generally is a
taxable event. However, no gain or loss is recognized if
property held for productive use in a trade or business or for
investment is exchanged for property of a ``like-kind'' which
is to be held for productive use in a trade or business or for
investment (sec. 1031). In general, any kind of real estate is
treated as of a like-kind with other real property as long as
the properties are both located either within or outside the
United States. In addition, certain types of property, such as
inventory, stocks and bonds, and partnership interests, are not
eligible for nonrecognition treatment under section 1031.
If section 1031 applies to an exchange of properties, the
basis of the property received in the exchange is equal to the
basis of the property transferred, decreased by any money
received by the taxpayer, and further adjusted for any gain or
loss recognized on the exchange.
Application of depreciation rules
Tangible personal property that is used predominantly
outside the United States generally is accorded a less
favorable depreciation regime than is property that is used
predominantly within the United States. Thus, under present
law, if a taxpayer exchanges depreciable U.S. property with a
low adjusted basis (relative to its fair market value) for
similar property situated outside the United States, the
adjusted basis of the acquired property will be the same as the
adjusted basis of the relinquished property, but the
depreciation rules applied to such acquired property generally
will be different than the rules that were applied to the
relinquished property.
Reasons for Change
The Congress believed that the depreciation and other rules
applicable to foreign- and domestic-use property are
sufficiently dissimilar so as to treat such property as not
``like-kind'' property for purposes of section 1031.
Explanation of Provision
The Act provides that personal property predominantly used
within the United States and personal property predominantly
used outside the United States are not ``like-kind''
properties. For this purpose, the use of the property
surrendered in the exchange will be determined based upon the
predominant use during the 24 months immediately prior to the
exchange. Similarly, for section 1031 to apply, property
received in the exchange must continue in the same predominant
use (i.e., foreign or domestic) for the 24 months immediately
after the exchange.
The 24-month period is reduced to such lesser time as the
taxpayer held the property, unless such shorter holding period
is a result of a transaction (or series of transactions)
structured to avoid the purposes of the provision. Property
described in section 168(g)(4) (generally, property used both
within and without the United States that is eligible for
accelerated depreciation as if used in the United States) will
be treated as property predominantly used in the United States.
Effective Date
The provision is effective for exchanges after June 8,
1997, unless the exchange is pursuant to a binding contract in
effect on such date and all times thereafter. A contract will
not fail to be considered to be binding solely because (1) it
provides for a sale in lieu of an exchange or (2) either the
property to be disposed of as relinquished property or the
property to be acquired as replacement property (whichever is
applicable) was not identified under the contract before June
9, 1997.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $4 million in 1998, $8 million in 1999, $11
million in 2000, $13 million in 2001, $15 million in 2002, $17
million in 2003, $19 million in 2004, $21 million in 2005, $23
million in 2006, and $25 million in 2007.
3. Impose holding period requirement for claiming foreign tax credits
with respect to dividends (sec. 1053 of the Act and new sec.
901(k) of the Code)
Present and Prior Law
A U.S. person that receives a dividend from a foreign
corporation generally is entitled to a credit for income taxes
paid to a foreign government on the dividend. This credit was
allowed under prior law without regard to the U.S. person's
holding period for the foreign corporation's stock. A U.S.
corporation that receives a dividend from a foreign corporation
in which it has a 10-percent or greater voting interest may be
entitled to a credit for the foreign taxes paid by the foreign
corporation. This credit also was allowed under prior law
without regard to the U.S. shareholder's holding period for the
foreign corporation's stock (secs. 902 and 960).
As a consequence of the foreign tax credit limitations of
the Code, certain taxpayers are unable to utilize their
creditable foreign taxes to reduce their U.S. tax liability.
U.S. shareholders that are tax-exempt receive no U.S. tax
benefit for foreign taxes paid on dividends they receive.
Reasons for Change
Although prior law imposed a holding period requirement for
the dividends-received deduction for a corporate shareholder
(sec. 246), there was no similar holding period requirement for
foreign tax credits with respect to dividends. As a result,
some U.S. persons engaged in tax-motivated transactions
designed to transfer foreign tax credits from persons that were
unable to benefit from such credits (such as a tax-exempt
entity or a taxpayer whose use of foreign tax credits was
prevented by the limitation) to persons that could use such
credits. These transactions sometimes involved a short-term
transfer of ownership of dividend-paying shares. Other
transactions involved the use of derivatives to allow a person
that could not benefit from foreign tax credits with respect to
a dividend to retain the economic benefit of the dividend while
another person received the foreign tax credit benefits.
Explanation of Provision
The Act denies a shareholder the foreign tax credits
normally available with respect to a dividend from a
corporation or a regulated investment company (``RIC'') if the
shareholder has not held the stock for a minimum period during
which it is not protected from risk of loss. Under the Act, the
minimum holding period for dividends on common stock is 16
days. The minimum holding period for dividends on certain
preferred stock is 46 days.
Where the holding period requirement is not met with
respect to a dividend from a foreign corporation, the Act
disallows the foreign tax credits for the foreign withholding
taxes that are paid with respect to the dividend. A withholding
tax for purposes of the provision includes any tax determined
on a gross basis, but does not include any tax which is in the
nature of a prepayment of a tax imposed on a net basis.
Where the holding period requirement is not met, the Act
denies foreign tax credits for withholding taxes both to the
recipient of the dividend and any other taxpayer (i.e., an
indirect shareholder) who would otherwise be entitled to claim
such foreign tax credits. It was intended that, in addition to
actual dividend payments, the provision apply to additional
dividend amounts that are deemed to be paid with respect to the
dividend under an applicable U.S. tax treaty. Furthermore, the
Act applies to indirect foreign tax credits otherwise allowable
for taxes paid by a lower-tier foreign corporation and for
foreign tax credits of a RIC that elects to treat its foreign
taxes as paid by the shareholders. The Act denies such credits
where any of the stock in the chain of ownership that is a
requirement for claiming the credits is held for less than the
required holding period.
The Act denies these same foreign tax credit benefits,
regardless of the shareholder's holding period for the stock,
to the extent that the shareholder has an obligation to make
payments related to the dividend (whether pursuant to a short
sale or otherwise) with respect to substantially similar or
related property.
The 16-day holding period for common stock dividends must
be satisfied during the 30-day period beginning on the date
which is 15 days before the date on which the share becomes ex-
dividend. The 46-day holding period for preferred stock
dividends must be satisfied during the 90-day period beginning
on the date which is 45 days before the date on which the share
becomes ex-dividend. For purposes of determining whether the
required holding period is met, section 246(c)(3) applies such
that the day the taxpayer disposes of the stock is taken into
account, but the day the taxpayer acquires the stock is not. In
addition, any period during which the shareholder has protected
itself from risk of loss (under the rules of section 246(c)(4))
is disregarded. For example, assume a taxpayer buys foreign
common stock. Assume also that, the day after the stock is
purchased, the taxpayer enters into an equity swap under which
the taxpayer is entitled to receive payments equal to the
losses on the stock, and the taxpayer retains the swap position
for the entire period it holds the stock. Under the Act, the
taxpayer would not be able to claim any foreign tax credits
with respect to dividends on the stock because the taxpayer's
holding period is limited to two days as a result of the equity
swap (see Treas. Reg. sec. 1.246-3(d)(2)(ex.1)). For purposes
of entitlement to indirect foreign tax credits (secs. 902 and
960), if a taxpayer's holding period is reduced as a result of
a contract for a bona fide sale of stock, the determination of
whether the holding period requirement is met is made as of the
date such contract is entered into; thus, the holding period
requirement for common stock would be met if the taxpayer held
the stock for 16 days or more as of the date the contract was
entered into. It was intended that the bona fide contract
exception apply only to periods during which the contract is in
effect.
The Act also provides an exception for foreign tax credits
with respect to certain dividends received by active dealers in
securities. In order to qualify for the exception, the
following requirements must be met: (1) the dividend must be
received by the entity on stock which it holds in its capacity
as a dealer in securities, (2) the entity must be subject to
net income taxation on the dividend (on either a residence or
worldwide income basis) in the foreign country in which it
actively conducts a securities business, and (3) the full
amount of the foreign taxes to which the exception applies must
be creditable under the foreign country's tax system. A
securities dealer for purposes of the exception is an entity
which (1) is engaged in the active conduct of a securities
business in a foreign country and (2) is registered as a
securities broker or dealer under the Securities Exchange Act
of 1934 or is licensed or authorized to conduct securities
activities in such foreign country and subject to bona fide
regulation by the securities regulatory authority of the
foreign country. The Congress intended that the requirements of
active conduct of a securities business by a securities dealer
and of registration or licensing under U.S. or foreign law
would be interpreted in the manner provided in the regulations
proposed under section 1296(b)(3) (as in effect prior to the
enactment of the Act). See Prop. Treas. Reg. sec. 1.1296-6.
Under the Act, the Secretary of the Treasury is granted
authority to issue regulations appropriate to carry out the
exception for securities dealers, including regulations to
prevent abuse of the exception and to treat other taxes as
qualifying for the exception. The Congress anticipated that
this regulatory authority could be used to treat as qualifying
for the exception internal withholding taxes imposed by a
foreign country on persons that are taxed on a residence basis
as a result of doing business in the foreign country.
If a taxpayer is denied foreign tax credits under the Act
because the 16- or 46-day holding period requirement is not
satisfied, the taxpayer would be entitled to a deduction for
the foreign taxes for which the credit is disallowed. This
deduction would be available even if the taxpayer claimed the
foreign tax credit for other taxes in the same taxable year.
No inference is intended as to the treatment under prior
law of tax-motivated transactions intended to transfer foreign
tax credit benefits.
Effective Date
The provision is effective for dividends paid or accrued
more than 30 days after the date of enactment. Where a dividend
is paid or accrued prior to the effective date, the provision
does not apply to additional dividend amounts that are deemed
to be paid with respect to the dividend under an applicable
U.S. tax treaty.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $23 million in 1998, $48 million in 1999,
$50 million in 2000, $53 million in 2001, $56 million in 2002,
$58 million in 2003, $61 million in 2004, $64 million in 2005,
$68 million in 2006 and $71 million in 2007.
4. Limitation on treaty benefits for payments to hybrid entities (sec.
1054 of the Act and new sec. 894(c) of the Code)
Present and Prior Law
Nonresident alien individuals and foreign corporations
(collectively, foreign persons) that are engaged in business in
the United States are subject to U.S. tax on the income from
such business in the same manner as a U.S. person. In addition,
the United States imposes tax on certain types of U.S. source
income, including interest, dividends and royalties, of foreign
persons not engaged in business in the United States. Such tax
is imposed on a gross basis and is collected through
withholding. The statutory rate of this withholding tax is 30
percent. However, most U.S. income tax treaties provide for a
reduction in the rate, or elimination, of this withholding tax.
Treaties generally provide for different applicable withholding
tax rates for different types of income. Moreover, the
applicable withholding tax rates differ among treaties. The
specific withholding tax rates pursuant to a treaty are the
result of negotiations between the United States and the treaty
partner.
The application of the withholding tax is more complicated
in the case of income derived through an entity, such as a
limited liability company, that is treated as a partnership for
U.S. tax purposes but may be treated as a corporation for
purposes of the tax laws of a treaty partner. The Treasury
regulations include specific rules that apply in the case of
income derived through an entity that is treated as a
partnership for U.S. tax purposes. In the case of a payment of
an item of U.S. source income to a U.S. partnership, the
partnership is required to impose the withholding tax to the
extent the item of income is includible in the distributive
share of a partner who is a foreign person. Tax-avoidance
opportunities could arise in applying the reduced rates of
withholding tax provided under a treaty to cases involving
income derived through a limited liability company or other
hybrid entity (e.g., an entity that is treated as a partnership
for U.S. tax purposes but as a corporation for purposes of the
treaty partner's tax laws).
Following the passage of the House bill and the Senate
amendment, proposed and temporary regulations were issued
addressing the application of the reduced rates of withholding
tax provided under a treaty in cases involving a hybrid entity.
Temp. Treas. Reg. sec. 1.894-1T.
Reasons for Change
The Congress was concerned about the potential tax-
avoidance opportunities available for foreign persons that
invest in the United States through hybrid entities. In
particular, the Congress understood that the interaction of the
tax laws and the applicable tax treaty could provide a business
structuring opportunity that would allow Canadian corporations
with U.S. subsidiaries to avoid both U.S. and Canadian income
taxes with respect to those U.S. operations. The Congress
believed that such tax-avoidance opportunities should be
eliminated.
Explanation of Provision
The Act limits the availability of a reduced rate of
withholding tax pursuant to an income tax treaty in order to
prevent tax avoidance. Under the Act, a foreign person is not
entitled to a reduced rate of withholding tax under a treaty
with a foreign country on an item of income derived through an
entity that is treated as a partnership (or is otherwise
treated as fiscally transparent) for U.S. tax purposes if (1)
such item is not treated for purposes of the taxation laws of
such foreign country as an item of income of such person, (2)
the foreign country does not impose tax on an actual
distribution of such item of income from such entity to such
person, and (3) the treaty itself does not contain a provision
addressing the applicability of the treaty in the case of
income derived through a partnership or other fiscally
transparent entity. In this regard, the foreign country will be
considered to impose tax on a distribution even though such tax
may be reduced or eliminated by reason of deductions or credits
otherwise available to the taxpayer. In addition, the Secretary
of the Treasury is authorized to prescribe regulations to
determine, in situations other than the situation specifically
described in the statutory provision, the extent to which a
taxpayer shall not be entitled to benefits under an income tax
treaty of the United States with respect to any payment
received by, or income attributable to activities of, an entity
that is treated as a partnership for U.S. federal income tax
purposes (or is otherwise treated as fiscally transparent for
such purposes) but is treated as fiscally non-transparent for
purposes of the tax laws of the jurisdiction of residence of
the taxpayer.
The Act addresses a potential tax-avoidance opportunity for
Canadian corporations with U.S. subsidiaries that arose because
of the interaction between the U.S. tax law, the Canadian tax
law, and the income tax treaty between the United States and
Canada. Through the use of a U.S. limited liability company,
which is treated as a partnership for U.S. tax purposes but as
a corporation for Canadian tax purposes, a payment of interest
(which is deductible for U.S. tax purposes) may be converted
into a dividend (which is excludable for Canadian tax
purposes). Accordingly, interest paid by a U.S. subsidiary
through a U.S. limited liability company to a Canadian parent
corporation would be deducted by the U.S. subsidiary for U.S.
tax purposes and would be excluded by the Canadian parent
corporation for Canadian tax purposes; the only tax on such
interest would be a U.S. withholding tax, which could have been
imposed at a reduced rate of 10 percent (rather than the full
statutory rate of 30 percent) pursuant to the income tax treaty
between the United States and Canada. Under the Act,
withholding tax is imposed at the full statutory rate of 30
percent in such case. The Act would not apply if the U.S.-
Canadian income tax treaty is amended to include a provision
reaching a similar result. Moreover, the Act would not apply if
Canada were to impose tax on the Canadian parent on dividends
received from the U.S. limited liability company.
The Congress noted that on June 30, 1997 the Secretary
issued proposed and temporary regulations addressing the
availability of treaty benefits in cases involving hybrid
entities. The Congress believed that these regulations are
consistent with the provision in the Act. The Congress also
believed that the provision in the Act and the temporary and
proposed regulations are consistent with U.S. treaty
obligations. Such provision and such regulations represent
interpretations of U.S. treaties clarifying those situations
involving hybrid entities in which taxpayers are entitled to
treaty benefits and those situations in which they are not. The
United States has recognized authority to implement its tax
treaties so as to avoid abuses.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997). Accordingly, the provision applies to items
of income received by the partnership (or other fiscally
transparent entity) on or after August 5, 1997.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $1 million per year in each of the years
1998 through 2007.
5. Interest on underpayments that are reduced by foreign tax credit
carrybacks (sec. 1055 of the Act and secs. 6601 and 6611 of the
Code)
Present and Prior Law
U.S. persons may credit foreign taxes against U.S. tax on
foreign source income. The amount of foreign tax credits that
can be claimed in a year is subject to a limitation that
prevents taxpayers from using foreign tax credits to offset
U.S. tax on U.S. source income. Separate limitations are
applied to specific categories of income. The amount of
creditable taxes paid or accrued in any taxable year which
exceeds the foreign tax credit limitation is permitted to be
carried back two years and carried forward five years.
For purposes of the computation of interest on overpayments
of tax, if an overpayment for a taxable year results from a
foreign tax credit carryback from a subsequent taxable year,
the overpayment is deemed not to arise prior to the filing date
for the subsequent taxable year in which the foreign taxes were
paid or accrued (sec. 6611(g)). Accordingly, interest does not
accrue on the overpayment prior to the filing date for the year
of the carryback that effectively created such overpayment. In
a decision that was subsequently overturned following enactment
of the Taxpayer Relief Act of 1997 (the ``Act''), the Court of
Federal Claims held that in the case of an underpayment of tax
(rather than an overpayment) for a taxable year that was
eliminated by a foreign tax credit carryback from a subsequent
taxable year, interest did not accrue on the underpayment that
was eliminated by the foreign tax credit carryback. Fluor Corp.
v. United States, 35 Fed. Cl. 520 (1996), rev'd, No. 96-5130
(Fed. Cir. 1997). The Court of Appeals for the Federal Circuit
held that interest continued to accrue on the underpayment of
tax that was eliminated by the foreign tax credit carryback,
and remanded the case for determination of the date on which
such interest ceased to accrue.
Reasons for Change
The Congress believed that the application of the interest
rules in the case of a deficiency that is reduced or eliminated
by a foreign tax credit carryback must be consistent with the
application of the interest rules in the case of an overpayment
that is created by a foreign tax credit carryback. The Congress
believed that in such cases the deficiency cannot be considered
to have been eliminated, and the overpayment cannot be
considered to have been created, until the filing date for the
taxable year in which the foreign tax credit carryback arises.
Accordingly, interest should continue to accrue on the
deficiency through such date. In addition, the Congress
believed that it is appropriate to clarify the interest rules
that apply in the case of a foreign tax credit carryback that
is itself triggered by another carryback from a subsequent
year.
Explanation of Provision
Under the Act, if an underpayment for a taxable year is
reduced or eliminated by a foreign tax credit carryback from a
subsequent taxable year, such carryback does not affect the
computation of interest on the underpayment for the period
ending with the filing date for such subsequent taxable year in
which the foreign taxes were paid or accrued. The Act also
clarifies the application of the interest rules of both section
6601 and section 6611 in the case of a foreign tax credit
carryback that is triggered by a net operating loss or net
capital loss carryback; in such a case, a deficiency is not
considered to have been reduced, and an overpayment is not
considered to have been created, until the filing date for the
subsequent year in which the loss carryback arose. No inference
is intended regarding the computation of interest under prior
law in the case of a foreign tax credit carryback (including a
foreign tax credit carryback that is triggered by a net
operating loss or net capital loss carryback).
Effective Date
The provision is effective for foreign taxes actually paid
or accrued in taxable years beginning after the date of
enactment (after August 5, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $8 million in 1998, $10 million in 1999, $2
million in 2000, and $1 million per year in each of 2001
through 2007.
6. Determination of period of limitations relating to foreign tax
credits (sec. 1056 of the Act and sec. 6511(d) of the Code)
Present and Prior Law
U.S. persons may credit foreign taxes against U.S. tax on
foreign source income. The amount of foreign tax credits that
can be claimed in a year is subject to a limitation that
prevents taxpayers from using foreign tax credits to offset
U.S. tax on U.S. source income. Separate limitations are
applied to specific categories of income. The amount of
creditable taxes paid or accrued in any taxable year which
exceeds the foreign tax credit limitation is permitted to be
carried back two years and carried forward five years.
For purposes of the period of limitations on filing claims
for credit or refund, in the case of a claim relating to an
overpayment attributable to foreign tax credits, the
limitations period is ten years from the filing date for the
taxable year with respect to which the claim is made. The
Internal Revenue Service has taken the position that, in the
case of a foreign tax credit carryforward, the period of
limitations is determined by reference to the year in which the
foreign taxes were paid or accrued (and not the year to which
the foreign tax credits are carried) (Rev. Rul. 84-125, 1984-2
C.B. 125). However, the court in Ampex Corp. v. United States,
620 F.2d 853 (Ct. Cl.1980), held that, in the case of a foreign
tax credit carryforward, the period of limitations is
determined by reference to the year to which the foreign tax
credits are carried (and not the year in which the foreign
taxes were paid or accrued).
Reasons for Change
The Congress believed that it is appropriate to identify
clearly the date on which the ten-year period of limitations
for claims with respect to foreign tax credits begins.
Explanation of Provision
Under the Act, in the case of a claim relating to an
overpayment attributable to foreign tax credits, the
limitations period is determined by reference to the year in
which the foreign taxes were paid or accrued (and not the year
to which the foreign tax credits are carried). No inference is
intended regarding the determination of such limitations period
under prior law.
Effective Date
The provision is effective for foreign taxes paid or
accrued in taxable years beginning after the date of enactment
(after August 5, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $1 million in 1998, $2 million in 1999, and
$1 million per year in each of 2000 through 2007.
7. Repeal special exception to foreign tax credit limitation for
alternative minimum tax purposes (sec. 1057 of the Act and sec.
59 of the Code)
Present and Prior Law
Present law imposes a minimum tax on a corporation to the
extent the taxpayer's minimum tax liability exceeds its regular
tax liability. The corporate minimum tax is imposed at a rate
of 20 percent on alternative minimum taxable income in excess
of a phased-out $40,000 exemption amount.
The combination of the taxpayer's net operating loss
carryover and foreign tax credits cannot reduce the taxpayer's
alternative minimum tax liability by more than 90 percent of
the amount determined without these items.
The Omnibus Budget Reconciliation Act of 1989 (``1989
Act'') provided a special exception to the limitation on the
use of the foreign tax credit against the tentative minimum
tax. In order to qualify for this exception, a corporation must
have met four requirements. First, more than 50 percent of both
the voting power and value of the stock of the corporation must
have been owned by U.S. persons who were not members of an
affiliated group which included such corporation. Second, all
of the activities of the corporation must have been conducted
in one foreign country with which the United States had an
income tax treaty in effect and such treaty must have provided
for the exchange of information between such country and the
United States. Third, the corporation generally must have
distributed to its shareholders all current earnings and
profits (except for certain amounts utilized for normal
maintenance or capital expenditures related to its existing
business). Fourth, all of such distributions which were
received by U.S. persons must have been utilized by such
persons in a U.S. trade or business. This exception applied to
taxable years beginning after March 31, 1990 (with a proration
rule effective for certain taxable years which included March
31, 1990).
Reasons for Change
The Congress believed that all taxpayers should be treated
the same with respect to the foreign tax credit limitation of
the alternative minimum tax.
Explanation of Provision
The Act repeals the special exception provided in the 1989
Act regarding the use of foreign tax credits for purposes of
the alternative minimum tax.
Effective Date
The provision is effective for taxable years beginning
after the date of enactment (i.e., after August 5, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $2 million in 1998, $5 million in 1999, $5
million in 2000, $5 million in 2001, $5 million in 2002, $5
million in 2003, $5 million in 2004, $5 million in 2005, $5
million in 2006, and $5 million in 2007.
G. Partnership Provisions
1. Allocation of basis of properties distributed to a partner by a
partnership (sec. 1061 of the 1997 Act and sec. 732(c) of the
Code)
Present and Prior Law
In general
The partnership provisions generally permit partners to
receive distributions of partnership property without
recognition of gain or loss (sec. 731).\260\ Rules are provided
for determining the basis of the distributed property in the
hands of the distributee, and for allocating basis among
multiple properties distributed, as well as for determining
adjustments to the distributee partner's basis in its
partnership interest. Property distributions are tax-free to a
partnership. Adjustments to the basis of the partnership's
remaining undistributed assets are not required unless the
partnership has made an election that requires basis
adjustments both upon partnership distributions and upon
transfers of partnership interests (sec. 754).
---------------------------------------------------------------------------
\260\ Exceptions to this nonrecognition rule apply: (1) when money
(and the fair market value of marketable securities) received exceeds a
partner's adjusted basis in the partnership (sec. 731(a)(1)); (2) when
only money, inventory and unrealized receivables are received in
liquidation of a partner's interest and loss is realized (sec.
731(a)(2)); (3) to certain disproportionate distributions involving
inventory and unrealized receivables (sec. 751(b)); and (4) to certain
distributions relating to contributed property (secs. 704(c) and 737).
In addition, if a partner engages in a transaction with a partnership
other than in its capacity as a member of the partnership, the
transaction generally is considered as occurring between the
partnership and one who is not a partner (sec. 707).
---------------------------------------------------------------------------
Partner's basis in distributed properties and partnership interest
Present law provides two different rules for determining a
partner's basis in distributed property, depending on whether
the distribution is in liquidation of the partner's interest in
the partnership. Generally, a substituted basis rule applies to
property distributed to a partner in liquidation. Thus, the
basis of property distributed in liquidation of a partner's
interest is equal to the partner's adjusted basis in its
partnership interest (reduced by any money distributed in the
same transaction) (sec. 732(b)).
By contrast, generally, a carryover basis rule applies to
property distributed to a partner other than in liquidation of
its partnership interest, subject to a cap (sec. 732(a)). Thus,
in a non-liquidating distribution, the distributee partner's
basis in the property is equal to the partnership's adjusted
basis in the property immediately before the distribution, but
not to exceed the partner's adjusted basis in its partnership
interest (reduced by any money distributed in the same
transaction). In a non-liquidating distribution, the partner's
basis in its partnership interest is reduced by the amount of
the basis to the distributee partner of the property
distributed and is reduced by the amount of any money
distributed (sec. 733).
Allocating basis among distributed properties
In the event that multiple properties are distributed by a
partnership, allocation rules are provided for determining
their bases in the distributee partner's hands. An allocation
rule is needed when the substituted basis rule for liquidating
distributions applies, in order to assign a portion of the
partner's basis in its partnership interest to each distributed
asset. An allocation rule is also needed in a non-liquidating
distribution of multiple assets when the total carryover basis
would exceed the partner's basis in its partnership interest,
so a portion of the partner's basis in its partnership interest
is assigned to each distributed asset.
Prior law provided for allocation in proportion to the
partnership's adjusted basis. The rule allocated basis first to
unrealized receivables and inventory items in an amount equal
to the partnership's adjusted basis (or if the allocated basis
is less than partnership basis, then in proportion to the
partnership's basis), and then among other properties in
proportion to their adjusted bases to the partnership (sec.
732(c)).\261\ Under this allocation rule, in the case of a
liquidating distribution, the distributee partner was able to
have a basis in the distributed property that exceeded the
partnership's basis in the property.
---------------------------------------------------------------------------
\261\ A special rule allows a partner that acquired a partnership
interest by transfer within two years of a distribution to elect to
allocate the basis of property received in the distribution as if the
partnership had a section 754 election in effect (sec. 732(d)). The
special rule also allows the Service to require such an allocation
where the value at the time of transfer of the property received
exceeds 110 percent of its adjusted basis to the partnership (sec.
732(d)). Treas. Reg. sec. 1.732-1(d)(4) generally requires the
application of section 732(d) where the allocation of basis under
section 732(c) upon a liquidation of the partner's interest would have
resulted in a shift of basis from non-depreciable property to
depreciable property.
---------------------------------------------------------------------------
Reasons for Change
The prior-law rule providing that distributee partners
allocate basis in proportion to the partnership's adjusted
basis in the distributed property has given rise to problems in
application.\262\ The Congress was concerned that the prior-law
rule permitted basis shifting transactions in which basis is
allocated so as to increase basis artificially, giving rise to
inflated depreciation deductions or artificially large losses,
for example. The Congress believed that these problems would be
significantly reduced by taking into account the fair market
value of property distributed by a partnership for purposes of
allocating basis in the hands of the distributee partner.
---------------------------------------------------------------------------
\262\ ``The failure of these rules to take fair market value into
account puts a high premium on tax planning in connection with in-kind
liquidating distributions. Allocation of the portion of the basis in
excess of the partnerships basis in the distributed assets according to
their relative market values would be a conceptually sound approach,
and would eliminate the strange results and manipulation possibilities
. . .'' W. McKee, W. Nelson and R. Whitmire, Federal Taxation of
Partnerships and Partners (3rd ed. 1997), sec. 19.06.
---------------------------------------------------------------------------
Explanation of Provision
The provision modifies the basis allocation rules for
distributee partners. It allocates a distributee partner's
basis adjustment among distributed assets first to unrealized
receivables and inventory items in an amount equal to the
partnership's basis in each such property (as under present
law). If the basis to be allocated is less than the sum of the
adjusted bases of the properties in the hands of the
partnership, then, to the extent a decrease is required to make
the total adjusted bases of the properties equal the basis to
be allocated, the decrease is allocated as described below for
adjustments that are decreases.
Under the provision, to the extent of any basis not
allocated under the above rules, basis is allocated first to
the extent of each distributed property's adjusted basis to the
partnership. Any remaining basis adjustment, if an increase, is
allocated among properties with unrealized appreciation in
proportion to their respective amounts of unrealized
appreciation (to the extent of each property's appreciation),
and then in proportion to their respective fair market values.
For example, assume that a partnership with two assets, A and
B, distributes them both in liquidation to a partner whose
basis in its interest is 55. Neither asset consists of
inventory or unrealized receivables. Asset A has a basis to the
partnership of 5 and a fair market value of 40, and asset B has
a basis to the partnership of 10 and a fair market value of 10.
Under the provision, basis is first allocated to asset A in the
amount of 5 and to asset B in the amount of 10 (their adjusted
bases to the partnership). The remaining basis adjustment is an
increase totaling 40 (the partner's 55 basis minus the
partnership's total basis in distributed assets of 15). Basis
is then allocated to asset A in the amount of 35, its
unrealized appreciation, with no allocation to asset B
attributable to unrealized appreciation because its fair market
value equals the partnership's adjusted basis. The remaining
basis adjustment of 5 is allocated in the ratio of the assets'
fair market values, i.e., 4 to asset A (for a total basis of
44) and 1 to asset B (for a total basis of 11).
If the remaining basis adjustment is a decrease, it is
allocated among properties with unrealized depreciation in
proportion to their respective amounts of unrealized
depreciation (to the extent of each property's depreciation),
and then in proportion to their respective adjusted bases
(taking into account the adjustments already made). A remaining
basis adjustment that is a decrease arises under the provision
when the partnership's total adjusted basis in the distributed
properties exceeds the amount of the partner's basis in its
partnership interest, and the latter amount is the basis to be
allocated among the distributed properties. For example, assume
that a partnership with two assets, C and D, distributes them
both in liquidation to a partner whose basis in its partnership
interest is 20. Neither asset consists of inventory or
unrealized receivables. Asset C has a basis to the partnership
of 15 and a fair market value of 15, and asset D has a basis to
the partnership of 15 and a fair market value of 5. Under the
provision, basis is first allocated to the extent of the
partnership's basis in each distributed property, or 15 to each
distributed property, for a total of 30. Because the partner's
basis in its interest is only 20, a downward adjustment of 10
(30 minus 20) is required. The entire amount of the 10 downward
adjustment is allocated to the property D, reducing its basis
to 5. Thus, the basis of property C is 15 in the hands of the
distributee partner, and the basis of property D is 5 in the
hands of the distributee partner.
Effective Date
The provision applies to partnership distributions after
the date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $26 million in 1998, $52 million in 1999,
$55 million in 2000, $57 million in 2001, $59 million in 2002,
$61 million in 2003, $64 million in 2004, $66 million in 2005,
$69 million in 2006, and $72 million in 2007.
2. Treatment of inventory items of a partnership (sec. 1062 of the 1997
Act and sec. 751 of the Code)
Present and Prior Law
Under prior law, upon the sale or exchange of a partnership
interest, any amount received that is attributable to
unrealized receivables, or to inventory that has substantially
appreciated, is treated as an amount realized from the sale or
exchange of property that is not a capital asset (sec. 751(a)).
Present and prior law provide a similar rule to the extent
that a distribution is treated as a sale or exchange of a
partnership interest. A distribution by a partnership in which
a partner receives substantially appreciated inventory or
unrealized receivables in exchange for its interest in certain
other partnership property (or receives certain other property
in exchange for its interest in substantially appreciated
inventory or unrealized receivables) is treated as a taxable
sale or exchange of property, rather than as a nontaxable
distribution (sec. 751(b)).
For purposes of these rules, inventory of a partnership
generally is treated as substantially appreciated if the fair
market value of the inventory exceeds 120 percent of adjusted
basis of the inventory to the partnership (sec. 751(d)(1)(A)).
In applying this rule, inventory property is excluded from the
calculation if a principal purpose for acquiring the inventory
property was to avoid the rules relating to inventory (sec.
751(d)(1)(B)).
Reasons for Change
The substantial appreciation requirement with respect to
inventory of a partnership has been criticized as ineffective
at properly treating income attributable to inventory as
ordinary income under the section 751 rules for partnerships
with profit margins below 20 percent.\263\ Because the Congress
believed that income attributable to inventory should be
treated as ordinary income, the Act repeals the substantial
appreciation requirement with respect to inventory, in the case
of partnership sales or exchanges.
---------------------------------------------------------------------------
\263\ The 1984 ALI study on partnership rules referred to the
substantial appreciation requirement as subject to manipulation and tax
planning (American Law Institute, Federal Income Tax Project:
Subchapter K: Proposals on the Taxation of Partners, (R. Cohen,
reporter, 1984), 26. In 1993 the definition of substantially
appreciated inventory was modified, and the present-law test relating
to a principal purpose of avoidance was added (Omnibus Budget
Reconciliation Act of 1993, P.L. 103-66, sec. 13206(e)(1)).
Nevertheless, the substantial appreciation requirement is still
criticized as ineffective (W. McKee, W. Nelson and R. Whitmire, Federal
Taxation of Partners and Partnerships, (3rd ed. 1997) sec. 16.04[2]).
---------------------------------------------------------------------------
Explanation of Provision
The Act eliminates the requirement that inventory be
substantially appreciated in order to give rise to ordinary
income in the case of sales or exchanges of partnership
interests under section 751(a) of the Code, but not in the case
of distributions under section 751(b) of the Code. Thus,
present law is retained with respect to distributions governed
by section 751(b). This conforms the treatment of inventory to
the treatment of unrealized receivables under the rules
relating to sales or exchanges of partnership interests.
Effective Date
The provision is effective for sales, exchanges, and
distributions after the date of enactment (August 5, 1997),
except that the provision does not apply to any sale or
exchange pursuant to a written binding contract in effect on
June 8, 1997, and at all times thereafter before such sale or
exchange.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $30 million in 1998, $66 million in 1999,
$69 million in 2000, $73 million in 2001, $77 million in 2002,
$80 million in 2003, $84 million in 2004, $89 million in 2005,
$93 million in 2006, and $98 million in 2007.
3. Treatment of appreciated property contributed to a partnership (sec.
1063 of the 1997 Act and secs. 704(c)(1)(B) and 737 of the
Code)
Present and Prior Law
Under present law, if a partner contributes appreciated
property to a partnership, no gain is recognized to the
contributing partner at the time of the contribution. The
contributing partner's basis in its partnership interest is
increased by the basis of the contributed property at the time
of the contribution. The pre-contribution gain is reflected in
the difference between the partner's capital account and its
basis in its partnership interest (``book/tax differential'').
Income, gain, loss, and deduction with respect to the
contributed property must be shared among the partners so as to
take account of the variation between the basis of the property
to the partnership and its fair market value at the time of
contribution (sec. 704(c)(1)(A)).
If the property is subsequently distributed to another
partner within 5 years of the contribution, the contributing
partner generally recognizes gain as if the property had been
sold for its fair market value at the time of the distribution
(sec. 704(c)(1)(B)). Similarly, the contributing partner
generally includes pre-contribution gain in income to the
extent that the value of other property distributed by the
partnership to that partner exceeds its adjusted basis in its
partnership interest, if the distribution by the partnership is
made within 5 years after the contribution of the appreciated
property (sec. 737).
Reasons for Change
The Congress was concerned that the inconsistency in
treatment of partnership sales and partnership distributions of
property contributed by partners makes it possible for partners
to circumvent the rule requiring pre-contribution gain on
contributed property to be allocated to the contributing
partner. In order to limit the inconsistency and to reduce
opportunities for circumventing this rule, the Congress
believed that the contributing partner should recognize pre-
contribution gain when the contributed property is distributed
to another partner, or the partnership distributes to the
contributing partner other property whose value exceeds that
partner's basis in its partnership interest, within 7 years
after the contribution of the appreciated property.
Explanation of Provision
The Act extends to 7 years the period in which a partner
recognizes pre-contribution gain with respect to property
contributed to a partnership. Thus, under the provision, a
partner that contributes appreciated property to a partnership
generally recognizes pre-contribution gain in the event that
the partnership distributes the contributed property to another
partner, or distributes to the contributing partner other
property whose value exceeds that partner's basis in its
partnership interest, if the distribution occurs within 7 years
after the contribution to the partnership.
Effective Date
The provision is effective for property contributed to a
partnership after June 8, 1997, except that the provision does
not apply to any property contributed to a partnership pursuant
to a written binding contract in effect on June 8, 1997, and at
all times thereafter before such contribution, if the contract
provides for the contribution of a fixed amount of property.
Revenue Effect
The provision is estimated neither to increase nor reduce
Federal fiscal year budget receipts in 1998, 1999, 2000, and
2001, and to increase Federal fiscal year budget receipts by $2
million in 2002, $10 million in 2003, $11 million in 2004, $11
million in 2005, $12 million in 2006, and $12 million in 2007.
H. Pension and Employee Benefit Provisions
1. Cashout of certain accrued benefits (sec. 1071 of the Act and sec.
411(a)(11) of the Code)
Present and Prior Law
Under present and prior law, in the case of an employee
whose plan participation terminates, a qualified plan may
involuntarily ``cash out'' the benefit (i.e., pay out the
balance to the credit of a plan participant without the
participant's consent, and, if applicable, the consent of the
participant's spouse) if the present value of the benefit does
not exceed a specified dollar amount. Under prior law, this
dollar amount was $3,500. Under present and prior law, if a
benefit is cashed out under this rule and the participant
subsequently returns to employment covered by the plan, then
service taken into account in computing benefits payable under
the plan after the return need not include service with respect
to which benefits were cashed out unless the employee ``buys
back'' the benefit. If the present value determined at the time
of a distribution to the participant exceeds the dollar limit,
then the present value at any subsequent time is deemed to
exceed the dollar limit.
Generally, a cash-out distribution from a qualified plan to
a plan participant can be rolled over, tax free, to an IRA or
to another qualified plan.
Reasons for Change
The Congress believed that the limit on involuntary cash-
outs should be raised to $5,000 in recognition of the effects
of inflation and the value of small benefits payable under a
qualified pension plan.
Explanation of Provision
The Act increases the limit on involuntary cash-outs to
$5,000 from $3,500 and permits plan amendments to increase the
cashout limit to up to $5,000 without violating the anti-
cutback rules (sec. 411(d)(6)).\264\ All other rules applicable
to cash-outs remain unchanged. For example, if, at the time of
a distribution the present value of a participant's benefit
exceeds $5,000, the benefit may not be involuntarily cashed out
even if the actual value of the benefit falls below $5,000.
Similarly, benefits of terminated vested participants can be
cashed out, as long as a cashout would have been permitted
under prior law if $5,000 were substituted for $3,500.
---------------------------------------------------------------------------
\264\ See section 1541 of the Act relating to adoption of plan
amendments.
---------------------------------------------------------------------------
Effective Date
The provision is effective for plan years beginning after
the date of enactment.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by less than $500,000 in 1997, $2 million in
1998, $6 million in 1999, $7 million in 2000, 2001 and 2002, $8
million in 2003 and 2004, $9 million in 2005 and 2006, and $10
million in 2007.
2. Election to receive taxable cash compensation in lieu of nontaxable
parking benefits (sec. 1072 of the Act and sec. 132(f) of the
Code)
Present and Prior Law
Under present and prior law, up to $170 per month of
employer-provided parking is excludable from gross income.
Under prior law, in order for the exclusion to apply, the
parking had to be provided in addition to and not in lieu of
any compensation otherwise payable to the employee. Under
present and prior law, employer-provided parking cannot be
provided as part of a cafeteria plan.
Reasons for Change
The Congress believed that it was appropriate to permit
employees to choose between employer-provided parking and cash.
Explanation of Provision
The Act provides that no amount is includible in the income
of an employee merely because the employer offers the employee
a choice between cash and employer-provided parking. The amount
of cash offered is includible in income only if the employee
chooses the cash instead of parking.
Under this provision, parking may be provided through
salary reduction. As under prior law, employer-provided parking
cannot be provided as part of a cafeteria plan.
Effective Date
The provision is effective with respect to taxable years
beginning after December 31, 1997.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $3 million in 1998, $8 million in 1999, $11
million in 2000, $12 million in 2001, $12 million in 2002, $13
million in 2003, $14 million in 2004, $14 million in 2005, $15
million in 2006, and $16 million in 2007.
3. Repeal of excess distribution and excess retirement accumulation
taxes (sec. 1073 of the Act and sec. 4980A of the Code)
Prior Law
Under prior law, a 15-percent excise tax was imposed on
excess distributions from qualified retirement plans, tax-
sheltered annuities, and IRAs. Excess distributions were
generally defined as the aggregate amount of retirement
distributions from such plans during any calendar year in
excess of $160,000 (for 1997) or 5 times that amount in the
case of a lump-sum distribution. The 15-percent excise tax did
not apply to distributions received in 1997, 1998, and 1999.
An additional 15-percent estate tax was imposed on an
individual's excess retirement accumulations. Excess retirement
accumulations were generally defined as the balance in
retirement plans in excess of the present value of a benefit
that would not be subject to the 15-percent tax in excess
distributions.
Reasons for Change
The excess distribution and retirement accumulation taxes
were designed to limit the overall tax-deferred savings by
individuals, as well as to help ensure that tax-favored
retirement vehicles were used primarily for retirement
purposes. The Congress believed that the limits on
contributions and benefits applicable to each type of vehicle
are sufficient limits on tax-deferred savings. Additional
penalties are unnecessary, and may also deter individuals from
saving. The excess accumulation and distribution taxes also
inappropriately penalize favorable investment returns.
Explanation of Provision
The Act repeals both the 15-percent excise tax on excess
distributions and the 15-percent estate tax on excess
retirement accumulations.
Effective Date
The provision repealing the excess distribution tax is
effective with respect to excess distributions received after
December 31, 1996. The repeal of the excess accumulation tax is
effective with respect to decedents dying after December 31,
1996.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $18 million in 1998, $19 million in 1999, $7
million in 2000, and increase such receipts by $18 million in
2001, $18 million in 2002, $16 million in 2003, $16 million in
2004, $14 million in 2005, $13 million in 2006, and $11 million
in 2007.
4. Tax on prohibited transactions (sec. 1074 of the Act and sec. 4975
of the Code)
Present and Prior Law
Present and prior law prohibit certain transactions
(prohibited transactions) between a qualified plan and a
disqualified person in order to prevent persons with a close
relationship to the qualified plan from using that relationship
to the detriment of plan participants and beneficiaries. A two-
tier excise tax is imposed on prohibited transactions. Under
prior law, the initial level tax was equal to 10-percent of the
amount involved with respect to the transaction. Under present
and prior law, if the transaction is not corrected within a
certain period, a tax equal to 100 percent of the amount
involved may be imposed.
Reasons for Change
The Congress believed it is appropriate to increase the
initial level prohibited transaction tax to discourage
disqualified persons from engaging in such transactions.
Explanation of Provision
The Act increases the initial-level prohibited transaction
tax from 10-percent to 15-percent.
Effective Date
The provision is effective with respect to prohibited
transactions occurring after the date of enactment (August 5,
1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $2 million in 1998, and $4 million per year
during the period 1999 through 2007.
5. Basis recovery rules (sec. 1075 of the Act and sec. 72 of the Code)
Present and Prior Law
Under present and prior law, amounts received as an annuity
under a tax-qualified pension plan generally are includible in
income in the year received, except to the extent the amount
received represents return of the recipient's investment in the
contract (i.e., basis). The portion of each annuity payment
that represents a return of basis generally is determined by a
simplified method. Under this method, the portion of each
annuity payment that is a return to basis is equal to the
employee's total basis as of the annuity starting date, divided
by the number of anticipated payments under a specified table,
shown below. The number of anticipated payments listed in the
table is based on the age of the primary annuitant on the
annuity starting date.
Number of
Age of primary annuitant payments
55 or less.............................................. 360
56-60................................................... 310
61-65................................................... 260
66-70................................................... 210
71 or more.............................................. 160
If the number of payments is fixed under the terms of the
annuity, that number is used instead of the number of
anticipated payments listed in the table. The simplified method
is not available if the primary annuitant has attained age 75
on the annuity starting date unless there are fewer than 5
years of guaranteed payments under the annuity. If, in
connection with commencement of annuity payments, the recipient
receives a lump-sum payment that is not part of the annuity
stream, such payment is taxable under the rules relating to
annuities (sec. 72) as if received before the annuity starting
date, and the investment in the contract used to calculate the
simplified exclusion ratio for the annuity payments is reduced
by the amount of the payment. In no event is the total amount
excluded from income as nontaxable return of basis greater than
the recipient's total investment in the contract.
Reasons for Change
The table for determining anticipated payments does not
differ depending on whether the annuity is payable in the form
of a single life annuity or a joint and survivor annuity.
Applying the table for single life annuities to joint and
survivor annuities understates the expected payments under a
joint and survivor annuity.
Explanation of Provision
Under the Act, the prior-law table would apply to benefits
based on the life of one annuitant. A separate table applies to
benefits based on the life of more than one annuitant, as
follows:
Number of
Combined age of annuitants payments
110 or less............................................. 410
111-120................................................. 360
121-130................................................. 310
131-140................................................. 260
141 and over............................................ 210
The new table applies to benefits based on the life of more
than one annutitant, even if the amount of the annuity varies
by annuitant. Thus, for example, the new table applies to a 50-
percent joint and survivor annuity. The new table does not
apply to an annuity paid on a single life merely because it has
additional features, e.g., a term certain.
Effective Date
The provision is effective with respect to annuity starting
dates beginning after December 31, 1997.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $1 million in 1998, $3 million in 1999, $6
million in 2000, $9 million in 2001, $11 million in 2002, $15
million in 2003, $18 million in 2004, $21 million in 2005, $24
million in 2006, and $27 million in 2007.
I. Other Revenue-Increase Provisions
1. Phase out suspense accounts for certain large farm corporations
(sec. 1081 of the Act and sec. 447 of the Code)
Present and Prior Law
A corporation (or a partnership with a corporate partner)
engaged in the trade or business of farming must use an accrual
method of accounting for such activities unless such
corporation (or partnership), for each prior taxable year
beginning after December 31, 1975, did not have gross receipts
exceeding $1 million. If a farm corporation is required to
change its method of accounting, the section 481 adjustment
resulting from such change is included in gross income ratably
over a 10-year period, beginning with the year of change. This
rule does not apply to a family farm corporation.
A provision of the Revenue Act of 1987 (``1987 Act'')
requires a family corporation (or a partnership with a family
corporation as a partner) to use an accrual method of
accounting for its farming business unless, for each prior
taxable year beginning after December 31, 1985, such
corporation (and any predecessor corporation) did not have
gross receipts exceeding $25 million. A family corporation is
one where at 50 percent or more of the stock of the corporation
is held by one (or in some limited cases, two or three)
families.
A family farm corporation that must change to an accrual
method of accounting as a result of the 1987 Act provision is
to establish a suspense account in lieu of including the entire
amount of the section 481 adjustment in gross income. The
initial balance of the suspense account equals the lesser of
(1) the section 481 adjustment otherwise required for the year
of change, or (2) the section 481 adjustment computed as if the
change in method of accounting had occurred as of the beginning
of the taxable year preceding the year of change.
The amount of the suspense account is required to be
included in gross income if the corporation ceases to be a
family corporation. In addition, if the gross receipts of the
corporation attributable to farming for any taxable year
declined to an amount below the lesser of (1) the gross
receipts attributable to farming for the last taxable year for
which an accrual method of accounting was not required, or (2)
the gross receipts attributable to farming for the most recent
taxable year for which a portion of the suspense account was
required to be included in income, a portion of the suspense
account was required to be included in gross income.
Reasons for Change
The Congress believed that an accrual method of accounting
more accurately measures the economic income of a corporation
than does the cash receipts and disbursements method and that
changes from one method of accounting to another should be
taken into account under section 481. However, the Congress
believed that it may be appropriate for a family farm
corporation to retain the use of the cash method of accounting
until such corporation reaches a certain size. At that time,
the corporation should be subject to tax accounting rules to
which other corporations are subject. In addition, the Congress
believed that the present-law suspense account provision
applicable to large family farm corporations may effectively
provide an exclusion for, rather than a deferral of, amounts
otherwise properly taken into account under section 481 upon
the required change in the method of accounting for such
corporations. However, the Congress recognized that requiring
the recognition of previously established suspense accounts may
impose liquidity concerns upon some farm corporations. Thus,
the Congress provided an extended period over which existing
suspense accounts must be restored to income and provided
further deferral where the corporation has insufficient income
for the year.
Explanation of Provision
The Act repeals the ability of a family farm corporation to
establish a suspense account when it is required to change to
an accrual method of accounting. Thus, under the Act, any
family farm corporation required to change to an accrual method
of accounting would restore the section 481 adjustment
applicable to the change in gross income ratably over a 10-year
period beginning with the year of change.
In addition, any taxpayer with an existing suspense account
is required to restore the account into income ratably over a
20-year period beginning in the first taxable year beginning
after June 8, 1997, subject to the requirement to restore such
accounts more rapidly when the corporation ceases to be a
qualified family farm corporation. The amount required to be
restored to income for a taxable year pursuant to the 20-year
spread period shall not exceed the net operating loss of the
corporation for the year (in the case of a corporation with a
net operating loss) or 50 percent of the net income of the
taxpayer for the year (for corporations with taxable income).
For this purpose, a net operating loss or taxable income is
determined without regard to the amount restored to income
under the Act. Any reduction in the amount required to be
restored to income is taken into account ratably over the
remaining years in the 20-year period or, if applicable, after
the end of the 20-year period. Amounts that extend beyond the
20-year period remain subject to the net operating loss and 50-
percent-of-taxable income rules. The net operating loss and 50-
percent-of-taxable income rules do not apply to restorations of
suspense accounts that are required when the corporation ceases
to be a qualified family farm corporation. In the case of a
family farm corporation that elects to be an S corporation for
a taxable year, the net operating loss and 50 percent of
taxable income limitations shall be determined by taking into
account all the items of income, gain, deduction and loss of
the corporation, whether or not such items are separately
stated under section 1366.
Finally, the Act repealed the present-law requirement to
accelerate the recovery of suspense accounts when the gross
receipts of the taxpayer diminishes.
Effective Date
The provision is effective for taxable years ending after
June 8, 1997.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $29 million in 1998, $33 million in 1999,
$35 million in 2000, $36 million in 2001, $37 million in 2002,
$39 million in 2003, $40 million in 2004, $41 million in 2005,
$43 million in 2006, and $44 million in 2007.
2. Modify net operating loss carryback and carryforward rules (sec.
1082 of the Act and sec. 172 of the Code)
Present and Prior Law
Under prior law, the net operating loss (``NOL'') of a
taxpayer (generally, the amount by which the business
deductions of a taxpayer exceeds its gross income) could be
carried back three years and carried forward 15 years to offset
taxable income in such years. A taxpayer may elect to forgo the
carryback of an NOL. Special rules apply to real estate
investment trusts (``REITs'') (no carrybacks), specified
liability losses (10-year carryback), and excess interest
losses (no carrybacks).
Reasons for Change
The Congress recognized that while Federal income tax
reporting requires a taxpayer to report income and file returns
based on a 12-month period, the natural business cycle of a
taxpayer may exceed 12 months. However, the Congress believed
that allowing a two-year carryback of NOLs is sufficient to
account for these business cycles, particularly since (1) many
deductions allowed for tax purposes relate to future, rather
than past, income streams and (2) certain deductions that do
relate to past income streams are granted special, longer
carryback periods under present law (which are retained by the
Act). In order to compensate for the shortening of the
carryback period, the Act extends the NOL carryforward period
to 20 years.
Explanation of Provision
The Act limits the NOL carryback period to two years and
extends the NOL carryforward period to 20 years. The Act does
not apply to the carryback rules relating to REITs, specified
liability losses, excess interest losses, and corporate capital
losses.
The Act does not apply to NOLs arising from casualty losses
of individual taxpayers. In addition, the Act does not apply to
NOLs attributable to losses incurred in Presidentially declared
disaster areas by taxpayers engaged in a farming business or a
small business. For this purpose, a ``small business'' means
any trade or business (including one conducted in or through a
corporation, partnership, or sole proprietorship) the average
annual gross receipts (as determined under sec. 448(c)) of
which are $5 million or less, and a ``farming business'' is
defined as in section 263A(e)(4).
Effective Date
The provision is effective for NOLs for taxable years
beginning after the date of enactment (i.e., after August 5,
1997). The provision does not apply to NOLs carried forward
from prior taxable years.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $42 million in 1998, $303 million in 1999,
$361 million in 2000, $256 million in 2001, $179 million in
2002, $136 million in 2003, $112 million in 2004, $100 million
in 2005, $93 million in 2006, and $90 million in 2007.
3. Modify general business credit carryback and carryforward rules
(sec. 1083 of the Act and sec. 38 of the Code)
Present and Prior Law
A qualified taxpayer is allowed to claim the rehabilitation
credit, the energy credit, the reforestation credit, the work
opportunity credit, the alcohol fuels credit, the research
credit, the low-income housing credit, the enhanced oil
recovery credit, the disabled access credit, the renewable
electricity production credit, the empowerment zone employment
credit, the Indian employment credit, the employer social
security credit, and the orphan drug credit (collectively,
known as the general business credit), subject to certain
limitations based on tax liability for the year. Under prior
law, unused general business credits generally could be carried
back three years and carried forward 15 years to offset tax
liability of such years, subject to the same limitations.
Explanation of Provision
The Act limits the carryback period for the general
business credit to one year and extends the carryforward period
to 20 years.
Effective Date
The provision is effective for credits arising in taxable
years beginning after December 31, 1997. The provision does not
apply to credits carried forward from prior taxable years.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $182 million in 1998, $300 million in 1999,
and $81 million in 2000; to decrease Federal fiscal year budget
receipts by $60 million in 2001, $32 million in 2002, and $9
million in 2003; and to increase Federal fiscal year budget
receipts by $5 million in 2004, $15 million in 2005, $21
million in 2006, and $25 million in 2007.
4. Expand the limitations on deductibility of interest and premiums
with respect to life insurance, endowment and annuity contracts (sec.
1084 of the Act and sec. 264 of the Code)
Present and Prior Law
Exclusion of inside buildup and amounts received by reason of death
No Federal income tax generally is imposed on a
policyholder with respect to the earnings under a life
insurance contract (``inside buildup'').\265\ Further, an
exclusion from Federal income tax is provided for amounts
received under a life insurance contract paid by reason of the
death of the insured (sec. 101(a)).
---------------------------------------------------------------------------
\265\ This favorable tax treatment is available only if the
policyholder has an insurable interest in the insured when the contract
is issued and if the life insurance contract meets certain requirements
designed to limit the investment character of the contract (sec. 7702).
Distributions from a life insurance contract (other than a modified
endowment contract) that are made prior to the death of the insured
generally are includible in income, to the extent that the amounts
distributed exceed the taxpayer's investment in the contract; such
distributions generally are treated first as a tax-free recovery of the
investment in the contract, and then as income (sec. 72(e)). In the
case of a modified endowment contract, however, in general,
distributions are treated as income first, loans are treated as
distributions (i.e., income rather than basis recovery first), and an
additional 10 percent tax is imposed on the income portion of
distributions made before age 59\1/2\ and in certain other
circumstances (secs. 72(e) and (v)). A modified endowment contract is a
life insurance contract that does not meet a statutory ``7-pay'' test,
i.e., generally is funded more rapidly than 7 annual level premiums
(sec. 7702A). Certain amounts received under a life insurance contract
on the life of a terminally or chronically ill individual, and certain
amounts paid for the sale or assignment to a viatical settlement
provider of a life insurance contract on the life of a terminally ill
or chronically ill individual, are treated as excludable as if paid by
reason of the death of the insured (sec. 101(g)).
---------------------------------------------------------------------------
Premium deduction limitation
Under prior law, no deduction was permitted for premiums
paid on any life insurance policy covering the life of any
officer or employee, or of any person financially interested in
any trade or business carried on by the taxpayer, when the
taxpayer is directly or indirectly a beneficiary under such
policy (sec. 264(a)(1)).
Interest deduction disallowance with respect to life insurance
Generally, no deduction is allowed for interest paid or
accrued on any indebtedness with respect to one or more life
insurance contracts or annuity or endowment contracts owned by
the taxpayer covering any individual (the ``COLI'' rules).
Under prior law, this limitation applied with respect to an
individual who is or was (1) an officer or employee of, or (2)
financially interested in, any trade or business currently or
formerly carried on by the taxpayer.
This interest deduction disallowance rule generally does
not apply to interest on debt with respect to contracts
purchased on or before June 20, 1986; rather, an interest
deduction limit based on Moody's Corporate Bond Yield Average--
Monthly Average Corporates applies in the case of such
contracts.\266\
---------------------------------------------------------------------------
\266\ In the case of contracts purchased after June 20, 1986,
phase-in generally apply with respect to otherwise deductible interest
paid or accrued after December 31, 1995, and before January 1, 1999, in
the case of debt incurred before January 1, 1996. In addition,
transition rules apply.
---------------------------------------------------------------------------
An exception to this interest disallowance rule is provided
for interest on indebtedness with respect to life insurance
policies covering up to 20 key persons. A key person is an
individual who is either an officer or a 20-percent owner of
the taxpayer. The number of individuals that can be treated as
key persons may not exceed the greater of (1) 5 individuals, or
(2) the lesser of 5 percent of the total number of officers and
employees of the taxpayer, or 20 individuals. For determining
who is a 20-percent owner, all members of a controlled group
are treated as one taxpayer. Interest paid or accrued on debt
with respect to a contract covering a key person is deductible
only to the extent the rate of interest does not exceed Moody's
Corporate Bond Yield Average--Monthly Average Corporates for
each month beginning after December 31, 1995, that interest is
paid or accrued.
The foregoing interest deduction limitation was added in
1996 to existing interest deduction limitations with respect to
life insurance and similar contracts.\267\
---------------------------------------------------------------------------
\267\ Since 1942, a limitation has applied to the deductibility of
interest with respect to single premium contracts (sec. 264(a)(2)). For
this purpose, a contract is treated as a single premium contract if (1)
substantially all the premiums on the contract are paid within a period
of 4 years from the date on which the contract is purchased, or (2) an
amount is deposited with the insurer for payment of a substantial
number of future premiums on the contract. Further, under a limitation
added in 1964, no deduction is allowed for any amount paid or accrued
on debt incurred or continued to purchase or carry a life insurance,
endowment, or annuity contract pursuant to a plan of purchase that
contemplates the systematic direct or indirect borrowing of part or all
of the increases in the cash value of the contract (sec. 264(a)(3)). An
exception to the latter rule is provided, permitting deductibility of
interest on bona fide debt that is part of such a plan, if no part of 4
of the annual premiums due during the first 7 years is paid by means of
debts (the ``4-out-of-7 rule'') (sec. 264(c)(1)). In addition to the
specific disallowance rules of section 264, generally applicable
principles of tax law apply.
---------------------------------------------------------------------------
Interest deduction limitation with respect to tax-exempt interest
income
No deduction is allowed for interest on debt incurred or
continued to purchase or carry obligations the interest on
which is wholly exempt from Federal income tax (sec.
265(a)(2)). In addition, in the case a financial institution, a
proration rule provides that no deduction is allowed for that
portion of the taxpayer's interest that is allocable to tax-
exempt interest (sec. 265(b)). The portion of the interest
deduction that is disallowed under this rule generally is the
portion determined by the ratio of the taxpayer's (1) average
adjusted bases of tax-exempt obligations acquired after August
7, 1986, to (2) the average adjusted bases for all of the
taxpayer's assets (sec. 265(b)(2)).\268\
---------------------------------------------------------------------------
\268\ Special rules apply for certain tax-exempt obligations of
small issuers (sec. 265(b)(3)).
---------------------------------------------------------------------------
Reasons for Change
The Congress understood that, under applicable State laws,
the holder of a life insurance policy generally is required to
have an insurable interest in the life of the insured
individual only when the policyholder purchases the life
insurance policy. The Congress understood that under State laws
relating to insurable interests, a taxpayer generally has an
insurable interest in the lives of its debtors. Further, rules
governing permitted investments of financial institutions may
allow the institutions to acquire cash value life insurance
covering the lives of debtors, as well as the lives of
individuals with other relationships to the taxpayer such as
shareholders, employees or officers. In addition, insurable
interest laws in many States have been expanded in recent
years, and States could decide in the future to expand further
the range of persons in whom a taxpayer has an insurable
interest.
For example, a business could purchase cash value life
insurance on the lives of its debtors, and increase the
investment in these contracts as the debt diminishes and even
after the debt is repaid. If a mortgage lender can (under
applicable State law and banking regulations) buy a cash value
life insurance policy on the lives of mortgage borrowers, the
lender may be able to deduct premiums or interest on debt with
respect to such a contract, if no other deduction disallowance
rule or principle of tax law applies to limit the deductions.
The premiums or interest could be deductible even after the
individual's mortgage loan is sold to another lender or to a
mortgage pool. If the loan were sold to a second lender, the
second lender might also be able to buy a cash value life
insurance contract on the life of the same borrower, and to
deduct premiums or interest with respect to that contract. The
Act addresses this issue by providing that no deduction is
allowed for premiums on any life insurance policy, or endowment
or annuity contract, if the taxpayer is directly or indirectly
a beneficiary under the policy or contract, and by providing
that no deduction is allowed for interest paid or accrued on
any indebtedness with respect to a life insurance policy, or an
endowment or annuity contract, covering the life of any
individual.
In addition, the Congress understood that taxpayers may be
seeking new means of deducting interest on debt that in
substance funds the tax-free inside build-up of life insurance
or the tax-deferred inside buildup of annuity and endowment
contracts.\269\ The Congress believed that present law was not
intended to promote tax arbitrage by allowing financial or
other businesses that have the ongoing ability to borrow funds
from depositors, bondholders, investors or other lenders to
concurrently invest a portion of their assets in cash value
life insurance contracts, or endowment or annuity contracts.
Therefore, the Act provides that, for taxpayers other than
natural persons, no deduction is allowed for the portion of the
taxpayer's interest expense that is allocable to unborrowed
policy cash values of any life insurance policy or annuity or
endowment contract issued after June 8, 1997.
---------------------------------------------------------------------------
\269\ See ``Fannie Mae Designing a Program to Link Life Insurance,
Loans,'' Washington Post, p. E3, February 8, 1997; ``Fannie Mae
Considers Whether to Bestow Mortgage Insurance,'' Wall St. Journal, p.
C1, April 22, 1997.
---------------------------------------------------------------------------
Explanation of Provision
Expansion of premium deduction limitation to individuals in whom
taxpayer has an insurable interest
Under the provision, the prior-law premium deduction
limitation is modified to provide that no deduction is
permitted for premiums paid on any life insurance, annuity or
endowment contract, if the taxpayer is directly or indirectly a
beneficiary under the contract.
The premium deduction limitation does not apply to premiums
with respect to any annuity contract described in section
72(s)(5) (relating to certain qualified pension plans, certain
retirement annuities, individual retirement annuities, and
qualified funding assets), nor to premiums with respect to any
annuity to which section 72(u) applies (relating to current
taxation of income on the contract in the case of an annuity
contract held by a person who is not a natural person).
Expansion of interest disallowance to individuals in whom taxpayer has
insurable interest
Under the provision, no deduction is allowed for interest
paid or accrued on any indebtedness with respect to a life
insurance policy, or endowment or annuity contract, covering
the life of any individual. Thus, the provision limits interest
deductibility in the case of such a contract covering any
individual in whom the taxpayer has an insurable interest under
applicable State law when the contract is first issued, except
as otherwise provided under present law with respect to key
persons and pre-1986 contracts.
The Act specifies the treatment of certain interest to
which the provision providing for expansion of interest
disallowance to individuals in whom taxpayer has insurable
interest otherwise would apply. The Act provides that in the
case of a transfer for valuable consideration of a life
insurance contract or any interest therein described in section
101(a)(2), the amount of the death benefit excluded from gross
income under section 101(a) may not exceed an amount equal to
the sum of the actual value of the consideration, premiums,
interest disallowed as a deduction under new section 264(a)(4),
and other amounts subsequently paid by the transferee. Thus,
under the provision, in the case of the transfer for value of a
life insurance contract, the interest with respect to the
contract that otherwise would be disallowed under new section
264(a)(4) is capitalized, reducing the amount included in
income by the transferee upon receipt by the transferee of the
amounts paid by reason of the death of the insured.
Pro rata disallowance of interest on debt to fund life insurance
In the case of a taxpayer other than a natural person, no
deduction is allowed for the portion of the taxpayer's interest
expense that is allocable to unborrowed policy cash surrender
values with respect to any life insurance policy or annuity or
endowment contract issued after June 8, 1997. Interest expense
is allocable to unborrowed policy cash values based on the
ratio of (1) the taxpayer's average unborrowed policy cash
values of life insurance policies, and annuity and endowment
contracts, issued after June 8, 1997, to (2) the sum of (a) in
the case of assets that are life insurance policies or annuity
or endowment contracts, the average unborrowed policy cash
values, and (b) in the case of other assets, the average
adjusted bases for all such other assets of the taxpayer.
An exception is provided for any policy or contract \270\
owned by an entity engaged in a trade or business, which covers
one individual who (at the time first insured under the policy
or contract) is (1) a 20-percent owner of the entity, or (2) an
individual (who is not a 20-percent owner) who is an officer,
director or employee of the trade or business. The exception
also applies in the case of a joint-life policy or contract
under which the sole insureds are a 20-percent owner and the
spouse of the 20-percent owner. A joint-life contract under
which the sole insureds are a 20-percent owner and his or her
spouse is the only type of policy or contract with more than
one insured that comes within the exception. Thus, for example,
if the insureds under a contract include an individual
described in the exception (e.g., an employee, officer,
director, or 20-percent owner) and any individual who is not
described in the exception (e.g., a debtor of the entity), then
the exception does not apply to the policy or contract. For
purposes of this exception, a 20-percent owner has the same
meaning as under present-law section 264(d)(4). In addition,
the Act provides that the pro rata interest disallowance rule
does not apply to any annuity contract to which section 72(u)
applies (relating to current taxation of income on the contract
in the case of an annuity contract held by a person who is not
a natural person). The Act provides that any policy or contract
that is not subject to the pro rata interest disallowance rule
by reason of this exception (for 20-percent owners, their
spouses, employees, officers and directors, and in the case of
an annuity contract to which section 72(u) applies) is not
taken into account in applying the ratio to determine the
portion of the taxpayer's interest expense that is allocable to
unborrowed policy cash values.
---------------------------------------------------------------------------
\270\ It was intended that if coverage for each insured individual
under a master contract is treated as a separate contract for purposes
of sections 817(h), 7702, and 7702A of the Code, then coverage for each
such insured individual is treated as a separate contract, for purposes
of the exception to the pro rata interest disallowance rule for a
policy or contract covering an individual who is a 20-percent owner,
employee, officer or director of the trade or business at the time
first covered. A master contract does not include any contract if the
contract (or any insurance coverage provided under the contract) is a
group life insurance contract within the meaning of Code section
848(e)(2). No inference was intended that coverage provided under a
master contract, for each such insured individual, is not treated as a
separate contract for each such individual for other purposes under
present law. A technical correction may be needed so that the statute
reflects this intent. See Title VI of H.R. 2676, the Tax Technical
Corrections Act of 1997, as passed by the House on November 5, 1997.
---------------------------------------------------------------------------
The unborrowed policy cash values means the cash surrender
value of the policy or contract determined without regard to
any surrender charge, reduced by the amount of any loan with
respect to the policy or contract. The cash surrender value is
to be determined without regard to any other contractual or
noncontractual arrangement that artificially depresses the cash
value of a contract.
If a trade or business (other than a sole proprietorship or
a trade or business of performing services as an employee) is
directly or indirectly the beneficiary under any policy or
contract, then the policy or contract is treated as held by the
trade or business. For this purpose, the amount of the
unborrowed cash value is treated as not exceeding the amount of
the benefit payable to the trade or business. In the case of a
partnership or S corporation, the provision applies at the
partnership or corporate level. The amount of the benefit is
intended to take into account the amount payable to the
business under the contract (e.g., as a death benefit) or
pursuant to another agreement (e.g., under a split dollar
agreement). The amount of the benefit is intended also to
include any amount by which liabilities of the business would
be reduced by payments under the policy or contract (e.g., when
payments under the policy reduce the principal or interest on a
liability owed to or by the business).
It is intended that the above exception under new section
264(f)(4)(A) (in the case of an employee, officer, director, or
20-percent owner) not be precluded from applying merely because
the trade or business holds an economic interest in the policy
but does not own an interest in the policy, for example, in the
case of collateral assignment split dollar insurance. \271\
This situation may arise if an individual employee owns a
policy but the trade or business holds an interest in the
policy by reason of being directly or indirectly a beneficiary
under the policy pursuant to a collateral assignment split
dollar arrangement. No inference is intended as to the
treatment under present law of any other aspect of the
arrangement (including, without limitation, the tax treatment
of the individual or the trade or business with respect to the
actual or constructive transfer of funds to the individual to
pay premiums).
---------------------------------------------------------------------------
\271\ A technical correction may be needed so that the statute
reflects this intent.
---------------------------------------------------------------------------
The issuer or policyholder of the life insurance policy or
endowment or annuity contract is required to report such
information as is necessary to carry out this rule. The
required reporting to the Treasury Secretary is an information
return (within the meaning of sec. 6724(d)(1)), and any
reporting required to be made by any other person is a payee
statement (within the meaning of sec. 6724(d)(2)\272\). The
Treasury Secretary may require reporting by the issuer or
policyholder of any relevant information either by regulations
or by any other appropriate guidance (including but not limited
to publication of a form). This statutory reporting requirement
does not supersede the authority of the Treasury Secretary
under section 6001 of the Code to require reporting necessary
to apply the premium or interest deduction limitations of the
Act, for example, reporting by businesses that own life
insurance, endowment or annuity contracts.
---------------------------------------------------------------------------
\272\ A technical correction may be needed so that the statute
reflects this intent. See Title VI of H.R. 2676, the Tax Technical
Corrections Act of 1997, as passed by the House on November 5, 1997.
---------------------------------------------------------------------------
If interest expense is disallowed under other provisions of
section 264 (limiting interest deductions with respect to life
insurance policies or endowment or annuity contracts) or under
section 265 (relating to tax-exempt interest), then the
disallowed interest expense is not taken into account under
this provision, and the average adjusted bases of assets is
reduced by the amount of debt, interest on which is so
disallowed. The provision is applied before present-law rules
relating to capitalization of certain expenses where the
taxpayer produces property (sec. 263A).
An aggregation rule is provided, treating related persons
as one for purposes of the provision. This aggregation rule is
intended to prevent taxpayers from avoiding the pro rata
interest limitation by owning life insurance, endowment or
annuity contracts, while incurring interest expense through a
related person.
The provision does not apply to any insurance company
subject to tax under subchapter L of the Code. Rather, the
rules reducing certain deductions for losses incurred, in the
case of property and casualty companies, and reducing reserve
deductions or dividends received deductions of life insurance
companies, are modified to take into account the increase in
cash values of life insurance policies or annuity or endowment
contracts held by insurance companies. For purposes of those
rules, an increase in the policy cash value for any policy or
contract is (1) the amount of the increase in the adjusted cash
value, reduced by (2) the gross premiums received with respect
to the policy or contract during the taxable year, and
increased by (3) distributions under the policy or contract to
which section 72(e) apply (other than amounts includable in the
policyholder's gross income). For this purpose, the adjusted
cash value means the cash surrender value of the policy or
contract, increased by (1) commissions payable with respect to
the policy or contract for the taxable year, and (2) asset
management fees, surrender and mortality charges, and any other
fees or charges, specified in regulations, which are imposed
(or would be imposed if the policy or contract were surrendered
or canceled) with respect to the policy or contract for the
taxable year.
Effective Date
The provisions apply with respect to contracts issued after
June 8, 1997.
To the extent of additional covered lives after June 8,
1997 under certain master contracts, the coverage of each
additional insured individual is treated as a new contract.
This treatment of additional covered lives applies only with
respect to coverage provided under a master contract, provided
that coverage for each insured individual is treated as a
separate contract (because such coverage is treated as a
separate contract for purposes of sections 817(h), 7702 and
7702A, and the master contract or any coverage provided
thereunder is not a group life insurance contract within the
meaning of section 848(e)(2)).\273\
---------------------------------------------------------------------------
\273\ This rule is consistent with the intended treatment of
coverage of insured individuals under master contracts under the
provision (as described above). A technical correction may be needed so
that the statute reflects this intent. See Title VI of H.R. 2676, the
Tax Technical Corrections Act of 1997, as passed by the House on
November 5, 1997.
---------------------------------------------------------------------------
For purposes of the effective date, a material increase in
the death benefit or other material change in the contract
causes the contract to be treated as a new contract. In the
case of an increase in the death benefit of a contract that is
converted to extended term insurance pursuant to nonforfeiture
provisions, in a transaction to which section 501(d)(2) of the
Health Insurance Portability and Accountability Act of 1996
(``HIPAA'') applies, the contract is not treated as a new
contract. It was not intended that a new contract is required
to be issued in connection with such a transaction, but rather,
it was intended that the increase in the death benefit of the
contract so converted in such a transaction not cause the
contract to be treated as a new contract for purposes of this
effective date.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $20 million in 1998, $53 million in 1999,
$93 million in 2000, $140 million in 2001, $193 million in
2002, $247 million in 2003, $299 million in 2004, $349 million
in 2005, $399 million in 2006, and $447 million in 2007.
5. Earned income credit compliance provisions (secs. 1085(a), (b) and
(d) of the Act and sec. 32 of the Code)
Overview
Certain eligible low-income workers are entitled to claim a
refundable earned income credit on their income tax return. A
refundable credit is a credit that not only reduces an
individual's tax liability but allows refunds to the individual
in excess of income tax liability. The amount of the credit an
eligible individual may claim depends upon whether the
individual has one, more than one, or no qualifying children,
and is determined by multiplying the credit rate by the
individual's \274\ earned income up to an earned income amount.
The maximum amount of the credit is the product of the credit
rate and the earned income amount. The credit is reduced by the
amount of the alternative minimum tax (``AMT'') the taxpayer
owes for the year. The credit is phased out above certain
income levels.
---------------------------------------------------------------------------
\274\ In the case of a married individual who files a joint return
with his or her spouse, the income for purposes of these tests is the
combined income of the couple.
---------------------------------------------------------------------------
For individuals with earned income (or AGI, if greater) in
excess of the beginning of the phaseout range, the maximum
credit amount is reduced by the phaseout rate multiplied by the
amount of earned income (or AGI, if greater) in excess of the
beginning of the phaseout range. For individuals with earned
income (or AGI, if greater) in excess of the end of the
phaseout range, no credit is allowed. The definition of AGI
used for phasing out the earned income credit disregards
certain losses. The losses disregarded are: (1) net capital
losses (if greater than zero); (2) net losses from trusts and
estates; (3) net losses from nonbusiness rents and royalties;
and (4) 50 percent of the net losses from business, computed
separately with respect to sole proprietorships (other than in
farming), sole proprietorships in farming, and other
businesses. Also, an individual is not eligible for the earned
income credit if the aggregate amount of ``disqualified
income'' of the taxpayer for the taxable year exceeds $2,250.
Disqualified income is the sum of: (1) interest (taxable and
tax-exempt); (2) dividends; (3) net rent and royalty income (if
greater than zero); (4) capital gain net income; and (5) net
passive income (if greater than zero) that is not self-
employment income. The earned income amount, the phaseout
amount and the disqualified income amount are indexed for
inflation.
The parameters for the credit depend upon the number of
qualifying children the individual claims. For 1997, the
parameters are given in the following table:
Present-Law Earned Income Credit Parameters
------------------------------------------------------------------------
Two or
more One No
qualifying qualifying qualifying
children child children
------------------------------------------------------------------------
Credit rate (percent)............... 40.00 34.00 7.65
Earned income amount................ $9,140 $6,500 $4,340
Maximum credit...................... $3,656 $2,210 $332
Phaseout begins..................... $11,930 $11,930 $5,430
Phaseout rate (percent)............. 21.06 15.98 7.65
Phaseout ends....................... $29,290 $25,760 $9,770
------------------------------------------------------------------------
In order to claim the credit, an individual must either
have a qualifying child or meet other requirements. A
qualifying child must meet a relationship test, an age test, an
identification test, and a residence test. In order to claim
the credit without a qualifying child, an individual must not
be a dependent and must be over age 24 and under age 65.
a. Deny EIC eligibility for prior acts of recklessness or
fraud (sec. 1085(a)(1) of Act and new sec. 32(k)(1)
of the Code)
Present and Prior Law
The accuracy-related penalty, which is imposed at a rate of
20 percent, applies to the portion of any underpayment that is
attributable to (1) negligence, (2) any substantial
understatement of income tax, (3) any substantial valuation
overstatement, (4) any substantial overstatement of pension
liabilities, or (5) any substantial estate or gift tax
valuation understatement (sec. 6662). Negligence includes any
careless, reckless, or intentional disregard of rules or
regulations, as well as any failure to make a reasonable
attempt to comply with the provisions of the Code.
The fraud penalty, which is imposed at a rate of 75
percent, applies to the portion of any underpayment that is
attributable to fraud (sec. 6663).
Neither the accuracy-related penalty nor the fraud penalty
is imposed with respect to any portion of an underpayment if it
is shown that there was a reasonable cause for that portion and
that the taxpayer acted in good faith with respect to that
portion.
Reasons for Change
The Congress believed that taxpayers who fraudulently claim
the EIC or recklessly or intentionally disregard EIC rules or
regulations should be penalized for doing so.
Explanation of Provision
Under the Act, a taxpayer who fraudulently claims the
earned income credit (EIC) is ineligible to claim the EIC for a
subsequent period of 10 years. In addition, a taxpayer who
erroneously claims the EIC due to reckless or intentional
disregard of rules or regulations is ineligible to claim the
EIC for a subsequent period of two years. These sanctions are
in addition to any other penalty imposed under present law. The
determination of fraud or of reckless or intentional disregard
of rules or regulations are made in a deficiency proceeding
(which provides for judicial review).
Effective Date
The provision was effective for taxable years beginning
after December 31, 1996.
Revenue Effect
The provisions relating to (a) the denial of EIC
eligibility for prior acts of recklessness or fraud, (b) the
recertification requirement when a taxpayer has been found
eligible for the EIC in the past, and (c) the due diligence
requirements for paid preparers are estimated to increase
Federal fiscal year budget receipts by less than $500,000 in
1998, $18 million in 1999, $25 million in 2000, $24 million in
2001, $21 million in 2002, $21 million in 2003, $21 million in
2004, $21 million in 2005, $21 million in 2006, and $21 million
in 2007.
b. Recertification required when taxpayer found to be
ineligible for EIC in past (sec. 1085(a)(1) of the
Act and new sec. 32(k)(2) of the Code)
Present and Prior Law
If an individual fails to provide a correct TIN and claims
the EIC, such omission is treated as a mathematical or clerical
error. Also, if an individual who claims the EIC with respect
to net earnings from self employment fails to pay the proper
amount of self-employment tax on such net earnings, the failure
is treated as a mathematical or clerical error for purposes of
the amount of EIC claims. Generally, taxpayers have 60 days in
which they can either provide a correct TIN or request that the
IRS follow the current-law deficiency procedures. If a taxpayer
fails to respond within this period, he or she must file an
amended return with a correct TIN or clarify that any self-
employment tax has been paid in order to obtain the EIC
originally claimed.
The IRS must follow deficiency procedures when
investigating other types of questionable EIC claims. Under
these procedures, contact letters are first sent to the
taxpayer. If the necessary information is not provided the
taxpayer, a statutory notice of deficiency is sent by certified
mail, notifying the taxpayer that the adjustment will be
assessed unless the taxpayer files a petition in Tax Court
within 90 days. If a petition is not filed within that time and
there is no other response to the statutory notice, the
assessment is made and the EIC is denied.
Reasons for Change
The Congress believed that the requirement of additional
information to determine EIC eligibility is prudent for
taxpayers who have incorrectly claimed the EIC in the past.
Explanation of Provision
Under Act, a taxpayer who has been denied the EIC as a
result of deficiency procedures is ineligible to claim the EIC
in subsequent years unless evidence of eligibility for the
credit is provided by the taxpayer. To demonstrate current
eligibility, the taxpayer is required to meet evidentiary
requirements established by the Secretary of the Treasury.
Failure to provide this information when claiming the EIC is
treated as a mathematical or clerical error. If a taxpayer is
recertified as eligible for the credit, the taxpayer is not
required to provide this information in the future unless the
IRS again denies the EIC as a result of a deficiency procedure.
Ineligibility for the EIC under the provision is subject to
review by the courts.
Effective Date
The provision was effective for taxable years beginning
after December 31, 1996.
Revenue Effect
The provisions relating to: (a) the denial of EIC
eligibility for prior acts of recklessness or fraud, (b) the
recertification requirement when a taxpayer has been found
eligible for the EIC in the past, and (c) the due diligence
requirements for paid preparers are estimated to increase
Federal fiscal year budget receipts by less than $500,000 in
1998, $18 million in 1999, $25 million in 2000, $24 million in
2001, $21 million in 2002, $21 million in 2003, $21 million in
2004, $21 million in 2005, $21 million in 2006, and $21 million
in 2007.
c. Due diligence requirements for paid preparers (sec.
1085(a)(2) of the Act and new sec. 6695(g) of the
Code)
Present and Prior Law
Several penalties apply in the case of an understatement of
tax that is caused by an income tax return preparer. First, if
any part of an understatement of tax on a return or claim for
refund is attributable to a position for which there was not a
realistic possibility of being sustained on its merits and if
any person who is an income tax return preparer with respect to
such return or claim for refund knew (or reasonably should have
known) of such position and such position was not disclosed or
was frivolous, then that return preparer is subject to a
penalty of $250 with respect to that return or claim (sec.
6694(a)). The penalty is not imposed if there is reasonable
cause for the understatement and the return preparer acted in
good faith.
In addition, if any part of an understatement of tax on a
return or claim for refund is attributable to a willful attempt
by an income tax return preparer to understate the tax
liability of another person or to any reckless or intentional
disregard of rules or regulations by an income tax return
preparer, then the income tax return preparer is subject to a
penalty of $1,000 with respect to that return or claim (sec.
6694(b)).
Also, a penalty for aiding and abetting the understatement
of tax liability is imposed in cases where any person aids,
assists in, procures, or advises with respect to the
preparation or presentation of any portion of a return or other
document if (1) the person knows or has reason to believe that
the return or other document will be used in connection with
any material matter arising under the tax laws, and (2) the
person knows that if the portion of the return or other
document were so used, an understatement of the tax liability
of another person would result (sec. 6701).
Additional penalties are imposed on return preparers with
respect to each failure to (1) furnish a copy of a return or
claim for refund to the taxpayer, (2) sign the return or claim
for refund, (3) furnish his or her identifying number, (4)
retain a copy or list of the returns prepared, and (5) file a
correct information return (sec. 6695). The penalty is $50 for
each failure and the total penalties imposed for any single
type of failure for any calendar year are limited to $25,000.
Reasons for Change
The Congress believed that more thorough efforts by return
preparers are important to improving EIC compliance.
Explanation of Provision
Under the Act, return preparers are required to fulfill
certain due diligence requirements with respect to returns they
prepare claiming the EIC. The penalty for failure to meet these
requirements is $100. This penalty is in addition to any other
penalty imposed under present law.
Effective Date
The provision was effective for taxable years beginning
after December 31, 1996.
Revenue Effect
The provisions relating to: (a) the denial of EIC
eligibility for prior acts of recklessness or fraud, (b) the
recertification requirement when a taxpayer has been found
eligible for the EIC in the past, and (c) the due diligence
requirements for paid preparers are estimated to increase
Federal fiscal year budget receipts by less than $500,000 in
1998, $18 million in 1999, $25 million in 2000, $24 million in
2001, $21 million in 2002, $21 million in 2003, $21 million in
2004, $21 million in 2005, $21 million in 2006, and $21 million
in 2007.
d. Modify the definition of AGI used to phase out the EIC
(secs. 1085(b) and (d) of the Act and sec. 32(c)(5)
of the Code)
Present Law
The EIC is phased out above certain income levels. For
individuals with earned income (or AGI, if greater) in excess
of the beginning of the phaseout range, the maximum credit
amount is reduced by the phaseout rate multiplied by the amount
of earned income (or AGI, if greater) in excess of the
beginning of the phaseout range. For individuals with earned
income (or AGI, if greater) in excess of the end of the
phaseout range, no credit is allowed. The definition of AGI
used for the phaseout of the earned income credit disregards
certain losses. The losses disregarded are: (1) net capital
losses (if greater than zero); (2) net losses from trusts and
estates; (3) net losses from nonbusiness rents and royalties;
and (4) 50 percent of the net losses from business, computed
separately with respect to sole proprietorships (other than in
farming), sole proprietorships in farming, and other
businesses.
Reasons for Change
The Congress believed it could improve the targeting of the
credit by expanding the definition of income used in phasing
out the credit. The Congress believed that the definition of
AGI used currently in phasing out the credit is too narrow and
disregards other components of ability-to-pay. Tax-exempt
interest and nontaxable distributions from pensions, annuities
and individual retirement arrangements increase individuals'
ability-to-pay and reduce the need for a tax credit. The
Congress also believed that denying more business losses would
more closely conform the definition of modified AGI to real
economic income.
Explanation of Provision
The Act modifies the definition of modified AGI used for
phasing out the EIC by adding two items of nontaxable income
and changing the percentage of certain losses disregarded. The
two items added are: (1) tax-exempt interest, and (2)
nontaxable distributions from pensions, annuities, and
individual retirement arrangements (but only if not rolled over
into similar vehicles during the applicable rollover period).
The Act also increases the disregarded amount of net business
losses from 50 percent to 75 percent, computed separately with
respect to sole proprietorships (other than farming), sole
proprietorships in farming, and other businesses.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by less than $500,000 in 1998, $72 million in
1999, $75 million in 2000, $79 million in 2001, $85 million in
2002, $89 million in 2003, $92 million in 2004, $94 million in
2005, $99 million in 2006, and $102 million in 2007.\275\
---------------------------------------------------------------------------
\275\ This estimate includes outlay reduction of $254 million for
1997-2002 and $650 million for 1997-2007.
---------------------------------------------------------------------------
6. Treatment of amounts received under the work requirements of the
Personal Responsibility and Work Opportunity Act of 1996 (sec.
1085(c) of the Act and sec. 32(c)(2)(B) of the Code)
Present Law
Workfare payments
Generally under the Personal Responsibility and Work
Opportunity Act of 1996, the receipt of certain government
assistance payments is denied unless the recipient meets
certain work requirements. The tax treatment of payments
received with respect to these work requirements (``workfare
payments'') was not specified in that legislation.
Earned income credit
Certain eligible low-income workers are entitled to claim a
refundable earned income credit on their income tax return. The
amount of the credit an eligible individual may claim depends
upon whether the individual has one, more than one, or no
qualifying children, and is generally determined by multiplying
the credit rate by the individual's earned income up to an
earned income amount. The maximum amount of the credit is the
product of the credit rate and the earned income amount. The
credit is reduced by the amount of the alternative minimum tax
(``AMT'') the taxpayer owes for the year. The credit is phased
out above certain income levels. For individuals with earned
income (or AGI, if greater) in excess of the beginning of the
phaseout range, the maximum credit amount is reduced by the
phaseout rate multiplied by the amount of earned income (or
AGI, if greater) in excess of the beginning of the phaseout
range. For individuals with earned income (or AGI, if greater)
in excess of the end of the phaseout range, no credit is
allowed. For these purposes, both earned income and AGI are
defined to include wages. There is no explicit provision
whether workfare payments are wages for purposes of the earned
income credit.
Reasons for Change
The Congress believed it inappropriate to provide the
earned income credit for workfare payments.
Explanation of Provision
The Act provides that workfare payments are not wages for
purposes of the earned income credit. There is no inference
intended with respect to whether workfare payments otherwise
qualify as wages for purposes of income and employment taxes or
as wages for purposes of an employer's eligibility for the work
opportunity tax credit and the welfare-to-work tax credit.
Also, there is no inference intended with respect to whether
workfare payments are wages for purposes of the earned income
credit before enactment of this provision.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
7. Eligibility for income forecast method (sec. 1086 of the Act and
secs. 167 and 168 of the Code)
Present and Prior Law
A taxpayer generally recovers the cost of property used in
a trade or business through depreciation or amortization
deductions over time. Tangible property generally is
depreciated under the modified Accelerated Cost Recovery System
(``MACRS'') of section 168, which applies specific recovery
periods and depreciation methods to the cost of various types
of depreciable property. Acquired intangible property generally
is amortized under section 197, which applies a 15-year
recovery period and the straight-line method to the cost of
applicable property.
MACRS does not apply to certain property, including any
motion picture film, video tape, or sound recording or to any
other property if the taxpayer properly elects to exclude such
property from MACRS and the taxpayer properly applies a unit-
of-production method or other appropriate method of
depreciation not expressed in a term of years. Section 197 does
not apply to certain intangible property, including property
produced by the taxpayer or any interest in a film, sound
recording, video tape, book or similar property not acquired in
transaction (or a series of related transactions) involving the
acquisition of assets constituting a trade or business or
substantial portion thereof. Thus, the cost of a film, video
tape, or similar property that is produced by the taxpayer or
is acquired on a ``stand-alone'' basis by the taxpayer may not
be recovered under either the MACRS depreciation provisions or
under the section 197 amortization provisions. The cost of such
property may be depreciated under the ``income forecast''
method.
The income forecast method is considered to be a method of
depreciation not expressed in a term of years. Under the income
forecast method, the depreciation deduction for a taxable year
for a property is determined by multiplying the cost of the
property (less estimated salvage value) by a fraction, the
numerator of which is the income generated by the property
during the year and the denominator of which is the total
forecasted or estimated income to be derived from the property
during its useful life. The income forecast method has been
held to be applicable for computing depreciation deductions for
motion picture films, television films and taped shows, books,
patents, master sound recordings and video games.\276\ Most
recently, the income forecast method has been held applicable
to consumer durable property subject to short-term ``rent-to-
own'' leases.\277\
---------------------------------------------------------------------------
\276\ See, e.g., Rev. Rul. 60-358, 1960-2 C.B. 68; Rev. Rul. 64-
273, 1964-2 C.B. 62; Rev. Rul 79-285, 1979-2 C.B. 91; and Rev. Rul. 89-
62, 1989-1 C.B. 78.
\277\ See, ABC Rentals of San Antonio v. Comm., 97 F.3d 392 (10th
Cir., 1996), pet. for rehg. filed (Nov. 16, 1996) where the Tenth
Circuit decision reversed the holding of ABC Rentals of San Antonio v.
Comm., 68 TCM 1362 (1994) and held that consumer durable property
subject to short-term, ``rent-to-own'' leases were eligible for the
income forecast method. For decisions supporting the Tax Court
memorandum decision denying eligibility for certain tangible personal
property, see El Charro TV Rental v. Comm., 79 F.3d 1145 (5th Cir.,
1996) (rent-to-own property not eligible) and Carland, Inc. v. Comm.,
90 T.C. 505 (1988), aff'd on this issue, 909 F.2d 1101 (8th Cir., 1990)
(railroad rolling stock subject to a lease not eligible).
---------------------------------------------------------------------------
Reasons for Change
Depreciation allowances attempt to measure the decline in
the value of property due to wear, tear, and obsolescence and
to match the cost recovery for the property with the income
stream produced by the property. The Congress believed that the
income forecast method of depreciation is, in theory, an
appropriate method to match the recovery of cost of property
with the income stream produced by the property. However, when
compared to MACRS, the income forecast method involves
significant complexities, including the determination of the
income estimated to be generated by the property, the
determination of the residual value of the property, and the
application of the look-back method. Thus, the Congress
believed that the availability of the income forecast method
should be limited to instances where the economic depreciation
of the property cannot be adequately reflected by the passage
of time alone or where the income stream from the property is
sufficiently unpredictable or uneven such that the application
of another method of depreciation may result in the distortion
of income. In addition, because the income forecast method is
elective, the Congress was concerned about taxpayer
selectivity.
Finally, the Congress provided a MACRS class life for
consumer durables subject to rent-to-own contracts, in order to
avoid future controversies with respect to the proper treatment
of such property.
Explanation of Provision
The Act clarifies the types of property to which the income
forecast method may be applied. Under the Act, the income
forecast method is available to motion picture films,
television films and taped shows, books, patents, master sound
recordings, copyrights, and other such property as designated
by the Secretary of the Treasury. It is expected that the
Secretary will exercise this authority such that the income
forecast method will be available to property the economic
depreciation of which cannot be adequately measured by the
passage of time alone or to property the income from which is
sufficiently unpredictable or uneven so as to result in the
distortion of income. The mere fact that property is subject to
a lease should not make the property eligible for the income
forecast method. The income forecast method is not to be
applicable to property to which section 197 applies.
In addition, consumer durables subject to rent-to-own
contracts are provided a three-year recovery period and a four-
year class life for MACRS purposes (and would not be eligible
for the income forecast method). Such property generally is
described in Rev. Proc. 95-38, 1995-2 C.B. 397. In addition,
the special 3-year recovery period may apply to any property
generally used in the home for personal, but not business, use.
Congress understood that certain rent-to-own property,
including computer and peripheral equipment, may be used in the
home for either personal or business purposes, and the taxpayer
may not be aware of how its customers may use the property. So
as not to increase the administrative burdens of taxpayers, the
Congress intended that if such dual-use property does not
represent a significant portion of a taxpayer's leasing
property and if such other leasing property predominantly is
qualified rent-to-own property, then such dual-use property
generally also would be qualified rent-to-own property.
However, if such dual-use property represents a significant
portion of the taxpayer's leasing property, the Congress
intended that the burden of proof be placed on the taxpayer to
show that such property is qualified rent-to-own property.
Further, the definition of ``rent-to-own contract'' includes
leases that provide for level regular periodic payments or
decreasing regular periodic payments, where no payment is less
than 40 percent of the largest payment.
Finally, the Congress clarified that the 3-year recovery
period provided by the Act only applies to property subject to
leases and no inference is intended as to whether any
arrangement constitutes a lease for tax purposes.
Effective Date
The provision is effective for property placed in service
after the date of enactment (after August 5, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $29 million in 1998, $41 million in 1999,
$62 million in 2000, $78 million in 2001, $38 million in 2002,
$27 million in 2003, $25 million in 2004, $17 million in 2005,
$17 million in 2006, and $18 million in 2007.
8. Modify the exception to the related party rule of section 1033 for
individuals to only provide an exception for de minimis amounts (sec.
1087 of the Act and sec. 1033 of the Code)
Present and Prior Law
Under section 1033, gain realized by a taxpayer from
certain involuntary conversions of property is deferred to the
extent the taxpayer purchases property similar or related in
service or use to the converted property within a specified
replacement period of time. Pursuant to a provision of Public
Law 104-7, subchapter C corporations (and certain partnerships
with corporate partners) are not entitled to defer gain under
section 1033 if the replacement property or stock is purchased
from a related person. A person is treated as related to
another person if the person bears a relationship to the other
person described in section 267(b) or 707(b)(1). An exception
to this related party rule provides that a taxpayer could
purchase replacement property or stock from a related person
and defer gain under section 1033 to the extent the related
person acquired the replacement property or stock from an
unrelated person within the replacement period.
Reasons for Change
The Congress believed that, except for de minimis cases,
individuals should be subject to the same rules with respect to
the acquisition of replacement property from a related person
as are other taxpayers.
Explanation of Provision
The Act expands the present-law denial of the application
of section 1033 to any other taxpayer (including an individual)
that acquires replacement property from a related party (as
defined by secs. 267(b) and 707(b)(1)) unless the taxpayer has
aggregate realized gain of $100,000 or less for the taxable
year with respect to converted property with aggregate realized
gains. In the case of a partnership (or S corporation), the
annual $100,000 limitation applies to both the partnership (or
S corporation) and each partner (or shareholder).
Effective Date
The provision applies to involuntary conversions occurring
after June 8, 1997.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $1 million in 1998, $4 million in 1999, $6
million in 2000, $8 million in 2001, $11 million in 2002, $13
million in 2003, $15 million in 2004, $17 million in 2005, $19
million in 2006, and $21 million in 2007.
9. Repeal of exception for certain sales by manufacturers to dealers
(sec. 1088 of the Act and sec. 811(c) of the Tax Reform Act of 1986)
Present and Prior Law
In general, under present law, the installment method of
accounting may not be used by dealers in personal property.
Prior law provided an exception which permits the use of the
installment method for installment obligations arising from the
sale of tangible personal property by a manufacturer of the
property (or an affiliate of the manufacturer) to a
dealer,\278\ but only if the dealer was obligated to make
payments of principal only when the dealer resold (or rented)
the property, the manufacturer had the right to repurchase the
property at a fixed (or ascertainable) price after no longer
than a 9-month period following the sale to the dealer, and
certain other conditions were met. In order to meet the other
conditions, the aggregate face amount of the installment
obligations that otherwise qualified for the exception must
have equaled at least 50 percent of the total sales to dealers
that gave rise to such receivables (the ``50-percent test'') in
both the taxable year and the preceding taxable year, except
that, if the taxpayer met all of the requirements for the
exception in the preceding taxable year, the taxpayer would not
have been treated as failing to meet the 50-percent test before
the second consecutive year in which the taxpayer did not
actually meet the test. In addition, these requirements must
have been met by the taxpayer in its first taxable year
beginning after October 22, 1986, except that obligations
issued before that date were treated as meeting the applicable
requirements if such obligations were conformed to the
requirements of the provision within 60 days of that date.
---------------------------------------------------------------------------
\278\ I.e., the sale of the property must be intended to be for
resale or leasing by the dealer.
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that the special exception that
permitted certain dealers to use the installment method was no
longer necessary or appropriate and the installment sale method
of accounting should not be available to such dealers.
Accordingly, the Act repeals that exception.
Explanation of Provision
The Act repeals the exception that permits the use of the
installment method of accounting for certain sales by
manufacturers to dealers.
Effective Date
The provision is effective for taxable years beginning one
year after the date of enactment (August 5, 1997). Any
resulting adjustment from a required change in accounting will
be includible ratably over the 4 taxable years beginning after
that date.\279\
---------------------------------------------------------------------------
\279\ A technical correction is necessary to accomplish this
result.
---------------------------------------------------------------------------
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $44 million in 1999, $97 million in 2000,
$106 million in both 2001 and 2002, $64 million in 2003, $21
million in 2004, $22 million in 2005, $23 million in 2006, and
$24 million in 2007.
10. Treatment of charitable remainder trusts (sec. 1089 of the Act and
sec. 664 of the Code)
Present and Prior Law
In general
Sections 170(f), 2055(e)(2) and 2522(c)(2) of present law
disallow a charitable deduction for income, estate or gift tax
purposes, respectively, where the donor transfers an interest
in property to a charity (e.g., a remainder) while also either
retaining an interest in that property (e.g., an income
interest) or transferring an interest in that property to a
noncharity for less than full and adequate consideration.
Exceptions to this general rule are provided for: (1) remainder
interests in charitable remainder annuity trusts, charitable
remainder unitrusts, pooled income funds, farms, and personal
residences; (2) present interests in the form of a guaranteed
annuity or a fixed percentage of the annual value of the
property; (3) an undivided portion of the donor's entire
interest in the property; and (4) a qualified conservation
easement.
Charitable remainder annuity trusts and charitable remainder unitrusts
A charitable remainder annuity trust is a trust which is
required to pay a fixed dollar amount, not less often than
annually, of at least 5 percent of the initial value of the
trust to a non-charity for the life of an individual or a
period of years not to exceed 20 years, with the remainder
passing to charity. A charitable remainder unitrust is a trust
which generally is required to pay, at least annually, a fixed
percentage of the fair market value of the trust's assets
determined at least annually to a noncharity for the life of an
individual or a period of years not to exceed 20 years, with
the remainder passing to charity (sec. 664(d)).
Distributions from a charitable remainder annuity trust or
charitable remainder unitrust are treated first as ordinary
income to the extent of the trust's current and previously
undistributed ordinary income for the trust's year in which the
distribution occurred; second, as capital gains to the extent
of the trust's current capital gain and previously
undistributed capital gain for the trust's year in which the
distribution occurred; third, as other income (e.g., tax-exempt
income) to the extent of the trust's current and previously
undistributed other income for the trust's year in which the
distribution occurred; and, fourth, as corpus (sec. 664(b)).
Distributions are includible in the income of the
beneficiary for the year that the annuity or unitrust amount is
required to be distributed even though the annuity or unitrust
amount is not distributed until after the close of the trust's
taxable year. Treas. Reg. sec. 1.664-1(d)(4).
On April 18, 1997, the Treasury Department proposed
regulations providing additional rules under sections 664 and
2702 to address the abuse described below and other perceived
abuses involving distributions from charitable remainder
trusts. One of those proposed rules would require that payment
of any required annuity or unitrust amount by a charitable
remainder trust (other than an ``income only'' unitrust) be
made by the close of the trust's taxable year in which such
payments are due. See Prop. Treas. Reg. secs. 1.664-2(a)(1)(i)
and 1.664-3(a)(1)(i).
Reasons for Change
The Congress was concerned that the interplay of the rules
governing the timing of income from distributions from
charitable remainder trusts (i.e., Treas. Reg. sec. 1.664-
1(d)(4) and the rules governing the character of distributions
(i.e., sec. 664(b)) created opportunities for abuse where the
required annual payments are a large portion of the trust and
realization of income and gain can be postponed until a year
later than the accrual of such large payments. For example,
some taxpayers have been creating charitable remainder
unitrusts with a requiredannual payout of 80 percent of the
trust's assets and then funding the trust with highly appreciated
nondividend paying stock which the trust sells in a year subsequent to
when the required distribution is includible in the beneficiary's
income and using proceeds from that sale to pay the required
distribution attributable to the prior year. Those taxpayers have
treated the distribution of 80 percent of the trust's assets
attributable to the trust's first required distribution as non-taxable
distributions of corpus because the trust had not realized any income
in its first taxable year. The Congress believed that such treatment is
abusive and is inconsistent with the purpose of the charitable
remainder trust rules. In order to limit this kind of abuse, the Act
provides that a trust cannot be a charitable remainder trust if the
required payout is greater than 50 percent of the initial fair market
value of the trust's assets (in the case of a charitable remainder
annuity trust) or 50 percent of the annual value of the trust's assets
(in the case of a charitable remainder unitrust).
In addition, the Congress was concerned that certain
charitable remainder trusts had been created primarily to
obtain the tax benefit of the trust's exemption from income tax
under section 664(c) and not to provide for charity. The
Congress was aware that many charitable remainder trusts have
been created where the actuarial value of the charitable
remainder interest at the time of creation is insignificant.
The Congress believed that requiring that the actuarial value
of the charitable remainder interest be at least 10 percent of
any transfers to the trust will insure that any benefits from
the creation of charitable remainder trusts be available only
where there is a significant benefit to charity.
The Congress intended that the provision of the Act not
limit or alter the validity of regulations proposed by the
Treasury Department on April 18, 1997, or the Treasury
Department's authority to address this or other abuses of the
rules governing the taxation of charitable remainder trusts or
their beneficiaries.
Explanation of Provision
50-percent payout limitation
Under the Act, a trust cannot be a charitable remainder
annuity trust if the annuity for any year is greater than 50
percent of the initial fair market value of the trust's assets
or be a charitable remainder unitrust if the percentage of
assets that are required to be distributed at least annually is
greater than 50 percent. Any trust that fails this 50-percent
rule will not be a charitable remainder trust whose taxation is
governed under section 664, but will be treated as a complex
trust and, accordingly, all its income will be taxed to its
beneficiaries or to the trust.
10-percent minimum value of remainder interest
In addition, the Act requires that the value of the
charitable remainder with respect to any transfer to a
qualified charitable remainder annuity trust or charitable
remainder unitrust be at least 10 percent of the net fair
market value of such property transferred in trust on the date
of the contribution to the trust. The 10-percent test is
measured on each transfer to the charitable remainder trust
and, consequently, a charitable remainder trust which meets the
10-percent test on the date of transfer will not subsequently
fail to meet that test if interest rates have declined between
the trust's creation and the death of a measuring life.
Similarly, where a charitable remainder trust is created for
the joint lives of two individuals with a remainder to charity,
the trust will not cease to qualify as a charitable remainder
trust because the value of the charitable remainder was less
than 10 percent of the trust's assets at the first death of
those two individuals.
The Act provided additional rules in order to provide
relief for trusts that do not meet the 10-percent rule. First,
where a transfer is made after July 28, 1997, to a charitable
remainder trust that fails the 10-percent test, the trust is
treated as meeting the 10-percent requirement if the governing
instrument of the trust is changed by reformation, amendment,
construction, or otherwise to meet such requirement by reducing
the payout rate or duration (or both) of any noncharitable
beneficiary's interest to the extent necessary to satisfy such
requirement so long as the reformation is commenced within the
period permitted for reformations of charitable remainder
trusts under section 2055(e)(3). The statute of limitations
applicable to a deficiency of any tax resulting from
reformation of the trust does not expire before the date one
year after the Treasury Department is notified that the trust
has been reformed. In substance, this rule relaxes the
requirements of section 2055(e)(3)(B) to the extent necessary
for the reformation for the trust to meet the 10-percent
requirement.
Second, a transfer to a trust will be treated as if the
transfer never had been made where a court having jurisdiction
over the trust subsequently declares the trust void (because,
e.g., the application of the 10-percent rule frustrates the
purposes for which the trust was created) and judicial
proceedings to revoke the trust are commenced within the period
permitted for reformations of charitable remainder trusts under
section 2055(e)(3). Under this provision, the effect of
``unwinding'' the trust is that any transactions made by the
trust with respect to the property transferred (e.g., income
earned on the assets transferred to the trust and capital gains
generated by the sales of the property transferred) would be
income and capital gain of the donor (or the donor's estate if
the trust was testamentary), and the donor (or the donor's
estate if the trust was testamentary) would not be permitted a
charitable deduction with respect to the transfer. The statute
of limitations applicable to a deficiency of any tax resulting
from ``unwinding'' the trust does not expire before the date
one year after the Treasury Department is notified that the
trust has been revoked.
Third, where an additional contribution is made after July
28, 1997, to a charitable remainder unitrust created before
July 29, 1997, and that unitrust would not meet the 10-percent
requirement with respect to the additional contribution, the
Act provides that such additional contribution will be treated,
under regulations to be issued by the Secretary of the
Treasury, as if it had been made to a new trust that does not
meet the 10-percent requirement, but which does not affect the
status of the original unitrust as a charitable remainder
trust.
Effective Date
50-percent payout limitation
The provision that requires that the payout rate of a
qualified charitable remainder trust be not exceed 50 percent
applies to transfers to a trust made after June 18, 1997.
10-percent minimum value of remainder interest
The requirement that the value of the charitable remainder
with respect to any transfer to a qualified remainder trust be
at least 10 percent of the fair market value of the assets
transferred in trust applies to transfers to a trust made after
July 28, 1997. However, the 10-percent requirement does not
apply to a charitable remainder trust created by a testamentary
instrument (e.g., a will or revocable trust) executed before
July 29, 1997, if the instrument is not modified after that
date and the settlor dies before January 1, 1999, or could not
be modified after July 28, 1997, because the settlor was under
a mental disability on that date (i.e., July 28, 1997) and all
times thereafter.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $6 million per year for each of the years
from 1997 through 2007.
11. Expanded SSA records for tax enforcement (secs. 1090(a)(1) and sec.
1090(b) of the Act and secs. 205(c)(2) and 454(e) of the Social
Security Act)
Present Law
Under the Family Support Act of 1988, States must require
each parent to furnish their social security number (SSN) for
birth records. Parents can apply directly to the Social
Security Administration (SSA) for an SSN for their child; or,
in most states, they may apply for the child's SSN when
obtaining a birth certificate. On an individual's SSN
application, the SSA currently requires the mother's maiden
name but not her SSN.
Reasons for Change
The Congress anticipates that the Internal Revenue Service
(IRS) will use this information to identify questionable claims
for the earned income credit, the dependent exemption, and
other tax benefits, before tax refunds are paid out.
Explanation of Provision
Under the Act, the SSA is required to obtain social
security numbers (SSNs) of both parents on minor children's
applications for SSNs. Also, the SSA will provide this
information to the IRS as part of the Data Master File (``DM-1
file'').
Effective Date
The provision was generally effective on the date of
enactment (August 5, 1997). The requirement that the SSA obtain
SSNs of both parents on minor children's applications for SSNs,
however, is effective for applications made 180 days after the
date of enactment.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $10 million per year from 1999 through 2007.
12. Using Federal case registry of child support orders for tax
enforcement purposes (secs. 1090(a)(2) and 1090(a)(3) of the
Act and sec. 453(h) of the Social Security Act)
Present Law
The Personal Responsibility and Work Opportunity
Reconciliation Act of 1996 mandated the creation of a Federal
Case Registry of Child Support Orders (the FCR) by October 1,
1998. Although HHS has not yet issued final regulations, the
FCR is required to include the names, and the State case
identification numbers of individuals who are owed or who owe
child support or for whom paternity is being established. It
may also include the social security numbers (SSNs) of these
individuals.
Reasons for Change
The Congress believed that the data collected by the State
and local governments and incorporated into the FCR can be
useful to the Internal Revenue Service (IRS). Therefore, the
provision makes this information available to the IRS to
enforce the tax law.
Explanation of Provision
Not later than October 1, 1998, the Secretary of the
Treasury will have access to the Federal Case Registry of Child
Support Orders. Also, by October 1, 1999, the data elements on
the State Case Registry will include the SSNs of children
covered by cases in the Registry, and the States will provide
the SSNs of these children to the FCR.
Effective Date
The provision is effective on October 1, 1998.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $10 million in 2001, $20 million in 2002,
$30 million in 2003, $40 million in 2004, $60 million in 2005,
$85 million in 2006, and $105 million in 2007.
13. Modification of estimated tax safe harbors (sec. 1091 of the Act
and sec. 6654 of the Code)
Present and Prior Law
Under present law, an individual taxpayer generally is
subject to an addition to tax for any underpayment of estimated
tax. An individual generally does not have an underpayment of
estimated tax if he or she makes timely estimated tax payments
at least equal to: (1) 100 percent of the tax shown on the
return of the individual for the preceding year (the ``100
percent of last year's liability safe harbor'') or (2) 90
percent of the tax shown on the return for the current year.
Under prior law, the 100 percent of last year's liability safe
harbor was modified to be a 110 percent of last year's
liability safe harbor for any individual with an AGI of more
than $150,000 as shown on the return for the preceding taxable
year. If a married individual filed a separate return for the
year for which an estimated tax installment payment was due,
the $150,000 amount became $75,000.
Explanation of Provision
The Act changes the 110 percent of last year's liability
safe harbor to be a 100 percent of last year's liability safe
harbor for taxable years beginning in 1998, a 105 percent of
last year's liability safe harbor for taxable years beginning
in 1999, 2000, and 2001, and a 112 percent of last year's
liability safe harbor for taxable years beginning in 2002.
In addition, no estimated tax penalties will be imposed
under section 6654 or section 6655 (relating to estimated tax
payments of individuals and corporations, respectively) for any
period before January 1, 1998, for any payment the due date of
which is before January 16, 1998, with respect to an
underpayment to the extent the underpayment is created or
increased by a provision of the Act.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $7,400 million in 1998, increase fiscal year
budget receipts by $4,000 million in 1999, increase fiscal year
budget receipts by $4,400 million in 2002, and reduce fiscal
year budget receipts by $1,000 million in 2003.
TITLE XI. FOREIGN TAX PROVISIONS
A. General Provisions
1. Simplify foreign tax credit limitation for individuals (sec. 1101 of
the Act and sec. 904 of the Code)
Present and Prior Law
In order to compute the foreign tax credit, a taxpayer
computes foreign source taxable income and foreign taxes paid
in each of the applicable separate foreign tax credit
limitation categories. In the case of an individual, under
prior law, this required the filing of IRS Form 1116.
In many cases, individual taxpayers who are eligible to
credit foreign taxes may have only a modest amount of foreign
source gross income, all of which is income from investments.
Taxable income of this type ordinarily is includible in the
single foreign tax credit limitation category for passive
income. However, under certain circumstances, the Code treats
investment-type income (e.g., dividends and interest) as income
in one of several other separate limitation categories (e.g.,
high withholding tax interest income or general limitation
income). For this reason, any taxpayer with foreign source
gross income was required to provide sufficient detail on IRS
Form 1116 to ensure that foreign source taxable income from
investments, as well as all other foreign source taxable
income, was allocated to the correct limitation category.
Reasons for Change
The Congress believed that a significant number of
individuals are entitled to credit relatively small amounts of
foreign tax imposed at modest effective tax rates on foreign
source investment income. For taxpayers in this class, the
applicable foreign tax credit limitations typically exceed the
amounts of taxes paid. Therefore, exempting these taxpayers
from the foreign tax credit limitation rules significantly
reduces the complexity of the tax law without significantly
altering actual tax liabilities. At the same time, however, the
Congress believed that this exemption should be limited to
those cases where the taxpayer receives a payee statement
showing the amount of the foreign source income and the foreign
tax.
Explanation of Provision
The Act allows individuals with no more than $300 ($600 in
the case of married persons filing jointly) of creditable
foreign taxes, and no foreign source income other than passive
income, an exemption from the foreign tax credit limitation
rules. (The Congress intended that an individual electing this
exemption will not be required to file IRS Form 1116 in order
to obtain the benefit of the foreign tax credit.) An individual
making this election is not entitled to any carryover of excess
foreign taxes to or from a taxable year to which the election
applies.
For purposes of this election, passive income generally is
defined to include all types of income that is foreign personal
holding company income under the subpart F rules, plus income
inclusions from foreign personal holding companies and passive
foreign investment companies, provided that the income is shown
on a payee statement furnished to the individual. For purposes
of this election, creditable foreign taxes include only foreign
taxes that are shown on a payee statement furnished to the
individual.
Effective Date
The provision applies to taxable years beginning after
December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $1 million in 1998 and by $1
million per year in each of the years 1999 through 2007.
2. Simplify translation of foreign taxes (sec. 1102 of the Act and
secs. 905(c) and 986 of the Code)
Present and Prior Law
Translation of foreign taxes
Foreign income taxes paid in foreign currencies are
required to be translated into U.S. dollar amounts using the
exchange rate as of the time such taxes are paid to the foreign
country or U.S. possession. This rule applies to foreign taxes
paid directly by U.S. taxpayers, which taxes are creditable in
the year paid or accrued, and to foreign taxes paid by foreign
corporations that are deemed paid by a U.S. corporation that is
a shareholder of the foreign corporation, and hence creditable,
in the year that the U.S. corporation receives a dividend or
has an income inclusion from the foreign corporation.
Redetermination of foreign taxes
Under prior law, for taxpayers that utilize the accrual
basis of accounting for determining creditable foreign taxes,
accrued and unpaid foreign tax liabilities denominated in
foreign currencies were translated into U.S. dollar amounts at
the exchange rate as of the last day of the taxable year of
accrual. If a difference existed between the dollar value of
accrued foreign taxes and the dollar value of those taxes when
paid, a redetermination of foreign taxes arose. A foreign tax
redetermination could occur in the case of a refund of foreign
taxes. A foreign tax redetermination also could arise because
the amount of foreign currency units actually paid differed
from the amount of foreign currency units accrued. In addition,
a redetermination could arise due to fluctuations in the value
of the foreign currency relative to the dollar between the date
of accrual and the date of payment.
As a general matter, a redetermination of foreign tax paid
or accrued directly by a U.S. person required notification of
the Internal Revenue Service and a redetermination of U.S. tax
liability for the taxable year for which the foreign tax was
claimed as a credit. The Treasury regulations provide
exceptions to this rule for de minimis cases. In the case of a
redetermination of foreign taxes that qualify for the indirect
(or ``deemed-paid'') foreign tax credit under sections 902 and
960, the Treasury regulations generally require taxpayers to
make appropriate adjustments to the payor foreign corporation's
pools of earnings and profits and foreign taxes.
Reasons for Change
The Congress believed that the administrative burdens
associated with the foreign tax credit can be reduced
significantly by permitting foreign taxes to be translated
using reasonably accurate average translation rates for the
period in which the tax payments are made. This approach will
reduce, sometimes substantially, the number of translation
calculations that are required to be made. In addition, the
Congress believed that taxpayers that are on the accrual basis
of accounting for purposes of determining creditable foreign
taxes should be permitted to translate those taxes into U.S.
dollar amounts in the year to which those taxes relate, and
should not be required to make adjustments or redetermination
to those translated amounts, if actual tax payments are made
within a reasonably short period of time after the close of
such year. Moreover, the Congress believed that it is
appropriate to use an average exchange rate for the taxable
year with respect to which such foreign taxes relate for
purposes of translating those taxes. On the other hand, the
Congress believed that a foreign tax not paid within a
reasonably short period after the close of the year to which
the taxes relate should not be treated as a foreign tax for
such year. By drawing a bright line between those foreign tax
payment delays that do and do not require a redetermination,
the Congress believed that a reasonable degree of certainty and
clarity will be added to the law in this area.
Explanation of Provision
Translation of foreign taxes
Translation of certain accrued foreign taxes
With respect to taxpayers that take foreign income taxes
into account when accrued, the Act generally provides for
foreign taxes to be translated at the average exchange rate for
the taxable year to which such taxes relate. This rule does not
apply (1) to any foreign income tax paid after the date two
years after the close of the taxable year to which such taxes
relate, (2) with respect to taxes of an accrual-basis taxpayer
that are actually paid in a taxable year prior to the year to
which they relate, or (3) to tax payments that are denominated
in an inflationary currency (as defined by regulations).
Translation of all other foreign taxes
Under the Act, foreign taxes not eligible for application
of the preceding rule generally are translated into U.S.
dollars using the exchange rates as of the time such taxes are
paid. The Act provides the Secretary of the Treasury with
authority to issue regulations that would allow foreign tax
payments to be translated into U.S. dollar amounts using an
average exchange rate for a specified period.
Redetermination of foreign taxes
Under the Act, a redetermination is required if: (1)
accrued taxes when paid differ from the amounts claimed as
credits by the taxpayer, (2) accrued taxes are not paid before
the date two years after the close of the taxable year to which
such taxes relate, or (3) any tax paid is refunded in whole or
in part. Thus, for example, the Act provides that if at the
close of the second taxable year after the taxable year to
which an accrued tax relates, any portion of the tax so accrued
has not yet been paid, a foreign tax redetermination under
section 905(c) is required for the amount representing the
unpaid portion of that accrued tax. In other words, the
previous accrual of any tax that is unpaid as of that date is
denied. Similarly, if the amount of foreign taxes paid exceeds
the amount accrued and claimed as a credit, a foreign tax
redetermination under section 905(c) is required for the
additional amount of such taxes. In cases where a
redetermination is required, as under prior law, the Act
specifies that the taxpayer must notify the Secretary, who will
redetermine the amount of the tax for the year or years
affected. In the case of indirect foreign tax credits,
regulatory authority is granted to prescribe appropriate
adjustments to the foreign corporation's pools of post-1986
foreign income taxes and post-1986 undistributed earnings in
lieu of such a redetermination.
The Act provides specific rules for the treatment of
accrued taxes that are paid more than two years after the close
of the taxable year to which such taxes relate. In the case of
the direct foreign tax credit, any such taxes subsequently paid
are taken into account for the taxable year to which such taxes
relate, but are translated into U.S. dollar amounts using the
exchange rates in effect as of the time such taxes are paid. In
the case of the indirect foreign tax credit, any such taxes
subsequently paid are taken into account for the taxable year
in which paid, and are translated into U.S. dollar amounts
using the exchange rates as of the time such taxes are paid.
For example, assume that in year 1 a taxpayer accrues 1,000
units of foreign tax that relate to year 1 and that give rise
to a foreign tax credit under section 901 and assume that the
currency involved is not inflationary. Further assume that as
of the end of year 1 the tax is unpaid. In this case, the Act
provides that the taxpayer translates 1,000 units of accrued
foreign tax into U.S. dollars at the average exchange rate for
year 1. If the 1,000 units of tax are paid by the taxpayer in
either year 2 or year 3, no redetermination of foreign tax is
required. If any portion of the tax so accrued remains unpaid
as of the end of year 3, however, the taxpayer is required to
redetermine its foreign tax accrued in year 1 to eliminate the
accrued but unpaid tax, thereby reducing its foreign tax credit
for such year. If the taxpayer pays the disallowed taxes in
year 4, the taxpayer again redetermines its foreign taxes (and
foreign tax credit) for year 1, but the taxes paid in year 4
are translated into U.S. dollars at the exchange rate for year
4.
Effective Date
The provision generally is effective for foreign taxes paid
(in the case of taxpayers using the cash basis for determining
the foreign tax credit) or accrued (in the case of taxpayers
using the accrual basis for determining the foreign tax credit)
in taxable years beginning after December 31, 1997. The
provision's changes to the foreign tax redetermination rules
apply to foreign taxes which relate to taxable years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $1 million per year in each of the
years 1998 through 2007.
3. Election to use simplified foreign tax credit limitation for
alternative minimum tax purposes (sec. 1103 of the Act and sec.
59 of the Code)
Present and Prior Law
Computing foreign tax credit limitations requires the
allocation and apportionment of deductions between items of
foreign source income and items of U.S. source income. Foreign
tax credit limitations must be computed both for regular tax
purposes and for purposes of the alternative minimum tax
(``AMT''). Under prior law, the allocation and apportionment of
deductions was required to be done separately for regular tax
foreign tax credit limitation purposes and AMT foreign tax
credit limitation purposes.
Reasons for Change
The process of allocating and apportioning deductions for
purposes of calculating the regular and AMT foreign tax credit
limitations can be complex. Taxpayers that had allocated and
apportioned deductions for regular foreign tax credit purposes
generally were required to reallocate and reapportion the same
deductions for AMT foreign tax credit purposes, based on assets
and income that reflect AMT adjustments (including
depreciation). However, the differences between regular taxable
income and alternative minimum taxable income often are
relevant primarily to U.S. source income. The Congress believed
that permitting taxpayers to use foreign source regular taxable
income in computing their AMT foreign tax credit limitation
will provide an appropriate simplification of the necessary
computations by eliminating the need to reallocate and
reapportion every deduction.
Explanation of Provision
The Act permits taxpayers to elect to use as their AMT
foreign tax credit limitation fraction the ratio of foreign
source regular taxable income to entire alternative minimum
taxable income, rather than the ratio of foreign source
alternative minimum taxable income to entire alternative
minimum taxable income. Under this election, foreign source
regular taxable income is used, however, only to the extent it
does not exceed entire alternative minimum taxable income. In
the event that foreign source regular taxable income does
exceed entire alternative minimum taxable income, and the
taxpayer has income in more than one foreign tax credit
limitation category, the Congress intended that the foreign
source taxable income in each such category generally will be
reduced by a pro rata portion of that excess.
The election is available only in the first taxable year
beginning after December 31, 1997 for which the taxpayer claims
an AMT foreign tax credit. The Congress intended that a
taxpayer will be treated, for this purpose, as claiming an AMT
foreign tax credit for any taxable year for which the taxpayer
chooses to have the benefits of the foreign tax credit and in
which the taxpayer is subject to the AMT or would be subject to
the AMT but for the availability of the AMT foreign tax credit.
The election, once made, will apply to all subsequent taxable
years, and may be revoked only with the consent of the
Secretary of the Treasury.
Effective Date
The provision applies to taxable years beginning after
December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $1 million per year in each of the
years 1998 through 2007.
4. Simplify treatment of personal transactions in foreign currency
(sec. 1104 of the Act and sec. 988 of the Code)
Present Law
When a U.S. taxpayer makes a payment in a foreign currency,
gain or loss (referred to as ``exchange gain or loss'')
generally arises from any change in the value of the foreign
currency relative to the U.S. dollar between the time the
currency was acquired (or the obligation to pay was incurred)
and the time that the payment is made. Gain or loss results
because foreign currency, unlike the U.S. dollar, is treated as
property for Federal income tax purposes.
Exchange gain or loss can arise in the course of a trade or
business or in connection with an investment transaction.
Exchange gain or loss also can arise where foreign currency was
acquired for personal use. For example, the IRS has ruled that
a taxpayer who convertsU.S. dollars to a foreign currency for
personal use while traveling abroad realizes exchange gain or loss on
reconversion of appreciated or depreciated foreign currency (Rev. Rul.
74-7, 1974-1 C.B. 198).
Prior to the Tax Reform Act of 1986 (``1986 Act''), most of
the rules for determining the Federal income tax consequences
of foreign currency transactions were embodied in a series of
court cases and revenue rulings issued by the IRS. Additional
rules of limited application were provided by Treasury
regulations. Pre-1986 law was believed to be unclear regarding
the character, the timing of recognition, and the source of
gain or loss due to fluctuations in the exchange rate of
foreign currency. The 1986 Act provided a comprehensive set of
rules for the U.S. tax treatment of transactions involving
foreign currencies.
However, the 1986 Act provisions designed to clarify the
treatment of currency transactions, primarily found in section
988 of the Code, apply to transactions entered into by an
individual only to the extent that expenses attributable to
such transactions are deductible under section 162 (as a trade
or business expense) or section 212 (as an expense of producing
income). Therefore, the principles of pre-1986 law continue to
apply to personal currency transactions.
Reasons for Change
An individual who lives or travels abroad generally cannot
use U.S. dollars to make all of the purchases incident to daily
life. If an individual must treat foreign currency in this
instance as property giving rise to U.S.-dollar income or loss
every time the individual, in effect, ``barters'' the foreign
currency for goods or services, the U.S. individual living in
or visiting a foreign country will have a significant
administrative burden that may bear little or no relation to
whether U.S.-dollar measured income has increased or decreased.
The Congress believed that individuals should be given relief
from the requirement to keep track of exchange gains on a
transaction-by-transaction basis in de minimis cases.
Explanation of Provision
If an individual acquires foreign currency and disposes of
it in a personal transaction and the exchange rate changes
between the acquisition and disposition of such currency, the
Act applies nonrecognition treatment to any resulting exchange
gain, provided that such gain does not exceed $200.
Transactions entered into in connection with a business trip
constitute personal transactions for purposes of this
provision, and exchange gain resulting from such transactions
is eligible for nonrecognition treatment under this provision.
The provision does not change the treatment of exchange losses.
The Congress understood that under other Code provisions such
losses typically are not deductible by individuals (e.g., sec.
165(c)).
Effective Date
The provision applies to taxable years beginning after
December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $1 million per year in each of the
years 1998 through 2007.
5. Simplify foreign tax credit limitation for dividends from 10/50
companies (sec. 1105 of the Act and sec. 904 of the Code)
Present and Prior Law
U.S. persons may credit foreign taxes against U.S. tax on
foreign source income. The amount of foreign tax credits that
can be claimed in a year is subject to a limitation that
prevents taxpayers from using foreign tax credits to offset
U.S. tax on U.S. source income. Separate limitations are
applied to specific categories of income.
Special foreign tax credit limitation rules apply in the
case of dividends received from a foreign corporation in which
the taxpayer owns at least 10 percent of the stock by vote and
which is not a controlled foreign corporation (a so-called
``10/50 company''). Under prior law, dividends received by the
taxpayer from each 10/50 company were subject to a separate
foreign tax credit limitation.
Reasons for Change
The Congress found that the prior-law rule that subjects
the dividends received from each so-called 10/50 company to a
separate foreign tax credit limitation imposes a substantial
record-keeping burden on companies and has the additional
negative effect of discouraging minority-position joint
ventures abroad. Indeed, the Congress was aware that recent
academic research suggests that the present-law requirements
may distort the form and amount of overseas investment
undertaken by U.S.-based enterprises. The research findings
suggest that the prior-law limitation ``greatly reduces the
attractiveness of joint ventures to American investors,
particularly ventures in low-tax foreign countries. Aggregate
data indicate that U.S. participation in international joint
ventures fell sharply after [enactment of prior law in] 1986.
The decline in U.S. joint venture activity is most pronounced
in low-tax countries. . . . Moreover, joint ventures in low-tax
countries use more debt and pay greater royalties to their U.S.
parents after 1986, which reflects their incentives to
economize on dividend payments.'' \280\
---------------------------------------------------------------------------
\280\ See, Mihir A. Desai and James R. Hines, Jr., `` `Basket'
Cases: International Joint Ventures after the Tax Reform Act of 1986,''
National Bureau of Economic Research, Working Paper #5755, September
1996.
---------------------------------------------------------------------------
The Congress believed that the joint venture can be an
efficient way for American business to exploit its know-how and
technology in foreign markets. If the prior-law limitation was
discouraging such joint ventures or altering the structure of
new ventures, the ability of American business to succeed
abroad could be diminished. The Congress believed it is
appropriate to modify the prior-law limitation to promote
simplicity and the ability of American business to compete
abroad.
Explanation of Provision
The Act generally provides for look-through treatment to
apply in characterizing dividends from 10/50 companies for
foreign tax credit limitation purposes. Under the Act, any
dividend from a 10/50 company paid out of earnings and profits
accumulated in a taxable year beginning after December 31, 2002
is treated as income in a foreign tax credit limitation
category in proportion to the ratio of the earnings and profits
attributable to income in such foreign tax credit limitation
category to the total earnings and profits.
In the case of dividends from a 10/50 company paid out of
earnings and profits accumulated in a taxable year beginning
before January 1, 2003, the Act provides that a single foreign
tax credit limitation generally applies to all such dividends
from all 10/50 companies. However, separate foreign tax credit
limitations continue to apply to any such dividends received by
the taxpayer from each 10/50 company that qualifies as a
passive foreign investment company.
For purposes of this provision, the rules of section 316
apply. Accordingly, distributions are treated as made from the
most recently accumulated earnings and profits. In addition,
for purposes of this provision, regulatory authority is granted
to provide rules regarding the treatment of distributions out
of earnings and profits for periods prior to the taxpayer's
acquisition of such stock.
Effective Date
The provision is effective for taxable years beginning
after December 31, 2002.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $57 million in 2003, $241 million in 2004,
$215 million in 2005, $227 million in 2006, and $242 million in
2007.
B. General Provisions Affecting Treatment of Controlled Foreign
Corporations (secs. 1111-1113 of the Act and secs. 902, 904, 951, 952,
959, 960, 961, 964, and 1248 of the Code)
Present and Prior Law
If an upper-tier controlled foreign corporation (``CFC'')
sells stock of a lower-tier CFC, the gain generally is included
in the income of U.S. 10-percent shareholders as subpart F
income and such U.S. shareholder's basis in the stock of the
first-tier CFC is increased to account for the inclusion. The
inclusion was not characterized for foreign tax credit
limitation purposes by reference to the nature of the income of
the lower-tier CFC; instead it generally was characterized as
passive income.
For purposes of the foreign tax credit limitations
applicable to so-called 10/50 companies, under prior law, a CFC
was not treated as a 10/50 company with respect to any
distribution out of its earnings and profits for periods during
which it was a CFC and, except as provided in regulations, the
recipient of the distribution was a U.S. 10-percent shareholder
in such corporation.
If subpart F income of a lower-tier CFC was included in the
gross income of a U.S. 10-percent shareholder, no provision of
prior law allowed adjustment of the basis of the upper-tier
CFC's stock in the lower-tier CFC.
The subpart F income earned by a foreign corporation during
its taxable year is taxed to the persons who are U.S. 10-
percent shareholders of the corporation on the last day, in
that year, on which the corporation is a CFC. In the case of a
U.S. 10-percent shareholder who acquired stock in a CFC during
the year, such inclusions are reduced by all or a portion of
the amount of dividends paid in that year by the foreign
corporation to any person other than the acquiror with respect
to that stock.
As a general rule, subpart F income does not include income
earned from sources within the United States if the income is
effectively connected with the conduct of a U.S. trade or
business by the CFC. This general rule does not apply, however,
if the income is exempt from, or subject to a reduced rate of,
U.S. tax pursuant to a provision of a U.S. treaty.
A U.S. corporation that owns at least 10 percent of the
voting stock of a foreign corporation is treated as if it had
paid a share of the foreign income taxes paid by the foreign
corporation in the year in which the foreign corporation's
earnings and profits become subject to U.S. tax as dividend
income of the U.S. shareholder. A U.S. corporation also may be
deemed to have paid taxes paid by a second- or third-tier
foreign corporation if certain conditions are satisfied; under
prior law, a U.S. corporation was not deemed to have paid taxes
paid by a fourth- or lower-tier foreign corporation.
Reasons for Change
The Congress believed that complexities were caused by
uncertainties and gaps in the prior-law statutory schemes for
taxing gains on dispositions of stock in CFCs as dividend
income or subpart F income. The Congress believed it
appropriate to reduce complexities by rationalizing these
rules.
The Congress also understood that certain arbitrary
limitations placed on the operation of the indirect foreign tax
credit may have resulted in taxpayers undergoing burdensome and
sometimes costly corporate restructuring. In other cases, there
was concern that these limitations may have contributed to
decisions by U.S. companies against acquiring foreign
subsidiaries. The Congress deemed it appropriate to ease these
restrictions.
Explanation of Provision
Lower-tier CFCs
Characterization of gain on stock disposition
Under the Act, if a CFC is treated as having gain from the
sale or exchange of stock in a foreign corporation, the gain is
treated as a dividend to the same extent that it would have
been so treated under section 1248 if the CFC were a U.S.
person. This provision, however, does not affect the
determination of whether the corporation whose stock is sold or
exchanged is a CFC.
Thus, for example, if a U.S. corporation owns 100 percent
of the stock of a foreign corporation, which owns 100 percent
of the stock of a second foreign corporation, then under the
Act, any gain of the first corporation upon a sale or exchange
of stock of the second corporation is treated as a dividend for
purposes of subpart F income inclusions to the U.S.
shareholder, to the extent of earnings and profits of the
second corporation attributable to periods in which the first
foreign corporation owned the stock of the second foreign
corporation while the latter was a CFC with respect to the U.S.
shareholder.
Gain on disposition of stock in a related corporation
created or organized under the laws of, and having a
substantial part of its assets in a trade or business in, the
same foreign country as the gain recipient, even if
recharacterized as a dividend under the proposal, is not
excluded from foreign personal holding company income under the
same-country exception that applies to actual dividends.
Under the Act, for purposes of this rule, a CFC is treated
as having sold or exchanged stock if, under any provision of
subtitle A of the Code, the CFC is treated as having gain from
the sale or exchange of such stock. Thus, for example, if a CFC
distributes to its shareholder stock in a foreign corporation,
and the distribution results in gain being recognized by the
CFC under section 311(b) as if the stock were sold to the
shareholder for fair market value, the Act makes clear that,
for purposes of this rule, the CFC is treated as having sold or
exchanged the stock.
The Act also repeals a provision added to the Code by the
Technical and Miscellaneous Revenue Act of 1988 that, except as
provided by regulations, requires a recipient of a distribution
from a CFC to have been a U.S. 10-percent shareholder of that
CFC for the period during which the earnings and profits which
gave rise to the distribution were generated in order to avoid
treating the distribution as one coming from a 10/50 company.
Thus, under the Act, a CFC is not treated as a 10/50 company
with respect to any distribution out of its earnings and
profits for periods during which it was a CFC, whether or not
the recipient of the distribution was a U.S. 10-percent
shareholder of the corporation when the earnings and profits
giving rise to the distribution were generated.
Adjustments to basis of stock
Under the Act, when a lower-tier CFC earns subpart F
income, and stock in that corporation is later disposed of by
an upper-tier CFC, the resulting income inclusion of the U.S.
10-percent shareholders, under regulations, is to be adjusted
to account for previous inclusions, in a manner similar to the
adjustments provided to the basis of stock in a first-tier CFC.
Thus, just as the basis of a U.S. 10-percent shareholder in a
first-tier CFC rises when subpart F income is earned and falls
when previously taxed income is distributed, so as to avoid
double taxation of the income on a later disposition of the
stock of that company, the subpart F income from gain on the
disposition of a lower-tier CFC generally is reduced by income
inclusions of earnings that were not subsequently distributed
by the lower-tier CFC.
For example, assume that a U.S. person is the owner of all
of the stock of a first-tier CFC which, in turn, is the sole
shareholder of a second-tier CFC. In year 1, the second-tier
CFC earns $100 of subpart F income which is included in the
U.S. person's gross income for that year. In year 2, the first-
tier CFC disposes of the second-tier CFC's stock and recognizes
$300 of income with respect to the disposition. All of that
income constitutes subpart F foreign personal holding company
income. Under the Act, the Secretary is granted regulatory
authority to reduce the U.S. person's year 2 subpart F
inclusion by $100--the amount of year 1 subpart F income of the
second-tier CFC that was included, in that year, in the U.S.
person's gross income. Such an adjustment, in effect, allows
for a step-up in the basis of the stock of the second-tier CFC
to the extent of its subpart F income previously included in
the U.S. person's gross income.
Subpart F inclusions in year of acquisition
If a U.S. 10-percent shareholder acquires the stock of a
CFC from another U.S. 10-percent shareholder during a taxable
year of the CFC in which it earns subpart F income, the Act
reduces the acquiror's subpart F income inclusion for that year
by a portion of the amount of the dividend deemed (under sec.
1248) to be received by the transferor. The portion by which
the inclusion is reduced (as is the case if a dividend was paid
to theprevious owner of the stock) does not exceed the lesser
of the amount of dividends with respect to such stock deemed received
(under sec. 1248) by other persons during the year or the amount
determined by multiplying the subpart F income for the year by the
proportion of the year during which the acquiring shareholder did not
own the stock.
Treatment of U.S. income earned by a CFC
Under the Act, an exemption or reduction by treaty of the
branch profits tax that would be imposed under section 884 on a
CFC does not affect the general statutory exemption from
subpart F income that is granted for U.S. source effectively
connected income. For example, assume a CFC earns income of a
type that generally would be subpart F income, and that income
is earned from sources within the United States in connection
with business operations therein. Further assume that
repatriation of that income is exempted from the U.S. branch
profits tax under a provision of an applicable U.S. income tax
treaty. The Act provides that, notwithstanding the treaty's
effect on the branch tax, the income is not treated as subpart
F income as long as it is not exempt from U.S. taxation (or
subject to a reduced rate of tax) under any other treaty
provision.
Extension of indirect foreign tax credit
The Act extends the application of the indirect foreign tax
credit (secs. 902 and 960) to taxes paid or accrued by certain
fourth-, fifth-, and sixth-tier foreign corporations. In
general, three requirements are required to be satisfied by a
foreign company at any of these tiers to qualify for the
credit. First, the company must be a CFC. Second, the U.S.
corporation claiming the credit under section 902(a) must be a
U.S. shareholder (as defined in sec. 951(b)) with respect to
the foreign company. Third, the product of the percentage
ownership of voting stock at each level from the U.S.
corporation down must equal at least 5 percent. The Act limits
the application of the indirect foreign tax credit below the
third tier to taxes paid in taxable years during which the
payor is a CFC. Foreign taxes paid below the sixth tier of
foreign corporations remain ineligible for the indirect foreign
tax credit.
Effective Dates
Lower-tier CFCs.--The provision that treats gains on
dispositions of stock in lower-tier CFCs as dividends under
section 1248 principles applies to gains recognized on
transactions occurring after the date of enactment (after
August 5, 1997).
The provision that expands look-through treatment, for
foreign tax credit limitation purposes, of dividends from CFCs
is effective for distributions after the date of enactment.
The provision that provides for regulatory adjustments to
U.S. shareholder inclusions, with respect to gains of CFCs from
dispositions of stock in lower-tier CFCs, is effective for
determining inclusions for taxable years of U.S. shareholders
beginning after December 31, 1997. Thus, the Act permits
regulatory adjustments to an inclusion occurring after the
effective date to account for income that was previously taxed
under the subpart F provisions either prior to or subsequent to
the effective date.
Subpart F inclusions in year of acquisition.--The provision
that permits dispositions of stock to be taken into
consideration in determining a U.S. shareholder's subpart F
inclusion for a taxable year is effective with respect to
dispositions occurring after the date of enactment.
Treatment of U.S. source income earned by a CFC.--The
provision concerning the effect of treaty exemptions from, or
reductions of, the branch profits tax on the determination of
subpart F income is effective for taxable years beginning after
December 31, 1986.
Extension of indirect foreign tax credit.--The provision
that extends application of the indirect foreign tax credit to
certain CFCs below the third tier is effective for foreign
taxes of CFCs for taxable years of such corporations beginning
after the date of enactment. However, the effective date rule
was not intended to preclude the creditability of foreign taxes
that were creditable when paid or accrued (e.g., foreign taxes
paid before the effective date by a third-tier CFC that
subsequently becomes a fourth-tier subsidiary).
In the case of any chain of foreign corporations, the taxes
of which would be eligible for the indirect foreign tax credit,
under prior law or under the Act, but for the denial of
indirect credits below the third or sixth tier, as the case may
be, no liquidation, reorganization, or similar transaction in a
taxable year beginning after the date of enactment will have
the effect of permitting taxes to be taken into account under
the indirect foreign tax credit provisions of the Code which
could not have been taken into account under those provisions
but for such transaction. It was intended that no such
transaction will have the effect of permitting credits for
taxes which, but for such transaction, would have been
noncreditable because they are taxes of a fourth-, fifth-, or
sixth-tier corporation for a taxable year beginning before the
date of enactment.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $2 million in 1998, $5 million in 1999, $7
million in 2000, $9 million in 2001, $10 million in 2002, $10
million in 2003, $11 million in 2004, $12 million in 2005, $13
million in 2006, and $14 million in 2007.
C. Modification of Passive Foreign Investment Company Provisions to
Eliminate Overlap with Subpart F, to Allow Mark-to-Market Election, and
to Require Measurement Based on Value for PFIC Asset Test (secs. 1121-
1124 of the Act and secs. 1291-1298 of the Code)
Present and Prior Law
Overview
U.S. citizens and residents and U.S. corporations
(collectively, ``U.S. persons'') are taxed currently by the
United States on their worldwide income, subject to a credit
against U.S. tax on foreign income based on foreign income
taxes paid with respect to such income. A foreign corporation
generally is not subject to U.S. tax on its income from
operations outside the United States.
Income of a foreign corporation generally is taxed by the
United States when it is repatriated to the United States
through payment to the corporation's U.S. shareholders, subject
to a foreign tax credit. However, a variety of regimes imposing
current U.S. tax on income earned through a foreign corporation
have been reflected in the Code. Today the principal anti-
deferral regimes set forth in the Code are the controlled
foreign corporation rules of subpart F (secs. 951-964) and the
passive foreign investment company rules (secs. 1291-1297).
Additional anti-deferral regimes set forth in the Code are the
foreign personal holding company rules (secs. 551-558); the
personal holding company rules (secs. 541-547); the accumulated
earnings tax (secs. 531-537); and the foreign investment
company and electing foreign investment company rules (secs.
1246-1247). The anti-deferral regimes included in the Code
overlap such that a given taxpayer may be subject to multiple
sets of anti-deferral rules.
Controlled foreign corporations
A controlled foreign corporation (``CFC'') is defined
generally as any foreign corporation if U.S. persons own more
than 50 percent of the corporation's stock (measured by vote or
value), taking into account only those U.S. persons that own at
least 10 percent of the stock (measured by vote only) (sec.
957). Stock ownership includes not only stock owned directly,
but also stock owned indirectly or constructively (sec. 958).
Certain income of a CFC (referred to as ``subpart F
income'') is subject to current U.S. tax. The United States
generally taxes the U.S. 10-percent shareholders of a CFC
currently on their pro rata shares of the subpart F income of
the CFC. In effect, the Code treats those U.S. shareholders as
having received a current distribution out of the CFC's subpart
F income. Such shareholders also are subject to current U.S.
tax on their pro rata shares of the CFC's earnings invested in
U.S. property. The foreign tax credit may reduce the U.S. tax
on these amounts.
Passive foreign investment companies
The Tax Reform Act of 1986 established an anti-deferral
regime for passive foreign investment companies (``PFICs''). A
PFIC is any foreign corporation if (1) 75 percent or more of
its gross income for the taxable year consists of passive
income, or (2) 50 percent or more of the average fair market
value of its assets consists of assets that produce, or are
held for the production of, passive income. For purposes of
applying the PFIC asset test, the assets of a CFC were required
under prior law to be measured using adjusted basis; the assets
of a foreign corporation that is not a CFC were measured under
prior law using fair market value unless the corporation elects
to use adjusted basis.
Two alternative sets of income inclusion rules apply to
U.S. persons that are shareholders in a PFIC. One set of rules
applies to PFICs that are ``qualified electing funds,'' under
which electing U.S. shareholders include currently in gross
income their respective shares of the PFIC's total earnings,
with a separate election to defer payment of tax, subject to an
interest charge, on income not currently received. The second
set of rules applies to PFICs that are not qualified electing
funds (``nonqualified funds''), under which the U.S.
shareholders pay tax on income realized from the PFIC and an
interest charge that is attributable to the value of deferral.
Overlap between subpart F and the PFIC provisions
A foreign corporation that is a CFC is also a PFIC if it
meets the passive income test or the passive asset test
described above. In such a case, under prior law, the U.S. 10-
percent shareholders were subject both to the subpart F
provisions (which require current inclusion of certain earnings
of the corporation) and to the PFIC provisions (which impose an
interest charge on amounts distributed from the corporation and
gains recognized upon the disposition of the corporation's
stock, unless an election is made to include currently all of
the corporation's earnings).
Reasons for Change
The anti-deferral rules for U.S. persons owning stock in
foreign corporations are very complex. Moreover, the
interactions between the anti-deferral regimes cause additional
complexity. The overlap between the subpart F rules and the
PFIC provisions was of particular concern to the Congress. The
PFIC provisions, which do not require a threshold level of
ownership by U.S. persons, apply where the U.S.-ownership
requirements of subpart F are not satisfied. However, the PFIC
provisions also applied to a U.S. shareholder that is subject
to the current inclusion rules of subpart F with respect to the
same corporation. The Congress believed that the additional
complexity caused by this overlap was unnecessary.
The Congress also understood that the interest-charge
method for income inclusion provided in the PFIC rules is a
substantial source of complexity for shareholders of PFICs.
Even without eliminating the interest-charge method,
significant simplification could be achieved by providing an
alternative income inclusion method for shareholders of PFICs.
Further, some taxpayers argued that they would have preferred
choosing the current-inclusion method afforded by the qualified
fund election, but were unable to do so because they could not
obtain the necessary information from the PFIC. Accordingly,
the Congress believed that a mark-to-market election would
provide PFIC shareholders with a fair alternative method for
including income with respect to the PFIC.
Explanation of Provision
Elimination of overlap between subpart F and the PFIC provisions
In the case of a PFIC that is also a CFC, the Act generally
treats the corporation as not a PFIC with respect to certain
10-percent shareholders. This rule applies if the corporation
is a CFC (within the meaning of section 957(a)) and the
shareholder is a U.S. shareholder (within the meaning of
section 951(b)) of such corporation (i.e., if the shareholder
is subject to the current inclusion rules of subpart F with
respect to such corporation).\281\ Moreover, the rule applies
for that portion of the shareholder's holding period with
respect to the corporation's stock which is after December 31,
1997 and during which the corporation is a CFC and the
shareholder is a U.S. shareholder. Accordingly, a shareholder
that is subject to current inclusion under the subpart F rules
with respect to stock of a PFIC that is also a CFC generally is
not subject also to the PFIC provisions with respect to the
same stock. The PFIC provisions continue to apply in the case
of a PFIC that is also a CFC to shareholders that are not
subject to subpart F (i.e., to shareholders that are U.S.
persons and that own (directly, indirectly, or constructively)
less than 10 percent of the corporation's stock by vote).
---------------------------------------------------------------------------
\281\ In the case of an optionholder, a technical correction may be
necessary to reflect this intent that the elimination of the overlap
apply only to the extent the person is subject to the current inclusion
rules of subpart F with respect to the corporation.
---------------------------------------------------------------------------
If a shareholder of a PFIC is subject to the rules
applicable to nonqualified funds before becoming eligible for
the special rules provided under the provision for shareholders
that are subject to subpart F, the stock held by such
shareholder continues to be treated as PFIC stock unless the
shareholder makes an election to pay tax and an interest charge
with respect to the unrealized appreciation in the stock or the
accumulated earnings of the corporation. Under section
1298(b)(1), stock of a corporation that was a PFIC that was not
a qualified electing fund continues to be treated as stock of a
PFIC unless the shareholder makes a recognition election under
rules similar to the rules of section 1291(d)(2). Pursuant to
section 1291(d)(2), the shareholder may elect either to
recognize gain as if such stock were sold or, in the case of a
CFC, to include in income the post-1986 earnings and profits of
the corporation attributable to the stock.281a
Accordingly, the provision eliminating the overlap between the
PFIC and CFC provisions does not apply to a shareholder of a
corporation that was a PFIC with respect to such shareholder
and that was a nonqualified fund unless the shareholder makes
such an election.
---------------------------------------------------------------------------
\281a\ In light of this Congressional intent to allow an election
with respect to either unrealized appreciation or accumulated earnings,
it is hoped that the provision of the Treasury regulations which limits
the availability of the latter election will be withdrawn. See Treas.
Reg. sec. 1.129111-9(i).
---------------------------------------------------------------------------
If, under the Act, a shareholder is not subject to the PFIC
provisions because the shareholder is subject to subpart F and
the shareholder subsequently ceases to be subject to subpart F
with respect to the corporation, for purposes of the PFIC
provisions, the shareholder's holding period for such stock is
treated as beginning immediately after such cessation.
Accordingly, in applying the rules applicable to PFICs that are
not qualified electing funds, the earnings of the corporation
are not attributed to the period during which the shareholder
was subject to subpart F with respect to the corporation and
was not subject to the PFIC provisions.
For purposes of the PFIC provisions, attribution rules
apply to the extent that the effect is to treat stock of a PFIC
as owned by a U.S. person. In general, if 50 percent or more in
value of the stock of a corporation is owned (directly or
indirectly) by or for any person, such person is considered as
owning a proportionate part of the stock owned directly or
indirectly by or for such corporation, determined based on the
person's proportionate interest in the value of such
corporation's stock. However, this 50-percent limitation does
not apply in the case of a corporation that is a PFIC; a person
that is a shareholder of a PFIC is considered as owning a
proportionate part of the stock owned directly or indirectly by
or for such PFIC, without regard to whether such shareholder
owns at least 50 percent of the PFIC's stock by value. It was
intended that these attribution rules apply without regard to
this provision treating a corporation as a non-PFIC with
respect to a shareholder. Accordingly, stock owned directly or
indirectly by or for a corporation that is not treated as a
PFIC under this provision for the qualified portion of the
shareholder's holding period nevertheless is attributed to such
shareholder, regardless of the shareholder's ownership
percentage of such corporation.\282\
---------------------------------------------------------------------------
\282\ A technical correction may be necessary to clarify this
result. See Title VI (sec. 10(b)) of H.R. 2676, the Tax Technical
Corrections Act of 1997, as passed by the House on November 5, 1997.
---------------------------------------------------------------------------
Mark-to-market election
The Act allows a shareholder of a PFIC to make a mark-to-
market election with respect to the stock of the PFIC, provided
that such stock is marketable (as defined below). Under such an
election, the shareholder includes in income each year an
amount equal to the excess, if any, of the fair market value of
the PFIC stock as of the close of the taxable year over the
shareholder's adjusted basis in such stock. The shareholder is
allowed a deduction for the excess, if any, of the adjusted
basis of the PFIC stock over its fair market value as of the
close of the taxable year. However, deductions are allowable
under this rule only to the extent of any net mark-to-market
gains with respect to the stock included by the shareholder for
prior taxable years.
Under the Act, this mark-to-market election is available
only for PFIC stock that is ``marketable.'' For this purpose,
PFIC stock is considered marketable if it is regularly tradedon
a national securities exchange that is registered with the Securities
and Exchange Commission or on the national market system established
pursuant to section 11A of the Securities and Exchange Act of 1934. In
addition, PFIC stock is considered marketable if it is regularly traded
on any exchange or market that the Secretary of the Treasury determines
has rules sufficient to ensure that the market price represents a
legitimate and sound fair market value. Any option on stock that is
considered marketable under the foregoing rules is treated as
marketable, to the extent provided in regulations. PFIC stock also is
treated as marketable, to the extent provided in regulations, if the
PFIC offers for sale (or has outstanding) stock of which it is the
issuer and which is redeemable at its net asset value in a manner
comparable to a U.S. regulated investment company (RIC).
In addition, the Act treats as marketable any PFIC stock
owned by a RIC that offers for sale (or has outstanding) any
stock of which it is the issuer and which is redeemable at its
net asset value. The Act treats as marketable any PFIC stock
held by any other RIC that otherwise publishes net asset
valuations at least annually, except to the extent provided in
regulations. It is believed that even for RICs that do not make
a market in their own stock, but that do regularly report their
net asset values in compliance with the securities laws,
inaccurate valuation may bring exposure to legal liabilities,
and this exposure may ensure the reliability of the values such
RICs assign to the PFIC stock they hold.
The shareholder's adjusted basis in the PFIC stock is
adjusted to reflect the amounts included or deducted under this
election. In the case of stock owned indirectly by a U.S.
person through a foreign entity (as discussed below), the basis
adjustments for mark-to-market gains and losses apply to the
basis of the PFIC in the hands of the intermediary owner, but
only for purposes of the subsequent application of the PFIC
rules to the tax treatment of the indirect U.S. owner. In
addition, similar basis adjustments are made to the adjusted
basis of the property actually held by the U.S. person by
reason of which the U.S. person is treated as owning PFIC
stock.
Amounts included in income pursuant to a mark-to-market
election, as well as gain on the actual sale or other
disposition of the PFIC stock, are treated as ordinary income.
Ordinary loss treatment also applies to the deductible portion
of any mark-to-market loss on PFIC stock, as well as to any
loss realized on the actual sale or other disposition of PFIC
stock to the extent that the amount of such loss does not
exceed the net mark-to-market gains previously included with
respect to such stock. The source of amounts with respect to a
mark-to-market election generally is determined in the same
manner as if such amounts were gain or loss from the sale of
stock in the PFIC.
An election to mark to market applies to the taxable year
for which made and all subsequent taxable years, unless the
PFIC stock ceases to be marketable or the Secretary of the
Treasury consents to the revocation of such election.
Under constructive ownership rules, U.S. persons that own
PFIC stock through certain foreign entities may make this
election with respect to the PFIC. These constructive ownership
rules apply to treat PFIC stock owned directly or indirectly by
or for a foreign partnership, trust, or estate as owned
proportionately by the partners or beneficiaries, except as
provided in regulations. Stock in a PFIC that is thus treated
as owned by a person is treated as actually owned by that
person for purposes of again applying the constructive
ownership rules. In the case of a U.S. person that is treated
as owning PFIC stock by application of this constructive
ownership rule, any disposition by the U.S. person or by any
other person that results in the U.S. person being treated as
no longer owning the PFIC stock, as well as any disposition by
the person actually owning the PFIC stock, is treated as a
disposition by the U.S. person of the PFIC stock.
In addition, a CFC that owns stock in a PFIC is treated as
a U.S. person that may make the election with respect to such
PFIC stock. Any amount includible (or deductible) in the CFC's
gross income pursuant to this mark-to-market election is
treated as foreign personal holding company income (or a
deduction allocable to foreign personal holding company
income). The source of such amounts, however, is determined by
reference to the actual residence of the CFC.
In the case of a taxpayer that makes the mark-to-market
election with respect to stock in a PFIC that is a nonqualified
fund after the beginning of the taxpayer's holding period with
respect to such stock, a coordination rule applies to ensure
that the taxpayer does not avoid the interest charge with
respect to amounts attributable to periods before such
election. A similar rule applies to RICs that make the mark-to-
market election under the Act after the beginning of their
holding period with respect to PFIC stock (to the extent that
the RIC had not previously marked to market the stock of the
PFIC).
Except as provided in the coordination rules described
above, the rules of section 1291 (with respect to nonqualified
funds) do not apply to a shareholder of a PFIC if a mark-to-
market election is in effect for the shareholder's taxable
year. Moreover, in applying section 1291 in a case where a
mark-to-market election was in effect for any prior taxable
year, the shareholder's holding period for the PFIC stock is
treated as beginning immediately after the last taxable year
for which such election applied.
A special rule applicable in the case of a PFIC shareholder
that becomes a U.S. person treats the adjusted basis of any
PFIC stock held by such person on the first day of the year in
which such shareholder becomes a U.S. person as equal to the
greater of its fair market value on such date or its adjusted
basis on such date. Such rule applies only for purposes of the
mark-to-market election.
Application of PFIC asset test
Under the Act, if the stock of a foreign corporation is
publicly traded for the taxable year, the PFIC asset test is
applied using fair market value for purposes of measuring the
PFIC's assets. For this purpose, the stock of a foreign
corporation is treated as publicly traded if such stock is
readily tradeable on a national securities exchange that is
registered with the Securities and Exchange Commission, the
national market system established pursuant to section 11A of
the Securities and Exchange Act of 1934, or any other exchange
or market that the Secretary of the Treasury determines has
rules sufficient to ensure that the market price represents a
sound fair market value. Because the PFIC asset test is applied
based on quarterly measurements of the corporation's assets,
the Congress intended that a corporation the stock of which is
publicly traded on each such quarterly measurement date during
the taxable year will be eligible for this asset measurement
rule for such taxable year. In applying the PFIC asset test,
the Congress intended that the total value of a publicly-traded
foreign corporation's assets generally will be treated as equal
to the sum of the aggregate value of its outstanding stock plus
its liabilities.
The Act did not change the rules applicable to non-
publicly-traded foreign corporations for purposes of the
measurement of assets in applying the PFIC asset test.
Accordingly, CFCs that are not publicly traded continue to be
required to measure their assets using adjusted basis, and any
other foreign corporations that are not publicly traded
continue to measure their assets using fair market value unless
they elect to use adjusted basis.
Effective Date
The provision is effective for taxable years of U.S.
persons beginning after December 31, 1997, and taxable years of
foreign corporations ending with or within such taxable years
of U.S. persons.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $24 million in 1998, $23 million in 1999,
$24 million in 2000, $26 million in 2001, $27 million in 2002,
$28 million in 2003, $29 million in 2004, $31 million in 2005,
$33 million in 2006, and $35 million in 2007.
D. Simplify Formation and Operation of International Joint Ventures
(secs. 1131, 1141-1145, and 1151 of the Act and secs. 367, 721, 1491-
1494, 6031, 6038, 6038B, 6046A, 6501, 6679, and 7701 of the Code)
Present and Prior Law
Under prior-law section 1491, an excise tax generally was
imposed on transfers of property by a U.S. person to a foreign
corporation as paid-in surplus or as a contribution to capital
or to a foreign partnership, estate or trust. The tax was 35
percent of the amount of gain inherent in the property
transferred but not recognized for income tax purposes at the
time of the transfer. However, several exceptions to the
section 1491 excise tax were available. Under prior-law section
1494(c), a substantial penalty applied in the case of a failure
to report a transfer described in section 1491.
Section 367 applies to require gain recognition upon
certain transfers by U.S. persons to foreign corporations.
Under section 367(d), a U.S. person that contributes intangible
property to a foreign corporation is treated as having sold the
property to the corporation and is treated as receiving deemed
royalty payments from the corporation. Under prior law, these
deemed royalty payments were treated as U.S. source income. A
U.S. person could elect to apply similar rules to a transfer of
intangible property to a foreign partnership that otherwise
would have been subject to the prior-law section 1491 excise
tax.
A foreign partnership may be required to file a partnership
return. If a foreign partnership fails to file a required
return, losses and credits with respect to the partnership may
be disallowed to the partnership. A U.S. person that acquires
or disposes of an interest in a foreign partnership, or whose
proportional interest in the partnership changes substantially,
may be required to file an information return with respect to
such event.
A partnership generally is considered to be a domestic
partnership if it is created or organized in the United States
or under the laws of the United States or any State. A foreign
partnership generally is any partnership that is not a domestic
partnership.
Reasons for Change
The Congress understood that the prior-law rules imposing
an excise tax on certain transfers of appreciated property to a
foreign entity unless the requirements for an exception from
such excise tax were satisfied operated as a trap for the
unwary. The Congress further understood that the special source
rule of prior law for deemed royalty payments with respect to a
transfer of an appreciated intangible to a foreign corporation
was intended to discourage such transfers. The Congress
believed that the imposition of enhanced information reporting
obligations with respect to both foreign partnerships and
foreign corporations would eliminate the need for both of these
sets of rules.
Explanation of Provision
The Act repealed the sections 1491-1494 excise tax and
information reporting rules that applied to certain transfers
of appreciated property by a U.S. person to a foreign entity.
Instead of the excise tax that applied under prior law to
transfers to a foreign estate or trust, gain recognition is
required upon a transfer of appreciated property by a U.S.
person to a foreign estate or trust, except as provided in
regulations. This rule does not apply to a transfer to a trust
to the extent that any person is treated as the owner of the
trust under section 679. For purposes of this recognition
provision, a U.S. trust that becomes a foreign trust is treated
as having transferred all of its assets to a foreign trust.
Instead of the excise tax that applied under prior law to a
transfer by a U.S. person to a foreign corporation as paid-in
surplus or as a contribution to capital in a transaction not
otherwise described in section 367 (e.g., a capital
contribution by a non-shareholder), regulatory authority is
granted under section 367 to treat such transfer as a fair
market value sale and to require gain recognition thereon.
Instead of the excise tax that applied under prior law to
transfers to foreign partnerships, regulatory authority is
granted to provide for gain recognition on a transfer of
appreciated property to a partnership in cases where such gain
otherwise would be transferred to a foreign partner. In
addition, regulatory authority is granted to deny the
nonrecognition treatment that is provided under section 1035 to
certain exchanges of insurance policies, where the transfer is
to a foreign person.
The Act repealed the rule that treated as U.S. source
income any deemed royalty arising under section 367(d). Under
the Act, in the case of a transfer of intangible property to a
foreign corporation, the deemed royalty payments under section
367(d) are treated as foreign source income to the same extent
that an actual royalty payment would be considered to be
foreign source income. Regulatory authority is granted to
provide similar treatment in the case of a transfer of
intangible property to a partnership.
The Act provides detailed information reporting rules in
the case of foreign partnerships. Under the Act, a foreign
partnership generally is required to file a partnership return
for a taxable year if the partnership has U.S. source income or
is engaged in a U.S. trade or business, except to the extent
provided in regulations. Regulatory authority is granted to
provide simplified filing procedures for foreign partnerships
required to file under this rule.
Under the Act, reporting rules similar to those applicable
in the case of controlled foreign corporations apply in the
case of foreign partnerships. A U.S. partner that controls a
foreign partnership is required to file an annual information
return with respect to such partnership. For this purpose, a
U.S. partner is considered to control a foreign partnership if
the partner holds more than a 50 percent interest in the
capital, profits, or, to the extent provided in regulations,
losses, of the partnership; a partner's interest in a
partnership is determined with application of constructive
ownership rules similar to those provided in section 267(c)
(other than paragraph (3)). Similar information reporting also
will be required from a U.S. 10-percent partner of a foreign
partnership that is controlled by U.S. 10-percent partners. A
$10,000 penalty applies to a failure to comply with these
reporting requirements; additional penalties of up to $50,000
apply in the case of continued noncompliance after notification
by the Secretary of the Treasury. Under the Act, the penalties
for failure to report information with respect to a controlled
foreign corporation are conformed with these penalties. Where
under these rules more than one U.S. person would be required
to file an information return with respect to the same foreign
entity, the Secretary of the Treasury may by regulations
provide that such information is required only from one person.
Under the Act, reporting by a U.S. person of an acquisition
or disposition of an interest in a foreign partnership, or a
change in the person's proportional interest in the
partnership, is required only in the case of acquisitions,
dispositions, or changes involving at least a 10-percent
interest. A $10,000 penalty applies to a failure to comply with
these reporting requirements; additional penalties of up to
$50,000 apply in the case of continued noncompliance after
notification by the Secretary. Under the Act, the penalties for
failure to report information with respect to an interest in a
foreign corporation are conformed with these penalties.
Under the Act, reporting rules similar to those applicable
in the case of transfers by U.S. persons to foreign
corporations apply in the case of transfers to foreign
partnerships. These reporting rules apply in the case of a
transfer to a foreign partnership only if the U.S. person holds
at least a 10-percent interest in the partnership or the value
of the property transferred by such person to the partnership
during a 12-month period exceeded $100,000. A penalty equal to
10 percent of the value of the property transferred applies to
a failure to comply with these reporting requirements. However,
this penalty is subject to a cap of $100,000 except in cases
where the failure to comply with the reporting requirements is
due to intentional disregard. Under the Act, the penalty for
failure to report transfers to a foreign corporation is
conformed with this penalty. In the case of a transfer to a
foreign partnership, failure to comply also results in gain
recognition with respect to the property transferred.
Under the Act, in the case of a failure to report required
information with respect to a foreign corporation, partnership,
or trust, the statute of limitations with respect to any event
or period, as the case may be, to which such information
relates does not expire before the date that is three years
after the date on which such information is provided.
Under the Act, regulatory authority is granted to provide
rules treating a partnership as a domestic or foreign
partnership, where such treatment is more appropriate, without
regard to where the partnership is created or organized.
Regulations issued under this grant of regulatory authority
generally will apply only to partnerships created or organized
after the date such regulations are filed with the Federal
Register (or, if earlier, the date of a public notice
substantially describing the expected contents of the
regulations). Section 7805(b)(2), which allows regulations to
have retroactive effect if issued within eighteen months of
enactment of the relevant statutory provision, is not
applicable in this case. Accordingly, regulations issued under
this grant of regulatory authority generally will not be
applied to reclassify pre-existing partnerships. The Congress
intended that the general rule for classifying a partnership as
domestic or foreign will continue to be the place where the
partnership is created or organized (or the laws under which it
is created or organized), and that the regulations will provide
a different classification result only in unusual cases. The
Congress also expected that any regulations will avoid period-
by-period reclassifications of partnerships. It is expected
that a recharacterization of a partnership under such
regulations will be based only on material factors such as the
residence of the partners and the extent to which the
partnership is engaged in business in the United States or
earns U.S. source income. It also is expected that such
regulations will provide guidance regarding the determination
of whether an entity that is a partnership for Federal income
tax purposes is to be considered to be created or organized in
the United States or under the law of the United States or any
State.
Effective Date
The provisions with respect to the repeal of sections 1491-
1494 were effective on the date of enactment (August 5, 1997).
The provisions with respect to the source of a deemed royalty
under section 367(d) are effective both for transfers made, and
for royalties deemed received, on or after the date of
enactment.
The provisions regarding information reporting with respect
to foreign partnerships generally are effective for partnership
taxable years beginning after the date of enactment. The
provisions regarding information reporting with respect to
interests in, and transfers to, foreign partnerships are
effective for transfers to, and changes in interests in,
foreign partnerships after the date of enactment. Taxpayers may
elect to apply these rules to transfers made after August 20,
1996 (and thereby avoid a penalty under section 1494(c)) and
the Secretary may prescribe simplified reporting requirements
for these cases. The provision with respect to the statute of
limitations in the case of noncompliance with reporting
requirements is effective for information returns due after the
date of enactment.
Regulations issued under the provision granting regulatory
authority with respect to the treatment of partnerships as
foreign or domestic will apply only to partnerships created or
organized after the date such regulations are filed with the
Federal Register or described in a public notice.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $500,000 in 1998, less than
$500,000 in 1999, $1 million in 2000, $1 million in 2001, $1
million in 2002, $1 million in 2003, $1 million in 2004, $1
million in 2005, $1 million in 2006, and $2 million in 2007.
E. Modification of Reporting Threshold for Stock Ownership
of a Foreign Corporation (sec. 1146 of the Act and
sec. 6046 of the Code)
Present and Prior Law
Several provisions of the Code require U.S. persons to
report information with respect to a foreign corporation in
which they are shareholders or officers or directors. Sections
6038 and 6035 generally require every U.S. citizen or resident
who is an officer or director, or who owns at least 10 percent
of the stock, of a foreign corporation that is a controlled
foreign corporation or a foreign personal holding company to
file Form 5471 annually.
Section 6046 mandates the filing of information returns by
certain U.S. persons with respect to a foreign corporation upon
the occurrence of certain events. Under prior law, the U.S.
persons required to file these information returns were those
who acquired 5 percent or more of the value of the stock of a
foreign corporation, others who became U.S. persons while
owning that percentage of the stock of a foreign corporation,
and U.S. citizens and residents who were officers or directors
of foreign corporations with such U.S. ownership.
A failure to file the required information return under
section 6038 may result in monetary penalties or reduction of
foreign tax credit benefits. A failure to file the required
information returns under sections 6035 or 6046 may result in
monetary penalties.
Reasons for Change
The Congress believed it appropriate to make the stock
ownership threshold at which reporting with respect to an
ownership interest in a foreign corporation is required
generally parallel to the thresholds that apply in the case of
other annual information reporting with respect to foreign
corporations. The Congress believed that increasing the
threshold for such reporting from 5 percent to 10 percent will
reduce the compliance burdens on taxpayers.
Explanation of Provision
The Act increases the threshold for stock ownership of a
foreign corporation that results in information reporting
obligations under section 6046 from 5 percent (based on value)
to 10 percent (based on vote or value).
Effective Date
The provision is effective for reportable transactions
occurring after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $1 million in 1998, $1 million in
1999, $2 million per year in each of 2000 through 2004, and $3
million per year in each of 2005 through 2007.
F. Other Foreign Simplification Provisions
1. Transition rule for certain trusts (sec. 1161 of the Act and sec.
7701(a)(30) of the Code)
Present and Prior Law
Under rules enacted pursuant to the Small Business Job
Protection Act of 1996, a trust is considered to be a U.S.
trust if two criteria are met. First, a court within the United
States must be able to exercise primary supervision over the
administration of the trust. Second, U.S. persons must have the
authority to control all substantial decisions of the trust. A
trust that does not satisfy both of these criteria is
considered to be a foreign trust. These rules for defining a
U.S. trust generally are effective for taxable years of a trust
that begin after December 31, 1996. A trust that qualified as a
U.S. trust under prior law could fail to qualify as a U.S.
trust under these new criteria.
Reasons for Change
The change in the criteria for qualification as a U.S.
trust could cause large numbers of existing domestic trusts to
become foreign trusts, unless they are able to make the
modifications necessary to satisfy the new criteria. The
Congress believed that an election is appropriate for those
existing domestic trusts that prefer to continue to be subject
to tax as U.S. trusts.
Explanation of Provision
Under the Act, the Secretary of the Treasury is granted
authority to allow nongrantor trusts that had been treated as
U.S. trusts under prior law to elect to continue to be treated
as U.S. trusts, notwithstanding the new criteria for
qualification as a U.S. trust.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1996.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $1 million in 1998, $3 million in 1999, and
$5 million per year in each of 2000 through 2007.
2. Simplify stock and securities trading safe harbor (sec. 1162 of the
Act and sec. 864(b)(2)(A) of the Code)
Present and Prior Law
A nonresident alien individual or foreign corporation that
is engaged in a trade or business within the United States is
subject to U.S. taxation at graduated rates on its net income
that is effectively connected with the trade or business. Under
a ``safe harbor'' rule, foreign persons that trade in stocks or
securities for their own accounts are not treated as engaged in
a U.S. trade or business for this purpose.
For a foreign corporation to qualify for the safe harbor,
it must not be a dealer in stocks or securities. In addition,
under prior law, if the principal business of the foreign
corporation was trading in stocks or securities for its own
account, the safe harbor generally did not apply if the
principal office of the corporation was in the United States.
For foreign persons who invest in securities trading
partnerships, the safe harbor applies only if the partnership
is not a dealer in stocks and securities. In addition, under
prior law, if the principal business of the partnership was
trading in stocks or securities for its own account, the safe
harbor generally did not apply if the principal office of the
partnership was in the United States.
Under Treasury regulations which apply to both corporations
and partnerships, the determination of the location of the
entity's principal office turns on the location of various
functions relating to the operation of the entity, including
communication with investors and the general public,
solicitation and acceptance of sales of interests, and
maintenance and audits of its books of account (Treas. reg.
sec. 1.864-2(c)(2)(ii) and (iii)). Under the regulations, the
location of the entity's principal office does not depend on
the location of the entity's management or where investment
decisions are made.
Reasons for Change
The Congress believed that the foreign principal office
requirement did not promote any important tax policy and had
been easily circumvented. The stock and securities trading safe
harbor serves to promote foreign investment in U.S. capital
markets. The Congress believed that the elimination of the
principal office rule would facilitate foreign investment in
U.S. markets. In this regard, the Congress noted that, because
the location of a partnership's or foreign corporation's
principal office was determined by the location of certain
administrative functions rather than the location of management
and investment decisions, the requirement of a foreign
principal office was met even if only administrative functions
were performed abroad.
Explanation of Provision
The Act modifies the stock and securities trading safe
harbor by eliminating the requirement for both partnerships and
foreign corporations that trade stocks or securities for their
own accounts that the entity's principal office not be within
the United States.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $500,000 per year in each of 1998
through 2007.
3. Clarification of determination of foreign taxes deemed paid (sec.
1163(a) of the Act and sec. 902 of the Code)
Present and Prior Law
Under section 902, a domestic corporation that receives a
dividend from a foreign corporation in which it owns 10 percent
or more of the voting stock is deemed to have paid a portion of
the foreign taxes paid by such foreign corporation. The
domestic corporation that receives a dividend is deemed to have
paid a portion of the foreign corporation's post-1986 foreign
income taxes based on the ratio of the amount of such dividend
to the foreign corporation's post-1986 undistributed earnings.
The foreign corporation's post-1986 foreign income taxes is the
sum of the foreign income taxes with respect to the taxable
year in which the dividend is distributed plus certain foreign
income taxes with respect to prior taxable years (beginning
after December 31, 1986).
Reasons for Change
The Congress believed it appropriate to clarify the
determination of foreign taxes deemed paid for purposes of the
indirect foreign tax credit.
Explanation of Provision
The Act clarifies that, for purposes of the deemed paid
credit under section 902 for a taxable year, a foreign
corporation's post-1986 foreign income taxes includes foreign
income taxes with respect to prior taxable years (beginning
after December 31, 1986) only to the extent such taxes are not
attributable to dividends distributed by the foreign
corporation in prior taxable years. No inference is intended
regarding the determination of foreign taxes deemed paid under
prior law.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $500,000 per year in each of the
years 1998 through 2007.
4. Clarification of foreign tax credit limitation for financial
services income (sec. 1163(b) of the Act and sec. 904 of the
Code)
Present Law
Under section 904, separate foreign tax credit limitations
apply to various categories of income. Two of these separate
limitation categories are passive income and financial services
income. For purposes of the separate foreign tax credit
limitation applicable to passive income, certain income that is
treated as high-taxed income is excluded from the definition of
passive income. For purposes of the separate foreign tax credit
limitation applicable to financial services income, the
definition of financial services income generally incorporates
passive income as defined for purposes of the separate
limitation applicable to passive income.
Reasons for Change
The Congress believed it appropriate to clarify that high-
taxed income is not excluded from the separate foreign tax
credit limitation for financial services income.
Explanation of Provision
The Act clarifies that the exclusion of income that is
treated as high-taxed income does not apply for purposes of the
separate foreign tax credit limitation applicable to financial
services income. No inference is intended regarding the
treatment of high-taxed income for purposes of the separate
foreign tax credit limitation applicable to financial services
income under prior law.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $500,000 in each of the years 1998
through 2007.
G. Other Foreign Provisions
1. Eligibility of licenses of computer software for foreign sales
corporation benefits (sec. 1171 of the Act and sec. 927 of the
Code)
Present and Prior Law
Under special tax provisions that provide an export
benefit, a portion of the foreign trade income of an eligible
foreign sales corporation (``FSC'') is exempt from Federal
income tax. Foreign trade income is defined as the gross income
of a FSC that is attributable to foreign trading gross
receipts. The term ``foreign trading gross receipts'' includes
the gross receipts of a FSC from the sale, lease, or rental of
export property and from services related and subsidiary to
such sales, leases, or rentals.
For purposes of the FSC rules, export property is defined
as property (1) which is manufactured, produced, grown, or
extracted in the United States by a person other than a FSC;
(2) which is held primarily for sale, lease, or rental in the
ordinary conduct of a trade or business by or to a FSC for
direct use, consumption, or disposition outside the United
States; and (3) not more than 50 percent of the fair market
value of which is attributable to articles imported into the
United States. Intangible property generally is excluded from
the definition of export property for purposes of the FSC
rules; this exclusion applies to copyrights other than films,
tapes, records, or similar reproductions for commercial or home
use. The temporary Treasury regulations provide that a license
of a master recording tape for reproduction outside the United
States is not excluded from the definition of export property
(Temp. Treas. Reg. sec. 1.927(a)-1T(f)(3)). Under prior law,
the statutory exclusion for intangible property did not contain
any specific reference to computer software. However, the
temporary Treasury regulations provided that a copyright on
computer software did not constitute export property, and that
standardized, mass marketed computer software constitutes
export property if such software is not accompanied by a right
to reproduce for external use (Temp. Treas. Reg. sec. 1.927(a)-
1T(f)(3)).
Reasons for Change
For purposes of the FSC provisions, films, tapes, records
and similar reproductions explicitly were included within the
definition of export property. In light of technological
developments, the Congress believed that computer software is
virtually indistinguishable from the enumerated films, tapes,
and records. Accordingly, the Congress believed that the
benefits of the FSC provisions similarly should be available to
computer software.
Explanation of Provision
The Act provides that computer software licensed for
reproduction abroad is not excluded from the definition of
export property for purposes of the FSC provisions.
Accordingly, computer software that is exported with a right to
reproduce is eligible for the benefits of the FSC provisions.
In light of the rapid innovations in the computer and software
industries, the Congress intended that the term ``computer
software'' be construed broadly to accommodate technological
changes in the products produced by both industries. No
inference is intended regarding the qualification as export
property of computer software licensed for reproduction abroad
under prior law.
Effective Date
The provision applies to gross receipts from computer
software licenses attributable to periods after December 31,
1997. Accordingly, in the case of a multi-year license, the
provision applies to gross receipts attributable to the period
of such license that is after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $27 million in 1998, $42 million in 1999,
$146 million in 2000, $173 million in 2001, $180 million in
2002, $191 million in 2003, $202 million in 2004, $227 million
in 2005, $252 million in 2006, and $277 million in 2007.
2. Increase dollar limitation on section 911 exclusion (sec. 1172 of
the Act and sec. 911 of the Code)
Present and Prior Law
U.S. citizens generally are subject to U.S. income tax on
all their income, whether derived in the United States or
elsewhere. A U.S. citizen who earns income in a foreign country
also may be taxed on such income by that foreign country. A
credit against the U.S. income tax imposed on foreign source
income is allowed for foreign taxes paid on such income.
U.S. citizens living abroad may be eligible to exclude from
their income for U.S. tax purposes certain foreign earned
income and foreign housing costs. In order to qualify for these
exclusions, a U.S. citizen must be either (1) a bona fide
resident of a foreign country or countries for an uninterrupted
period that includes an entire taxable year or (2) present in a
foreign country or countries for 330 days out of any 12
consecutive month period. In addition, the taxpayer must have
his or her tax home in a foreign country.
The exclusion for foreign earned income generally applies
to income earned from sources outside the United States as
compensation for personal services actually rendered by the
taxpayer. Under prior law, the maximum exclusion for foreign
earned income for a taxable year was $70,000.
The exclusion for housing costs applies to reasonable
expenses, other than deductible interest and taxes, paid or
incurred by or on behalf of the taxpayer for housing for the
taxpayer and his or her spouse and dependents in a foreign
country. The exclusion amount for housing costs for a taxable
year is equal to the excess of such housing costs for the
taxable year over an amount computed pursuant to a specified
formula.
The combined earned income exclusion and housing cost
exclusion may not exceed the taxpayer's total foreign earned
income. The taxpayer's foreign tax credit is reduced by the
amount of the credit that is attributable to excluded income.
Reasons for Change
The Congress recognized that for U.S. businesses to be
effective competitors overseas it is necessary to dispatch U.S.
citizens or residents to sites of foreign operations. Being
stationed abroad typically imposes additional financial burdens
on the employee and his or her family. These burdens may arise
from maintaining two homes (one in the United States and one
abroad), additional personal travel to maintain family ties, or
the added expenses of living in a foreign location that has a
high cost of living. Businesses often remunerate their
employees for these additional burdens by paying higher wages.
Because the increased remuneration is offset by larger burdens,
the remuneration does not truly reflect an increase in economic
well being. The Congress, therefore, believed that the
exclusion of section 911 is a simple way to prevent taxpayers
from facing an increased tax burden when there has been no
increase in economic well being by accepting an overseas
assignment.
The Congress further observed that the prior-law $70,000
exclusion remained unchanged for the past 10 years, while the
extra costs from working abroad have increased with worldwide
inflation. The Congress, therefore, believed it appropriate to
increase the exclusion permitted under section 911. In
addition, as a rough measure for the increased burden that may
be expected to arise from future inflation, the Congress
believed it appropriate to index the level of the section 911
exclusion amount to future changes in the domestic cost of
living.
Explanation of Provision
Under the Act, the $70,000 limitation on the exclusion for
foreign earned income is increased to $80,000, in increments of
$2,000 each year beginning in 1998. Under the Act, the
limitation on the exclusion for foreign earned income then is
indexed for inflation beginning in 2008 (for inflation after
2006).
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $15 million in 1998, $30 million in 1999,
$50 million in 2000, $67 million in 2001, $82 million in 2002,
$97 million in 2003, $103 million in 2004, $111 million in
2005, $119 million in 2006, and $127 million in 2007.
3. Treatment of certain securities positions under the subpart F
investment in U.S. property rules (sec. 1173 of the Act and
sec. 956 of the Code)
Present and Prior Law
Under the rules of subpart F (secs. 951-964), the U.S. 10-
percent shareholders of a controlled foreign corporation (CFC)
are required to include in income currently for U.S. tax
purposes certain earnings of the CFC, whether or not such
earnings are distributed currently to the shareholders. The
U.S. 10-percent shareholders of a CFC are subject to current
U.S. tax on their shares of certain income earned by the CFC
(referred to as ``subpart F income''). The U.S. 10-percent
shareholders also are subject to current U.S. tax on their
shares of the CFC's earnings to the extent invested by the CFC
in certain U.S. property.
A shareholder's current income inclusion with respect to a
CFC's investment in U.S. property for a taxable year is based
on the CFC's average investment in U.S. property for such year.
For this purpose, the U.S. property held by the CFC must be
measured as of the close of each quarter in the taxable year.
U.S. property generally is defined to include tangible property
located in the United States, stock of a U.S. corporation,
obligations of a U.S. person, and the right to use certain
intellectual property in the United States. Exceptions are
provided for, among other things, obligations of the United
States, U.S. bank deposits, certain trade or business
obligations, and stock or debts of certain unrelated U.S.
corporations. For purposes of these rules, the term
``obligation'' generally includes any bond, note, debenture,
certificate, bill receivable, note receivable, open account, or
other indebtedness, whether or not issued at a discount and
whether or not bearing interest. Temp. Treas. Reg. section
1.956-2T(d)(2).
Reasons for Change
The Congress believed that guidance is needed regarding the
treatment of certain transactions entered into by securities
dealers in the ordinary course of business under the investment
in U.S. property provisions of subpart F. The Congress believed
that deposits of collateral or margin in the ordinary course of
business should not give rise to an income inclusion as an
investment in U.S. property under the provisions of subpart F.
Similarly, the Congress believed that repurchase agreements
entered into in the ordinary course of business should not give
rise to an income inclusion as an investment in U.S. property.
Explanation of Provision
The Act provides two additional exceptions from the
definition of U.S. property for purposes of the subpart F
rules. Both exceptions relate to transactions entered into by a
securities or commodities dealer in the ordinary course of its
business as a securities or commodities dealer.
The first exception covers the deposit of collateral or
margin by a securities or commodities dealer, or the receipt of
such a deposit by a dealer in securities or commodities, if
such deposit is made or received on commercial terms in the
ordinary course of the dealer's business as a securities or
commodities dealer. This exception applies to deposits of
margin or collateral for securities loans, notional principal
contracts, options contracts, forward contracts, futures
contracts, and any other financial transaction with respect to
which the Secretary of the Treasury determines that the posting
of collateral or margin is customary.
The second exception covers repurchase agreement
transactions and reverse repurchase agreement transactions
entered into by or with a dealer in securities or commodities
in the ordinary course of its business as a securities or
commodities dealer. The exception applies only to the extent
that the obligation under the transaction does not exceed the
fair market value of readily marketable securities transferred
or otherwise posted as collateral.
For purposes of these two additional exceptions under
section 956, the term ``dealer in securities'' has the meaning
provided under section 475 and the term ``dealer in
commodities'' means futures commission merchants and dealers in
commodities within the meaning of the new definition that is
added to section 475 by the Act. No inference is intended
regarding the treatment of these transactions under prior law.
In addition, the addition of these two exceptions under section
956 is not intended to create any inference regarding the
treatment of an obligation of a U.S. person to return stock
that is borrowed pursuant to a securities loan.
Effective Date
The provision is effective for taxable years of foreign
corporations beginning after December 31, 1997, and taxable
years of U.S. shareholders with or within which such taxable
years of foreign corporations end.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $1 million in 1998 and by $2 million per
year in each of the years 1999 through 2007.
4. Treat service income of nonresident alien individuals earned on
foreign ships as foreign source income and disregard the U.S.
presence of such individuals (sec. 1174 of the Act and secs.
861, 863, 872, 3401, and 7701 of the Code)
Present and Prior Law
Nonresident alien individuals generally are subject to U.S.
taxation and withholding on their U.S. source income.
Compensation for labor and personal services performed within
the United States was considered U.S. source unless such income
qualified for a de minimis exception. To qualify for the
exception, the compensation paid to a nonresident alien
individual must not exceed $3,000, the compensation must
reflect services performed on behalf of a foreign employer, and
the individual must be present in the United Sates for not more
than 90 days during the taxable year. Special rules apply to
exclude certain items from the gross income of a nonresident
alien. An exclusion applies to gross income derived by a
nonresident alien individual from the international operation
of a ship if the country in which such individual is resident
provides a reciprocal exemption for U.S. residents. However,
this exclusion does not apply to income from personal services
performed by an individual crew member on board a ship.
Consequently, under prior law, wages exceeding $3,000 in a
taxable year that were earned by nonresident alien individual
crew members of a foreign ship while the vessel was within U.S.
territory were subject to income taxation by the United States.
U.S. residents are subject to U.S. tax on their worldwide
income. In general, a non-U.S. citizen is considered to be a
resident of the United States if the individual (1) has entered
the United States as a lawful permanent U.S. resident or (2) is
present in the United States for 31 or more days during the
current calendar year and has been present in the United States
for a substantial period of time--183 or more days--during a
three-year period computed by weighting toward the present year
(the ``substantial presence test''). An individual generally is
treated as present in the United States on any day if such
individual is physically present in the United States at any
time during the day. Certain categories of individuals (e.g.,
foreign government employees and certain students) are not
treated as U.S. residents even if they are present in the
United States for the requisite period of time. Under prior
law, crew members of a foreign vessel who were on board the
vessel while it was stationed within U.S. territorial waters
were treated as present in the United States.
Reasons for Change
The Congress understood that U.S. tax rules impose a
significant compliance burden on nonresident alien individuals
who are present in the United States for short periods of time
as members of the regular crew of a foreign vessel and who may
not be permitted to leave such vessel during those periods. The
Congress believed that an exemption from U.S. tax is
appropriate for the income earned by a nonresident alien
individual from personal services performed as a member of the
regular crew of a foreign vessel. Moreover, the Congress
believed that such an individual's presence in the United
States as a regular crew member of a foreign vessel should not
be taken into account for purposes of determining whether the
individual is treated as a resident alien for U.S. tax
purposes.
Explanation of Provision
The Act treats gross income of a nonresident alien
individual, who is present in the United States as a member of
the regular crew of a foreign vessel, from the performance of
personal services in connection with the international
operation of a ship as income from foreign sources. Thus, such
income is exempt from U.S. income and withholding tax. However,
the treatment of income of a nonresident alien crew member of a
foreign vessel as foreign source income will not apply for
purposes of the pension rules and certain employee benefit
provisions. In addition, for purposes of determining whether an
individual is a U.S. resident under the substantial presence
test, the Act provides that any day that such individual is
present as a member of the regular crew of a foreign vessel is
disregarded if the individual does not otherwise engage in
trade or business within the United States on such day.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $2 million in 1998, $4 million in 1999, and
$3 million per year in each of 2000 through 2007.
5. Exceptions under subpart F for active financing income (sec. 1175 of
the Act (canceled pursuant to Line Item Veto Act) and sec. 954
of the Code)
Present and Prior Law
Under the subpart F rules, certain U.S. shareholders of a
controlled foreign corporation (``CFC'') are subject to U.S.
tax currently on certain income earned by the CFC, whether or
not such income is distributed to the shareholders. The income
subject to current inclusion under the subpart F rules
includes, among other things, ``foreign personal holding
company income'' and insurance income. The U.S. 10-percent
shareholders of a CFC also are subject to current inclusion
with respect to their shares of the CFC's foreign base company
services income (i.e., income derived from services performed
for a related person outside the country in which the CFC is
organized).
Foreign personal holding company income generally consisted
of the following: dividends, interest, royalties, rents and
annuities; net gains from sales or exchanges of (1) property
that gives rise to the preceding types of income, (2) property
that does not give rise to income, and (3) interests in trusts,
partnerships, and REMICs; net gains from commodities
transactions; net gains from foreign currency transactions; and
income that is equivalent to interest. The Act added two
additional categories of foreign personal holding company
income: income from notional principal contracts and payments
in lieu of dividends.
Insurance income subject to current inclusion under the
subpart F rules includes any income of a CFC attributable to
the issuing or reinsuring of any insurance or annuity contract
in connection with risks located in a country other than the
CFC's country of organization. Subpart F insurance income also
includes income attributable to an insurance contract in
connection with risks located within the CFC's country of
organization, as the result of an arrangement under which
another corporation receives a substantially equal amount of
consideration for insurance of other-country risks. Investment
income of a CFC that is allocable to any insurance or annuity
contract related to risks located outside the CFC's country of
organization is taxable as subpart F insurance income (Prop.
Treas. reg. sec. 1.953-1(a)). Investment income allocable to
risks located within the CFC's country of organization
generally is taxable as foreign personal holding company
income.
Special rules apply with respect to certain captive
insurance companies. The definition of CFC and the application
of the current inclusion rules to U.S. shareholders are
broadened in the case of such a captive.
Reasons for Change
The subpart F rules historically have been aimed at
requiring current inclusion by the U.S. shareholders of income
of a CFC that is either passive or easily moveable. Prior to
the enactment of the 1986 Act, exceptions from foreign personal
holding company income were provided for income derived in the
conduct of a banking, financing, or similar business or derived
from certain investments made by an insurance company. The
Congress was concerned that the 1986 Act's repeal of these
exceptions resulted in the extension of the subpart F
provisions to income that is neither passive nor easily
moveable. The Congress believed that the provision of
exceptions from foreign personal holding company income for
income from the active conduct of an insurance, banking,
financing or similar business is appropriate.
Explanation of Canceled Provision
Under the Act, a temporary exception from foreign personal
holding company income would have applied to income that is
derived in the active conduct of a banking, financing or
similar business by a CFC that is predominantly engaged in the
active conduct of such business. For this purpose, income
derived in the active conduct of a banking, financing, or
similar business generally would have been determined under the
principles applicable in determining financial services income
for foreign tax credit limitation purposes. However, in the
case of a corporation that is engaged in the active conduct of
a banking or securities business, the income that is eligible
for this exception would have been determined under the
principles applicable in determining the income which is
treated as nonpassive income for purposes of the passive
foreign investment company provisions. The Congress generally
intended that the income of a corporation engaged in the active
conduct of a banking or securities business that would have
been eligible for this exception would have been the income
that is treated as nonpassive under the regulations proposed
under prior law section 1296(b). See Prop. Treas. Reg. secs.
1.1296-4 and 1.1296-6. In this regard, the Congress intended
that eligible income would have included income or gains with
respect to foreclosed property which is incident to the active
conduct of a banking business. The Act would have directed the
Secretary of the Treasury to prescribe regulations applying
look-through treatment in characterizing for this purpose
dividends, interest, income equivalent to interest, rents, and
royalties from related persons.
For purposes of the temporary exception, a corporation
would have been considered to be predominantly engaged in the
active conduct of a banking, financing, or similar business if
it is engaged in the active conduct of a banking or securities
business or is a qualified bank affiliate or qualified
securities affiliate. In this regard, the Congress intended
that a corporation would have been considered to be engaged in
the active conduct of a banking or securities business if the
corporation would be treated as so engaged under the
regulations proposed under prior law section 1296(b); the
Congress further intended that qualified bank affiliates and
qualified securities affiliates would have been as determined
under such proposed regulations. See Prop. Treas. Reg. secs.
1.1296-4 and 1.1296-6.
Alternatively, a corporation would have been considered to
be engaged in the active conduct of a banking, financing or
similar business if more than 70 percent of its gross income is
derived from such business from transactions with unrelated
persons located within the country under the laws of which the
corporation is created or organized. For this purpose, income
derived by a qualified business unit of a corporation from
transactions with unrelated persons located in the country in
which the qualified business unit maintains its principal
office and conducts substantial business activity would have
been treated as derived by the corporation from transactions
with unrelated persons located within the country in which the
corporation is created or organized. A person other than a
natural person would have been considered to be located within
the country in which it maintains an office through which it
engages in a trade or business and by which the transaction is
effected. A natural person would have been treated as located
within the country in which such person is physically located
when such person enters into the transaction.
The Act would have provided a temporary exception from
foreign personal holding company income for certain investment
income of a qualifying insurance company with respect to risks
located within the CFC's country of creation or organization.
The rules of this provision of the Act differ from the rules of
present-law section 953 of the Code, which determines the
subpart F inclusions of a U.S. shareholder relating to
insurance income of a CFC. Such insurance income under section
953 generally is computed in accordance with the rules of
subchapter L of the Code. The Congress believed that review of
the rules of this provision would be appropriate when final
guidance under section 953 is published by the Treasury
Department.
The Act would have provided a temporary exception for
income (received from a person other than a related person)
from investments made by a qualifying insurance company of its
reserves or 80 percent of its unearned premiums (as defined for
purposes of the provision). For this purpose, in the case of
contracts regulated in the country in which sold as property,
casualty, or health insurance contracts, unearned premiums and
reserves would havebeen defined as unearned premiums and
reserves for losses incurred determined using the methods and interest
rates that would be used if the qualifying insurance company were
subject to tax under subchapter L of the Code. Thus, for this purpose,
unearned premiums would have been determined in accordance with section
832(b)(4), and reserves for losses incurred would have been determined
in accordance with section 832(b)(5) and 846 of the Code (as well as
any other rules applicable to a U.S. property and casualty insurance
company with respect to such amounts).
In the case of a contract regulated in the country in which
sold as a life insurance or annuity contract, the following
three alternative rules for determining reserves would have
been provided under the Act. The Congress intended that any one
of the three rules could have been elected with respect to a
particular line of business.
First, reserves for such contracts could have been
determined generally under the rules applicable to domestic
life insurance companies under subchapter L of the Code, using
the methods there specified, but substituting for the interest
rates in Code section 807(d)(2)(B) an interest rate determined
for the country in which the qualifying insurance company was
created or organized, calculated in the same manner as the mid-
term applicable Federal interest rate (``AFR'') (within the
meaning of section 1274(d)).
Second, the reserves for such contracts could have been
determined generally using a preliminary term foreign reserve
method, except that the interest rate to be used would be the
interest rate determined for the country in which the
qualifying insurance company was created or organized,
calculated in the same manner as the mid-term AFR. If a
qualifying insurance company uses such a preliminary term
method with respect to contracts insuring risks located in the
country in which the company is created or organized, then such
method would have been the method that applies for purposes of
this election.
Third, reserves for such contracts could have been
determined to be equal to the net surrender value of the
contract (as defined in section 807(e)(1)(A)).
In no event could the reserve for any contract at any time
have exceeded the foreign statement reserve for the contract,
reduced by any catastrophe or deficiency reserve. This rule
would have applied, whether the contract is regulated as a
property, casualty, health, life insurance, annuity, or any
other type of contract.
The Act also would have provided a temporary exception for
income from investment of assets equal to (1) one-third of
premiums earned during the taxable year on insurance contracts
regulated in the country in which sold as property, casualty,
or health insurance contacts, and (2) the greater of 10 percent
of reserves, or, in the case of a qualifying insurance company
that is a startup company, $10 million. For this purpose, a
startup company would have been a company (including any
predecessor) that has not been engaged in the active conduct of
an insurance business for more than 5 years. The Congress
intended that the 5-year period would have commenced when the
foreign company first is engaged in the active conduct of an
insurance business. If the foreign company was formed before
being acquired by the U.S. shareholder, the 5-year period would
have commenced when the acquired company first was engaged in
the active conduct of an insurance business. The Congress
intended that in the event of the acquisition of a book of
business from another company through an assumption or
indemnity reinsurance transaction, the period would have
commenced when the acquiring company first engaged in the
active conduct of an insurance business, except that if more
than a substantial part (e.g., 80 percent) of the business of
the ceding company is acquired, then the 5-year period would
have commenced when the ceding company first engaged in the
active conduct of an insurance business. In addition, the
Congress did not intend that reinsurance transactions among
related persons be used to multiply the number of 5-year
periods.
To prevent the shifting of relatively high-yielding assets
to generate investment income that qualifies under this
temporary exception, the Act would have provided that, under
rules prescribed by the Secretary, income is allocated to
contracts as follows. In the case of contracts that are
separate-account-type contracts (including variable contracts
not meeting the requirements of sec. 817), only the income
specifically allocable to such contracts would have been taken
into account. In the case of other contracts, income not
specifically allocable would have been allocated ratably among
such contracts.
Under the Act, a qualifying insurance company would have
been defined as any entity which: (1) is regulated as an
insurance company under the laws of the country in which it is
incorporated; (2) derives at least 50 percent of its net
written premiums from the insurance or reinsurance of risks
situated within its country of incorporation; and (3) is
engaged in the active conduct of an insurance business and
would be subject to tax under subchapter L if it were a
domestic corporation.
The Act would have provided that this provision does not
apply to investment income (includable in the income of a U.S.
shareholder of a CFC pursuant to section 953) allocable to
contracts that insure related party risks or risks located in a
country other than the country in which the qualifying
insurance company is created or organized.
The Act would have provided an anti-abuse rule applicable
for purposes of these temporary exceptions. For purposes of
applying these exceptions, items with respect to a transaction
or series of transactions would have been disregarded if one of
the principal purposes of the transaction or transactions is to
qualify income or gain for these exceptions, including any
change in the method of computing reserves or any other
transaction or transactions one of the principal purposes of
which is the acceleration or deferral of any item in order to
claim the benefits of these exceptions.
The Act also would have provided an exception from foreign
base company services income for income derived from services
performed in connection with the active conduct of a banking,
financing, insurance or similar business by a CFC that is
predominantly engaged in the active conduct of such business or
is a qualifying insurance company.
The Congress recognized that insurance, banking, financing,
and similar businesses are businesses the active conduct of
which involves the generation of income, such as interest and
dividends, of a type that generally is treated as passive for
purposes of subpart F. For purposes of this temporary
provision, the Congress intended to delineate the income
derived in the active conduct of such businesses, while
retaining the anti-deferral rules of subpart F with respect to
income not derived in the active conduct of these financial
services businesses. However, the Congress recognized that the
line between income derived in the active conduct of such
businesses and income otherwise derived by entities so engaged
can be difficult to draw. The Congress believed that the issues
of the determination of income derived in the active conduct of
such businesses and the potential mobility of the business
activity and income recognition of insurance, banking,
financing, and similar businesses require further study. In the
event that it became necessary to consider a possible extension
of the provision in the future, the Congress invited the
comments of taxpayers and the Treasury Department regarding
these issues.
Effective Date
The provision would have applied only to taxable years of
foreign corporations beginning in 1998, and to taxable years of
United States shareholders with or within which such taxable
years of foreign corporations end.
Revenue Effect
The provision was estimated to have reduced Federal fiscal
year budget receipts by $23 million in 1998, $68 million in
1999, and $3 million in 2000.
Line Item Veto Action
This provision was identified by the Joint Committee on
Taxation as a limited tax benefit within the meaning of the
Line Item Veto Act. The President canceled this provision
pursuant to the Line Item Veto Act. A modified version of the
provision was included in H.R. 2513, which was passed by the
House on November 8, 1997.\283\
---------------------------------------------------------------------------
\283\ See report of the House Committee on Ways and Means, H. Rept.
105-318, Part I, October 9, 1997.
TITLE XII. SIMPLIFICATION PROVISIONS RELATING TO INDIVIDUALS AND
BUSINESSES
A. Provisions Relating to Individuals
1. Modifications to standard deduction of dependents; AMT treatment of
certain minor children (sec. 1201 of the Act and secs. 63(c)
and 59(j) of the Code)
Present and Prior Law
Standard deduction of dependents.--Under present law, the
standard deduction of a taxpayer for whom a dependency
exemption is allowed on another taxpayer's return can not
exceed the lesser of (1) the standard deduction for an
individual taxpayer (projected to be $4,250 for 1998) or (2)
the greater of $500 (indexed) \284\ or the dependent's earned
income (sec. 63(c)(5)).
---------------------------------------------------------------------------
\284\ Projected to be $700 for 1998.
---------------------------------------------------------------------------
Taxation of unearned income of children under age 14.--The
tax on a portion of the unearned income (e.g., interest and
dividends) of a child under age 14 is the additional tax that
the child's custodial parent would pay if the child's unearned
income were included in that parent's income. The portion of
the child's unearned income which is taxed at the parent's top
marginal rate is the amount by which the child's unearned
income is more than the sum of (1) $500 \285\ (indexed) plus
(2) the greater of (a) $500 \286\ (indexed) or (b) the child's
itemized deductions directly connected with the production of
the unearned income (sec. 1(g)).
---------------------------------------------------------------------------
\285\ Projected to be $700 for 1998.
\286\ Projected to be $700 for 1998.
---------------------------------------------------------------------------
Alternative minimum tax (``AMT'') exemption for children
under age 14.--Single taxpayers are entitled to an exemption
from the alternative minimum tax (``AMT'') of $33,750. However,
in the case of a child under age 14, his exemption from the
AMT, in substance, is the unused alternative minimum tax
exemption of the child's custodial parent, limited to the sum
of earned income and $1,000 (indexed) \287\ (sec. 59(j)).
---------------------------------------------------------------------------
\287\ Projected to be $1,400 for 1998.
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that significant simplification of
the existing income tax system could be achieved by providing
larger exemptions such that taxpayers with incomes less than
the exemption are not required to compute and pay any tax. The
Congress particularly believed that the present-law exemptions
of dependent children were too small.
Explanation of Provision
Standard deduction of dependents.--The Act increases the
standard deduction for a taxpayer with respect to whom a
dependency exemption is allowed on another taxpayer's return to
the lesser of (1) the standard deduction for individual
taxpayers or (2) the greater of: (a) $500 \288\ (indexed for
inflation as under present law), or (b) the individual's earned
income plus $250. The $250 amount is indexed for inflation
after 1998.
---------------------------------------------------------------------------
\288\ Projected to be $700 for 1998.
---------------------------------------------------------------------------
Alternative minimum tax exemption for children under age
14.--The Act increases the AMT exemption amount for a child
under age 14 to the lesser of (1) $33,750 or (2) the sum of the
child's earned income plus $5,000. The $5,000 amount is indexed
for inflation after 1998.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated to decrease Federal fiscal year
budget receipts by $2 million in 1998, $38 million in 1999, $35
million per year in each of years 2000 through 2004, $38
million in 2005, $37 million in 2006, and $36 million in 2007.
2. Increase de minimis threshold for estimated tax to $1,000 for
individuals (sec. 1202 of the Act and sec. 6654 of the Code)
Present and Prior Law
An individual taxpayer generally is subject to an addition
to tax for any underpayment of estimated tax (sec. 6654). An
individual generally does not have an underpayment of estimated
tax if he or she makes timely estimated tax payments at least
equal to: (1) 100 percent of the tax shown on the return of the
individual for the preceding year (the ``100 percent of last
year's liability safe harbor'') or (2) 90 percent of the tax
shown on the return for the current year. The 100 percent of
last year's liability safe harbor is modified to be a 110
percent of last year's liability safe harbor for any individual
with an AGI of more than $150,000 as shown on the return for
the preceding taxable year. These percentages are further
modified for certain years. For example, see section 1091 of
the Act. Income tax withholding from wages is considered to be
a payment of estimated taxes. In general, payment of estimated
taxes must be made quarterly. The addition to tax is not
imposed where the total tax liability for the year, reduced by
any withheld tax, is less than $500.
Reasons for Change
The Congress determined that raising the individual
estimated tax de minimis threshold will simplify the tax laws
for a number of taxpayers.
Explanation of Provision
The Act increases the $500 individual estimated tax de
minimis threshold to $1,000.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $134 million in 1998, $17 million in 1999,
$18 million in 2000, $19 million in 2001, $20 million in 2002,
$21 million in 2003, $22 million in 2004, $24 million in 2005,
$25 million in 2006, and $26 million in 2007.
3. Treatment of certain reimbursed expenses of rural letter carrier's
vehicles (sec. 1203 of the Act and sec. 162 of the Code)
Present and Prior Law
A taxpayer who uses his or her automobile for business
purposes may deduct the business portion of the actual
operation and maintenance expenses of the vehicle, plus
depreciation (subject to the limitations of sec. 280F).
Alternatively, the taxpayer may elect to utilize a standard
mileage rate in computing the deduction allowable for business
use of an automobile that has not been fully depreciated. Under
this election, the taxpayer's deduction equals the applicable
rate multiplied by the number of miles driven for business
purposes and is taken in lieu of deductions for depreciation
and actual operation and maintenance expenses.
An employee of the U.S. Postal Service may compute his
deduction for business use of an automobile in performing
services involving the collection and delivery of mail on a
rural route by using, for all business use mileage, 150 percent
of the standard mileage rate.
Rural letter carriers are paid an equipment maintenance
allowance (EMA) to compensate them for the use of their
personal automobiles in delivering the mail. The tax
consequences of the EMA are determined by comparing it with the
automobile expense deductions that each carrier is allowed to
claim (using either the actual expenses method or the 150
percent of the standard mileage rate). If the EMA exceeds the
allowable automobile expense deductions, the excess generally
is subject to tax. If the EMA falls short of the allowable
automobile expense deductions, a deduction is allowed only to
the extent that the sum of this shortfall and all other
miscellaneous itemized deductions exceeds two percent of the
taxpayer's adjusted gross income.
Reasons for Change
The filing of tax returns by rural letter carriers can be
complex. Under prior law, those who are reimbursed at more than
the 150 percent rate must report their reimbursement as income
and deduct their expenses as miscellaneous itemized deductions
(subject to the two-percent floor). Permitting the income and
expenses to wash, so that neither will have to be reported on
the rural letter carrier's tax return, will simplify these tax
returns.
Explanation of Provision
The Act repeals the special rate for Postal Service
employees of 150 percent of the standard mileage rate. In its
place, the Act requires that the rate of reimbursement provided
by the Postal Service to rural letter carriers be considered to
be equivalent to their expenses. The rate of reimbursement that
is considered to be equivalent to their expenses is the rate of
reimbursement contained in the 1991 collective bargaining
agreement, which may be increased by no more than the rate of
inflation.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated to decrease Federal fiscal year
budget receipts by less than $500,000 in 1998, $1 million in
1999, $1 million in 2000, $1 million in 2001, $1 million in
2002, $1 million in 2003, $1 million in 2004, $1 million in
2005, $1 million in 2006, and $1 million in 2007.
4. Travel expenses of Federal employees participating in a Federal
criminal investigation (sec. 1204 of the Act and sec. 162 of
the Code)
Present and Prior Law
Unreimbursed ordinary and necessary travel expenses paid or
incurred by an individual in connection with temporary
employment away from home (e.g., transportation costs and the
cost of meals and lodging) are generally deductible, subject to
the two-percent floor on miscellaneous itemized deductions.
Travel expenses paid or incurred in connection with indefinite
employment away from home, however, are not deductible. A
taxpayer's employment away from home in a single location is
indefinite rather than temporary if it lasts for one year or
more; thus, no deduction is permitted for travel expenses paid
or incurred in connection with such employment (sec. 162(a)).
If a taxpayer's employment away from home in a single location
lasts for less than one year, whether such employment is
temporary or indefinite is determined on the basis of the facts
and circumstances.
Reasons for Change
The Congress believed that it would be inappropriate if
this provision in the tax laws were to be a hindrance to the
investigation of a Federal crime.
Explanation of Provision
The one-year limitation with respect to deductibility of
expenses while temporarily away from home does not include any
period during which a Federal employee is certified by the
Attorney General (or the Attorney General's designee) as
traveling on behalf of the Federal Government in a temporary
duty status to investigate or provide support services to the
investigation of a Federal crime. Thus, expenses for these
individuals during these periods are fully deductible,
regardless of the length of the period for which certification
is given (provided that the other requirements for
deductibility are satisfied). Prosecuting a Federal crime or
providing support services to the prosecution of a Federal
crime is considered part of investigating a Federal crime.\289\
---------------------------------------------------------------------------
\289\ See Title VI (sec. 611(a)) of H.R. 2676, the Tax Technical
Corrections Act of 1997, as passed by the House on November 5, 1997.
---------------------------------------------------------------------------
Effective Date
The provision is effective for amounts paid or incurred
with respect to taxable years ending after the date of
enactment (August 5, 1997).
Revenue Effect
The provision is estimated to decrease Federal fiscal year
budget receipts by less than $500,000 in each of 1998 through
2007.
5. Payment of taxes by commercially acceptable means (sec. 1205 of the
Act and sec. 6311 of the Code)
Present and Prior Law
Payment of taxes may be made by checks or money orders, to
the extent and under the conditions provided by Treasury
regulations (sec. 6311).
Reasons for Change
Additional payment mechanisms (such as credit cards, debit
cards, and charge cards) have become commonly used and reliable
forms of payment. Some taxpayers may find paying taxes by these
mechanisms more convenient than paying by check or money order.
Explanation of Provision
In general
The Internal Revenue Service (IRS) is engaged in a long-
term modernization of its information systems, the Tax Systems
Modernization (TSM) Program. This modernization is intended to
address deficiencies in the current IRS information systems and
to plan effectively for future information system needs and
requirements. The systems changes are designed to reduce the
burden on taxpayers, generate additional revenue through
improved voluntary compliance, and achieve productivity gains
throughout the IRS. One key element of this program is
electronic filing of tax returns.
At the present time, increasing reliance is being placed
upon electronic funds transfers for payment of obligations. In
light of this, the IRS seeks to integrate these payment methods
in its TSM program, including electronic filing of returns, as
well as into its traditional collection functions. The Act
allows the IRS to accept payment by any commercially acceptable
means that the Secretary deems appropriate, to the extent and
under the conditions provided in Treasury regulations. This
will include, for example, electronic funds transfers,
including those arising from credit cards, debit cards, and
charge cards.
The IRS contemplates that it will proceed to negotiate
contracts to implement this provision with one or more private
sector credit and debit card systems. The Act provides that the
IRS may not pay any fees or provide any other consideration
with respect to any such contracts.
Billing error resolution
In the course of processing these transactions, it will be
necessary to resolve billing errors and other disputes. The
Internal Revenue Code contains mechanisms for the determination
of tax liability, defenses and other taxpayer protections, and
the resolution of disputes with respect to those liabilities.
The Truth-in-Lending Act contains provisions for determination
of credit card liabilities, defenses and other consumer
protections, and the resolution of disputes with respect to
these liabilities.
The Act excludes credit card, debit card, and charge card
issuers and processing mechanisms from the resolution of tax
liability, but makes IRS subject to the Truth-in-Lending
provisions insofar as those provisions impose obligations and
responsibilities with regard to the ``billing error''
resolution process. It is not intended that consumers obtain
additional ways to dispute their tax liabilities under the
Truth-in-Lending provisions.
The Act also specifically includes the use of debit cards
in this provision and provides that the corresponding defenses
and ``billing error'' provisions of the Electronic Fund
TransferAct will apply in a similar manner.
The Act adds new section 6311(d)(3) to the Code. This
section describes the circumstances under which section 161 of
the Truth-in-Lending Act (``TILA'') and section 908 of the
Electronic Fund Transfer Act (``EFTA'') apply to disputes that
may arise in connection with payments of taxes made by credit
card or debit card. Subsections (A) through (C) recognize that
``billing errors'' relating to the credit card account, such as
an error arising from a credit card transaction posted to a
cardholder's account without the cardholder's authorization, an
amount posted to the wrong cardholder's account, or an
incorrect amount posted to a cardholder's account as a result
of a computational error or numerical transposition, are
governed by the billing error provisions of section 161 of
TILA. Similarly, subsections 6311(d)(3)(A)-(C) provide that
errors such as those described above which arise in connection
with payments of internal revenue taxes made by debit card, are
governed by section 908 of EFTA.
The Internal Revenue Code provides that refunds are only
authorized to be paid to the person who made the overpayment
(generally the taxpayer). Subsection 6311(d)(3)(E), however,
provides that where a taxpayer is entitled to receive funds as
a result of the correction of a billing error made under
section 161 of TILA in connection with a credit card
transaction, or under section 908 of EFTA in connection with a
debit card transaction, the IRS is authorized to utilize the
appropriate credit card or debit card system to initiate a
credit to the taxpayer's credit card or debit card account. The
IRS may, therefore, provide such funds through the taxpayer's
credit card or debit card account rather than directly to the
taxpayer.
On the other hand, subsections 6311(d)(3)(A)-(C) provide
that any alleged error or dispute asserted by a taxpayer
concerning the merits of the taxpayer's underlying tax
liability or tax return is governed solely by existing tax
laws, and is not subject to section 161 or section 170 of TILA,
section 908 of EFTA, or any similar provisions of State law.
Absent the exclusion from section 170 of TILA, in a collection
action brought against the cardholder by the card issuer the
cardholder might otherwise assert as a defense that the IRS had
incorrectly computed his tax liability. A collection action
initiated by a credit card issuer against the taxpayer/
cardholder will be an inappropriate vehicle for the
determination of a taxpayer's tax liability, especially since
the United States will not be a party to such an action.
Similarly, without the exclusion from section 161 of TILA
and section 908 of EFTA, a taxpayer could contest the merits of
his tax liability by putting the charge which appears on the
credit card bill in dispute. Pursuant to TILA or EFTA, the
taxpayer's card issuer will have to investigate the dispute,
thereby finding itself in the middle of a dispute between the
IRS and the taxpayer. It is believed that it is improper to
attempt to resolve tax disputes through the billing process. It
is also noted that the taxpayer retains the traditional,
existing remedies for resolving tax disputes, such as resolving
the dispute administratively with the IRS, filing a petition
with the Tax Court after receiving a statutory notice of
deficiency, or paying the disputed tax and filing a claim for
refund (and subsequently filing a refund suit if the claim is
denied or not acted upon).
Creditor status
The TILA imposes various responsibilities and obligations
on creditors. Although the definition of the term ``creditor''
set forth in 15 U.S.C. sec. 1602 is limited, and will generally
not include the IRS, in the case of an open-end credit plan
involving a credit card, the card issuer and any person who
honors the credit card are, pursuant to 15 U.S.C. sec. 1602(f),
creditors.
In addition, 12 CFR sec. 226.12(e) provides that the
creditor must transmit a credit statement to the card issuer
within 7 business days from accepting the return or forgiving
the debt. There is a concern that the response deadlines
otherwise imposed by 12 CFR sec. 226.12(e), if applicable, will
be difficult for the IRS to comply with (given the volume of
payments the IRS is likely to receive in peak periods). This
could subject the IRS to unwarranted damage actions.
Consequently, the bill generally provides an exception to
creditor status for the IRS.
Privacy protections
The Act also addresses privacy questions that arise from
the IRS' participation in credit card processing systems. It is
believed that taxpayers expect that the maximum possible
protection of privacy will be accorded any transactions they
have with the IRS. Accordingly, the Act provides the greatest
possible protection of taxpayers' privacy that is consistent
with developing and operating an efficient tax administration
system. It is expected that the principle will be fully
observed in the implementation of this provision.
A key privacy issue is the use and redisclosure of tax
information by financial institutions for purposes unrelated to
the processing of credit card charges, i.e., marketing and
related uses. To accept credit card charges by taxpayers, the
IRS will have to disclose tax information to financial
institutions to obtain payment and to resolve billing disputes.
To obtain payment, the IRS will have to disclose, at a minimum,
information on the ``credit slip,'' i.e., the dollar amount of
the payment and the taxpayer's credit card number.
The resolution of billing disputes may require the
disclosure of additional tax information to financial
institutions. In most cases, providing a copy of the credit
slip and verifying the transaction amount will be sufficient.
Conceivably, financial institutions could require some
information regarding the underlying liability even where the
dispute concerns a ``billing dispute'' matter. This additional
information will not necessarily be shared as widely as the
initial payment data. In lieu of disclosing further
information, the IRS may elect to allow disputed amounts to be
charged back to the IRS and to reinstate the corresponding tax
liability.
Despite the language in most cardholder agreements that
permits redisclosure of credit card transaction information,
the public may be largely unaware of how widely that
information is shared. For example, some financial institutions
may share credit, payment, and purchase information with
private credit bureaus, who, in turn, may sell this information
to direct mail marketers, and others. Without use and
redisclosure restrictions, taxpayers may discover that some
traditionally confidential tax information might be widely
disseminated to direct mail marketers and others.
It is intended that credit or debit card transaction
information will generally be restricted to those uses
necessary to process payments and resolve billing errors, as
well as other purposes that are specified in the statute. The
Act directs the Secretary to issue published procedures on what
constitutes authorized uses and disclosures. It is anticipated
that the Secretary's published procedures will prohibit the use
of transaction information for marketing tax-related services
by the issuer or any marketing that targets only those who use
their credit card to pay their taxes. It is also anticipated
that the published procedures will prohibit the sale of
transaction information to a third party.
Effective Date
The provision is effective nine months after the date of
enactment. The IRS may, in this interim period, conduct
internal tests and negotiate with card issuers, but may not
accept credit or debit cards for payment of tax liability.
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts in each of 1998 through
2007.
B. Provisions Relating to Businesses Generally
1. Modifications to look-back method for long-term contracts (sec. 1211
of the Act and secs. 460 and 167(g) of the Code)
Present and Prior Law
Taxpayers engaged in the production of property under a
long-term contract generally must compute income from the
contract under the percentage of completion method. Under the
percentage of completion method, a taxpayer must include in
gross income for any taxable year an amount that is based on
the product of (1) the gross contract price and (2) the
percentage of the contract completed as of the end of the year.
The percentage of the contract completed as of the end of the
year is determined by comparing costs incurred with respect to
the contract as of the end of the year with estimated total
contract costs.
Because the percentage of completion method relies upon
estimated, rather than actual, contract price and costs to
determine gross income for any taxable year, a ``look-back
method'' is applied in the year a contract is completed in
order to compensate the taxpayer (or the Treasury Department)
for the acceleration (or deferral) of taxes paid over the
contract term. The first step of the look-back method is to
reapply the percentage of completion method using actual
contract price and costs rather than estimated contract price
and costs. The second step generally requires the taxpayer to
recompute its tax liability for each year of the contract using
gross income as reallocated under the look-back method. If
there is any difference between the recomputed tax liability
and the tax liability as previously determined for a year, such
difference is treated as a hypothetical underpayment or
overpayment of tax to which the taxpayer applies a rate of
interest equal to the overpayment rate, compounded daily.\290\
The taxpayer receives (or pays) interest if the net amount of
interest applicable to hypothetical overpayments exceeds (or is
less than) the amount of interest applicable to hypothetical
underpayments.
---------------------------------------------------------------------------
\290\ The overpayment rate equals the applicable Federal short-term
rate plus two percentage points. This rate is adjusted quarterly by the
IRS. Thus, in applying the look-back method for a contract year, a
taxpayer may be required to use five different interest rates.
---------------------------------------------------------------------------
The look-back method must be reapplied for any item of
income or cost that is properly taken into account after the
completion of the contract.
The look-back method does not apply to any contract that is
completed within two taxable years of the contract commencement
date if the gross contract price does not exceed the lesser of
(1) $1 million or (2) one percent of the average gross receipts
of the taxpayer for the preceding three taxable years. In
addition, a simplified look-back method is available to certain
pass-through entities and, pursuant to Treasury regulations, to
certain other taxpayers. Under the simplified look-back method,
the hypothetical underpayment or overpayment of tax for a
contract year generally is determined by applying the highest
rate of tax applicable to such taxpayer to the change in gross
income as recomputed under the look-back method.
Reasons for Change
Prior law may have required multiple applications of the
look-back method with respect to a single contract or may have
otherwise subjected contracts to the look-back method even
though amounts necessitating the look-back calculations were de
minimis relative to the aggregate contract income. In addition,
the use of multiple interest rates complicated the mechanics of
the look-back calculation. The Congress wished to address these
concerns.
Explanation of Provision
Election not to apply the look-back method for de minimis amounts
The Act provides that a taxpayer may elect not to apply the
look-back method with respect to a long-term contract if for
each prior contract year, the cumulative taxable income (or
loss) under the contract as determined using estimated contract
price and costs is within 10 percent of the cumulative taxable
income (or loss) as determined using actual contract price and
costs.
Thus, under the election, upon completion of a long-term
contract, a taxpayer would be required to apply the first step
of the look-back method (the reallocation of gross income using
actual, rather than estimated, contract price and costs), but
is not required to apply the additional steps of the look-back
method if the application of the first step resulted in de
minimis changes to the amount of income previously taken into
account for each prior contract year.
The election applies to all long-term contracts completed
during the taxable year for which the election is made and to
all long-term contracts completed during subsequent taxable
years, unless the election is revoked with the consent of the
Secretary of the Treasury.
Example 1.--A taxpayer enters into a three-year contract
and upon completion of the contract, determines that annual net
income under the contract using actual contract price and costs
is $100,000, $150,000, and $250,000, for Years 1, 2, and 3,
respectively, under the percentage of completion method. An
electing taxpayer need not apply the look-back method to the
contract if it had reported cumulative net taxable income under
the contract using estimated contract price and costs of
between $90,000 and $110,000 as of the end of Year 1; and
between $225,000 and $275,000 as of the end of Year 2.
Election not to reapply the look-back method
The taxpayer may elect to not reapply the look-back method
with respect to a contract if, as of the close of any taxable
year after the year the contract is completed, the cumulative
taxable income (or loss) under the contract is within 10
percent of the cumulative look-back income (or loss) as of the
close of the most recent year in which the look-back method was
applied (or would have applied but for the other de minimis
exception described above). In applying this rule, amounts that
are taken into account after completion of the contract are not
discounted.
Thus, an electing taxpayer need not apply or reapply the
look-back method if amounts that are taken into account after
the completion of the contract are de minimis.
The election applies to all long-term contracts completed
during the taxable year for which the election is made and to
all long-term contracts completed during subsequent taxable
years, unless the election is revoked with the consent of the
Secretary of the Treasury.
Example 2.--A taxpayer enters into a three-year contract
and reports taxable income of $12,250, $15,000 and $12,750, for
Years 1 through 3, respectively, with respect to the contract.
Upon completion of the contract, cumulative look-back income
with respect to the contract is $40,000, and 10 percent of such
amount is $4,000. After the completion of the contract, the
taxpayer incurs additional costs of $2,500 in each of the next
three succeeding years (Years 4, 5, and 6) with respect to the
contract. Under the provision, an electing taxpayer does not
apply or reapply the look-back method for Year 4 because the
cumulative amount of contract taxable income ($37,500) is
within 10 percent of cumulative look-back income as of the
completion of the contract ($40,000). However, the look-back
method must be applied for Year 5 because the cumulative amount
of contract taxable income ($35,000) is not within 10 percent
of cumulative look-back income as of the completion of the
contract ($40,000). Finally, the taxpayer does not reapply the
look-back method for Year 6 because the cumulative amount of
contract taxable income ($32,500) is within 10 percent of
cumulative look-back income as of the last application of the
look-back method ($35,000).
Interest rates used for purposes of the look-back method
The Act provides that for purposes of the look-back method,
only one rate of interest is to apply for each accrual period.
An accrual period with respect to a taxable year begins on the
day after the return due date (determined without regard to
extensions) for the taxable year and ends on such return due
date for the following taxable year. The applicable rate of
interest is the overpayment rate in effect for the calendar
quarter in which the accrual period begins.
Effective Date
The provision applies to contracts completed in taxable
years ending after the date of enactment (i.e., after August 5,
1997). The change in the interest rate calculation also applies
for purposes of the look-back method applicable to the income
forecast method of depreciation for property placed in service
after September 13, 1995.
Revenue Effect
The provision is estimated to decrease Federal fiscal year
budget receipts by $1 million in 1998, $2 million in 1999, $3
million in 2000, $4 million in 2001, $4 million in 2002, $4
million in 2003, $4 million in 2004, $5 million in 2005, $5
million in 2006, and $5 million in 2007.
2. Minimum tax treatment of certain property and casualty insurance
companies (sec. 1212 of the 1997 Act and sec. 56(g)(4)(B) of
the Code)
Present and Prior Law
Present and prior law provide that certain property and
casualty insurance companies may elect to be taxed only on
taxable investment income for regular tax purposes (sec.
831(b)). Eligible property and casualty insurance companies are
those whose net written premiums (or if greater, direct written
premiums) for the taxable year exceed $350,000 but do not
exceed $1,200,000.
All corporations including insurance companies are subject
to an alternative minimum tax. Alternative minimum taxable
income is increased by 75 percent of the excess of adjusted
current earnings over alternative minimum taxable income
(determined without regard to this adjustment and without
regard to net operating losses).
Reasons for Change
The Congress believed that property and casualty companies
small enough to be eligible to simplify their regular tax
computation by electing to be taxed only on taxable investment
income should be accorded comparable simplicity in the
calculation of their alternative minimum tax. Under prior law,
the simplicity under the regular tax was nullified because
electing companies were required to calculate underwriting
income for tax purposes under the alternative minimum tax. The
provision thus simplifies the entire Federal income tax
calculation for a group of small taxpayers whom Congress has
previously determined merit a simpler tax calculation.
Explanation of Provision
The Act provides that a property and casualty insurance
company that elects for regular tax purposes to be taxed only
on taxable investment income determines its adjusted current
earnings under the alternative minimum tax without regard to
any amount not taken into account in determining its gross
investment income under section 834(b). Thus, adjusted current
earnings of an electing company is determined without regard to
underwriting income (or underwriting expense, as provided in
sec. 56(g)(4)(B)(i)(II)).
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $1 million in 1998, $2 million in 1999, and
$3 million in each of 2000 through 2007.
3. Treatment of construction allowances provided to lessees (sec. 1213
of the bill and new sec. 110 of the Code)
Present and Prior Law
Depreciation allowances for property used in a trade or
business generally are determined under the modified
Accelerated Cost Recovery System (``MACRS'') of section 168.
Depreciation allowances for improvements made on leased
property are determined under MACRS, even if the MACRS recovery
period assigned to the property is longer than the term of the
lease (sec. 168(i)(8)).\291\ This rule applies whether the
lessor or lessee places the leasehold improvements in
service.\292\ If a leasehold improvement constitutes an
addition or improvement to nonresidential real property already
placed in service, the improvement is depreciated using the
straight-line method over a 39-year recovery period, beginning
in the month the addition or improvement was placed in service
(secs. 168(b)(3), (c)(1), (d)(2), and (l)(6)). A lessor of
leased property that disposes of a leasehold improvement that
was made by the lessor for the lessee of the property may take
the adjusted basis of the improvement into account for purposes
of determining gain or loss if the improvement is irrevocably
disposed of or abandoned by the lessor at the termination of
the lease (sec. 168(i)(8)).
---------------------------------------------------------------------------
\291\ The Tax Reform Act of 1986 (``1986 Act'') modified the
Accelerated Cost Recovery System (``ACRS'') to institute MACRS. Prior
to the adoption of ACRS by the Economic Recovery Act of 1981, taxpayers
were allowed to depreciate the various components of a building as
separate assets with separate useful lives. The use of component
depreciation was repealed upon the adoption of ACRS. The denial of
component depreciation also applies under MACRS, as provided by the
1986 Act.
\292\ Former Code sections 168(f)(6) and 178 provided that in
certain circumstances, a lessee could recover the cost of leasehold
improvements made over the remaining term of the lease. These
provisions were repealed by the 1986 Act.
---------------------------------------------------------------------------
The gross income of a lessor of real property does not
include any amount attributable to the value of buildings
erected, or other improvements made by, a lessee that revert to
the lessor at the termination of a lease (sec. 109).
Issues have arisen as to the proper treatment of amounts
provided to a lessee by a lessor for property to be constructed
and used by the lessee pursuant to the lease (``construction
allowances''). In general, incentive payments are includible in
income as accessions to wealth.\293\ A coordinated issue paper
issued by the Internal Revenue Service (``IRS'') on October 7,
1996, states the IRS position that construction allowances
generally should be included in income in the year received.
However, the paper does recognize that amounts received by a
lessee from a lessor and expended by the lessee on assets owned
by the lessor were not includible in the lessee's income. The
issue paper provides that tax ownership is determined by
applying a ``benefits and burdens of ownership'' test that
includes an examination of the following factors: (1) whether
legal title passes; (2) how the parties treat the transaction;
(3) whether an equity interest was acquired in the property;
(4) whether the contract creates present obligations on the
seller to execute and deliver a deed and on the buyer to make
payments; (5) whether the right of possession is vested; (6)
who pays property taxes; (7) who bears the risk of loss or
damage to the property; (8) who receives the profits from the
operation and sale of the property; (9) who carries insurance
with respect to the property; (10) who is responsible for
replacing the property; and (11) who has the benefits of any
remainder interests in the property.
---------------------------------------------------------------------------
\293\ John B. White, Inc. v. Comm., 55 T.C. 729 (1971), aff'd per
curiam 458 F. 2d 989 (3d Cir.), cert. denied, 409 U.S. 876 (1972).
However, see, e.g., Federated Department Stores v. Comm., 51 T.C. 500
(1968) aff'd 426 F. 2d 417 (6th Cir. 1970) and The May Department
Stores Co. v. Comm., 33 TCM 1128 (1974), aff'd 519 F. 2d 1154 (8th Cir.
1975) with respect to the application of section 118 to certain
payments.
---------------------------------------------------------------------------
Reasons for Change
The Congress understood that it is common industry practice
for a lessor to custom improve retail space for the use by a
lessee pursuant to a lease. Such leasehold improvements may be
provided by the lessor directly constructing the improvements
to the lessee's specifications. Alternatively, the lessee may
receive a construction allowance from the lessor pursuant to
the lease in order for the lessee to build or improve the
property. The Congress believed that the tax treatment of
lessors and lessees in either case should be the same. The
Congress understood that the IRS issue paper reaches a similar
conclusion in cases where the lessor is treated as the tax
owner of the constructed or improved property. However, the
Congress was concerned that the traditional factors cited by
the IRS in making the determination of who is the tax owner of
the property may be applied differently by the lessor and the
lessee and may lead to controversies between the IRS and
taxpayers. Thus, the Act provides a safe harbor such that it
will be assumed that a construction allowance is used to
construct or improve lessor property (and is properly
excludible by the lessee) when long-lived property is
constructed or improved and used pursuant to a short-term
lease. In addition, the Act provides safeguards to ensure that
lessors and lessees consistently treat the property subject to
the construction allowance as nonresidential real property
owned by the lessor.
Explanation of Provision
The Act provides that the gross income of a lessee does not
include amounts received in cash (or treated as a rent
reduction) from a lessor under a short-term lease of retail
space for the purpose of the lessee's construction or
improvement of qualified long-term real property for use in the
lessee's trade or business at such retail space. The exclusion
only applies to the extent theallowance does not exceed the
amount expended by the lessee on the construction or improvement of
qualified long-term real property. For this purpose, ``qualified long-
term real property'' means nonresidential real property that is part
of, or otherwise present at, retail space used by the lessee and that
reverts to the lessor at the termination of the lease. A ``short-term
lease'' means a lease or other agreement for the occupancy or use of
retail space for a term of 15 years or less (as determined pursuant to
sec. 168(i)(3)). ``Retail space'' means real property leased, occupied,
or otherwise used by the lessee in its trade or business of selling
tangible personal property or services to the general public.
The Act provides that the lessor must treat the amounts
expended on the construction allowance as nonresidential real
property owned by the lessor. However, the lessee's exclusion
is not dependent upon the lessor's treatment of the property as
nonresidential real property. The present-law rule that allows
lessors to take losses with respect to certain leasehold
improvements abandoned at the end of the term of the lease
(sec. 168(i)(8)) will apply to property treated as owned by the
lessor under the Act.
The Act contains reporting requirements to ensure that both
the lessor and lessee treat such amounts as nonresidential real
property owned by the lessor. Under regulations, the lessor and
the lessee shall, at such times and in such manner as provided
by the regulations, furnish to the Secretary of the Treasury
information concerning the amounts received (or treated as a
rent reduction), the amounts expended on qualified long-term
real property, and such other information as the Secretary
deems necessary to carry out the provisions of the Act. It is
expected that the Secretary, in promulgating such regulations,
will attempt to minimize the administrative burdens of
taxpayers while ensuring compliance with the Act.
No inference is intended as to the treatment of amounts
that are not subject to the provision, and that the provisions
of the IRS issue paper and present and prior law (including
case law) will continue to apply where applicable.
Effective Date
The provision applies to leases entered into after the date
of enactment (i.e., after August 5, 1997). No inference is
intended as to the treatment of amounts that are not subject to
the provision.
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
C. Partnership Simplification Provisions
1. General provisions
a. Simplified flow-through for electing large partnerships
(sec. 1221 of the Act and new secs. 771-777 of the
Code)
Present and Prior Law
Treatment of partnerships in general
A partnership generally is treated as a conduit for Federal
income tax purposes. Each partner takes into account separately
his distributive share of the partnership's items of income,
gain, loss, deduction or credit. The character of an item is
the same as if it had been directly realized or incurred by the
partner. Limitations affecting the computation of taxable
income generally apply at the partner level.
The taxable income of a partnership is computed in the same
manner as that of an individual, except that no deduction is
permitted for personal exemptions, foreign taxes, charitable
contributions, net operating losses, certain itemized
deductions, or depletion. Elections affecting the computation
of taxable income derived from a partnership are made by the
partnership, except for certain elections such as those
relating to discharge of indebtedness income and the foreign
tax credit.
Capital gains
Under prior law, the net capital gain of an individual was
taxed generally at the same rates applicable to ordinary
income, subject to a maximum marginal rate of 28 percent.\294\
Net capital gain is the excess of net long-term capital gain
over net short-term capital loss. Individuals with a net
capital loss generally may deduct up to $3,000 of the loss each
year against ordinary income. Net capital losses in excess of
the $3,000 limit may be carried forward indefinitely.
---------------------------------------------------------------------------
\294\ Section 311 of the 1997 Act, as proposed to be amended by
Title VI of H.R. 2676, the Tax Technical Corrections Act of 1997, as
passed by the House on November 5, 1997, provides a 28-percent rate for
the net capital gain attributable to collectibles, certain gain from
small business stock, gains and losses from capital assets held more
than one year but not more than 18 months, the net short-term capital
loss, and any long-term capital loss carryover. It also provides a 25-
percent rate for the net capital gain attribuable to unrecaptured
section 1250 depreciation (in the case of section 1231 dispositions,
this is limited to the net section 1231 gain), reduced by any net loss
from items taken into account in computing the 28-percent gain. It also
provides a 20-percent rate on the net capital gain, reduced by the
amount of the 28-percent rate gain and the unrecaptured section 1250
depreciation. These provisions generally become effective during 1997.
Finally, beginning in 2001 and 2006, it also provides two categories of
gain for certain assets held more than five years.
---------------------------------------------------------------------------
A special rule applies to gains and losses on the sale,
exchange or involuntary conversion of certain trade or business
assets (sec. 1231). In general, net gains from such assets are
treated as long-term capital gains but net losses are treated
as ordinary losses.
A partner's share of a partnership's net short-term capital
gain or loss and net long-term capital gain or loss from
portfolio investments is separately reported to the partner. A
partner's share of a partnership's net gain or loss under
section 1231 generally is also separately reported.
Deductions and credits
Miscellaneous itemized deductions (e.g., certain investment
expenses) are deductible only to the extent that, in the
aggregate, they exceed two percent of the individual's adjusted
gross income.
In general, taxpayers are allowed a deduction for
charitable contributions, subject to certain limitations. The
deduction allowed an individual generally cannot exceed 50
percent of the individual's adjusted gross income for the
taxable year. The deduction allowed a corporation generally
cannot exceed 10 percent of the corporation's taxable income.
Excess contributions are carried forward for five years.
A partner's distributive share of a partnership's
miscellaneous itemized deductions and charitable contributions
is separately reported to the partner.
Each partner is allowed his distributive share of credits
against his taxable income.
Foreign taxes
The foreign tax credit generally allows U.S. taxpayers to
reduce U.S. income tax on foreign income by the amount of
foreign income taxes paid or accrued with respect to that
income. In lieu of electing the foreign tax credit, a taxpayer
may deduct foreign taxes. The total amount of the credit may
not exceed the same proportion of the taxpayer's U.S. tax which
the taxpayer's foreign source taxable income bears to the
taxpayer's worldwide taxable income for the taxable year.
Unrelated business taxable income
Tax-exempt organizations are subject to tax on income from
unrelated businesses. Certain types of income (such as
dividends, interest and certain rental income) are not treated
as unrelated business taxable income. Thus, for a partner that
is an exempt organization, whether partnership income is
unrelated business taxable income depends on the character of
the underlying income. Income from a publicly traded
partnership, however, is treated as unrelatedbusiness taxable
income regardless of the character of the underlying income.
Special rules related to oil and gas activities
Taxpayers involved in the search for and extraction of
crude oil and natural gas are subject to certain special tax
rules. As a result, in the case of partnerships engaged in such
activities, certain specific information is separately reported
to partners.
A taxpayer who owns an economic interest in a producing
deposit of natural resources (including crude oil and natural
gas) is permitted to claim a deduction for depletion of the
deposit as the minerals are extracted. In the case of oil and
gas produced in the United States, a taxpayer generally is
permitted to claim the greater of a deduction for cost
depletion or percentage depletion. Cost depletion is computed
by multiplying a taxpayer's adjusted basis in the depletable
property by a fraction, the numerator of which is the amount of
current year production from the property and the denominator
of which is the property's estimated reserves as of the
beginning of that year. Percentage depletion is equal to a
specified percentage (generally, 15 percent in the case of oil
and gas) of gross income from production. Cost depletion is
limited to the taxpayer's basis in the depletable property;
percentage depletion is not so limited. Once a taxpayer has
exhausted its basis in the depletable property, it may continue
to claim percentage depletion deductions (generally referred to
as ``excess percentage depletion'').
Certain limitations apply to the deduction for oil and gas
percentage depletion. First, percentage depletion is not
available to oil and gas producers who also engage (directly or
indirectly) in significant levels of oil and gas retailing or
refining activities (so-called ``integrated producers'' of oil
and gas). Second, the deduction for percentage depletion may be
claimed by a taxpayer only with respect to up to 1,000 barrels-
per-day of production. Third, the percentage depletion
deduction may not exceed 100 percent of the taxpayer's net
income for the taxable year from the depletable oil and gas
property. Fourth, a percentage depletion deduction may not be
claimed to the extent that it exceeds 65 percent of the
taxpayer's pre-percentage depletion taxable income.
In the case of a partnership that owns depletable oil and
gas properties, the depletion allowance is computed separately
by the partners and not by the partnership. In computing a
partner's basis in his partnership interest, basis is increased
by the partner's share of any partnership-related excess
percentage depletion deductions and is decreased (but not below
zero) by the partner's total amount of depletion deductions
attributable to partnership property.
Intangible drilling and development costs (``IDCs'')
incurred with respect to domestic oil and gas wells generally
may be deducted at the election of the taxpayer. In the case of
integrated producers, no more than 70 percent of IDCs incurred
during a taxable year may be deducted. IDCs not deducted are
capitalized and generally are either added to the property's
basis and recovered through depletion deductions or amortized
on a straight-line basis over a 60-month period.
The special treatment granted to IDCs incurred in the
pursuit of oil and gas may give rise to an item of tax
preference or (in the case of corporate taxpayers) an adjusted
current earnings (``ACE'') adjustment for the alternative
minimum tax. The tax preference item is based on a concept of
``excess IDCs.'' In general, excess IDCs are the excess of IDCs
deducted for the taxable year over the amount of those IDCs
that would have been deducted had they been capitalized and
amortized on a straight-line basis over 120 months commencing
with the month production begins from the related well. The
amount of tax preference is then computed as the difference
between the excess IDC amount and 65 percent of the taxpayer's
net income from oil and gas (computed without a deduction for
excess IDCs). For IDCs incurred in taxable years beginning
after 1992, the ACE adjustment related to IDCs is repealed for
taxpayers other than integrated producers. Moreover, beginning
in 1993, the IDC tax preference generally is repealed for
taxpayers other than integrated producers. In this case,
however, the repeal of the excess IDC preference may not result
in more than a 40 percent reduction (30 percent for taxable
years beginning in 1993) in the amount of the taxpayer's
alternative minimum taxable income computed as if that
preference had not been repealed.
Passive losses
The passive loss rules generally disallow deductions and
credits from passive activities to the extent they exceed
income from passive activities. Losses not allowed in a taxable
year are suspended and treated as current deductions from
passive activities in the next taxable year. These losses are
allowed in full when a taxpayer disposes of the entire interest
in the passive activity to an unrelated person in a taxable
transaction. Passive activities include trade or business
activities in which the taxpayer does not materially
participate. (Limited partners generally do not materially
participate in the activities of a partnership.) Passive
activities also generally include rental activities (regardless
of the taxpayer's material participation).\295\ Portfolio
income (such as interest and dividends), and expenses allocable
to such income, are not treated as income or loss from a
passive activity.
---------------------------------------------------------------------------
\295\ An indivdiual who actively participates in rental real estate
activity and holds at least a 10-percent interest may deduct up to
$25,000 of passive losses. The $25,000 amount phases out as the
individual's income increases from $100,000 to $150,000.
---------------------------------------------------------------------------
The $25,000 allowance also applies to low-income housing
and rehabilitation credits (on a deduction equivalent basis),
regardless of whether the taxpayer claiming the credit actively
participates in the rental real estate activity generating the
credit. In addition, the income phaseout range for the $25,000
allowance for rehabilitation credits is $200,000 to $250,000
(rather than $100,000 to $150,000). For interests acquired
after December 31, 1989 in partnerships holding property placed
in service after that date, the $25,000 deduction-equivalent
allowance is permitted for the low-income housing credit
without regard to the taxpayer's income.
A partnership's operations may be treated as multiple
activities for purposes of the passive loss rules. In such
case, the partnership must separately report items of income
and deductions from each of its activities.
Income, loss and other items from a publicly traded
partnership are treated as separate from income and loss from
any other publicly traded partnership, and also as separate
from any income or loss from passive activities.
The Omnibus Budget Reconciliation Act of 1993 added a rule,
effective for taxable years beginning after December 31, 1993,
treating a taxpayer's rental real estate activities in which he
materially participates as not subject to limitation under the
passive loss rules if the taxpayer meets eligibility
requirements relating to real property trades or businesses in
which he performs services (sec. 469(c)(7)). Real property
trade or business means any real property development,
redevelopment, construction, reconstruction, acquisition,
conversion, rental, operation, management, leasing, or
brokerage trade or business. An individual taxpayer generally
meets the eligibility requirements if (1) more than half of the
personal services the taxpayer performs in trades or business
during the taxable year are performed in real property trades
or businesses in which the taxpayer materially participates,
and (2) such taxpayer performs more than 750 hours of services
during the taxable year in real property trades or businesses
in which the taxpayer materially participates.
REMICs
A tax is imposed on partnerships holding a residual
interest in a real estate mortgage investment conduit
(``REMIC''). The amount of the tax is the amount of excess
inclusions allocable to partnership interests owned by certain
tax-exempt organizations (``disqualified organizations'')
multiplied by the highest corporate tax rate.
Contribution of property to a partnership
In general, a partner recognizes no gain or loss upon the
contribution of property to a partnership. However, income,
gain, loss and deduction with respect to property contributed
to a partnership by a partner must be allocated among the
partners so as to take into account the difference between the
basis of the property to the partnership and its fair market
value at the time of contribution. In addition, the
contributing partner must recognize gain or loss equal to such
difference if the property is distributed to another partner
within seven years of its contribution (sec. 704(c)), or if
other property is distributed to the contributor within the
seven year period (sec. 737).
Election of optional basis adjustments
In general, the transfer of a partnership interest or a
distribution of partnership property does not affect the basis
of partnership assets. A partnership, however, may elect to
make certain adjustments in the basis of partnership property
(sec. 754). Under a section 754 election, the transfer of a
partnership interest generally results in an adjustment in the
partnership's basisin its property for the benefit of the
transferee partner only, to reflect the difference between that
partner's basis for his interest and his proportionate share of the
adjusted basis of partnership property (sec. 743(b)). Also under the
election, a distribution of property to a partner in certain cases
results in an adjustment in the basis of other partnership property
(sec. 734(b)).
Terminations
A partnership terminates if either (1) all partners cease
carrying on the business, financial operation or venture of the
partnership, or (2) within a 12-month period 50 percent or more
of the total partnership interests are sold or exchanged (sec.
708).
Reasons for Change
The requirement that each partner take into account
separately his distributive share of a partnership's items of
income, gain, loss, deduction and credit can result in the
reporting of a large number of items to each partner. The
schedule K-1, on which such items are reported, contains space
for more than 40 items. Reporting so many separately stated
items is burdensome for individual investors with relatively
small, passive interests in large partnerships. In many
respects such investments are indistinguishable from those made
in corporate stock or mutual funds, which do not require
reporting of numerous separate items.
In addition, the number of items reported under the current
regime makes it difficult for the Internal Revenue Service to
match items reported on the K-1 against the partner's income
tax return. Matching is also difficult because items on the K-1
are often modified or limited at the partner level before
appearing on the partner's tax return.
By significantly reducing the number of items that must be
separately reported to partners by an electing large
partnership, the provision eases the reporting burden of
partners and facilitates matching by the IRS. Moreover, it is
understood that the Internal Revenue Service is considering
restricting the use of substitute reporting forms by large
partnerships. Reduction of the number of items makes possible a
short standardized form.
Explanation of Provisions
In general
The Act modifies the tax treatment of an electing large
partnership (generally, any partnership that elects under the
provision, if the number of partners in the preceding taxable
year is 100 or more) and its partners. The provision provides
that each partner takes into account separately the partner's
distributive share of the following items, which are determined
at the partnership level: (1) taxable income or loss from
passive loss limitation activities; (2) taxable income or loss
from other activities (e.g., portfolio income or loss); (3) net
capital gain or loss to the extent allocable to passive loss
limitation activities and other activities; (4) tax-exempt
interest; (5) net alternative minimum tax adjustment separately
computed for passive loss limitation activities and other
activities; (6) general credits; (7) low-income housing credit;
(8) rehabilitation credit; (9) credit for producing fuel from a
nonconventional source; (10) creditable foreign taxes and
foreign source items; and (11) any other items to the extent
that the Secretary determines that separate treatment of such
items is appropriate.\296\ Separate treatment may be
appropriate, for example, should changes in the law necessitate
such treatment for any items. For example, special rules may be
appropriate to coordinate with the separate rates applicable to
capital gains under the 1997 Act.
---------------------------------------------------------------------------
\296\ In determining the amounts required to be separately taken
into account by a partner, those provisions of the large partnership
rules governing computations of taxable income are applied separately
with respect to that partner by taking into account that partner's
distributive share of the partnership's items of income, gain, loss,
deduction or credit. This rule permits partnerships to make otherwise
valid special allocations of partnership items to partners.
---------------------------------------------------------------------------
Under the Act, the taxable income of an electing large
partnership is computed in the same manner as that of an
individual, except that the items described above are
separately stated and certain modifications are made. These
modifications include disallowing the deduction for personal
exemptions, the net operating loss deduction and certain
itemized deductions.\297\ All limitations and other provisions
affecting the computation of taxable income or any credit
(except for the at risk, passive loss and itemized deduction
limitations, and any other provision specified in regulations)
are applied at the partnership (and not the partner) level.
---------------------------------------------------------------------------
\297\ An electing large partnership is allowed a deduction under
section 212 for expenses incurred for the production of income, subject
to 70-percent disallowance. No income from an electing large
partnership is treated as fishing or farming income.
---------------------------------------------------------------------------
All elections affecting the computation of taxable income
or any credit generally are made by the partnership.
Capital gains
Under the Act, netting of capital gains and losses occurs
at the partnership level. A partner in a large partnership
takes into account separately his distributive share of the
partnership's net capital gain or net capital loss.\298\ Such
net capital gain or loss is treated as long-term capital gain
or loss. Special rules may be appropriate for capital gains or
losses that are subject to differing rates of tax.
---------------------------------------------------------------------------
\298\ The term ``net capital gain'' has the same meaning as in
section 1222(11). The term ``net capital loss'' means the excess of the
losses from sales or exchanges of capital assets over the gains from
sales or exchanges of capital assets. Thus, the partnership cannot
offset any portion of capital losses against ordinary income.
---------------------------------------------------------------------------
Any excess of net short-term capital gain over net long-
term capital loss is consolidated with the partnership's other
taxable income and is not separately reported.
A partner's distributive share of the partnership's net
capital gain is allocated between passive loss limitation
activities and other activities. The net capital gain is
allocated to passive loss limitation activities to the extent
of net capital gain from sales and exchanges of property used
in connection with such activities, and any excess is allocated
to other activities. A similar rule applies for purposes of
allocating any net capital loss.
Any gains and losses of the partnership under section 1231
are netted at the partnership level. Net gain is treated as
long-term capital gain and is subject to the rules described
above. Net loss is treated as ordinary loss and consolidated
with the partnership's other taxable income.
Deductions
The Act contains two special rules for deductions. First,
miscellaneous itemized deductions are not separately reported
to partners. Instead, 70 percent of the amount of such
deductions is disallowed at the partnership level; \299\ the
remaining 30 percent is allowed at the partnership level in
determining taxable income, and is not subject to the two-
percent floor at the partner level.
---------------------------------------------------------------------------
\299\ The 70 percent figure is intended to approximate the amount
of such deductions that would be denied at the partner level as a
result of the two-percent floor.
---------------------------------------------------------------------------
Second, charitable contributions are not separately
reported to partners under the Act. Instead, the charitable
contribution deduction is allowed at the partnership level in
determining taxable income, subject to the limitations that
apply to corporate donors.
Credits in general
Under the Act, general credits are separately reported to
partners as a single item. General credits are any credits
other than the low-income housing credit, the rehabilitation
credit and the credit for producing fuel from a nonconventional
source. A partner's distributive share of general credits is
taken into account as a current year general business credit.
Thus, for example, the credit for clinical testing expenses is
subject to the existing limitations on the general business
credit. The refundable credit for gasoline used for exempt
purposes and the refund or credit for undistributed capital
gains of a regulated investment company are allowed to the
partnership, and thus are not separately reported to partners.
In recognition of their special treatment under the passive
loss rules, the low-income housing and rehabilitation credits
are separately reported.\300\ In addition, the credit for
producing fuel from a nonconventional source is separately
reported.
---------------------------------------------------------------------------
\300\ It is understood that the rehabilitation and low-income
housing credits which are subject to the same passive loss rules (i.e.,
in the case of the low-income housing credit, where the partnership
interest was acquired or the property was placed in service before
1990) could be reported together on the same line.
---------------------------------------------------------------------------
The Act imposes credit recapture at the partnership level
and determines the amount of recapture by assuming that the
credit fully reduced taxes. Such recapture is applied first to
reduce the partnership's current year credit, if any; the
partnership is liable for any excess over that amount. Under
the Act, the transfer of an interest in an electing large
partnership does not trigger recapture.
Foreign taxes
The Act retains present-law treatment of foreign taxes. The
partnership reports to the partner creditable foreign taxes and
the source of any income, gain, loss or deduction taken into
account by the partnership. Elections, computations and
limitations are made by the partner.
Tax-exempt interest
The Act retains present-law treatment of tax-exempt
interest. Interest on a State or local bond is separately
reported to each partner.
Unrelated business taxable income
The Act retains present-law treatment of unrelated business
taxable income. Thus, a tax-exempt partner's distributive share
of partnership items is taken into account separately to the
extent necessary to comply with the rules governing such
income.
Passive losses
Under the Act, a partner in an electing large partnership
takes into account separately his distributive share of the
partnership's taxable income or loss from passive loss
limitation activities. The term ``passive loss limitation
activity'' means any activity involving the conduct of a trade
or business (including any activity treated as a trade or
business under sec. 469(c)(5) or (6)) and any rental activity.
A partner's share of an electing large partnership's taxable
income or loss from passive loss limitation activities is
treated as an item of income or loss from the conduct of a
trade or business which is a single passive activity, as
defined in the passive loss rules. Thus, an electing large
partnership generally is not required to separately report
items from multiple activities.
A partner in an electing large partnership also takes into
account separately his distributive share of the partnership's
taxable income or loss from activities other than passive loss
limitation activities. Such distributive share is treated as an
item of income or expense with respect to property held for
investment. Thus, portfolio income (e.g., interest and
dividends) is reported separately and is reduced by portfolio
deductions and allocable investment interest expense.
In the case of a partner holding an interest in an electing
large partnership which is not a limited partnership interest,
such partner's distributive share of any items are taken into
account separately to the extent necessary to comply with the
passive loss rules. Thus, for example, income of an electing
large partnership is not treated as passive income with respect
to the general partnership interest of a partner who materially
participates in the partnership's trade or business.
Under the Act, the requirement that the passive loss rule
be separately applied to each publicly traded partnership (sec.
469(k) of the Code) continues to apply.
Alternative minimum tax
Under the Act, alternative minimum tax (``AMT'')
adjustments and preferences are combined at the partnership
level. An electing large partnership would report to partners a
net AMT adjustment separately computed for passive loss
limitation activities and other activities. In determining a
partner's alternative minimum taxable income, a partner's
distributive share of any net AMT adjustment is taken into
account instead of making separate AMT adjustments with respect
to partnership items. The net AMT adjustment is determined by
using the adjustments applicable to individuals (in the case of
partners other than corporations), and by using the adjustments
applicable to corporations (in the case of corporate partners).
Except as provided in regulations, the net AMT adjustment is
treated as a deferral preference for purposes of the section 53
minimum tax credit.
Discharge of indebtedness income
If an electing large partnership has income from the
discharge of any indebtedness, such income is separately
reported to each partner. In addition, the rules governing such
income (sec. 108) are applied without regard to the large
partnership rules. Partner-level elections under section 108
are made by each partner separately. Thus, for example, the
large partnership provisions do not affect section 108(d)(6),
which provides that certain section 108 rules apply at the
partner level, or section 108(b)(5), which provides for an
election to reduce the basis of depreciable property. The large
partnership provisions also do not affect the election under
108(c) (added by the Omnibus Budget Reconciliation Act of 1993)
to exclude discharge of indebtedness income with respect to
qualified real property business indebtedness.
REMICs
For purposes of the tax on partnerships holding residual
interests in REMICs, all interests in an electing large
partnership are treated as held by disqualified organizations.
Thus, an electing large partnership holding a residual interest
in a REMIC is subject to a tax equal to the excess inclusions
multiplied by the highest corporate rate. The amount subject to
tax is excluded from partnership income.
Election of optional basis adjustments
Under the Act, an electing large partnership may still
elect to adjust the basis of partnership assets with respect to
transferee partners. The computation of an electing large
partnership's taxable income is made without regard to the
section 743(b) adjustment. The section 743(b) adjustment is
made only with respect to the transferee partner. In addition,
an electing large partnership is permitted to adjust the basis
of partnership property under section 734(b) if property is
distributed to a partner.
Terminations
The Act provides that an electing large partnership does
not terminate for tax purposes solely because 50 percent of its
interests are sold or exchanged within a 12-month period.
Partnerships and partners subject to large partnership rules
Definition of electing large partnership
An ``electing large partnership'' is any partnership that
elects under the provision, if the number of partners in the
preceding taxable year is 100 or more. The number of partners
is determined by counting only persons directly holding
partnership interests in the taxable year, including persons
holding through nominees; persons holding indirectly (e.g.,
through another partnership) are not counted. Regulations may
provide, however, that if the number of partners in any taxable
year falls below 100, the partnership may not be treated as an
electing large partnership. The election applies to the year
for which made and all subsequent years and cannot be revoked
without the Secretary's consent.
Special rules for certain service partnerships
An election under this provision is not effective for any
partnership if substantially all the partners are: (1)
individuals performing substantial services in connection with
the partnership's activities, or personal service corporations
the owner-employees of which perform such services; (2) retired
partners who had performed such services; or (3) spouses of
partners who had performed such services. In addition, the term
``partner'' does not include any individual performing
substantial services in connection with the partnership's
activities and holding a partnership interest, or an individual
who formerly performed such services and who held a partnership
interest at the time the individual performed such services.
Exclusion for commodity partnerships
An election under this provision is not effective for any
partnership the principal activity of which is the buying and
selling of commodities (not described in sec. 1221(1)), or
options,futures or forwards with respect to commodities.
Special rules for partnerships holding oil and gas properties
Simplified reporting treatment of electing large
partnerships with oil and gas activities
The Act provides special rules for electing large
partnerships with oil and gas activities that operate under the
simplified reporting regime. These partnerships are
collectively referred to herein as ``oil and gas large
partnerships.'' Generally, the Act provides that an oil and gas
large partnership reports information to its partners under the
general simplified large partnership reporting regime described
above. To prevent the extension of percentage depletion
deductions to persons excluded therefrom under present law,
however, certain partners are treated as disqualified persons
under the Act.
The treatment of a disqualified person's distributive share
of any item of income, gain, loss, deduction, or credit
attributable to any partnership oil or gas property is
determined under the Act without regard to the special rules
applicable to large partnerships. Thus, an oil and gas large
partnership reports information related to oil and gas
activities to a partner who is a disqualified person in the
same manner and to the same extent that it reports such
information to that partner under present law. The simplified
reporting rules of the Act, however, apply with respect to
reporting such a partner's share of items not related to oil
and gas activities.
The Act defines two categories of taxpayers as disqualified
persons. The first category encompasses taxpayers who do not
qualify for the deduction for percentage depletion under
section 613A (i.e., integrated producers of oil and gas). The
second category includes any person whose average daily
production of oil and gas (for purposes of determining the
depletable oil and natural gas quantity under section
613A(c)(2)) is at least 500 barrels for its taxable year in
which (or with which) the partnership's taxable year ends. In
making this computation, all production of domestic crude oil
and natural gas attributable to the partner is taken into
account, including such partner's proportionate share of any
production of the large partnership.
A taxpayer that falls within a category of disqualified
person has the responsibility of notifying any large
partnership in which it holds a direct or indirect interest
(e.g., through a pass-through entity) of its status as such.
Thus, for example, if an integrated producer owns an interest
in a partnership which in turn owns an interest in an oil and
gas large partnership, it is responsible for providing the
management of the electing large partnership information
regarding its status as a disqualified person and details
regarding its indirect interest in the electing large
partnership.
Under the Act, an oil and gas large partnership computes
its deduction for oil and gas depletion under the general
statutory rules (subject to certain exceptions described below)
under the assumptions that the partnership is the taxpayer and
that it qualifies for the percentage depletion deduction. The
amount of the depletion deduction, as well as other oil and gas
related items, generally are reported to each partner (other
than to partners who are disqualified persons) as components of
that partner's distributive share of taxable income or loss
from passive loss limitation activities. The Act provides that
in computing the partnership's oil and gas percentage depletion
deduction, the 1,000-barrel-per-day limitation does not apply.
In addition, an oil and gas large partnership is allowed to
compute percentage depletion under the Act without applying the
65-percent-of-taxable-income limitation under section
613A(d)(1).
An election to deduct IDCs under section 263(c) is made at
the partnership level. Since the Act treats those taxpayers
required by the Code (sec. 291) to capitalize 30 percent of
IDCs as disqualified persons, an oil and gas large partnership
may pass through a full deduction of IDCs to its partners who
are not disqualified persons. In contrast to prior law, an oil
and gas large partnership also has the responsibility with
respect to its partners who are not disqualified persons for
making an election under section 59(e) to capitalize and
amortize certain specified IDCs. Partners who are disqualified
persons are permitted to make their own separate section 59(e)
elections under the Act.
Consistent with the general reporting regime for electing
large partnerships, the Act provides that a single AMT
adjustment (under either corporate or non-corporate principles,
as the case may be) is made and reported to the partners (other
than disqualified persons) of an oil and gas large partnership
as a separate item. This separately-reported item is affected
by the limitation on the repeal of the tax preference for
excess IDCs. For purposes of computing this limitation, the Act
treats an oil and gas large partnership as the taxpayer. Thus,
the limitation on repeal of the IDC preference is applied at
the partnership level and is based on the cumulative reduction
in the partnership's alternative minimum taxable income
resulting from repeal of that preference.
The Act provides that in making partnership-level
computations, any item of income, gain, loss, deduction, or
credit attributable to a partner who is a disqualified person
is disregarded. For example, in computing the partnership's net
income from oil and gas for purposes of determining the IDC
preference (if any) to be reported to partners who are not
disqualified persons as part of the AMT adjustment,
disqualified persons' distributive shares of the partnership's
net income from oil and gas are not to be taken into account.
Regulatory authority
The Secretary of the Treasury is granted authority to
prescribe such regulations as may be appropriate to carry out
the purposes of the provisions.
Effective Date
The provision generally applies to partnership taxable
years beginning after December 31, 1997.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $6 million in 1998, $8 million per year in
each of 1999 through 2002, and $9 million per year in each of
2003 through 2007.
b. Simplified audit procedures for electing large
partnerships (sec. 1222 of the Act and secs. 6240,
6241, 6242, 6245, 6246, 6247, 6249, 6251, 6255, and
6256 of the Code)
Present and Prior Law
In general
Prior to 1982, regardless of the size of a partnership,
adjustments to a partnership's items of income, gain, loss,
deduction, or credit had to be made in separate proceedings
with respect to each partner individually. Because a large
partnership sometimes had many partners located in different
audit districts, adjustments to items of income, gains, losses,
deductions, or credits of the partnership had to be made in
numerous actions in several jurisdictions, sometimes with
conflicting outcomes.
The Tax Equity and Fiscal Responsibility Act of 1982
(``TEFRA'') established unified audit rules applicable to all
but certain small (10 or fewer partners) partnerships. These
rules require the tax treatment of all ``partnership items'' to
be determined at the partnership, rather than the partner,
level. Partnership items are those items that are more
appropriately determined at the partnership level than at the
partner level, as provided by regulations.
Under the TEFRA rules, a partner must report all
partnership items consistently with the partnership return or
must notify the IRS of any inconsistency. If a partner fails to
report any partnership item consistently with the partnership
return, the IRS may make a computational adjustment and
immediately assess any additional tax that results.
Administrative proceedings
Under the TEFRA rules, a partner must report all
partnership items consistently with the partnership return or
must notify the IRS of any inconsistency. If a partner fails to
report any partnership item consistently with the partnership
return, the IRS may make a computational adjustment and
immediately assess any additional tax that results.
The IRS may challenge the reporting position of a
partnership by conducting a single administrative proceeding to
resolve the issue with respect to all partners. But the IRS
must still assess any resulting deficiency against each of the
taxpayers who were partners in the year in which the
understatement of tax liability arose.
Any partner of a partnership can request an administrative
adjustment or a refund for his own separate tax liability. Any
partner also has the right to participate in partnership-level
administrative proceedings. A settlement agreement with respect
to partnership items binds allparties to the settlement.
Tax Matters Partner
The TEFRA rules establish the ``Tax Matters Partner'' as
the primary representative of a partnership in dealings with
the IRS. The Tax Matters Partner is a general partner
designated by the partnership or, in the absence of
designation, the general partner with the largest profits
interest at the close of the taxable year. If no Tax Matters
Partner is designated, and it is impractical to apply the
largest profits interest rule, the IRS may select any partner
as the Tax Matters Partner.
Notice requirements
The IRS generally is required to give notice of the
beginning of partnership-level administrative proceedings and
any resulting administrative adjustment to all partners whose
names and addresses are furnished to the IRS. For partnerships
with more than 100 partners, however, the IRS generally is not
required to give notice to any partner whose profits interest
is less than one percent.
Adjudication of disputes concerning partnership items
After the IRS makes an administrative adjustment, the Tax
Matters Partner (and, in limited circumstances, certain other
partners) may file a petition for readjustment of partnership
items in the Tax Court, the district court in which the
partnership's principal place of business is located, or the
Claims Court.
Statute of limitations
The IRS generally cannot adjust a partnership item for a
partnership taxable year if more than 3 years have elapsed
since the later of the filing of the partnership return or the
last day for the filing of the partnership return.
Reasons for Change
Audit procedures for large partnerships are inefficient and
more complex than those for other large entities. The IRS must
assess any deficiency arising from a partnership audit against
a large number of partners, many of whom cannot easily be
located and some of whom are no longer partners. In addition,
audit procedures are cumbersome and can be complicated further
by the intervention of partners acting individually.
Explanation of Provision
The Act creates a new audit system for electing large
partnerships. The provision defines ``electing large
partnership'' the same way for audit and reporting purposes
(generally, any partnership that elects under the reporting
provisions, if the number of partners in the preceding taxable
year is 100 or more).
As under prior law, electing large partnerships and their
partners are subject to unified audit rules. Thus, the tax
treatment of ``partnership items'' are determined at the
partnership, rather than the partner, level. The term
``partnership items'' is defined as under prior law.
Unlike prior law, however, partnership adjustments
generally will flow through to the partners for the year in
which the adjustment takes effect. Thus, the current-year
partners' share of current-year partnership items of income,
gains, losses, deductions, or credits will be adjusted to
reflect partnership adjustments that take effect in that year.
The adjustments generally will not affect prior-year returns of
any partners (except in the case of changes to any partner's
distributive shares).
In lieu of flowing an adjustment through to its partners,
the partnership may elect to pay an imputed underpayment. The
imputed underpayment generally is calculated by netting the
adjustments to the income and loss items of the partnership and
multiplying that amount by the highest tax rate (whether
individual or corporate). A partner may not file a claim for
credit or refund of his allocable share of the payment. A
partnership may make this election only if it meets
requirements set forth in Treasury regulations designed to
ensure payment (for example, in the case of a foreign
partnership).
Regardless of whether a partnership adjustment flows
through to the partners, an adjustment must be offset if it
requires another adjustment in a year after the adjusted year
and before the year the offsetted adjustment takes effect. For
example, if a partnership expensed a $1,000 item in year 1, and
it was determined in year 4 that the item should have been
capitalized and amortized ratably over 10 years, the adjustment
in year 4 would be $700, apart from any interest or penalty.
(The $900 adjustment for the improper deduction would be offset
by $200 of adjustments for amortization deductions.) The year 4
partners would be required to include an additional $700 in
income for that year. The partnership may ratably amortize the
remaining $700 of expenses in years 4-10.
In addition, the partnership, rather than the partners
individually, generally is liable for any interest and
penalties that result from a partnership adjustment. Interest
is computed for the period beginning on the return due date for
the adjusted year and ending on the earlier of the return due
date for the partnership taxable year in which the adjustment
takes effect or the date the partnership pays the imputed
underpayment. Thus, in the above example, the partnership would
be liable for 4 years' worth of interest (on a declining
principal amount).
Penalties (such as the accuracy and fraud penalties) are
determined on a year-by-year basis (without offsets) based on
an imputed underpayment. All accuracy penalty criteria and
waiver criteria (such as reasonable cause, substantial
authority, etc.) are determined as if the partnership were a
taxable individual. Accuracy and fraud penalties are assessed
and accrue interest in the same manner as if asserted against a
taxable individual.
Any payment (for Federal income taxes, interest, or
penalties) that an electing large partnership is required to
make is non-deductible.
If a partnership ceases to exist before a partnership
adjustment takes effect, the former partners are required to
take the adjustment into account, as provided by regulations.
Regulations are also authorized to prevent abuse and to enforce
efficiently the audit rules in circumstances that present
special enforcement considerations (such as partnership
bankruptcy).
Administrative proceedings
Under the electing large partnership audit rules, a partner
is not permitted to report any partnership items inconsistently
with the partnership return, even if the partner notifies the
IRS of the inconsistency. The IRS may treat a partnership item
that was reported inconsistently by a partner as a mathematical
or clerical error and immediately assess any additional tax
against that partner.
As under prior law, the IRS may challenge the reporting
position of a partnership by conducting a single administrative
proceeding to resolve the issue with respect to all partners.
Unlike under prior law, however, partners will have no right
individually to participate in settlement conferences or to
request a refund.
Partnership representative
The Act requires each electing large partnership to
designate a partner or other person to act on its behalf. If an
electing large partnership fails to designate such a person,
the IRS is permitted to designate any one of the partners as
the person authorized to act on the partnership's behalf. After
the IRS's designation, an electing large partnership could
still designate a replacement for the IRS-designated partner.
Notice requirements
Unlike under prior law, the IRS is not required to give
notice to individual partners of the commencement of an
administrative proceeding or of a final adjustment. Instead,
the IRS is authorized to send notice of a partnership
adjustment to the partnership itself by certified or registered
mail. The IRS could give proper notice by mailing the notice to
the last known address of the partnership, even if the
partnership had terminated its existence.
Adjudication of disputes concerning partnership items
As under prior law, an administrative adjustment could be
challenged in the Tax Court, the district court in which the
partnership's principal place of business is located, or the
Claims Court. However, only the partnership, and not partners
individually, can petition for a readjustment of partnership
items.
If a petition for readjustment of partnership items is
filed by the partnership, the court with which the petition is
filed will have jurisdiction to determine the tax treatment of
all partnership items of the partnership for the partnership
taxable year to which the notice of partnership adjustment
relates, and the proper allocation of such items among the
partners. Thus, the court's jurisdiction is not limited to the
items adjusted in the notice.
Statute of limitations
Absent an agreement to extend the statute of limitations,
the IRS generally could not adjust a partnership item of an
electing large partnership more than 3 years after the later of
the filing of the partnership return or the last day for the
filing of the partnership return. Special rules apply to false
or fraudulent returns, a substantial omission of income, or the
failure to file a return. The IRS would assess and collect any
deficiency of a partner that arises from any adjustment to a
partnership item subject to the limitations period on
assessments and collection applicable to the year the
adjustment takes effect (secs. 6248, 6501 and 6502).
Regulatory authority
The Secretary of the Treasury is granted authority to
prescribe regulations as may be necessary to carry out the
simplified audit procedure provisions, including regulations to
prevent abuse of the provisions through manipulation. The
regulations may include rules that address transfers of
partnership interests, in anticipation of a partnership
adjustment, to persons who are tax-favored (e.g., corporations
with net operating losses, tax-exempt organizations, and
foreign partners) or persons who are expected to be unable to
pay tax (e.g., shell corporations). For example, if prior to
the time a partnership adjustment takes effect, a taxable
partner transfers a partnership interest to a nonresident alien
to avoid the tax effect of the partnership adjustment, the
rules may provide, among other things, that income related to
the partnership adjustment is treated as effectively connected
taxable income, that the partnership adjustment is treated as
taking effect before the partnership interest was transferred,
or that the former partner is treated as a current partner to
whom the partnership adjustment is allocated.
Effective Date
The provision applies to partnership taxable years
beginning after December 31, 1997.\301\
---------------------------------------------------------------------------
\301\ A technical correction may be needed so that the statute
reflects this intent. See Title VI of H.R. 2676, the Tax Technical
Corrections Act of 1997, as passed by the House on November 5, 1997.
---------------------------------------------------------------------------
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by less than $500,000 in each of 1998 through
2000, and by $1 million per year for 2001 through 2007.
c. Due date for furnishing information to partners of
electing large partnerships (sec. 1223 of the Act
and sec. 6031(b) of the Code)
Present and Prior Law
A partnership required to file an income tax return with
the Internal Revenue Service must also furnish an information
return to each of its partners on or before the day on which
the income tax return for the year is required to be filed,
including extensions. Under regulations, a partnership must
file its income tax return on or before the fifteenth day of
the fourth month following the end of the partnership's taxable
year (on or before April 15, for calendar year partnerships).
This is the same deadline by which most individual partners
must file their tax returns.
Reasons for Change
Information returns that are received on or shortly before
April 15 (or later) are difficult for individuals to use in
preparing their tax returns (or in computing their payments)
that are due on that date.
Explanation of Provision
The Act provides that an electing large partnership must
furnish information returns to partners by the first March 15
following the close of the partnership's taxable year. Electing
large partnerships are those partnerships subject to the
simplified reporting and audit rules (generally, any
partnership that elects under the reporting provision, if the
number of partners in the preceding taxable year is 100 or
more).
The provision also provides that, if the partnership is
required to provide copies of the information returns to the
Internal Revenue Service on magnetic media, each schedule (such
as each Schedule K-1) with respect to each partner is treated
as a separate information return with respect to the corrective
periods and penalties that are generally applicable to all
information returns.
Effective Date
The provision is effective for partnership taxable years
beginning after December 31, 1997.\302\
---------------------------------------------------------------------------
\302\ A technical correction may be needed so that the statute
reflects this intent. See Title VI of H.R. 2676, the Tax Technical
Corrections Act of 1997, as passed by the House on November 5, 1997.
---------------------------------------------------------------------------
Revenue Effect
The provision is estimated to have no effect on Federal
fiscal year budget receipts.
d. Partnership returns required on magnetic media (sec.
1224 of the Act and sec. 6011 of the Code)
Present and Prior Law
Partnerships are permitted, but not required, to provide
the tax return of the partnership (Form 1065), as well as
copies of the schedules sent to each partner (Form K-1), to the
Internal Revenue Service on magnetic media.
Reasons for Change
Most entities that file large numbers of documents with the
Internal Revenue Service must do so on magnetic media.
Conforming the reporting provisions for partnerships to the
generally applicable information reporting rules will
facilitate intergration of partnership information into already
existing data systems.
Explanation of Provision
The Act provides generally that any partnership is required
to provide the tax return of the partnership (Form 1065), as
well as copies of the schedule sent to each partner (Form K-1),
to the Internal Revenue Service on magnetic media. An exception
is provided for partnerships with 100 or fewer partners.
Effective Date
The provision is effective for partnership taxable years
beginning after December 31, 1997.\303\
---------------------------------------------------------------------------
\303\ A technical correction may be needed so that the statute
reflects this intent. See Title VI of H.R. 2676, the Tax Technical
Corrections Act of 1997, as passed by the House on November 5, 1997.
---------------------------------------------------------------------------
Revenue Effect
The provision is estimated to have a negligible revenue
effect.
e. Treatment of partnership items of individual retirement
arrangements (sec. 1225 of the Act and sec. 6012 of
the Code)
Present and Prior Law
Return filing requirements
An individual retirement account (``IRA'') is a trust which
generally is exempt from taxation except for the taxes imposed
on income from an unrelated trade or business. A fiduciary of a
trust that is exempt from taxation (but subject to the taxes
imposed on income from an unrelated trade or business)
generally is required to file a return on behalf of the trust
for a taxable year if the trust has gross income of $1,000 or
more included in computing unrelated business taxable income
for that year (Treas. Reg. sec. 1.6012-3(a)(5)).
Unrelated business taxable income is the gross income
(including gross income from a partnership) derived by an
exempt organization from an unrelated trade or business, less
certain deductions which are directly connected with the
carrying on of such trade or business (sec. 512(a)(1). In
calculating unrelated business taxable income, exempt
organizations (including IRAs) generally also are permitted a
specific deduction of $1,000 (sec. 512(b)(12)).
Unified audits of partnerships
All but certain small partnerships are subject to unified
audit rules established by the Tax Equity and Fiscal
Responsibility Act of 1982. These rules require the tax
treatment of all ``partnership items'' to be determined at the
partnership, rather than the partner, level. Partnership items
are those items that are more appropriately determined at the
partnership level than at the partner level, including such
items as gross income and deductions of the partnership.
Reasons for Change
Under prior law, tax returns often were required to be
filed for IRAs that had no taxable income and, consequently, no
tax liability. The filing of these returns by taxpayers, and
the processing of these returns by the IRS, impose significant
costs. Imposing this burden is unnecessary to the extent that
the income of the IRA has been derived from an interest in a
partnership that is subject to partnership-level audit rules.
In these circumstances, the appropriateness of any deductions
may be determined at the partnership level, and an additional
filing is unnecessary to facilitate this determination.
Explanation of Provision
The Act modifies the filing threshold for an IRA with an
interest in a partnership that is subject to the partnership-
level audit rules. A fiduciary of such an IRA could treat the
trust's share of partnership taxable income as gross income,
for purposes of determining whether the trust meets the $1,000
gross income filing threshold. A fiduciary of an IRA that
receives taxable income from a partnership that is subject to
partnership-level audit rules of less than $1,000 (before the
$1,000 specific deduction) is not required to file an income
tax return if the IRA does not have any other income from an
unrelated trade or business.
Effective Date
The provision applies to taxable years beginning after
December 31, 1997.\304\
---------------------------------------------------------------------------
\304\ A technical correction may be needed so that the statute
reflects this intent. See Title VI of H.R. 2676, the Tax Technical
Corrections Act of 1997, as passed by the House on November 5, 1997.
---------------------------------------------------------------------------
Revenue Effect
The provision is estimated to have no revenue effect.
2. Other partnership audit rules
a. Treatment of partnership items in deficiency proceedings
(sec. 1231 of the Act and sec. 6234 of the Code)
Present and Prior Law
Partnership proceedings under rules enacted in TEFRA \305\
must be kept separate from deficiency proceedings involving the
partners in their individual capacities. Prior to the Tax
Court's opinion in Munro v. Commissioner, 92 T.C. 71 (1989),
the IRS computed deficiencies by assuming that all items that
were subject to the TEFRA partnership procedures were correctly
reported on the taxpayer's return. However, where the losses
claimed from TEFRA partnerships were so large that they offset
any proposed adjustments to nonpartnership items, no deficiency
could arise from a non-TEFRA proceeding, and if the partnership
losses were subsequently disallowed in a partnership
proceeding, the non-TEFRA adjustments might be uncollectible
because of the expiration of the statute of limitations with
respect to nonpartnership items.
---------------------------------------------------------------------------
\305\ Tax Equity and Fiscal Responsibility Act of 1982.
---------------------------------------------------------------------------
Faced with this situation in Munro, the IRS issued a notice
of deficiency to the taxpayer that presumptively disallowed the
taxpayer's TEFRA partnership losses for computational purposes
only. Although the Tax Court ruled that a deficiency existed
and that the court had jurisdiction to hear the case, the court
disapproved of the methodology used by the IRS to compute the
deficiency. Specifically, the court held that partnership items
(whether income, loss, deduction, or credit) included on a
taxpayer's return must be completely ignored in determining
whether a deficiency exists that is attributable to
nonpartnership items.
Reasons for Change
The opinion in Munro creates problems for both taxpayers
and the IRS. For example, a taxpayer would be harmed in the
case where he has invested in a TEFRA partnership and is also
subject to the deficiency procedures with respect to
nonpartnership item adjustments, since computing the tax
liability without regard to partnership items will have the
same effect as if the partnership items were disallowed. If the
partnership items were losses, the effect will be a greatly
increased deficiency for the nonpartnership items. If, when the
partnership proceedings are completed, the taxpayer is
ultimately allowed any part of the losses, the taxpayer will
receive part of the increased deficiency back in the form of an
overpayment. However, in the interim, the taxpayer will have
been subject to assessment and collection of a deficiency
inflated by items still in dispute in the partnership
proceeding. In essence, a taxpayer in such a case would be
deprived of a prepayment forum with respect to the partnership
item adjustments. The IRS would be harmed if a taxpayer's
income is primarily from a TEFRA partnership, since the IRS may
be unable to adjust nonpartnership items such as medical
expense deductions, home mortgage interest deductions or
charitable contribution deductions because there would be no
deficiency since, under Munro, the income must be ignored.
Explanation of Provision
The Act overrules Munro and allow the IRS to return to its
prior practice of computing deficiencies by assuming that all
TEFRA items whose treatment has not been finally determined had
been correctly reported on the taxpayer's return. This
eliminates the need to do special computations that involve the
removal of TEFRA items from a taxpayer's return, and will
restore to taxpayers a prepayment forum with respect to the
TEFRA items. In addition, the provision provides a special rule
to address the factual situation presented in Munro.
Specifically, the Act provides a declaratory judgment
procedure in the Tax Court for adjustments to an oversheltered
return. An oversheltered return is a return that shows no
taxable income and a net loss from TEFRA partnerships. In such
a case, the IRS is authorized to issue a notice of adjustment
with respect to non-TEFRA items, notwithstanding that no
deficiency would result from the adjustment. However, the IRS
could only issue such a notice if a deficiency would have
arisen in the absence of the net loss from TEFRA partnerships.
The Tax Court is granted jurisdiction to determine the
correctness of such an adjustment as well as to make a
declaration with respect to any other item for the taxable year
to which the notice of adjustment relates, except for
partnership items and affected items which require partner-
level determinations. No tax is due upon such a determination,
but a decision of the Tax Court is treated as a final decision,
permitting an appeal of the decision by either the taxpayer or
the IRS. An adjustment determined to be correct would thus have
the effect of increasing the taxable income that is deemed to
have been reported on the taxpayer's return. If the taxpayer's
partnership items were then adjusted in a subsequent
proceeding, the IRS has preserved its ability to collect tax on
any increased deficiency attributable to the nonpartnership
items.
Alternatively, if the taxpayer chooses not to contest the
notice of adjustment within the 90-day period, the Act provides
that when the taxpayer's partnership items are finally
determined, the taxpayer has the right to file a refund claim
for tax attributable to the items adjusted by the earlier
notice of adjustment for the taxable year. Although a refund
claim is not generally permitted with respect to a deficiency
arising from a TEFRA proceeding, such a rule is appropriate
with respect to a defaulted notice of adjustment because
taxpayers may not challenge such a notice when issued since it
does not require the payment of additional tax.
In addition, the Act incorporates a number of provisions
intended to clarify the coordination between TEFRA audit
proceedings and individual deficiency proceedings. Under these
provisions, any adjustment with respect to a non-partnership
item that caused an increase in tax liability with respect to a
partnership item would be treated as a computational adjustment
and assessed after the conclusion of the TEFRA proceeding.
Accordingly, deficiency procedures do not apply with respect to
this increase in tax liability, and the statute of limitations
applicable to TEFRA proceedings are controlling.
Effective Date
The provision is effective for partnership taxable years
ending after the date of enactment.
b. Partnership return to be determinative of audit
procedures to be followed (sec. 1232 of the Act and
sec. 6231 of the Code)
Present and Prior Law
TEFRA established unified audit rules applicable to all
partnerships, except for partnerships with 10 or fewer
partners, each of whom is a natural person (other than a
nonresident alien) or an estate, and for which each partner's
share of each partnership item is the same as that partner's
share of every other partnership item. Partners in the exempted
partnerships are subject to regular deficiency procedures.
Reasons for Change
The IRS often finds it difficult to determine whether to
follow the TEFRA partnership procedures or the regular
deficiency procedures. If the IRS determines that there were
fewer than 10 partners in the partnership but was unaware that
one of the partners was a nonresident alien or that there was a
special allocation made during the year, the IRS might
inadvertently apply the wrong procedures and possibly
jeopardize any assessment. Permitting the IRS to rely on a
partnership's return would simplify the IRS' task.
Explanation of Provision
The Act permits the IRS to apply the TEFRA audit procedures
if, based on the partnership's return for the year, the IRS
reasonably determines that those procedures should apply.
Similarly, the provision permits the IRS to apply the normal
deficiency procedures if, based on the partnership's return for
the year, the IRS reasonably determines that those procedures
should apply.
Effective Date
The provision is effective for partnership taxable years
ending after the date of enactment.
c. Provisions relating to statute of limitations
i. Suspend statute when an untimely petition is filed
(sec. 1233(a) of the Act and sec. 6229 of the Code)
Present and Prior Law
In a deficiency case, section 6503(a) provides that if a
proceeding in respect of the deficiency is placed on the docket
of the Tax Court, the period of limitations on assessment and
collection is suspended until the decision of the Tax Court
becomes final, and for 60 days thereafter. The counterpart to
this provision with respect to TEFRA cases is contained in
section 6229(d). That section provides that the period of
limitations is suspended for the period during which an action
may be brought under section 6226 and, if an action is brought
during such period, until the decision of the court becomes
final, and for 1 year thereafter. As a result of this
difference in language, the running of the statute of
limitations in a TEFRA case will only be tolled by the filing
of a timely petition whereas in a deficiency case, the statute
of limitations is tolled by the filing of any petition,
regardless of whether the petition is timely.
Reasons for Change
Under prior law, if an untimely petition was filed in a
TEFRA case, the statute of limitations could expire while the
case was still pending before the court. To prevent this from
occurring, the IRS must make assessments against all of the
investors during the pendency of the action and if the action
is in the Tax Court, presumably abate such assessments if the
court ultimately determines that the petition was timely. These
steps are burdensome to the IRS and to taxpayers.
Explanation of Provision
The Act conforms the suspension rule for the filing of
petitions in TEFRA cases with the rule under section 6503(a)
pertaining to deficiency cases. Under the provision, the
statute of limitations in TEFRA cases is suspended by the
filing of any petition under section 6226, regardless of
whether the petition is timely or valid, and the suspension
will remain in effect until the decision of the court becomes
final, and for one year thereafter. Hence, if the statute of
limitations is open at the time that an untimely petition is
filed, the limitations period would no longer continue to run
and possibly expire while the action is pending before the
court.
Effective Date
The provision is effective with respect to all cases in
which the period of limitations has not expired under present
law as of the date of enactment (August 5, 1997).
ii. Suspend statute of limitations during bankruptcy
proceedings (sec. 1233(b) of the Act and sec. 6229
of the Code)
Present and Prior Law
The period for assessing tax with respect to partnership
items generally is the longer of the periods provided by
section 6229 or section 6501. For partnership items that
convert to nonpartnership items, section 6229(f) provides that
the period for assessing tax shall not expire before the date
which is 1 year after the date that the items become
nonpartnership items. Section 6503(h) provides for the
suspension of the limitations period during the pendency of a
bankruptcy proceeding. However, this provision only applies to
the limitations periods provided in sections 6501 and 6502.
Because the suspension provision in section 6503(h) applies
only to the limitations periods provided in section 6501 and
6502, some uncertainty exists as to whether section 6503(h)
applies to suspend the limitations period pertaining to
converted items provided in section 6229(f) when a petition
naming a partner as a debtor in a bankruptcy proceeding is
filed. As a result, the limitations period provided in section
6229(f) may continue to run during the pendency of the
bankruptcy proceeding, notwithstanding that the IRS is
prohibited from making an assessment against the debtor because
of the automatic stay provisions of the Bankruptcy Code.
Reasons for Change
The ambiguity in prior law made it difficult for the IRS to
adjust partnership items that convert to nonpartnership items
by reason of a partner going into bankruptcy. In addition, any
uncertainty may have resulted in increased requests for the
bankruptcy court to lift the automatic stay to permit the IRS
to make an assessment with respect to the converted items.
Explanation of Provision
The Act clarifies that the statute of limitations is
suspended for a partner who is named in a bankruptcy petition.
The suspension period is for the entire period during which the
IRS is prohibited by reason of the bankruptcy proceeding from
making an assessment, and for 60 days thereafter. The provision
does not purport to create any inference as to the proper
interpretation of prior law.
Effective Date
The provision is effective with respect to all cases in
which the period of limitations has not expired under present
law as of the date of enactment (August 5, 1997).
iii. Extend statute of limitations for bankrupt TMPs
(sec. 1233(c) of the Act and sec. 6229 of the Code)
Present and Prior Law
Section 6229(b)(1)(B) provides that the statute of
limitations is extended with respect to all partners in the
partnership by an agreement entered into between the tax
matters partner (TMP) and the IRS. However, Temp. Treas. Reg.
secs. 301.6231(a)(7)-1T(1)(4) and 301.6231(c)-7T(a) provide
that upon the filing of a petition naming a partner as a debtor
in a bankruptcy proceeding, that partner's partnership items
convert to nonpartnership items, and if the debtor was the tax
matters partner, such status terminates. These rules are
necessary because of the automatic stay provision contained in
11 U.S.C. sec. 362(a)(8). As a result, if a consent to extend
the statute of limitations is signed by a person who would be
the TMP but for the fact that at the time that the agreement is
executed the person was a debtor in a bankruptcy proceeding,
the consent would not be binding on the other partners because
the person signing the agreement was no longer the TMP at the
time that the agreement was executed.
Reasons for Change
The IRS is not automatically notified of bankruptcy filings
and cannot easily determine whether a taxpayer is in
bankruptcy, especially if the audit of the partnership is being
conducted by one district and the taxpayer resides in another
district, as is frequently the situation in TEFRA cases. If the
IRS does not discover that a person signing a consent is in
bankruptcy, the IRS may mistakenly rely on that consent. As a
result, the IRS may be precluded from assessing any tax
attributable to partnership item adjustments with respect to
any of the partners in the partnership.
Explanation of Provision
The Act provides that unless the IRS is notified of a
bankruptcy proceeding in accordance with regulations, the IRS
can rely on a statute extension signed by a person who is the
tax matters partner but for the fact that said person was in
bankruptcy at the time that the person signed the agreement.
Statute extensions granted by a bankrupt TMP in these cases are
binding on all of the partners in the partnership. The
provision is not intended to create any inference as to the
proper interpretation of prior law.
Effective Date
The provision is effective for extension agreements entered
into after the date of enactment (August 5, 1997).
d. Expansion of small partnership exception (sec. 1234 of
the Act and sec. 6231 of the Code)
Present and Prior Law
TEFRA established unified audit rules applicable to all
partnerships, except for partnerships with 10 or fewer
partners, each of whom is a natural person (other than a
nonresident alien) or an estate, and for which each partner's
share of each partnership item is the same as that partner's
share of every other partnership item. Partners in the exempted
partnerships are subject to regular deficiency procedures.
Reasons for Change
The more existence of a C corporation as a partner or of a
special allocation does not warrant subjecting the partnership
and its partners of an otherwise small partnership to the TEFRA
procedures.
Explanation of Provision
The Act permits a small partnership to have a C corporation
as a partner or to specially allocate items without
jeopardizing its exception from the TEFRA rules. However, the
provision retains the prohibition against having a flow-through
entity (other than an estate of a deceased partner) as a
partner for purposes of qualifying for the small partnership
exception.
Effective Date
The provision is effective for partnership taxable years
ending after the date of enactment (August 5, 1997).
e. Exclusion of partial settlements from 1-year limitation
on assessment (sec. 1235 of the Act and sec.
6229(f) of the Code)
Present and Prior Law
The period for assessing tax with respect to partnership
items generally is the longer of the periods provided by
section 6229 or section 6501. For partnership items that
convert to nonpartnership items, section 6229(f) provides that
the period for assessing tax shall not expire before the date
which is 1 year after the date that the items become
nonpartnership items. Section 6231(b)(1)(C) provides that the
partnership items of a partner for a partnership taxable year
become nonpartnership items as of the date the partner enters
into a settlement agreement with the IRS with respect to such
items.
Reasons for Change
When a partial settlement agreement is entered into, the
assessment period for the items covered by the agreement may be
different than the assessment period for the remaining items.
This fractured statute of limitations poses a significant
tracking problem for the IRS and necessitates multiple
computations of tax with respect to each partner's investment
in the partnership for the taxable year.
Explanation of Provision
The Act provides that if a partner and the IRS enter into a
settlement agreement with respect to some but not all of the
partnership items in dispute for a partnership taxable year and
other partnership items remain in dispute, the period for
assessing any tax attributable to the settled items is
determined as if such agreement had not been entered into.
Consequently, the limitations period that is applicable to the
last item to be resolved for the partnership taxable year is
controlling with respect to all disputed partnership items for
the partnership taxable year. The provision does not purport to
create any inference as to the proper interpretation of prior
law.
Effective Date
The provision is effective for settlements entered into
after the date of enactment (August 5, 1997).
f. Extension of time for filing a request for
administrative adjustment (sec. 1236 of the Act and
sec. 6227 of the Code)
Present and Prior Law
If an agreement extending the statute is entered into with
respect to a non-TEFRA statute of limitations, that agreement
also extends the statute of limitations for filing refund
claims (sec. 6511(c)). There is no comparable provision for
extending the time for filing refund claims with respect to
partnership items subject to the TEFRA partnership rules.
Reasons for Change
The absence of an extension for filing refund claims in
TEFRA proceedings hinders taxpayers that may want to agree to
extend the TEFRA statute of limitations but want to preserve
their option to file a refund claim later.
Explanation of Provision
The Act provides that if a TEFRA statute extension
agreement is entered into, that agreement also extends the
statute of limitations for filing refund claims attributable to
partnership items or affected items until 6 months after the
expiration of the limitations period for assessments.
Effective Date
The provision is effective as if included in the amendments
made by section 402 of the Tax Equity and Fiscal Responsibility
Act of 1982.
g. Availability of innocent spouse relief in context of
partnership proceedings (sec. 1237 of the Act and
sec. 6230 of the Code)
Present and Prior Law
In general, an innocent spouse may be relieved of liability
for tax, penalties and interest if certain conditions are met
(sec. 6013(e)). However, existing law does not provide the
spouse of a partner in a TEFRA partnership with a judicial
forum to raise the innocent spouse defense with respect to any
tax or interest that relates to an investment in a TEFRA
partnership.
Reasons for Change
Providing a forum in which to raise the innocent spouse
defense with respect to liabilities attributable to adjustments
to partnership items (including penalties, additions to tax and
additional amounts) would make the innocent spouse rules more
uniform.
Explanation of Provision
The Act provides both a prepayment forum and a refund forum
for raising the innocent spouse defense in TEFRA cases.
With respect to a prepayment forum, the provision provides
that within 60 days of the date that a notice of computational
adjustment relating to partnership items is mailed to the
spouse of a partner, the spouse could request that the
assessment be abated. Upon receipt of such a request, the
assessment is abated and any reassessment will be subject to
the deficiency procedures. If an abatement is requested, the
statute of limitations does not expire before the date which is
60 days after the date of the abatement. If the spouse files a
petition with the Tax Court, the Tax Court only has
jurisdiction to determine whether the requirements of section
6013(e) have been satisfied. In making this determination, the
treatment of the partnership items that gave rise to the
liability in question is conclusive.
Alternatively, the Act provides that the spouse of a
partner could file a claim for refund to raise the innocent
spouse defense. The claim has to be filed within 6 months from
the date that the notice of computational adjustment is mailed
to the spouse. If the claim is not allowed, the spouse could
file a refund action. For purposes of any claim or suit under
this provision, the treatment of the partnership items that
gave rise to the liability in question is conclusive.
Effective Date
The provision is effective as if included in the amendments
made by section 402 of the Tax Equity and Fiscal Responsibility
Act of 1982.
h. Determination of penalties at partnership level (sec.
1238 of the Act and sec. 6221 of the Code)
Present and Prior Law
Partnership items include only items that are required to
be taken into account under the income tax subtitle. Penalties
are not partnership items since they are contained in the
procedure and administration subtitle. As a result, penalties
may only be asserted against a partner through the application
of the deficiency procedures following the completion of the
partnership-level proceeding.
Reasons for Change
Many penalties are based upon the conduct of the taxpayer.
With respect to partnerships, the relevant conduct often occurs
at the partnership level. In addition, applying penalties at
the partner level through the deficiency procedures following
the conclusion of the unified proceeding at the partnership
level increases the administrative burden on the IRS and can
significantly increase the Tax Court's inventory.
Explanation of Provision
The Act provides that the partnership-level proceeding is
to include a determination of the applicability of penalties at
the partnership level. However, the provision allows partners
to raise any partner-level defenses in a refund forum.
Effective Date
The provision is effective for partnership taxable years
ending after the date of enactment (August 5, 1997).
i. Provisions relating to Tax Court jurisdiction (sec. 1239
of the Act and secs. 6225 and 6226 of the Code)
Present and Prior Law
Improper assessment and collection activities by the IRS
during the 150-day period for filing a petition or during the
pendency of any Tax Court proceeding, ``may be enjoined in the
proper court.'' Prior law may be unclear as to whether this
includes the Tax Court.
For a partner other than the Tax Matters Partner to be
eligible to file a petition for redetermination of partnership
items in any court or to participate in an existing case, the
period for assessing any tax attributable to the partnership
items of that partner must not have expired. Since such a
partner would only be treated as a party to the action if the
statute of limitations with respect to them was still open, the
law is unclear whether the partner would have standing to
assert that the statute of limitations had expired with respect
to them.
Reasons for Change
Clarifying the Tax Court's jurisdiction simplifies the
resolution of tax cases.
Explanation of Provision
The Act clarifies that an action to enjoin premature
assessments of deficiencies attributable to partnership items
may be brought in the Tax Court. The provision also permits a
partner to participate in an action or file a petition for the
sole purpose of asserting that the period of limitations for
assessing any tax attributable to partnership items has expired
for that person. Additionally, the provision clarifies that the
Tax Court has overpayment jurisdiction with respect to affected
items.
Effective Date
The provision is effective for partnership taxable years
ending after the date of enactment (August 5, 1997).
j. Treatment of premature petitions filed by notice
partners or 5-percent groups (sec. 1240 of the Act
and sec. 6226 of the Code)
Present and Prior Law
The Tax Matters Partner is given the exclusive right to
file a petition for a readjustment of partnership items within
the 90-day period after the issuance of the notice of a final
partnership administrative adjustment (FPAA). If the Tax
Matters Partner does not file a petition within the 90-day
period, certain other partners are permitted to file a petition
within the 60-day period after the close of the 90-day period.
There are ordering rules for determining which action goes
forward and for dismissing other actions.
Reasons for Change
A petition that is filed within the 90-day period by a
person who is not the Tax Matters Partner is dismissed. Thus,
if the Tax Matters Partner does not file a petition within the
90-day period and no timely and valid petition is filed during
the succeeding 60-day period, judicial review of the
adjustments set forth in the notice of FPAA is foreclosed and
the adjustments are deemed to be correct.
Explanation of Provision
The Act treats premature petitions filed by certain
partners within the 90-day period as being filed on the last
day of the following 60-day period under specified
circumstances, thus affording the partnership with an
opportunity for judicial review that was not available under
prior law.
Effective Date
The provision is effective with respect to petitions filed
after the date of enactment (August 5, 1997).
k. Bonds in case of appeals from certain proceedings (sec.
1241 of the Act and sec. 7485 of the Code)
Present and Prior Law
A bond must be filed to stay the collection of deficiencies
pending the appeal of the Tax Court's decision in a TEFRA
proceeding. The amount of the bond must be based on the court's
estimate of the aggregate deficiencies of the partners.
Reasons for Change
The Tax Court cannot easily determine the aggregate changes
in tax liability of all of the partners in a partnership who
will be affected by the Court's decision in the proceeding.
Clarifying the calculation of the bond amount would simplify
the Tax Court's task.
Explanation of Provision
The Act clarifies that the amount of the bond should be
based on the Tax Court's estimate of the aggregate liability of
the parties to the action (and not all of the partners in the
partnership). For purposes of this provision, the amount of the
bond could be estimated by applying the highest individual rate
to the total adjustments determined by the Tax Court and
doubling that amount to take into account interest and
penalties.
Effective Date
The provision is effective as if included in the amendments
made by section 402 of the Tax Equity and Fiscal Responsibility
Act of 1982.
l. Suspension of interest where delay in computational
adjustment resulting from certain settlements (sec.
1242 of the Act and sec. 6601 of the Code)
Present and Prior Law
Interest on a deficiency generally is suspended when a
taxpayer executes a settlement agreement with the IRS and
waives the restrictions on assessments and collections, and the
IRS does not issue a notice and demand for payment of such
deficiency within 30 days. Interest on a deficiency that
results from an adjustment of partnership items in TEFRA
proceedings, however, is not suspended.
Reasons for Change
Processing settlement agreements and assessing the tax due
takes a substantial amount of time in TEFRA cases. A taxpayer
is not afforded any relief from interest during this period.
Explanation of Provision
The Act suspends interest where there is a delay in making
a computational adjustment relating to a TEFRA settlement.
Effective Date
The provision is effective with respect to adjustments
relating to taxable years beginning after the date of enactment
(August 5, 1997).
m. Special rules for administrative adjustment requests
with respect to bad debts or worthless securities
(sec. 1243 of the Act and sec. 6227 of the Code)
Present and Prior Law
The non-TEFRA statute of limitations for filing a claim for
credit or refund generally is the later of (1) three years from
the date the return in question was filed or (2) two years from
the date the claimed tax was paid, whichever is later (sec.
6511(b)). However, an extended period of time, seven years from
the date the return was due, is provided for filing a claim for
refund of an overpayment resulting from a deduction for a
worthless security or bad debt (sec. 6511(d)).
Under the TEFRA partnership rules, a request for
administrative adjustment (``RAA'') must be filed within three
years after the later of (1) the date the partnership return
was filed or (2) the due date of the partnership return
(determined without regard to extensions) (sec. 6227(a)(1)). In
addition, the request must be filed before a final partnership
administrative adjustment (``FPAA'') is mailed for the taxable
year (sec. 6227(a)(2)). There is no special provision for
extending the time for filing an RAA that relates to a
deduction for a worthless security or an entirely worthless bad
debt.
Reasons for Change
Whether and when a stock or debt becomes worthless is a
question of fact that may not be determinable until after the
year in which it appears the loss has occurred. An extended
statute of limitations allows partners in a TEFRA partnership
the same opportunity to file a delayed claim for refund in
these difficult factual situations as other taxpayers are
permitted.
Further, on past occasions, the IRS issued FPAAs that did
not adjust the partnership's tax return. This action created
wasteful paperwork, and may have, in some cases truncated the
appeals rights of individual partners. A special rule is
necessary to permit partners who may have been adversely
impacted by this past practice of the IRS to avail themselves
of the extended period irrespective of whether an FPAA has been
issued.
Explanation of Provision
The Act extends the time for the filing of an RAA relating
to the deduction by a partnership for a worthless security or
bad debt. In these circumstances, in lieu of the three-year
period provided in sec. 6227(a)(1), the period for filing an
RAA is seven years from the date the partnership return was due
with respect to which the request is made (determined without
regard to extensions). The RAA is still required to be filed
before the FPAA is mailed for the taxable year.
Effective Date
The provision is effective as if included in the amendments
made by section 402 of the Tax Equity and Fiscal Responsibility
Act of 1982.
Revenue Effect
The provisions included in item 2 (other partnership audit
rules) are estimated to reduce Federal fiscal year budget
receipts by $2 million in 1998 and by less than $500,000 per
year in each of 1999 through 2007.
3. Closing of partnership taxable year with respect to deceased partner
(sec. 1246 of the Act and sec. 706(c)(2)(A) of the Code)
Present and Prior Law
The partnership taxable year closes with respect to a
partner whose entire interest is sold, exchanged, or
liquidated. Such year, however, generally does not close upon
the death of a partner. Thus, a decedent's entire share of
items of income, gain, loss, deduction and credit for the
partnership year in which death occurs is taxed to the estate
or successor in interest rather than to the decedent on his or
her final income tax return. See Estate of Hesse v.
Commissioner, 74 T.C. 1307, 1311 (1980).
Reasons for Change
The rule leaving open the partnership taxable year with
respect to a deceased partner was adopted in 1954 to prevent
the bunching of income that could occur with respect to a
partnership reporting on a fiscal year other than the calendar
year. Without this rule, as many as 23 months of income might
have been reported on the partner's final return. Legislative
changes occurring since 1954 have required most partnerships to
adopt a calendar year, reducing the possibility of bunching.
Consequently, income and deductions are better matched if the
partnership taxable year closes upon a partner's death and
partnership items are reported on the decedent's last return.
Prior law closed the partnership taxable year with respect
to a deceased partner only if the partner's entire interest is
sold or exchanged pursuant to an agreement existing at the time
of death. By closing the taxable year automatically upon death,
the provision reduces the need for such agreements.
Explanation of Provision
The provision provides that the taxable year of a
partnership closes with respect to a partner whose entire
interest in the partnership terminates, whether by death,
liquidation or otherwise. The provision does not change prior
law with respect to the effect upon the partnership taxable
year of a transfer of a partnership interest by a debtor to the
debtor's estate (under Chapters 7 or 11 of Title 11, relating
to bankruptcy).
Effective Date
The provision applies to partnership taxable years
beginning after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $500,000 per year in each of 1998
through 2007.
D. Modifications of Rules for Real Estate Investment Trusts (secs.
1251-1263 of the Act and secs. 856 and 857 of the Code)
Present and Prior Law
Overview
In general, a real estate investment trust (``REIT'') is an
entity that receives most of its income from passive real
estate related investments and that receives conduit treatment
for income that is distributed to shareholders. If an entity
meets the qualifications for REIT status, the portion of its
income that is distributed to the investors each year generally
is taxed to the investors without being subjected to a tax at
the REIT level; the REIT generally is subject to a corporate
tax only on the income that it retains and on certain income
from property that qualifies as foreclosure property.
Election to be treated as a REIT
In order to qualify as a REIT, and thereby receive conduit
treatment, an entity must elect REIT status. A newly-electing
entity generally cannot have earnings and profits accumulated
from any year in which the entity was in existence and not
treated as a REIT (sec. 857(a)(3)). To satisfy this
requirement, the entity must distribute, during its first REIT
taxable year, any earnings and profits that were accumulated in
non-REIT years. For this purpose, under prior law,
distributions by the entity generally are treated as being made
from the most recently accumulated earnings and profits.
Taxation of REITs
Overview
In general, if an entity qualifies as a REIT by satisfying
the various requirements described below, the entity is taxable
as a corporation on its ``real estate investment trust taxable
income'' (``REITTI''), and also is taxable on certain other
amounts (sec. 857). REITTI is the taxable income of the REIT
with certain adjustments (sec. 857(b)(2)). The most significant
adjustment is a deduction for dividends paid. The allowance of
this deduction is the mechanism by which the REIT becomes a
conduit for income tax purposes.
Capital gains
A REIT that has a net capital gain for a taxable year
generally is subject to tax on such capital gain under the
capital gains tax regime generally applicable to corporations
(sec. 857(b)(3)). However, a REIT may diminish or eliminate its
tax liability attributable to such capital gain by paying a
``capital gain dividend'' to its shareholders (sec.
857(b)(3)(C)). A capital gain dividend is any dividend or part
of a dividend that is designated by the payor REIT as a capital
gain dividend in a written notice mailed to shareholders.
Shareholders who receive capital gain dividends treat the
amount of such dividends as long-term capital gain regardless
of the holding period of their stock (sec. 857(b)(3)(C)).
A regulated investment company (``RIC''), but not a REIT,
may elect to retain and pay income tax on net long-term capital
gains it received during the tax year. If a RIC makes this
election, the RIC shareholders must include in their income as
long-term capital gains their proportionate share of these
undistributed long-term capital gains as designated by the RIC.
The shareholder is deemed to have paid the shareholder's share
of the tax, which can be credited or refunded to the
shareholder. Also, the basis of the shareholder's shares is
increased by the amount of the undistributed long-term capital
gains (less the amount of capital gains tax paid by the RIC)
included in the shareholder's long-term capital gains.
Income from foreclosure property
In addition to tax on its REITTI, a REIT is subject to tax
at the highest rate of tax paid by corporations on its net
income from foreclosure property (sec. 857(b)(4)). Net income
from foreclosure property is the excess of the sum of gains
from foreclosure property that is held for sale to customers in
the ordinary course of a trade or business and gross income
from foreclosure property (other than income that otherwise
would qualify under the 75-percent income test described below)
over all allowable deductions directly connected with the
production of such income.
Foreclosure property is any real property or personal
property incident to such real property that is acquired by a
REIT as a result of default or imminent default on a lease of
such property or indebtedness secured by such property,
provided that (unless acquired as foreclosure property) such
property was not held by the REIT for sale to customers (sec.
856(e)). Under prior law, a property generally may be treated
as foreclosure property for a period of two years after the
date the property is acquired by the REIT. The IRS may grant
extensions of the period for treating the property as
foreclosure property if the REIT establishes that an extension
of the grace period is necessary for the orderly liquidation of
the REIT's interest in the property. The grace period cannot be
extended beyond six years from the date the property is
acquired by the REIT.
Property will cease to be treated as foreclosure property
if, after 90 days after the date of acquisition, the REIT
operates the foreclosure property in a trade or business other
than through an independent contractor from whom the REIT does
not derive or receive any income (sec. 856(e)(4)(C)).
Income or loss from prohibited transactions
In general, a REIT must derive its income from passive
sources and not engage in any active trade or business.
Accordingly, in addition to the tax on its REITTI and on its
net income from foreclosure property, a 100 percent tax is
imposed on the net income of a REIT from ``prohibited
transactions'' (sec. 857(b)(6)). A prohibited transaction is
the sale or other disposition of property described in section
1221(1) of the Code (property held for sale in the ordinary
course of a trade or business) other than foreclosure property.
Thus, the 100 percent tax on prohibited transactions helps to
ensure that the REIT is a passive entity and may not engage in
ordinary retailing activities such as sales to customers of
condominium units or subdivided lots in a development project.
A safe harbor is provided for certain sales that otherwise
might be considered prohibited transactions (sec.
857(b)(6)(C)). The safe harbor is limited to seven or fewer
sales a year or, alternatively, any number of sales provided
that the aggregate adjusted basis of the property sold does not
exceed 10 percent of the aggregate basis of all the REIT's
assets at the beginning of the REIT's taxable year.
Requirements for REIT status
A REIT must satisfy four tests on a year-by-year basis:
organizational structure, source of income, nature of assets,
and distribution of income. These tests are intended to allow
conduit treatment in circumstances in which a corporate tax
otherwise would be imposed, only if there really is a pooling
of investment arrangement that is evidenced by its
organizational structure, if its investments are basically in
real estate assets, and if its income is passive income from
real estate investment, as contrasted with income from the
operation of business involving real estate. In addition,
substantially all of the entity's income must be passed through
to its shareholders on a current basis.
Organizational structure requirements
To qualify as a REIT, an entity must be for its entire
taxable year a corporation or an unincorporated trust or
association that would be taxable as a domestic corporation but
for the REIT provisions, and must be managed by one or more
trustees (sec. 856(a)). The beneficial ownership of the entity
must be evidenced by transferable shares or certificates of
ownership. Except for the first taxable year for which an
entity elects to be a REIT, the beneficial ownership of the
entity must be held by 100 or more persons, and the entity may
not be so closely held by individuals that it would be treated
as a personal holding company if all its adjusted gross income
constituted personal holding company income. Under prior law, a
REIT is disqualified for any year in which it does not comply
with regulations to ascertain the actual ownership of the
REIT's outstanding shares. Treasury regulations require that
the entity request information from certain shareholders
regarding shares directly or indirectly owned by them.
Income requirements
Overview
In order for an entity to qualify as a REIT, at least 95
percent of its gross income generally must be derived from
certain passive sources (the ``95-percent test''). In addition,
at least 75 percent of its income generally must be from
certain real estate sources (the ``75-percent test''),
including rents from real property.
In addition, under prior law, less than 30 percent of the
entity's gross income may be derived from gain from the sale or
other disposition of stock or securities held for less than one
year, real property held less than four years (other than
foreclosure property, or property subject to an involuntary
conversion within the meaning of sec. 1033), and property that
is sold or disposed of in a prohibited transaction (sec.
856(c)(4)).
Definition of rents from real property
For purposes of the income requirements, rents from real
property generally include: (1) rents from interests in real
property; (2) charges for services customarily rendered or
furnished in connection with the rental of real property,
whether or not such charges are separately stated; and (3) rent
attributable to personal property that is leased under or in
connection with a lease of real property, but only if the rent
attributable to such personal property does not exceed 15
percent of the total rent for the year under the lease (sec.
856(d)(1)).
Services provided to tenants are regarded as customary if,
in the geographic market within which the building is located,
tenants in buildings that are of a similar class (for example,
luxury apartment buildings) are customarily provided with the
service. The furnishing of water, heat, light, and air
conditioning, the cleaning of windows, public entrances, exits,
and lobbies, the performance of general maintenance, and of
janitorial and cleaning services, the collection of trash, the
furnishing of elevator services, telephone answering services,
incidental storage space, laundry equipment, watchman or guard
service, parking facilities and swimming pool facilities are
examples of services that are customarily furnished to tenants
of a particular class of buildings in many geographical
marketing areas (Treas. Reg. sec. 1.856-4(b)).
Exclusion of rents from related tenants
Amounts are not treated as qualified rent if they are
received from corporate or noncorporate tenants in which the
REIT, directly or indirectly, has an ownership interest of 10
percent or more (sec. 856(d)(2)(B)).
Exclusion of rents where services to tenants are performed
by related contractors
Where a REIT furnishes or renders services to the tenants,
amounts received or accrued with respect to such property
generally are not treated as qualifying rents unless the
services are furnished through an independent contractor (sec.
856(d)(2)(C)). A REIT may furnish or render a service directly,
however, if the service would not generate unrelated business
taxable income under section 512(b)(3) if provided by an
organization described in section 511(a)(2). In general, an
independent contractor is a person who does not own more than a
35 percent interest in the REIT (sec. 856(d)(3)(A)), and in
which no more than a 35 percent interest is held by persons
with a 35 percent or greater interest in the REIT (sec.
856(d)(3)(B)).
Constructive ownership rules involving corporations
For purposes of determining the REIT's ownership interest
in a tenant and whether a contractor is independent, the
attribution rules of section 318 apply, except that 10 percent
is substituted for 50 percent where it appears in subparagraph
(C) of section 318(a)(2) and 318(a)(3) (sec. 856(d)(5)). Thus,
under section 318(a)(2)(C) (as so modified), if 10 or more
percent of a REIT or other corporation is owned, directly or
indirectly, by or for a person, that person is treated as
owning that person's proportionate share of any stock owned
directly or indirectly by that corporation.
Constructive ownership rules involving partnerships
Under section 318, stock owned, directly or indirectly, by
or for a partnership is considered owned proportionately by its
partners (sec. 318(a)(2)(A)). In addition, stock owned,
directly or indirectly, by or for a partner is considered owned
by the partnership (sec. 318(a)(3)(A)). However, stock
constructively owned by a partnership is not considered as
owned for purposes of being constructively owned by partners
(sec. 318(a)(5)(C)). The following examples illustrate the
application of these provisions for purposes of the related
tenant and independent contractor rules.
Constructive ownership of tenant
If a REIT owns a 10 percent or greater interest in a person
that is a tenant of the REIT, rents paid by that person to the
REIT are not qualifying rents to the REIT (sec. 856(d)(2)(B)).
Example 1--If 10 percent or more of a REIT's shares are
owned by a partnership and a partner owning a one-percent
interest in that partnership also owns a 10-percent or greater
interest in a person that is a tenant of the REIT, rents paid
by the tenant to the REIT are not qualifying rents to the REIT;
the 10-percent or greater interest in the tenant is considered
owned by the partnership (sec. 318(a)(3)(A)) and in turn by the
REIT (secs. 318(a)(3)(C) and 856(d)(5)).
Example 2--If a REIT owns a 30-percent interest in a
partnership that in turn owns a 40-percent interest in a person
that is a tenant of the REIT, rents paid by that person to the
REIT are not qualifying rents to the REIT because the REIT is
considered to own more than 10 percent of the tenant (sec.
318(a)(2)(A)).
Example 3--If 10 percent or more of a REIT's shares are
owned by persons who are 50-percent partners in a partnership
whose other partners own the entirety of the interests in a
tenant of the REIT, none of the interests in the tenant are
considered owned by the partners who own interests in the REIT
(sec. 318(a)(5)(C)).
Constructive ownership of contractor
If a person providing services to tenants of the REIT owns
a greater-than-35-percent interest in the REIT, or if another
person owns a greater-than-35-percent interest in both the REIT
and a person providing services, amounts received or accrued by
the REIT with respect to the property are not qualifying rents
because the service provider does not qualify as an independent
contractor (sec. 856(d)(3)).
Example 4--If more than 35 percent of a REIT's shares are
owned by a partnership and a partner owning a one-percent
interest in that partnership also owns a greater-than-35-
percent interest in a contractor, that person will not be
considered an independent contractor because the partnership
owns more than 35 percent of the REIT's shares and will also be
considered to own a greater-than-35-percent interest in the
contractor (sec. 318(a)(3)A)).
Example 5--If more than 35 percent of a REIT's shares are
owned by a person who owns a one-percent interest in a
partnership and another one-percent partner in that partnership
owns more than 35 percent of the interests in a contractor, the
independent contractor definition will not be met because the
partnership will be considered to own more than 35 percent
interests in both the REIT and the contractor (sec. 318
(a)(3)(A)).
Hedging instruments
Interest rate swaps or cap agreements that protect a REIT
from interest rate fluctuations on variable rate debt incurred
to acquire or carry real property are treated as securities
under the 30-percent test and payments under these agreements
are treated as qualifying under the 95-percent test (sec.
856(c)(6)(G)).
Treatment of shared appreciation mortgages
For purposes of the income requirements for qualification
as a REIT, and for purposes of the prohibited transaction
provisions, any income derived from a ``shared appreciation
provision'' is treated as gain recognized on the sale of the
``secured property.'' For these purposes, a shared appreciation
provision is any provision that is in connection with an
obligation that is held by the REIT and secured by an interest
in real property, which provision entitles the REIT to receive
a specified portion of any gain realized on the sale or
exchange of such real property (or of any gain that would be
realized if the property were sold on a specified date).
Secured property for these purposes means the real property
that secures the obligation that has the shared appreciation
provision.
In addition, for purposes of the income requirements for
qualification as a REIT, and for purposes of the prohibited
transactions provisions, the REIT is treated as holding the
secured property for the period during which it held the shared
appreciation provision (or, if shorter, the period during which
the secured property was held by the person holding such
property), and the secured property is treated as property
described in section 1221(1) if it is such property in the
hands of the obligor on the obligation to which the shared
appreciation provision relates (or if it would be such property
if held by the REIT). For purposes of the prohibited
transaction safe harbor, the REIT is treated as having sold the
secured property at the time that it recognizes income on
account of the shared appreciation provision, and any
expenditures made by the holder of the secured property are
treated as made by the REIT.
Asset requirements
To satisfy the asset requirements to qualify for treatment
as a REIT, at the close of each quarter of its taxable year, an
entity must have at least 75 percent of the value of its assets
invested in real estate assets, cash and cash items, and
government securities (sec. 856(c)(5)(A)). Moreover, not more
than 25 percent of the value of the entity's assets can be
invested in securities of any one issuer (other than government
securities and other securities described in the preceding
sentence). Further, these securities may not comprise more than
five percent of the entity's assets or more than 10 percent of
the outstanding voting securities of such issuer (sec.
856(c)(5)(B)). The term real estate assets is defined to mean
real property (including interests in real property and
mortgages on real property) and interests in REITs (sec.
856(c)(6)(B)).
REIT subsidiaries
Under present law, all the assets, liabilities, and items
of income, deduction, and credit of a ``qualified REIT
subsidiary'' are treated as the assets, liabilities, and
respective items of the REIT that owns the stock of the
qualified REIT subsidiary. A subsidiary of a REIT is a
qualified REIT subsidiary if and only if 100 percent of the
subsidiary's stock is owned by the REIT at all times that the
subsidiary is in existence. If at any time the REIT ceases to
own 100 percent of the stock of the subsidiary, or if the REIT
ceases to qualify for (or revokes an election of) REIT status,
such subsidiary is treated as a new corporation that acquired
all of its assets in exchange for its stock (and assumption of
liabilities) immediately before the time that the REIT ceased
to own 100 percent of the subsidiary's stock, or ceased to be a
REIT as the case may be.
Distribution requirements
To satisfy the distribution requirement, a REIT must
distribute as dividends to its shareholders during the taxable
year an amount equal to or exceeding (i) the sum of 95 percent
of its REITTI other than net capital gain income and 95 percent
of the excess of its net income from foreclosure property over
the tax imposed on that income minus (ii) certain excess
noncash income. Excess noncash items include (1) the excess of
the amounts that the REIT is required to include in income
under section 467 with respect to certain rental agreements
involving deferred rents, over the amounts that the REIT
otherwise would recognize under its regular method of
accounting, (2) in the case of a REIT using the cash method of
accounting, the excess of the amount of original issue discount
and coupon interest that the REIT is required to take into
account with respect to a loan to which section 1274 applies,
over the amount of money and fair market value of other
property received with respect to the loan, and (3) income
arising from the disposition of a real estate asset in certain
transactions that failed to qualify as like-kind exchanges
under section 1031.
Explanation of Provisions
Overview
The Act modifies many of the provisions relating to the
requirements for qualification as, and the taxation of, a REIT.
In particular, the modifications relate to the general
requirements for qualification as a REIT, the taxation of a
REIT, the income requirements for qualification as a REIT, and
certain other provisions.
Alterative penalty for failure to make requests of shareholders (sec.
1251 of the Act)
The Act replaces the rule that disqualifies a REIT for any
year in which the REIT failed to comply with Treasury
regulations to ascertain its ownership, with an intermediate
penalty for failing to do so. The penalty is $25,000 ($50,000
for intentional violations) for any year in which the REIT did
not comply with the ownership regulations. The REIT also is
required, when requested by the IRS, to send curative demand
letters.
In addition, a REIT that complied with the Treasury
regulations for ascertaining its ownership, and which did not
know, or have reason to know, that it was so closely held as to
be classified as a personal holding company, is treated as
meeting the requirement that it not be a personal holding
company.
De minimis rule for tenant service income (sec. 1252 of the Act)
The Act permits a REIT to render a de minimis amount of
impermissible services to tenants, or in connection with the
management of property, and still treat amounts received with
respect to that property as rent. The value of the
impermissible services may not exceed one percent of the gross
income from the property. For these purposes, the services may
not be valued at less than 150 percent of the REIT's direct
cost of the services.
Attribution rules applicable to tenant ownership (sec. 1253 of the Act)
The Act modifies the application of the rule attributing
ownership from partners to partnerships (sec. 318(a)(3)(A)) for
purposes of defining non-qualifying rent from related persons
(sec. 856(d)(2)), so that attribution occurs only when a
partner owns directly or indirectly a 25-percent or greater
interest in the partnership. Thus, a REIT and a tenant will not
be treated as related (and, therefore, rents paid by the tenant
to the REIT will not be treated as non-qualifying rents) if the
REIT's shares are owned by a partnership and a partner owning a
directly and indirectly less-than-25-percent interest in that
partnership also owns an interest in the tenant. The related
tenant rule (sec. 856(d)(2)(B)) also will not be violated where
owners of the REIT and owners of the tenant are partners in a
partnership and either the owners of the REIT or the owners of
the tenant are directly and indirectly less-than-25-percent
partners in the partnership.
In addition, the Act extends, to the definition of an
independent contractor under section 856(d)(3), the
modification to the attribution to partnerships of section
318(a)(3)(A) so that attribution occurs only when a partner
owns a 25-percent or greater interest in the partnership. Thus,
a person providing services will not fail to be an independent
contractor (and, therefore, amounts received or accrued by the
REIT with respect to the property will not be treated as non-
qualifying rents) where the REIT's shares are owned by a
partnership and a partner owning a directly and indirectly a
less-than-25-percent interest in the partnership also owns an
interest in a contractor. Similarly, a contractor will not fail
to be an independent contractor where owners of the REIT and
owners of the contractor are partners in a partnership and
either the owners of the REIT or owners of the tenant are
directly and indirectly less-than-25-percent partners in the
partnership.
Credit for tax paid by REIT on retained capital gains (sec. 1254 of the
Act)
The Act permits a REIT to elect to retain and pay income
tax on net long-term capital gains it received during the tax
year, just as a RIC is permitted under present law. Thus, if a
REIT made this election, the REIT shareholders would include in
their income as long-term capital gains their proportionate
share of the undistributed long-term capital gains as
designated by the REIT. The shareholder would be deemed to have
paid the shareholder's share of the tax, which would be
credited or refunded to the shareholder. Also, the basis of the
shareholder's shares would be increased by the amount of the
undistributed long-term capital gains (less the amount of
capital gains tax paid by the REIT) included in the
shareholder's long-term capital gains.
Repeal of 30-percent gross income requirement (sec. 1255 of the Act)
The Act repeals the rule that requires less than 30 percent
of a REIT's gross income be derived from gain from the sale or
other disposition of stock or securities held for less than one
year, certain real property held less than four years, and
property that is sold or disposed of in a prohibited
transaction.
Modification of earnings and profits for determining whether REIT has
earnings and profits from non-REIT year (sec. 1256 of the Act)
The Act changes the ordering rule for purposes of the
requirement that newly-electing REITs distribute earnings and
profits that were accumulated in non-REIT years. Under the Act,
distributions of accumulated earnings and profits generally are
treated as made from the entity's earliest accumulated earnings
and profits, rather than the most recently accumulated earnings
and profits. These distributions are not treated as
distributions for purposes of calculating the dividends paid
deduction.
Treatment of foreclosure property (sec. 1257 of the Act)
The Act lengthens the original grace period for foreclosure
property until the last day of the third full taxable year
following the election. The grace period also can be extended
for an additional three years by filing a request to the IRS. A
REIT can revoke an election to treat property as foreclosure
property for any taxable year by filing a revocation on or
before its due date for filing its tax return.
In addition, the Act conforms the definition of independent
contractor for purposes of the foreclosure property rule (sec.
856(e)(4)(C)) to the definition of independent contractor for
purposes of the general rules (sec. 856(d)(2)(C)).
Payments under hedging instruments (sec. 1258 of the Act)
The Act treats income from all hedges that reduce the
interest rate risk of REIT liabilities, not just from interest
rate swaps and caps, as qualifying income under the 95-percent
test. Thus, payments to a REIT under an interest rate swap, cap
agreement, option, futures contract, forward rate agreement or
any similar financial instrument entered into by the REIT to
hedge its indebtedness incurred or to be incurred (and any gain
from the sale or other disposition of these instruments) are
treated as qualifying income for purposes of the 95-percent
test.
Excess noncash income (sec. 1259 of the Act)
The Act (1) expands the class of excess noncash items that
are not subject to the distribution requirement to include
income from the cancellation of indebtedness and (2) extends
the treatment of original issue discount and coupon interest as
excess noncash items to REITs that use an accrual method of
taxation.
Prohibited transaction safe harbor (sec. 1260 of the Act)
The Act excludes from the prohibited sales rules property
that was involuntarily converted.
Shared appreciation mortgages (sec. 1261 of the Act)
The Act provides that interest received on a shared
appreciation mortgage is not subject to the tax on prohibited
transactions where the property subject to the mortgage is sold
within four years of the REIT's acquisition of the mortgage
pursuant to a bankruptcy plan of the mortgagor unless the REIT
acquired the mortgage knew or had reason to know that the
property subject to the mortgage would be sold in a bankruptcy
proceeding.
Wholly-owned REIT subsidiaries (sec. 1262 of the Act)
The Act permits any corporation wholly-owned by a REIT to
be treated as a qualified subsidiary, regardless of whether the
corporation had always been owned by the REIT. Where the REIT
acquired an existing corporation, any such corporation is
treated as being liquidated as of the time of acquisition by
the REIT and then reincorporated (thus, any of the subsidiary's
pre-REIT built-in gain would be subject to tax under the normal
rules of sec. 337). In addition, any pre-REIT earnings and
profits of the subsidiary must be distributed before the end of
the REIT's taxable year.
Effective Date
The provisions are effective for taxable years beginning
after the date of enactment (August 5, 1997).
Revenue Effect
The provisions are estimated to reduce Federal fiscal year
budget receipts by $4 million in 1998, $5 million in both 1999
and 2000, $6 million in 2001, $7 million in both 2002 and 2003,
$8 million in 2004, $9 million in 2005, $10 million in 2006,
and $11 million in 2007.
E. Repeal of the 30-percent (``Short-Short'') Test for Regulated
Investment Companies (sec. 1271 of the Act and sec. 851(b)(3) of the
Code)
Present and Prior Law
A regulated investment company (``RIC'') generally is
treated as a conduit for Federal income tax purposes. The Code
provides conduit treatment by permitting a RIC to deduct
dividends paid to its shareholders in computing its taxable
income. In order to qualify for conduit treatment, the RIC must
be a domestic corporation that, at all times during the taxable
year, is registered under the Investment Company Act of 1940 as
a management company or as a unit investment trust, or has
elected to be treated as a business development company under
that Act (sec. 851(a)). In addition, a corporation must elect
such status and must satisfy certain tests (sec. 851(b)). In
particular, under prior law, a corporation must derive less
than 30 percent of its gross income from the sale or
disposition of certain investments (including stock,
securities, options, futures, and forward contracts) held less
than three months (the ``short-short test'') (sec. 851(b)(3)).
Reasons for Change
The short-short test restricts the investment flexibility
of RICs. The test can, for example, limit a RIC's ability to
``hedge'' its investments (e.g., to use options to protect
against adverse market moves).
The test also burdens a RIC with significant recordkeeping,
compliance, and administration costs. The RIC must keep track
of the holding periods of assets and the relative percentages
of short-term gain that it realizes throughout the year. The
Congress believed that the short-short test places unnecessary
limitations upon a RIC's activities.
Explanation of Provision
The 30-percent test (or short-short test) is repealed.
Effective Date
The provision is effective for taxable years beginning
after the date of enactment (after August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $17 million in 1998, $23 million in 1999,
$27 million in 2000, $33 million in 2001, $38 million in 2002,
$45 million in 2003, $53 million in 2004, $61 million in 2005,
$71 million in 2006, and $82 million in 2007.
F. Taxpayer Protections
1. Provide reasonable cause exception for additional penalties (sec.
1281 of the Act and secs. 6652, 6683, and 7519 of the Code)
Present and Prior Law
Many penalties in the Code may be waived if the taxpayer
establishes reasonable cause. For example, the accuracy-related
penalty (sec. 6662) may be waived with respect to any item if
the taxpayer establishes reasonable cause for his treatment of
the item and that he acted in good faith (sec. 6664(c)).
Reasons for Change
The Congress believed that it is appropriate to provide a
reasonable cause exception for several additional penalties
where one does not currently exist.
Explanation of Provision
The Act provides that the following penalties may be waived
if the failure is shown to be due to reasonable cause and not
willful neglect:
(1) the penalty for failure to make a report in connection
with deductible employee contributions to a retirement savings
plan (sec. 6652(g));
(2) the penalty for failure to make a report as to certain
small business stock (sec. 6652(k));
(3) the penalty for failure of a foreign corporation to
file a return of personal holding company tax (sec. 6683); and
(4) the penalty for failure to make required payments for
entities electing not to have the required taxable year (sec.
7519).
Effective Date
The provision was effective for taxable years beginning
after the date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
2. Clarification of period for filing claims for refunds (sec. 1282 of
the Act and sec. 6512 of the Code)
Present and Prior Law
The Code contains a series of limitations on tax refunds.
Section 6511 of the Code provides both a limitation on the time
period in which a claim for refund can be made (section
6511(a)) and a limitation on the amount that can be allowed as
a refund (section 6511(b)). Section 6511(a) provides the
general rule that a claim for refund must be filed within 3
years of the date of the return or 2 years of the date of
payment of the taxes at issue, whichever is later. Section
6511(b) limits the refund amount that can be covered: if a
return was filed, a taxpayer can recover amounts paid within 2
years before the claim. Section 6512(b)(3) incorporates these
rules where taxpayers who challenge deficiency notices in Tax
Court are found to be entitled to refunds.
In Commissioner v. Lundy, 116 S. Ct. 647 (1996), the
taxpayer had not filed a return, but received a notice of
deficiency within 3 years after the date the return was due and
challenged the proposed deficiency in Tax Court. The Supreme
Court held that the taxpayer could not recover overpayments
attributable to withholding during the tax year, because no
return was filed and the 2-year ``look back'' rule applied.
Since over withheld amounts are deemed paid as of the date the
taxpayer's return was first due (i.e., more than 2 years before
the notice of deficiency was issued), such overpayments could
not be recovered. By contrast, if the same taxpayer had filed a
return on the date the notice of deficiency was issued, and
then claimed a refund, the 3-year ``look back'' rule would
apply, and the taxpayer could have obtained a refund of the
over withheld amounts.
Reasons for Change
The Congress believed it appropriate to eliminate this
disparate treatment.
Explanation of Provision
The Act permits taxpayers who initially fail to file a
return, but who receive a notice of deficiency and file suit to
contest it in Tax Court during the third year after the return
due date, to obtain a refund of excessive amounts paid within
the 3-year period prior to the date of the deficiency notice.
Effective Date
The provision applies to claims for refund with respect to
taxable years ending after the date of enactment (August 5,
1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
3. Repeal of authority to disclose whether a prospective juror has been
audited (sec. 1283 of the Act and sec. 6103 of the Code)
Present and Prior Law
In connection with a civil or criminal tax proceeding to
which the United States is a party, the Secretary must
disclose, upon the written request of either party to the
lawsuit, whether an individual who is a prospective juror has
or has not been the subject of an audit or other tax
investigation by the Internal Revenue Service (sec.
6103(h)(5)).
Reasons for Change
This disclosure requirement, as it has been interpreted by
several recent court decisions, has created significant
difficulties in the civil and criminal tax litigation process.
First, the litigation process can be substantially slowed. It
can take the Secretary a considerable period of time to compile
the information necessary for a response (some courts have
required searches going back as far as 25 years). Second,
providing early release of the list of potential jurors to
defendants (which several recent court decisions have required,
to permit defendants to obtain disclosure of the information
from the Secretary) can provide an opportunity for harassment
and intimidation of potential jurors in organized crime, drug,
and some tax protester cases. Third, significant judicial
resources have been expended in interpreting this procedural
requirement that might better be spent resolving substantive
disputes. Fourth, differing judicial interpretations of this
provision have caused confusion. In some instances, defendants
convicted of criminal tax offenses have obtained reversals of
those convictions because of failures to comply fully with this
provision.
Explanation of Provision
The Act repeals the requirement that the Secretary
disclose, upon the written request of either party to the
lawsuit, whether an individual who is a prospective juror has
or has not been the subject of an audit or other tax
investigation by the Internal Revenue Service.
Effective Date
The provision was effective for judicial proceedings
commenced after the date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have no revenue effect.
4. Clarify statute of limitations for items from pass-through entities
(sec. 1284 of the Act and sec. 6501 of the Code)
Present and Prior Law
Passthrough entities (such as S corporations, partnerships,
and certain trusts) generally are not subject to income tax on
their taxable income. Instead, these entities file information
returns and the entities' shareholders (or beneficial owners)
report their pro rata share of the gross income and are liable
for any taxes due.
Some believe that, prior to 1993, it may have been unclear
as to whether the statute of limitations for adjustments that
arise from distributions from passthrough entities should be
applied at the entity or individual level (i.e., whether the 3-
year statute of limitations for assessments runs from the time
that the entity files its information return or from the time
that a shareholder timely files his or her income tax return).
In 1993, the Supreme Court held that the limitations period for
assessing the income tax liability of an S corporation
shareholder runs from the date the shareholder's return is
filed (Bufferd v. Comm., 113 S. Ct. 927 (1993)).
Reasons for Change
Uncertainty regarding the correct statute of limitations
hinders the resolution of factual and legal issues and creates
needless litigation over collateral matters.
Explanation of Provision
The Act clarifies that the return that starts the running
of the statute of limitations for a taxpayer is the return of
the taxpayer and not the return of another person from whom the
taxpayer has received an item of income, gain, loss, deduction,
or credit.
Effective Date
The provision was effective for taxable years beginning
after the date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have no revenue effect.
5. Awarding of administrative costs and attorneys fees (sec. 1285 of
the Act and sec. 7430 of the Code)
Present and Prior Law
Any person who substantially prevails in any action brought
by or against the United States in connection with the
determination, collection, or refund of any tax, interest, or
penalty may be awarded reasonable administrative costs incurred
before the IRS and reasonable litigation costs incurred in
connection with any court proceeding.
No time limit is specified for the taxpayer to apply to the
IRS for an award of administrative costs. In addition, no time
limit is specified for a taxpayer to appeal to the Tax Court an
IRS decision denying an award of administrative costs. Finally,
the procedural rules for adjudicating a denial of
administrative costs are unclear.
Reasons for Change
The proper procedures for applying for a cost award are
uncertain in some instances. Clarifying these procedures will
decrease litigation over these procedural issues and will
provide for expedited settlement of these claims.
Explanation of Provision
The Act provides that a taxpayer who seeks an award of
administrative costs must apply for such costs within 90 days
of the date on which the taxpayer was determined to be a
prevailing party. The Act also provides that a taxpayer who
seeks to appeal an IRS denial of an administrative cost award
must petition the Tax Court within 90 days after the date that
the IRS mails the denial notice.
The Act clarifies that dispositions by the Tax Court of
petitions relating only to administrative costs are to be
reviewed in the same manner as other decisions of the Tax
Court.
Effective Date
The provision was effective with respect to costs incurred
in civil actions or proceedings commenced after the date of
enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have no revenue effect.
TITLE XIII. ESTATE, GIFT, AND TRUST SIMPLIFICATION PROVISIONS
1. Eliminate gift tax filing requirements for gifts to charities (sec.
1301 of the Act and sec. 6019 of the Code)
Present and Prior Law
A gift tax generally is imposed on lifetime transfers of
property by gift (sec. 2501). In computing the amount of
taxable gifts made during a calendar year, a taxpayer generally
may deduct the amount of any gifts made to a charity (sec.
2522). Generally, this charitable gift deduction is available
for outright gifts to charity, as well as gifts of certain
partial interests in property (such as a remainder interest). A
gift of a partial interest in property must be in a prescribed
form in order to qualify for the deduction.
Individuals who make gifts in excess of $10,000 to any one
donee during the calendar year generally are required to file a
gift tax return (sec. 6019). Under prior law, this filing
requirement applied to all gifts, whether charitable or
noncharitable, and whether or not the gift qualified for a gift
tax charitable deduction. Thus, under prior law, a gift tax
return was required to be filed for gifts to charity in excess
of $10,000, even though no gift tax was payable on the
transfer.
Reasons for Change
Because a charitable gift does not give rise to a gift tax
liability, many donors were unaware of the requirement to file
a gift tax return for charitable gifts in excess of $10,000.
Failure to file a gift tax return under these circumstances
could have exposed the donor to penalties. The Act eliminated
this potential trap for the unwary.
Explanation of Provision
The Act provides that gifts to charity are not subject to
the gift tax filing requirements of section 6019, as long as
the donor has transferred his entire interest in the property,
and the transfer qualifies for the gift tax charitable
deduction under section 2522. The filing requirements for gifts
of partial interests in property remain unchanged.
Effective Date
The provision is effective for gifts made after the date of
enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
2. Clarification of waiver of certain rights of recovery (sec. 1302 of
the Act and secs. 2207A and 2207B of the Code)
Present and Prior Law
For estate and gift tax purposes, a marital deduction is
allowed for qualified terminable interest property (QTIP). Such
property generally is included in the surviving spouse's gross
estate upon his or her death. The surviving spouse's estate is
entitled to recover the portion of the estate tax attributable
to inclusion of QTIP from the person receiving the property,
unless the spouse directs otherwise by will (sec. 2207A). Under
prior law, a will provision specifying that all taxes shall be
paid by the estate was sufficient to waive the right of
recovery.
A decedent's gross estate includes the value of previously
transferred property in which the decedent retains enjoyment or
the right to income (sec. 2036). The estate is entitled to
recover from the person receiving the property a portion of the
estate tax attributable to the inclusion (sec. 2207B). Under
prior law, this right could be waived only by a provision in
the will (or revocable trust) specifically referring to section
2207B.
Reasons for Change
It was understood that persons utilizing standard
testamentary language often inadvertently waived the right of
recovery with respect to QTIP. Similarly, persons waiving a
right to contribution were unlikely to refer to the Code
section granting the right. Accordingly, the Congress believed
that allowing the right of recovery (or right of contribution)
to be waived only by specific reference would simplify the
drafting of wills by better conforming with the testator's
likely intent.
Explanation of Provision
The Act provides that the right of recovery with respect to
QTIP is waived only to the extent that language in the
decedent's will or revocable trust specifically so indicates
(e.g., by a specific reference to QTIP, the QTIP trust, section
2044, or section 2207A). Thus, a general provision specifying
that all taxes be paid by the estate is no longer sufficient to
waive the right of recovery.
The Act also provides that the right of contribution for
property over which the decedent retained enjoyment or the
right to income is waived by a specific indication in the
decedent's will or revocable trust, but specific reference to
section 2207B is no longer required.
Effective Date
The provision applies to decedents dying after the date of
enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
3. Transitional rule under section 2056A (sec. 1303 of the Act and sec.
2056A of the Code)
Present and Prior Law
A ``marital deduction'' generally is allowed for estate and
gift tax purposes for the value of property passing to a
spouse. The Technical and Miscellaneous Revenue Act of 1988
(``TAMRA'') denied the marital deduction for property passing
to an alien spouse outside a qualified domestic trust
(``QDT''). An estate tax generally is imposed on corpus
distributions from a QDT.
TAMRA defined a QDT as a trust that, among other things,
required all trustees to be U.S. citizens or domestic
corporations. This provision was modified in the Omnibus Budget
Reconciliation Acts of 1989 and 1990 to require that at least
one trustee be a U.S. citizen or domestic corporation and that
no corpus distribution be made unless such trustee has the
right to withhold any estate tax imposed on the distribution
(the ``withholding requirement'').
Reasons for Change
Wills drafted under the TAMRA rules must be revised to
conform with the withholding requirement, even though both the
TAMRA rule and its successor ensure that a U.S. trustee is
personally liable for the estate tax on a QDT. Reinstatement of
the TAMRA rule for wills drafted in reliance upon it reduces
the number of will revisions necessary to comply with statutory
changes, thereby simplifying estate planning.
Explanation of Provision
The Act provides that certain trusts created before the
enactment of the Omnibus Budget Reconciliation Act of 1990 are
treated as satisfying the withholding requirement if the
governing instruments require that all trustees be U.S.
citizens or domestic corporations.
Effective Date
The provision applies as if included in the Omnibus Budget
Reconciliation Act of 1990.
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
4. Treatment for estate tax purposes of short-term obligations held by
nonresident aliens (sec. 1304 of the Act and sec. 2105 of the
Code)
Present and Prior Law
The United States imposes estate tax on assets of
noncitizen nondomiciliaries that were situated in the United
States at the time of the individual's death. Debt obligations
of a U.S. person, the United States, a political subdivision of
a State, or the District of Columbia are considered property
located within the United States if held by a nonresident not a
citizen of the United States (sec. 2014(c)).
Special rules apply to treat certain bank deposits and debt
instruments the income from which qualifies for the bank
deposit interest exemption and the portfolio interest exemption
as property from without the United States despite the fact
that such items are obligations of a U.S. person, the United
States, a political subdivision of a State, or the District of
Columbia (sec. 2105(b)). Income from such items is exempt from
U.S. income tax in the hands of the nonresident recipient
(secs. 871(h) and 871(i)(2)(A)). The effect of these special
rules is to exclude these items from the U.S. gross estate of a
nonresident not a citizen of the United States. The Tax Reform
Act of 1986 amended section 871(h) to address the interaction
of the portfolio interest exemption and the treatment of
certain interest received by controlled foreign corporations.
However, because of this amendment, these special rules no
longer covered obligations that generated short-term OID income
despite the fact that such income was exempt from U.S. income
tax in the hands of the nonresident recipient (sec.
871(g)(1)(B)(i)).
Reasons for Change
The Congress believed that the income and estate tax
treatments of short-term OID obligations held by nonresident
aliens should conform. A purpose of exempting short-term OID
income derived by nonresident aliens from U.S. income tax is to
enhance the ability of U.S. borrowers to raise funds from
foreign lenders, and such purpose would have been hindered by
the lack of a corresponding exemption for U.S. estate tax.
Moreover, to the extent the interest from such an obligation is
exempt from U.S. income tax, the inclusion of the instrument in
the nonresident noncitizen's U.S. estate would have been a trap
for the unwary.
Explanation of Provision
The Act provides that any debt obligation, the income from
which would be eligible for the exemption for short-term OID
under section 871(g)(1)(B)(i) if such income were received by
the decedent on the date of his death, is treated as property
located outside of the United States in determining the U.S.
estate tax liability of a nonresident not a U.S. citizen. No
inference is intended with respect to the estate tax treatment
of such obligations under prior law.
Effective Date
The provision is effective for estates of decedents dying
after the date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
5. Certain revocable trusts treated as part of estate (sec. 1305 of the
Act and secs. 646 and 2652(b)(1) of the Code)
Present and Prior Law
Both estates and revocable inter vivos trusts can function
to settle the affairs of a decedent and distribute assets to
heirs. In the case of revocable inter vivos trusts, the grantor
transfers property into a trust which is revocable during his
or her lifetime. Upon the grantor's death, the power to revoke
ceases and the trustee then performs the settlement functions
typically performed by the executor of an estate. While both
estates and revocable trusts perform essentially the same
function after the testator or grantor's death, there are a
number of ways in which an estate and a revocable trust operate
differently. First, there can be only one estate per decedent
while there can be more than one revocable trust. Second,
estates are in existence only for a reasonable period of
administration; revocable trusts can perform the same
settlement functions as an estate, but may continue in
existence thereafter as testamentary trusts.
Numerous differences presently exist between the income tax
treatment of estates and revocable trusts, including: (1)
estates are allowed a charitable deduction for amounts
permanently set aside for charitable purposes while post death
revocable trusts are allowed a charitable deduction only for
amounts paid to charities; (2) the active participation
requirement of the passive loss rules under section 469 is
waived in the case of estates (but not revocable trusts) for
two years after the owner's death; and (3) estates (but not
revocable trusts) can qualify for section 194 amortization of
reforestation expenditures.
Reasons for Change
The use of revocable trusts may offer certain non-tax
advantages for estate planning as compared to a traditional
estate plan. There are several differences, however, between
the Federal tax treatment of revocable trusts and an estate.
These differences may have discouraged individuals from
utilizing revocable trusts for estate planning where they might
otherwise be appropriate or efficient. Accordingly, in an
effort to minimize these tax differences, the Congress believed
it was appropriate to allow an election to treat a revocable
trust as part of the decedent's estate during a reasonable
period of administration.
Explanation of Provision
The Act provides an irrevocable election to treat a
qualified revocable trust as part of the decedent's estate for
Federal income tax purposes. This elective treatment is
effective for taxable years ending after the date of the
decedent's death and before the date which is two years after
his or her death (if no estate tax return is required) or the
date which is six months after the final determination of
estate tax liability (if an estate tax return is required). The
election must be made by both the executor of the decedent's
estate (if any) and the trustee of the revocable trust no later
than the time required for filing the income tax return of the
estate for its first taxable year, taking into account any
extensions. A conforming change is made to section 2652(b) for
generation-skipping transfer tax purposes.
For this purpose, a qualified revocable trust is any trust
(or portion thereof) which was treated under section 676 as
owned by the decedent with respect to whom the election is
being made, by reason of a power in the grantor (i.e., trusts
that are treated as owned by the decedent solely by reason of a
power in a nonadverse party would not qualify).
The separate share rule (described below) generally will
apply when a qualified revocable trust is treated as part of
the decedent's estate.
Effective Date
The provision applies to decedents dying after the date of
enactment (August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $3 million per year for the years 1998
through 2007.
6. Distributions during first 65 days of taxable year of estate (sec.
1306 of the Act and sec. 663(b) of the Code)
Present and Prior Law
In general, trusts and estates are treated as conduits for
Federal income tax purposes; income received by a trust or
estate that is distributed to a beneficiary in the trust or
estate's taxable year ``ending with or within'' the taxable
year of the beneficiary is taxable to the beneficiary in that
year; income that is retained by the trust or estate is
initially taxable to the trust or estate. In the case of
distributions of previously accumulated income by trusts (but
not estates), there may be additional tax under the so-called
``throwback'' rules if the beneficiary to whom the
distributions were made has marginal rates higher than those of
the trust. Under the ``65-day rule,'' a trust may elect to
treat distributions paid within 65 days after the close of its
taxable year as paid on the last day of its taxable year. Under
prior law, the 65-day rule was not applicable to estates.
Reasons for Change
In order to minimize the tax differences between estates
and revocable trusts, the Congress believed that the 65-day
rule should be allowed to estates as well as to trusts.
Explanation of Provision
The Act extends application of the 65-day rule to
distributions by estates. Thus, an executor can elect to treat
distributions paid by the estate within 65 days after the close
of the estate's taxable year as having been paid on the last
day of such taxable year.
Effective Date
The provision applies to taxable years beginning after the
date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
7. Separate share rules available to estates (sec. 1307 of the Act and
sec. 663(c) of the Code)
Present and Prior Law
Trusts with more than one beneficiary must use the
``separate share'' rule in order to provide different tax
treatment of distributions to different beneficiaries to
reflect the income earned by different shares of the trust's
corpus.\306\ Treasury regulations provide that ``[t]he
application of the separate share rule . . . will generally
depend upon whether distributions of the trust are to be made
in substantially the same manner as if separate trusts had been
created. . . . Separate share treatment will not be applied to
a trust or portion of a trust subject to a power to distribute,
apportion, or accumulate income or distribute corpus to or for
the use of one or more beneficiaries within a group or class of
beneficiaries, unless the payment of income, accumulated
income, or corpus of a share of one beneficiary cannot affect
the proportionate share of income, accumulated income, or
corpus of any shares of the other beneficiaries, or unless
substantially proper adjustment must thereafter be made under
the governing instrument so that substantially separate and
independent shares exist.'' Treas. Reg. sec. 1.663(c)-3. Under
prior law, the separate share rule did not apply to estates.
---------------------------------------------------------------------------
\306\ Application of the separate share rule is not elective; it is
mandatory if there are separate shares in the trust.
---------------------------------------------------------------------------
Reasons for Change
The Congress understood that estates typically do not have
separate shares. Nonetheless, where separate shares do exist in
an estate, the inapplicability of the separate share rule to
estates may result in one beneficiary or class of beneficiaries
being taxed on income payable to, or accruing to, a separate
beneficiary or class of beneficiaries. Accordingly, the
Congress believed that a more equitable taxation of an estate
and its beneficiaries would be achieved with the application of
the separate share rule to an estate where, under the
provisions of the decedent's will or applicable local law,
there are separate shares in the estate.
Explanation of Provision
The Act extends the application of the separate share rule
to estates. There are separate shares in an estate when the
governing instrument of the estate (e.g., the will and
applicable local law) creates separate economic interests in
one beneficiary or class of beneficiaries such that the
economic interests of those beneficiaries (e.g., rights to
income or gains from specified items of property) are not
affected by economic interests accruing to another separate
beneficiary or class of beneficiaries. For example, a separate
share in an estate would exist where the decedent's will
provides that all of the shares of a closely-held corporation
are devised to one beneficiary and that any dividends paid to
the estate by that corporation should be paid only to that
beneficiary and any such dividends would not affect any other
amounts which that beneficiary would receive under the will. As
in the case of trusts, the application of the separate share
rule is mandatory where separate shares exist.
Effective Date
The provision applies to decedents dying after the date of
enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
8. Executor of estate and beneficiaries treated as related persons for
disallowance of losses (sec. 1308 of the Act and secs. 267(b)
and 1239(b) of the Code)
Present and Prior Law
Section 267 disallows a deduction for any loss on the sale
of an asset to a person related to the taxpayer. For the
purposes of section 267, the following parties are related
persons: (1) a trust and the trust's grantor, (2) two trusts
with the same grantor, (3) a trust and a beneficiary of the
trust, (4) a trust and a beneficiary of another trust, if both
trusts have the same grantor, and (5) a trust and a corporation
the stock of which is more than 50 percent owned by the trust
or the trust's grantor.
Section 1239 disallows capital gain treatment on the sale
of depreciable property to a related person. For purposes of
section 1239, a trust and any beneficiary of the trust are
treated as related persons, unless the beneficiary's interest
is a remote contingent interest.
Under prior law, neither section 267 nor section 1239
treated an estate and a beneficiary of the estate as related
persons.
Reasons for Change
The Congress believed that the disallowance rules under
sections 267 and 1239 with respect to transactions between
related parties should apply to an estate and a beneficiary of
that estate for the same reasons that such rules apply to a
trust and a beneficiary of that trust.
Explanation of Provision
Under the Act, an estate and a beneficiary of that estate
are treated as related persons for purposes of sections 267 and
1239, except in the case of a sale or exchange in satisfaction
of a pecuniary bequest.
Effective Date
The provision applies to taxable years beginning after the
date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
9. Simplified taxation of earnings of pre-need funeral trusts (sec.
1309 of the Act and sec. 684 of the Code)
Present and Prior Law
A pre-need funeral trust is an arrangement where an
individual purchases funeral services or merchandise from a
funeral home for the benefit of a specified person in advance
of that person's death. (The beneficiary may be either the
purchaser or another person.) The purchaser enters into a
contract with the provider of such services or merchandise
whereby the purchaser selects the services or merchandise to be
provided upon the death of the beneficiary, and agrees to pay
for them in advance of the beneficiary's death. Such amounts
(or a portion thereof) are held in trust during the
beneficiary's lifetime and are paid to the seller upon the
beneficiary's death.
Under prior law, pre-need funeral trusts generally were
treated as grantor trusts, and the annual income earned by such
trusts was taxed to the purchaser/grantor of the trust. Rev.
Rul. 87-127. Any amount received from the trust by the seller
(as payment for services or merchandise) is includible in the
gross income of the seller.
Reasons for Change
To the extent that pre-need funeral trusts were treated as
grantor trusts under prior law, numerous individual taxpayers
were required to account for the earnings of such trusts on
their tax returns, even though the earnings with respect to any
one taxpayer may have been small. The Congress believed that
this recordkeeping burden on individuals could be eased, and
that compliance with the tax laws would be improved, if such
trusts instead were taxed at the entity level, with one
simplified annual return filed by the trustee reporting the
aggregate income from all such trusts administered by the
trustee.
Explanation of Provision
The Act allows the trustee of a pre-need funeral trust to
elect special tax treatment for such a trust, to the extent the
trust would otherwise be treated as a grantor trust. A
qualified funeral trust is defined as one which meets the
following requirements: (1) the trust arises as the result of a
contract with a person engaged in the trade or business of
providing funeral or burial services or merchandise; (2) the
only beneficiaries of the trust are individuals with respect to
whom such services or merchandise are to be provided at their
death; (3) the only contributions to the trust are
contributions by or for the benefit of the trust beneficiaries;
(4) the trust's only purpose is to hold and invest funds that
will be used to make payments for funeral or burial services or
merchandise for the trust beneficiaries; and (5) the trust has
not accepted contributions totaling more than $7,000 by or for
the benefit of any individual. For this purpose,
``contributions'' include all amounts transferred to the trust,
regardless of how denominated in the contract. Contributions do
not, however, include income or gain earned with respect to
property in the trust. For purposes of applying the $7,000
limit, if a purchaser has more than one contract with a single
trustee (or related trustees), all such trusts are treated as
one trust. Similarly, if the Secretary of the Treasury
determines that a purchaser has entered into separate contracts
with unrelated trustees to avoid the $7,000 limit described
above, the Secretary may require that such trusts be treated as
one trust. For contracts entered into after 1998, the $7,000
limit is indexed annually for inflation.
The trustee's election to have this provision apply to a
qualified funeral trust is to be made separately with respect
to each purchaser's trust. It is anticipated that the
Department of the Treasury will issue prompt guidance with
respect to the simplified reporting requirements so that if the
election is made, a single annual trust return may be filed by
the trustee, separately listing the amount of income earned
with respect to each purchaser. If the election is made, the
trust is not treated as a grantor trust and the amount of tax
paid with respect to each purchaser's trust is determined in
accordance with the income tax rate schedule generally
applicable to estates and trusts (Code sec. 1(e)), but no
deduction is allowed under section 642(b). The tax on the
annual earnings of the trust is payable by the trustee.
As under prior law, amounts received from the trust by the
seller are treated as payments for services and merchandise and
are includible in the gross income of the seller. No gain or
loss is recognized to the purchaser of the trust for payments
from the trust to the purchaser upon cancellation of the
contract, and the purchaser takes a carryover basis in any
assets received from the trust upon cancellation.
Effective Date
The provision is effective for taxable years ending after
the date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $2 million per year for the years 1998
through 2007.
10. Adjustments for gifts within 3 years of decedent's death (sec. 1310
of the Act and secs. 2035 and 2038 of the Code)
Present and Prior Law
The first $10,000 of gifts of present interests to each
donee during any one calendar year are excluded from Federal
gift tax.
The value of the gross estate includes the value of any
previously transferred property if the decedent retained the
power to revoke the transfer (sec. 2038). The gross estate also
includes the value of any property with respect to which such
power is relinquished during the three years before death (sec.
2035). There has been significant litigation as to whether
these rules require that certain transfers made from a
revocable trust within three years of death be includible in
the gross estate. See, e.g., Jalkut Estate v. Commissioner, 96
T.C. 675 (1991) (transfers from revocable trust includible in
gross estate); McNeely v. Commissioner, 16 F.3d 303 (8th Cir.
1994) (transfers from revocable trust not includible in gross
estate); Kisling v. Commissioner, 32 F.3d 1222 (8th Cir. 1994)
(acq.) (transfers from revocable trust not includible in gross
estate).
Reasons for Change
The inclusion of certain property transferred during the
three years before death is directed at transfers that would
otherwise reduce the amount subject to estate tax by more than
the amount subject to gift tax, disregarding appreciation
between the times of gift and death. Because all amounts
transferred from a revocable trust are subject to the gift tax,
the Congress believed that inclusion of such amounts was
unnecessary where the transferor has retained no power over the
property transferred out of the trust. The Congress believed
that clarifying these rules statutorily would lend certainty to
these rules.
Explanation of Provision
The Act codifies the rule set forth in the McNeely and
Kisling cases to provide that a transfer from a revocable trust
(i.e., a trust described under section 676) is treated as if
made directly by the grantor. Thus, an annual exclusion gift
from such a trust is not included in the gross estate. The
provision is not intended to modify the result reached in the
Kisling case.
The provision also revises section 2035 to improve its
clarity.
Effective Date
The provision applies to decedents dying after the date of
enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have no effect on Federal
fiscal year budget receipts.
11. Clarify relationship between community property rights and
retirement benefits (sec. 1311 of the Act and sec.
2056(b)(7)(C) of the Code)
Present and Prior Law
Community property
Under State community property laws, each spouse owns an
undivided one-half interest in each community property asset.
In community property jurisdictions, a nonparticipant spouse
may be treated as having a vested community property interest
in either his or her spouse's qualified plan, individual
retirement arrangement (``IRA''), or simplified employee
pension (``SEP'') plan.
Transfer tax treatment of qualified plans
In the Retirement Equity Act of 1984 (``REA''), qualified
retirement plans were required to provide automatic survivor
benefits (1) in the case of a participant who retires under the
plan, in the form of a qualified joint and survivor annuity,
and (2) in the case of a vested participant who dies before the
annuity starting date and who has a surviving spouse, in the
form of a preretirement survivor annuity. A participant
generally is permitted to waive such annuities, provided he or
she obtains the written consent of his or her spouse.
The Tax Reform Act of 1986 (``1986 Act'') repealed the
estate tax exclusion, formerly contained in sections 2039(c)
and 2039(d), for certain interests in qualified plans owned by
a nonparticipant spouse attributable to community property laws
and made certain other changes to conform the transfer tax
treatment of qualified and nonqualified plans.
As a result of these changes made by REA and the 1986 Act,
the transfer tax treatment of married couples residing in a
community property State was unclear where either spouse was
covered by a qualified plan.
Reasons for Change
The Congress believed that survivorship interests in
annuities in community property States should be accorded
similar treatment to the tax treatment of interests in such
annuities in non-community property States. Accordingly, the
Act clarifies that the transfer at death of a survivorship
interest in an annuity to a surviving spouse will be a
deductible marital transfer under the QTIP rules regardless of
whether the decedent's annuity interest arose out of his or her
employment or arose under community property laws by reason of
the employment of his or her spouse.
Explanation of Provision
The Act clarifies that the marital deduction is available
with respect to a nonparticipant spouse's interest in an
annuity attributable to community property laws where he or she
predeceases the participant spouse. Under the provision, the
nonparticipant spouse's interest in an annuity arising under
the community property laws of a State that passes to the
surviving participant spouse may qualify for treatment as QTIP
under section 2056(b)(7).
The provision is not intended to create an inference
regarding the treatment under prior law of a transfer to a
surviving spouse of the decedent spouse's interest in an
annuity arising under community property laws. The provision is
not intended to modify the result of the Supreme Court's
decision in Boggs v. Boggs, 117 S.Ct. 1754 (1997).
Effective Date
The provision applies to decedents dying, or waivers,
transfers and disclaimers made, after the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
12. Treatment under qualified domestic trust rules of forms of
ownership which are not trusts (sec. 1312 of the Act and sec.
2056A(c) of the Code)
Present and Prior Law
A marital deduction generally is allowed for estate and
gift tax purposes for the value of property passing to a
spouse. The marital deduction is not available for property
passing to an alien spouse outside a qualified domestic trust
(``QDT''). An estate tax generally is imposed on corpus
distributions from a QDT.
Trusts are not permitted in some countries (e.g., many
civil law countries).\307\ As a result, it was not possible
under prior law to create a QDT in those countries.
---------------------------------------------------------------------------
\307\ Note that in some civil law States (e.g., Louisiana), an
entity similar to a trust, called a usufruct, exists.
---------------------------------------------------------------------------
Reasons for Change
The estate of a decedent with a nonresident spouse should
not be precluded from qualifying for the marital deduction in
situations where the use of a trust is prohibited by another
country. Accordingly, the Congress believed it was appropriate
to grant regulatory authority to allow qualification for the
marital deduction in such situations where the Treasury
Department determines that another similar arrangement allows
the U.S. to retain jurisdiction and provides adequate security
for the payment of U.S. transfer taxes on subsequent transfers
by the surviving spouse of the property transferred by the
decedent.
Explanation of Provision
The Act provides the Treasury Department with regulatory
authority to treat as trusts legal arrangements that have
substantially the same effect as a trust. It is anticipated
that such regulations, if any, would only permit a marital
deduction with respect to non-trust arrangements under which
the U.S. would retain jurisdiction and adequate security to
impose U.S. transfer tax on transfers by the surviving spouse
of the property transferred by the decedent. Possible
arrangements could include the adoption of a bilateral treaty
that provides for the collection of U.S. transfer tax from the
noncitizen surviving spouse or a closing agreement process
under which the surviving spouse waives treaty benefits, allows
the U.S. to retain taxing jurisdiction and provides adequate
security with respect to such transfer taxes.
Effective Date
The provision applies to decedents dying after the date of
enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
13. Opportunity to correct certain failures under section 2032A (sec.
1313 of the Act and sec. 2032A of the Code)
Present and Prior Law
For estate tax purposes, an executor may elect to value
certain real property used in farming or other closely held
business operations at its current use value rather than its
highest and best use (sec. 2032A). A written agreement signed
by each person with an interest in the property must be filed
with the election.
In 1984, section 2032A was amended to provide that if an
executor makes a timely election that substantially complies
with Treasury regulations, but fails to provide all required
information or the signatures of all persons required to enter
into the agreement, the executor may supply the missing
information within a reasonable period of time (not exceeding
90 days) after notification by the Treasury Department.
Treasury regulations require that a notice of election and
certain information be filed with the Federal estate tax return
(Treas. Reg. sec. 20.2032A-8). The administrative policy of the
Treasury Department was to disallow current use valuation
elections unless the required information was supplied.
Reasons for Change
It was understood that executors commonly fail to include
with the filed estate tax return a recapture agreement signed
by all persons with an interest in the property or all
information required by Treasury regulations. The Congress
believed that allowing such signatures or information to be
supplied later would be consistent with the legislative intent
of section 2032A and would ease return filing.
Explanation of Provision
The Act extends the procedures allowing subsequent
submission of information to any executor who makes the
election and submits the recapture agreement, without regard to
compliance with the Treasury regulations. Thus, the Act allows
the current use valuation election if the executor supplies the
required information within a reasonable period of time (not
exceeding 90 days) after notification by the IRS. During that
time period, the provision also allows the addition of
signatures to a previously filed agreement.
Effective Date
The provision applies to decedents dying after the date of
enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
14. Authority to waive requirement of U.S. trustee for qualified
domestic trusts (sec. 1314 of the Act and sec. 2056A(a)(1)(A) of the
Code)
Present and Prior Law
In general, in order for a trust to be a QDT, a U.S.
trustee must have the power to approve all corpus distributions
from the trust. In some countries, trusts cannot have any U.S.
trustees. As a result, trusts established in those countries
could not qualify as a QDT under prior law.
Reasons for Change
The estate of a decedent with a nonresident spouse should
not be precluded from qualifying for the marital deduction in
situations where the use of a U.S. trustee is prohibited by
another country. Accordingly, the Congress believed it was
appropriate to grant regulatory authority to allow
qualification for the marital deduction in such situations
where the Treasury Department determines that the U.S. can
retain jurisdiction and other adequate security has been
provided for the payment of U.S. transfer taxes on subsequent
transfers by the surviving spouse of the property transferred
by the decedent.
Explanation of Provision
In order to permit the establishment of a QDT in those
situations where a country prohibits a trust from having a U.S.
trustee, the Act provides the Treasury Department with
regulatory authority to waive the requirement that a QDT have a
U.S. trustee. It is anticipated that such regulations, if any,
provide an alternative mechanism under which the U.S. would
retain jurisdiction and adequate security to impose U.S.
transfer tax on transfers by the surviving spouse of the
property transferred by the decedent.
Effective Date
The provision applies to decedents dying after the date of
enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have no effect on Federal
fiscal year budget receipts.
TITLE XIV. EXCISE TAX AND OTHER SIMPLIFICATION PROVISIONS
A. Excise Tax Simplification Provisions
1. Increase de minimis limit for after-market alterations subject to
heavy truck and luxury automobile excise taxes (sec. 1401 of
the Act and secs. 4001 and 4051 of the Code)
Present and Prior Law
An excise tax is imposed on retail sales of truck chassis
and truck bodies suitable for use in a vehicle with a gross
vehicle weight of over 33,000 pounds. The tax is equal to 12
percent of the retail sales price. An excise tax also is
imposed on retail sales of luxury automobiles. The tax
currently is equal to 8 percent of the amount by which the
retail sales price exceeds an inflation-adjusted $30,000 base.
(The rate is reduced by 1 percentage point per year through
2002, and the tax is not imposed after 2002.) Anti-abuse rules
prevent the avoidance of these taxes through separate purchases
of major component parts. With certain exceptions, tax at the
rate applicable to the vehicle is imposed on the subsequent
installation of parts and accessories within six months after
purchase of a taxable vehicle. The exceptions include a de
minimis exception for parts and accessories with an aggregate
price that does not exceed $200 (or such other amount as
Treasury may by regulation prescribe).
Reasons for Change
Retailers generally are responsible for taxes on truck
chassis and bodies and luxury automobiles. In the case of a
subsequent installation, however, the owner or operator of the
vehicle is responsible for paying the tax attributable to the
installation and the installer is secondarily liable.
Increasing the de minimis amount should significantly reduce
the number of return filers and relieve many persons from the
administrative burden of filing an excise tax return reporting
a very small amount of tax.
Explanation of Provision
The tax on subsequent installation of parts and accessories
does not apply to parts and accessories with an aggregate price
that does not exceed $1,000.
Effective Date
The increase in the threshold for taxing after-market
additions under the heavy truck and luxury car excise taxes is
effective for installations on vehicles sold after the date of
the Act's enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
2. Modify treatment of tires under the heavy highway vehicle retail
excise tax (sec. 1402 of the Act and sec. 4052 of the Code)
Present and Prior Law
A 12-percent retail excise tax is imposed on certain heavy
highway trucks and trailers, and on highway tractors. A
separate manufacturers' excise tax is imposed on tires weighing
more than 40 pounds. This tire tax is imposed as a fixed dollar
amount which varies based on the weight of the tire. Because
tires are taxed separately, the value of tires installed on a
highway vehicle was excluded from the 12-percent excise tax on
heavy highway vehicles under prior law. The determination of
value was factual and gave rise to numerous tax audit
challenges.
Reasons for Change
The Congress believed that allowing a credit for the tire
tax actually paid on truck tires would simplify the application
of the retail truck tax.
Explanation of Provision
The prior-law exclusion of the value of tires installed on
a taxable highway vehicle is repealed. Instead, a credit for
the amount of manufacturers' excise tax actually paid on the
tires is allowed.
Effective Date
The provision is effective for sales after December 31,
1997.
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $66 million in 1998, $94 million in 1999,
$96 million in 2000, $97 million in 2001, $99 million in 2002,
$101 million in 2003, $102 million in 2004, $105 million in
2005, $108 million in 2006, and $110 million in 2007.
3. Simplification of excise taxes on distilled spirits, wine, and beer
(secs. 1411-1422 of the Act and secs. 5008, 5053, 5055, 5115,
5175, and 5207, and new secs. 5222 and 5418 of the Code)
Prior Law
Imported distilled spirits returned to plant.--Excise tax
that has been paid on domestic distilled spirits is credited or
refunded if the spirits are later returned to bonded premises.
Under prior law, tax was imposed on imported bottled spirits
when they are withdrawn from customs custody, but the tax is
not refunded or credited if the spirits are later returned to
bonded premises.
Cancellation of export bonds.--An exporter that withdraws
distilled spirits from bonded warehouses for export or
transportation to a customs bonded warehouse without the
payment of tax must furnish a bond to cover the withdrawal.
Under prior law, the required bonds were canceled ``on the
submission of such evidence, records, and certification
indicating exportation as the Secretary may by regulations
prescribe.''
Location of records of distilled spirits plant.--
Proprietors of distilled spirits plants were required to
maintain records and reports relating to their production,
storage, denaturation, and processing activities on the
premises where the operations covered by the record are carried
on.
Transfers from brewery to distilled spirits plant.--A
distilled spirits plant could receive on its bonded premises
beer to be used in the production of distilled spirits only if
the beer was produced on contiguous brewery premises.
Sign not required for wholesale dealers.--Wholesale liquor
dealers were required to post a sign identifying the firm as
such. Failure to do so was subject to a penalty.
Refund on returns of merchantable wine.--Excise tax paid on
domestic wine that was returned to bond as unmerchantable was
refunded or credited, and the wine was once again treated as
wine in bond on the premises of a bonded wine cellar.
Increased sugar limits for certain wine.--Natural wines
could be sweetened to correct high acid content. For most
wines, however, sugar could not constitute more than 35 percent
(by volume) of the combined sugar and juice used to produce the
wine. Up to 60 percent sugar could be used in wine made from
loganberries, currants, and gooseberries. If the amount of
sugar used exceeded the applicable limitation, the wine was
required to be labeled ``substandard.''
Beer withdrawn for embassy use.--Imported beer to be used
for the family and official use of representatives of foreign
governments or public international organizations may be
withdrawn from customs bonded warehouses without payment of
excise tax. Under prior law, no similar exemption applied to
domestic beer withdrawn from a brewery or entered into a bonded
customs warehouse for the same authorized use.
Beer withdrawn for destruction.--Removals of beer from a
brewery are exempt from tax if the removal is for export,
because the beer is unfit for beverage use, for laboratory
analysis, research, development and testing, for the brewer's
personal or family use, or as supplies for certain vessels and
aircraft.
Drawback on exported beer.--Under prior law, a domestic
producer that exports beer could recover the tax (receive a
``drawback'') found to have been paid on the exported beer upon
the ``submission of such evidence, records and certificates
indicating exportation'' required by regulations.
Imported beer transferred in bulk to brewery and imported
wine transferred in bulk to wineries.--Imported beer and wine
were subject to tax when removed from customs custody.
Reasons for Change
Until 1980, the method of collecting alcohol excise taxes
required the regular presence of Treasury Department inspectors
at alcohol production facilities. In 1980, the method of
collecting tax was changed to a bonded premises system under
which examinations and collection procedures are similar to
those used in connection with other Federal excise taxes.
A number of reporting and recordkeeping requirements need
to be modified to conform to the current collection system. The
Congress determined that appropriate modification will allow
the Bureau of Alcohol, Tobacco, and Firearms to administer
alcohol excise taxes more efficiently and relieve taxpayers of
unnecessary paperwork burdens.
The prior-law rules under which the Code permitted tax-free
removals of alcoholic beverages (or allowed a credit or refund
of tax on a return to bonded premises) resulted in
inappropriate disparities in the treatment of different types
of alcoholic beverages. In addition, these rules unduly limited
available options for complying with environmental and other
laws that regulate the destruction and disposition of alcoholic
beverages. Under the bonded premises system, these rules can be
liberalized without jeopardizing the collection of tax
revenues.
Other provisions of prior law (i.e., the sign requirement
and the sugar limits for certain wine) were determined to be
outdated and thus appropriately repealed or revised.
Explanation of Provisions
Imported distilled spirits returned to plant.--Refunds or
credits of the tax are available for imported bottled spirits
that are returned to distilled spirits plants.
Cancellation of export bonds.--The certification
requirements are relaxed to allow the bonds to be canceled if
there is such proof of exportation as the Secretary may
require.
Location of records of distilled spirits plant.--Records
and reports are permitted to be maintained elsewhere other than
on the plant premises.
Transfers from brewery to distilled spirits plant.--Beer
may be brought from any brewery for use in the production of
spirits. Such beer is exempt from excise tax, subject to
Treasury Department regulations.
Sign not required for wholesale dealers.--The requirement
that a sign be posted is repealed.
Refund on returns of merchantable wine.--A refund or credit
is available in the case of all domestic wine returned to bond,
whether or not unmerchantable.
Increased sugar limits for certain wine.--Up to 60 percent
sugar is permitted in any wine made from juice, such as
cranberry or plum juice, with an acid content of 20 or more
parts per thousand.
Beer withdrawn for embassy use.--Subject to the Treasury
Department's regulatory authority, an exemption similar to that
currently available for imported beer is provided for domestic
beer.
Beer withdrawn for destruction.--An exemption from tax is
added for removals for destruction, subject to Treasury
regulations.
Drawback on exported beer.--The certification requirement
is relaxed to allow a drawback of tax paid if there is such
proof of exportation as the Secretary may by regulations
require.
Imported beer transferred in bulk to brewery and imported
wine transferred in bulk to wineries.--Subject to Treasury
Department regulations, beer and wine imported in bulk may be
withdrawn from customs custody and transferred in bulk to a
brewery (beer) or a winery (wine) without payment of tax. The
proprietor of the brewery to which the beer is transferred or
of the winery to which the wine is transferred is liable for
the tax imposed on beer or wine withdrawn from customs custody
and the importer is relieved of liability.
Effective Date
The provision to repeal the requirement that wholesale
liquor dealers post a sign outside their place of business
takes effect on the date of enactment. The other provisions
take effect on the first day of the calendar quarter that
begins at least 180 days after the date of enactment.
Revenue Effect
The provisions are estimated to have a negligible effect on
Federal fiscal year budget receipts.
4. Authority for Internal Revenue Service to grant exemptions from
excise tax registration requirements (sec. 1431 of the Act and
sec. 4222 of the Code)
Present and Prior Law
The Code exempts certain types of sales (e.g., sales for
use in further manufacture, sales for export, and sales for use
by a State or local government or a nonprofit educational
organization) from certain excise taxes imposed on
manufacturers and retailers. These exemptions generally apply
only if the seller, the purchaser, and any person to whom the
article is resold by the purchaser (the second purchaser) are
registered with the Internal Revenue Service. The IRS can waive
the registration requirement for the purchaser and second
purchaser in some but not all cases.
Reasons for Change
The Congress believed that allowing the Internal Revenue
Service to waive the registration requirement for purchasers
and second purchasers in all cases would permit more efficient
administration of the exemptions and reduce paperwork burdens
on taxpayers.
Explanation of Provision
The IRS is authorized to waive the registration requirement
for purchasers and second purchasers in all cases.
Effective Date
The provision applies to sales made pursuant to waivers
issued after the date of enactment.
Revenue Effect
The provision is estimated to have no effect on Federal
fiscal year budget receipts.
5. Repeal of expired excise tax provisions (sec. 1432 of the Act and
secs. 4051, 4495-4498, and 4681-4682 of the Code)
Present and Prior Law
The Code included a provision relating to a temporary
reduction in the tax on piggyback trailers sold before July 18,
1985, and provisions relating to the tax on the removal of hard
minerals from the deep seabed before June 28, 1990.
An excise tax is imposed on the sale or use by the
manufacturer or importer of certain ozone-depleting chemicals
(sec. 4681). The amount of the tax generally is determined by
multiplying the base tax amount applicable for the calendar
year by an ozone-depleting factor assigned to each taxable
chemical. The base tax amount was $5.80 per pound in 1996 and
will increase by 45 cents per pound per year thereafter. The
Code contains provisions for special rates of tax applicable to
years before 1996 (e.g., sec. 4282(g)(1), (2), (3), and (5)).
Reasons for Change
The Congress believed that the elimination of out-of-date,
``deadwood'' provisions will simplify the Code by removing
unneeded Code sections.
Explanation of Provision
These provisions are repealed, as deadwood.
Effective Date
The provisions were effective on the date of enactment
(August 5, 1997).
Revenue Effect
These provisions are estimated to have no effect on Federal
fiscal year budget receipts.
6. Modifications to excise tax on certain arrows (sec. 1433 of the Act
and sec. 4161 of the Code)
Present and Prior Law
An 11-percent manufacturer's excise tax is imposed on bows
having a draw weight of 10 pounds or more, and under prior law
on arrows that either were 18 inches or more in length or were
suitable for use with a taxable bow. The prior-law tax was
imposed on the manufacturer's sales price of the completed
arrow.
Reasons for Change
The Congress determined that imposing the excise tax on the
component parts of the arrow before they are shipped to the
assembler of the arrow will improve compliance with, and
collection of, the tax by reducing the potential number of tax
collection points.
Explanation of Provision
Under the Act, the prior-law excise tax on arrows is
replaced with a manufacturers' excise tax on the four component
parts of the arrow: shafts, points, nocks, and vanes. The tax
rate is increased to 12.4 percent of the sale price of each of
these four components to offset the reduction in aggregate
value subjected to tax compared to present-law valuation of the
completed arrow.
Effective Date
The provision was effective for arrow components sold after
September 30, 1997.
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
7. Modifications to heavy highway vehicle retail excise tax (sec. 1434
of the Act and sec. 4051 of the Code)
Present and Prior Law
A 12-percent retail excise tax is imposed on certain heavy
highway trucks and trailers, and on highway tractors. Small
trucks (those with a gross vehicle weight not over 33,000
pounds) and lighter trailers (those with a gross vehicle weight
not over 26,000 pounds) are exempt from the tax. The tax
applies to the first retail sale of a new or remanufactured
vehicle. The determination under present law of whether a
particular modification to an existing vehicle constitutes
remanufacture (taxable) or a repair (nontaxable) is factual and
generally is based on whether the transportation function of
the vehicle is changed, the vehicle was wrecked or, in the case
of worn vehicles, whether the cost of the modification exceeds
75 percent of the value of the modified vehicle.
No tax is imposed on trucks, tractors, and trailers when
they are sold for resale or long-term lease, if the purchaser
is registered with the Treasury Department. In such cases,
purchasers are liable for the tax when the vehicle is sold or
leased. The tax is based on the sales price in the transaction
to which it applies.
Reasons for Change
The Congress believed that the 75-percent-of value
threshold should apply in determining whether repairs to a
wrecked vehicle constitute remanufacture, and that a
certification requirement for resales of trucks, tractors, and
trailers will simplify administration of the tax.
Explanation of Provision
The Act makes two changes to the heavy vehicle excise tax:
(1) The 75-percent-of-value threshold applies in
determining whether repairs to a wrecked vehicle constitute
remanufacture; and
(2) The registration requirement currently applicable to
certain sales of trucks, tractors, and trailers for resale is
replaced with a certification requirement.
Effective Date
The provision is effective after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $5 million in 1998, $8 million per year in
1999, 2000, and 2001, $9 million per year in 2002 and 2003, $10
million per year in 2004 and 2005, and $11 million per year in
2006 and 2007.
8. Treatment of skydiving flights as noncommercial aviation (sec. 1435
of the Act and sec. 4081 and 4261 of the Code)
Present and Prior Law
Under prior law, commercial passenger aviation, or air
transportation for which a fare was charged, was subject to a
10-percent ad valorem excise tax for the Airport and Airway
Trust Fund.\308\ Noncommercial aviation, or air transportation
which is not ``for hire'' is subject to a fuels tax for the
Trust Fund. In the case of skydiving flights, questions arose
under prior law as to when the flight was commercial aviation
subject to the ticket tax and when it was noncommercial
aviation subject to the fuels tax. In general, if instruction
was offered, the flight was noncommercial aviation. Otherwise,
the flight was treated as commercial aviation. Many skydiving
flights carry both persons receiving instruction and others not
receiving instruction.
---------------------------------------------------------------------------
\308\ The Act, in a separate provision (sec. 1031), modified the
tax on commercial aviation and extended all aviation excise taxes for
10 years.
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that the tax treatment of skydiving
flights as commercial or noncommercial needed to be clarified.
Explanation of Provision
The Act specifies that flights which are exclusively
dedicated to skydiving are taxed as noncommercial aviation
flights, regardless of whether instruction is offered to any of
the passengers.
Effective Date
The provision was effective for flights beginning after
September 30, 1997.
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
9. Eliminate double taxation of certain aviation fuels sold to
producers by ``fixed base operators'' (sec. 1436 of the Act and
sec. 4091 of the Code)
Present and Prior Law
Code section 4091 imposes a tax on the sale of aviation
fuel by any producer (defined to include a wholesale
distributor). Fuel sold at many rural airports is sold by
retail dealers who do not qualify as wholesale distributors.
This fuel is purchased by the retailers tax-paid. In certain
instances, fuel which has been purchased tax-paid by a retailer
will be re-sold to a producer, e.g., to enable the producer to
serve one of its customers at the airport. When this fuel is
resold at retail by the producer, a second tax may be imposed.
Under prior law, the Code contained no provision allowing a
refund of the first tax in such cases.
Reasons for Change
The Congress believed that permitting a producer to obtain
refund of tax previously paid on aviation fuel that it buys
will improve the fairness of the tax collection for such fuel.
Explanation of Provision
The Act permits a producer to obtain a refund of tax
previously paid on aviation fuel that the producer buys.
Effective Date
The provision was effective for fuel acquired by a producer
after September 30, 1997.
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
B. Tax-Exempt Bond Provisions
Overview
Interest on State and local government bonds generally is
excluded from gross income for purposes of the regular
individual and corporate income taxes if the proceeds of the
bonds are used to finance direct activities of these
governmental units (Code sec. 103).
Unlike the interest on governmental bonds, described above,
interest on private activity bonds generally is taxable. A
private activity bond is a bond issued by a State or local
governmental unit acting as a conduit to provide financing for
private parties in a manner violating either (1) a private
business use and payment test or (2) a private loan
restriction. However, interest on private activity bonds is not
taxable if (1) the financed activity is specified in the Code
and (2) at least 95 percent of the net proceeds of the bond
issue is used to finance the specified activity.
Issuers of State and local government bonds must satisfy
numerous other requirements, including arbitrage restrictions
(for all such bonds) and annual State volume limitations (for
most private activity bonds) for the interest on these bonds to
be excluded from gross income.
1. Repeal of $100,000 limitation on unspent proceeds under 1-year
exception from rebate (sec. 1441 of the Act and sec. 148 of
Code)
Present and Prior Law
Subject to limited exceptions, arbitrage profits from
investing bond proceeds in investments unrelated to the
governmental purpose of the borrowing must be rebated to the
Federal Government. No rebate is required if the gross proceeds
of an issue are spent for the governmental purpose of the
borrowing within six months after issuance.
Under prior law, this six-month exception is deemed to be
satisfied by issuers of governmental bonds (other than tax and
revenue anticipation notes) and qualified 501(c)(3) bonds if
(1) all proceeds other than an amount not exceeding the lesser
of five percent or $100,000 are so spent within six months and
(2) the remaining proceeds are spent within one year after the
bonds are issued.
Reasons for Change
Exemption of interest paid on State and local bonds from
Federal income tax provides an implicit subsidy to State and
local governments for their borrowing costs. The principal
Federal policy concern underlying the arbitrage rebate
requirement is to discourage the earlier and larger than
necessary issuance of tax-exempt bonds to take advantage of the
opportunity to profit by investing funds borrowed at low-cost
tax-exempt rates in higher yielding taxable investments. If at
least 95 percent of the proceeds of an issue of governmental
and 501(c)(3) bonds is spent within six months, and the
remainder is spent within one year, opportunities for such
arbitrage profit are significantly limited.
Explanation of Provision
The $100,000 limit on proceeds that may remain unspent
after six months for certain governmental and qualified
501(c)(3) bonds otherwise exempt from the rebate requirement is
deleted. Thus, if at least 95 percent of the proceeds of these
bonds is spent within six months after their issuance, and the
remainder is spent within one year, the six-month exception is
deemed to be satisfied.
Effective Date
The provision applies to bonds issued after the date of
enactment (August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $500,000 in 1998, $2 million in
1999, $3 million in 2000, $5 million in 2001, $6 million in
2002, $8 million in 2003, $9 million in 2004, $10 million in
2005, $11 million in 2006, and $12 million in 2007.
2. Exception from rebate for earnings on bona fide debt service fund
under construction bond rules (sec. 1442 of the Act and sec.
148 of the Code)
Present and Prior Law
In general, arbitrage profits from investing bond proceeds
in investments unrelated to the governmental purpose of the
borrowing must be rebated to the Federal Government. An
exception is provided for certain construction bond issues if
the bonds are governmental bonds, qualified 501(c)(3) bonds, or
exempt-facility private activity bonds for governmentally-owned
property.
This exception is satisfied only if the available
construction proceeds of the issue are spent at minimum
specified rates during the 24-month period after the bonds are
issued. The exception does not apply to bond proceeds invested
after the 24-month expenditure period as part of a reasonably
required reserve or replacement fund, a bona fide debt service
fund under prior law, or to certain other investments (e.g.,
sinking funds). Issuers of these construction bonds also may
elect to comply with a penalty regime in lieu of rebating
arbitrage profits if they fail to satisfy the exception's
spending requirements.
Reasons for Change
Bond proceeds invested in a bona fide debt service fund
generally must be spent at least annually for current debt
service. The short-term nature of investments in such funds
results in only limited potential for generating arbitrage
profits. If the spending requirements of the 24-month rebate
exception are satisfied, the administrative complexity of
calculating rebate on these proceeds outweighs the other
Federal policy concerns addressed by the rebate requirement.
Explanation of Provision
The Act exempts earnings on bond proceeds invested in bona
fide debt service funds from the arbitrage rebate requirement
and the penalty requirement of the 24-month exception if the
spending requirements of that exception are otherwise
satisfied.
Effective Date
The provision applies to bonds issued after the date of
enactment (August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $500,000 in 1998, $1 million in
1999, $2 million in 2000, $3 million in 2001, $3 million in
2002, $4 million in 2003, $5 million in 2004, $6 million in
2005, $6 million in 2006, and $7 million in 2007.
3. Repeal of debt service-based limitation on investment in certain
nonpurpose investments (sec. 1443 of the Act and sec. 148 of
the Code)
Present and Prior Law
Issuers of all tax-exempt bonds generally are subject to
two sets of restrictions on investment of their bond proceeds
to limit arbitrage profits. The first set requires that tax-
exempt bond proceeds be invested at a yield that is not
materially higher (generally defined as 0.125 percentage
points) than the bond yield (``yield restrictions'').
Exceptions are provided to this restriction for investments
during any of several ``temporary periods'' pending use of the
proceeds and, throughout the term of the issue, for proceeds
invested as part of a reasonably required reserve or
replacement fund or a ``minor'' portion of the issue proceeds.
Except for temporary periods and amounts held pending use
to pay current debt service, prior law also limited the amount
of the proceeds of private activity bonds (other than qualified
501(c)(3) bonds) that may be invested at materially higher
yields at any time during a bond year to 150 percent of the
debt service for that bond year. This restriction affected
primarily investments in reasonably required reserve or
replacement funds. Present law and prior law further restricts
the amount of proceeds from the sale of bonds that may be
invested in these reserve funds to ten percent of such
proceeds.
The second set of restrictions requires generally that all
arbitrage profits earned on investments unrelated to the
governmental purpose of the borrowing be rebated to the Federal
Government (``arbitrage rebate''). Arbitrage profits include
all earnings (in excess of bond yield) derived from the
investment of bond proceeds (and subsequent earnings on any
such earnings).
Reasons for Change
The 150-percent of debt service limit was enacted before
enactment of the arbitrage rebate requirement and the ten-
percent limit on the size of reasonably required reserve or
replacement funds. It was intended to eliminate arbitrage-
motivated activities available from investment of such reserve
funds. Provided that comprehensive yield restriction and
arbitrage rebate requirements and the present-law overall size
limit on reserve funds are maintained, the 150-percent of debt
service yield restriction limit is duplicative.
Explanation of Provision
The Act repeals the 150-percent of debt service yield
restriction.
Effective Date
The provision applies to bonds issued after the date of
enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible revenue
effect on Federal fiscal year budget receipts.
4. Repeal of expired provisions relating to student loan bonds (sec.
1444 of the Act and sec. 148 of the Code)
Present and Prior Law
Prior law included two special exceptions to the arbitrage
rebate and pooled financing temporary period rules for certain
qualified student loan bonds. These exceptions applied only to
bonds issued before January 1, 1989.
Explanation of Provision
These special exceptions are deleted as ``deadwood.''
Effective Date
The provision applies to bonds issued after the date of
enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have a no effect on Federal
fiscal year budget receipts.
C. Tax Court Procedures
1. Overpayment determinations of Tax Court (sec. 1451 of the Act and
sec. 6512 of the Code)
Present and Prior Law
The Tax Court may order the refund of an overpayment
determined by the Court, plus interest, if the IRS fails to
refund such overpayment and interest within 120 days after the
Court's decision becomes final. Whether such an order is
appealable is uncertain.
In addition, it is unclear whether the Tax Court has
jurisdiction over the validity or merits of certain credits or
offsets (e.g., providing for collection of student loans, child
support, etc.) made by the IRS that reduce or eliminate the
refund to which the taxpayer was otherwise entitled.
Reasons for Change
Clarification of the jurisdiction of the Tax Court and the
ability to appeal orders of the Tax Court would provide for
greater certainty for taxpayers and the government in
conducting cases before the Tax Court. Clarification will also
reduce litigation.
Explanation of Provision
The Act clarifies that an order to refund an overpayment is
appealable in the same manner as a decision of the Tax Court.
The Act also clarifies that the Tax Court does not have
jurisdiction over the validity or merits of the credits or
offsets that reduce or eliminate the refund to which the
taxpayer was otherwise entitled.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $3 million in each of 1998 through 2007.
2. Redetermination of interest pursuant to motion (sec. 1452 of the Act
and sec. 7481 of the Code)
Present and Prior Law
A taxpayer may seek a redetermination of interest after
certain decisions of the Tax Court have become final by filing
a petition with the Tax Court.
Reasons for Change
Congress concluded that it would be beneficial to taxpayers
if a proceeding for a redetermination of interest supplemented
the original deficiency action brought by the taxpayer to
redetermine the deficiency determination of the IRS. A motion,
rather than a petition, is a more appropriate pleading for
relief in these cases.
Explanation of Provision
The Act provides that a taxpayer must file a ``motion''
(rather than a `petition'') to seek a redetermination of
interest in the Tax Court. The Act also clarifies that the Tax
Court's jurisdiction to redetermine the amount of interest
under section 7481(c) does not depend on whether the interest
is underpayment or overpayment interest. In clarifying the Tax
Court's jurisdiction over interest determinations, the Congress
did not intend to limit any other remedies that taxpayers may
currently have with respect to such determinations, including
in particular refund proceedings relating solely to the amount
of interest due.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to have no revenue effect.
3. Application of net worth requirement for awards of litigation costs
(sec. 1453 of the Act and sec. 7430 of the Code)
Present and Prior Law
Any person who substantially prevails in any action brought
by or against the United States in connection with the
determination, collection, or refund of any tax, interest, or
penalty may be awarded reasonable administrative costs incurred
before the IRS and reasonable litigation costs incurred in
connection with any court proceeding. A person who
substantially prevails must meet certain net worth requirements
to be eligible for an award of administrative or litigation
costs. In general, only an individual whose net worth does not
exceed $2,000,000 is eligible for an award, and only a
corporation or partnership whose net worth does not exceed
$7,000,000 is eligible for an award. (The net worth
determination with respect to a partnership or S corporation
applies to all actions that are in substance partnership
actions or S corporation actions, including unified entity-
level proceedings under sections 6226 or 6228, that are
nominally brought in the name of a partner or a shareholder.)
Reasons for Change
Although the net worth requirements are explicit for
individuals, corporations, and partnerships, it is not clear
which net worth requirement is to apply to other potential
litigants. It is also unclear how the individual net worth
rules are to apply to individuals filing a joint tax return.
Clarifying these rules will provide certainty for potential
claimants and will decrease needless litigation over procedural
issues.
Explanation of Provision
The Act provides that the net worth limitations currently
applicable to individuals also apply to estates and trusts. The
Act also provides that individuals who file a joint tax return
shall be treated as separate individuals for purposes of
computing the net worth limitations (resulting in a net worth
limitation of $4,000,000 for individuals who file a joint
return).
Effective Date
The provision applies to proceedings commenced after the
date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
receipts by $1 million in 1998, $2 million in 1999, $2 million
in 2000, $2 million in 2001, $2 million in 2002, $2 million in
2003, $2 million in 2004, $2 million in 2005, $2 million in
2006, and $2 million in 2007.
4. Tax Court jurisdiction for determination of employment status (sec.
1454 of the Act and new sec. 7436 of the Code)
Present and Prior Law
The Tax Court is a court of limited jurisdiction,
established under Article I of the Constitution. The Tax Court
only has the jurisdiction that is expressly conferred on it by
statute (sec. 7442).
Reasons for Change
Congress concluded that it will be advantageous to
taxpayers to have the option of going to the Tax Court to
resolve certain disputes regarding employment status.
Explanation of Provision
The Act provides that, in connection with the audit of any
person, if there is an actual controversy involving a
determination by the IRS as part of an examination that (1) one
or more individuals performing services for that person are
employees of that person or (2) that person is not entitled to
relief under section 530 of the Revenue Act of 1978, the Tax
Court has jurisdiction to determine whether the IRS is correct.
For example, one way the IRS could make the required
determination is through a mechanism similar to the employment
tax early referral procedures.\309\ A failure to agree would
also be considered a determination for this purpose, to the
extent permitted under Tax Court rules.
---------------------------------------------------------------------------
\309\ See Announcement 96-13 and Announcement 97-52.
---------------------------------------------------------------------------
The Act provides for de novo review (rather than review of
the administrative record). Assessment and collection of the
tax attributable to those issues would be suspended while the
matter is pending in the Tax Court. Any determination by the
Tax Court would have the force and effect of a decision of the
Tax Court and would be reviewable as such; accordingly, it
would be binding on the parties. Awards of costs and certain
fees (pursuant to section 7430) would be available to eligible
taxpayers with respect to Tax Court determinations pursuant to
this proposal. The Act also provides a number of procedural
rules to incorporate this new jurisdiction within the existing
procedures applicable in the Tax Court.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
D. Other Provisions
1. Due date for first quarter estimated tax payments by private
foundations (sec. 1461 of the Act and sec. 6655(c) of the Code)
Present and Prior Law
Under section 4940, tax-exempt private foundations
generally are required to pay an excise tax equal to two
percent of their net investment income for the taxable year.
Under section 6655(g)(3), private foundations are required to
pay estimated tax with respect to their excise tax liability
under section 4940 (as well as any unrelated business income
tax liability under section 511).\310\ Section 6655(c) provides
that this estimated tax is payable in quarterly installments
and that, for calendar-year foundations, the first quarterly
installment is due on April 15th. Under section 6655(i),
foundations with taxable years other than the calendar year
must make their quarterly estimated tax payments no later than
the dates in their fiscal years that correspond to the dates
applicable to calendar-year foundations.
---------------------------------------------------------------------------
\310\ Generally, the amount of the first quarter payment must be at
least 25 percent of the lesser of (1) the preceding year's tax
liability, as shown on the foundation's Form 990-PF, or (2) 95 percent
of the foundation's current-year tax liability.
---------------------------------------------------------------------------
Reasons for Change
Because a private foundation's estimated tax payments are
determined, in part, by reference to the foundation's tax
liability for the preceding year, Congress concluded that the
due date of a foundation's first-quarter estimated tax payment
should be the same as the date for filing the foundation's
annual return (Form 990-PF) for the preceding year.
Explanation of Provision
The Act amends section 6655(g)(3) to provide that a
calendar-year foundation's first-quarter estimated tax payment
is due on May 15th (which is the same day that its annual
return, Form 990-PF, for the preceding year is due). As a
result of the operation of present-law section 6655(i), fiscal-
year foundations will be required to make their first-quarter
estimated tax payment no later than the 15th day of the fifth
month of their taxable year.
Effective Date
The provision applies to taxable years beginning after
August 5, 1997, the date of enactment.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $2 million in 1998, and by less than
$500,000 per year in each of 1999 through 2007.
2. Withholding of Commonwealth income taxes from wages of Federal
employees (sec. 1462 of the Act and sec. 5517 of Title 5,
United States Code)
Present and Prior Law
If State law provides generally for the withholding of
State income taxes from the wages of employees in a State, the
Secretary of the Treasury shall (upon the request of the State)
enter into an agreement with the State providing for the
withholding of State income taxes from the wages of Federal
employees in the State. For this purpose, a State is a State,
territory, or possession of the United States. The Court of
Appeals for the Federal Circuit recently held in Romero v.
United States (38 F.3d 1204 (1994)) that Puerto Rico was not
encompassed within this definition; consequently, the court
invalidated an agreement between the Secretary of the Treasury
and Puerto Rico that provided for the withholding of Puerto
Rico income taxes from the wages of Federal employees.
Reasons for Change
The Congress believed that employees of the United States
should be in no better or worse position than other employees
with respect to Commonwealth income tax withholding.
Explanation of Provision
The Act makes any Commonwealth eligible to enter into an
agreement with the Secretary of the Treasury that would provide
for income tax withholding from the wages of Federal employees.
Effective Date
The provision is effective on January 1, 1998.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $2 million in 1998, $3 million in 1999, $1
million in 2000, $1 million in 2001, $1 million in 2002, $1
million in 2003, $1 million in 2004, $1 million in 2005, $1
million in 2006, and $1 million in 2007.
3. Certain notices disregarded under provision increasing interest rate
on large corporate underpayments (sec. 1463 of the Act and sec.
6621 of the Code)
Present and Prior Law
The interest rate on a large corporate underpayment of tax
is the Federal short-term rate plus five percentage points. A
large corporate underpayment is any underpayment by a
subchapter C corporation of any tax imposed for any taxable
period, if the amount of such underpayment for such period
exceeds $100,000. The large corporate underpayment rate
generally applies to periods beginning 30 days after the
earlier of the date on which the first letter of proposed
deficiency, a statutory notice of deficiency, or a
nondeficiency letter or notice of assessment or proposed
assessment is sent. For this purpose, a letter or notice is
disregarded if the taxpayer makes a payment equal to the amount
shown on the letter or notice within that 30 day period.
Reasons for Change
The large corporate underpayment rate generally applies if
the underpayment of tax for a taxable period exceeded $100,000,
even if the initial letter or notice of deficiency, proposed
deficiency, assessment, or proposed assessment was for an
amount less than $100,000. Thus, for example, under prior law,
a notice relating to a relatively minor mathematical error by
the taxpayer may have resulted in the application of the large
corporate underpayment rate to a subsequently identified tax
deficiency.
Explanation of Provision
For purposes of determining the period to which the large
corporate underpayment rate applies, any letter or notice is
disregarded if the amount of the deficiency, proposed
deficiency, assessment, or proposed assessment set forth in the
letter or notice is not greater than $100,000 (determined by
not taking into account any interest, penalties, or additions
to tax).
Effective Date
The provision is effective for purposes of determining
interest for periods after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $1 million in 1998, $1 million in 1999, $1
million in 2000, $1 million in 2001, $1 million in 2002, $1
million in 2003, $1 million in 2004, $1 million in 2005, $1
million in 2006, and $1 million in 2007.
TITLE XV. PENSION AND EMPLOYEE BENEFIT PROVISIONS
A. Pension Simplification Provisions
1. Matching contributions of self-employed individuals not treated as
elective deferrals (sec. 1501 of the Act and sec. 402(g) of the Code)
Present and Prior Law
Under present and prior law, a qualified cash or deferred
arrangement (a ``section 401(k) plan'') is a type of tax-
qualified pension plan under which employees can elect to make
pre-tax deferrals. An employee's annual elective deferrals are
subject to a dollar limit ($9,500 for 1997). Employers may make
matching contributions based on employees' elective deferrals.
In the case of employees, such matching contributions are not
subject to the $9,500 limit on elective deferrals. Elective
deferrals are subject to a special nondiscrimination test,
called the average deferral percentage (``ADP'') test. Under
the ADP test, the maximum amount of elective deferrals that can
be made by highly compensated employees is based on the amount
of elective deferrals made by nonhighly compensated employees.
Matching contributions are subject to a similar
nondiscrimination test, called the average contribution
percentage (``ACP'') test. An employer may treat certain
qualified matching contributions as elective deferrals for
purposes of satisfying the ADP test.
Under present and prior law, a SIMPLE retirement plan is
either an individual retirement arrangement (``IRA'') or part
of a 401(k) plan that meets certain requirements. Under a
SIMPLE retirement plan, employees can elect to make pre-tax
deferrals of up to $6,000 per year. Employers are required to
make either a matching contribution of up to 3-percent of the
employee's compensation or, alternatively, the employer can
elect to make a lower percentage contribution on behalf of all
eligible employees. Contributions to a SIMPLE retirement plan
are not subject to the ADP or ACP tests.
Under prior law, matching contributions made for a self-
employed individual were generally treated as additional
elective deferrals by the self-employed individual who received
the matching contribution. Accordingly, elective deferrals and
matching contributions for self-employed individuals were
subject to the dollar limits on elective deferrals and, in the
case of a 401(k) plan, treated as elective deferrals for
purposes of the ADP test.
Reasons for Change
The Congress believed it was appropriate to treat self-
employed individuals in the same manner as other employees with
regard to the limitations on matching contributions.
Explanation of Provision
The Act provides that matching contributions for self-
employed individuals are treated the same as matching
contributions for employees, i.e., they are not subject to the
elective deferral limits and are not treated as elective
deferrals for purposes of the ADP test (unless the employer
elects to treat qualified matching contributions as elective
deferrals under the ADP test). The provision does not apply to
qualified matching contributions that are treated as elective
deferrals for purposes of satisfying the ADP test.
Effective Date
The provision is effective for years beginning after
December 31, 1997. In the case of SIMPLE retirement plans
(including SIMPLE IRAs and SIMPLE 401(k)s), the provision is
effective for years beginning after December 31, 1996.\311\
---------------------------------------------------------------------------
\311\ A technical correction may be necessary so that the statute
reflects this intent with respect to SIMPLE 401(k) plans.
---------------------------------------------------------------------------
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $1 million per year for each of
years 1998 through 2007.
2. Modification of prohibition on assignment or alienation (sec. 1502
of the Act, sec. 401(a)(13) of the Code, and sec. 206(d) of ERISA)
Present and Prior Law
Under present and prior law, amounts held in a qualified
retirement plan for the benefit of a participant are not,
except in very limited circumstances, assignable or available
to personal creditors of the participant. A plan may permit a
participant, at such time as benefits under the plan are in pay
status, to make a voluntary revocable assignment of an amount
not in excess of 10-percent of any benefit payment, provided
the purpose is not to defray plan administration costs. In
addition, a plan may comply with a qualified domestic relations
order issued by a state court requiring benefit payments to
former spouses or other ``alternate payees'' even if the
participant is not in pay status.
Under prior law, there was no specific exception under the
Employee Retirement Income Security Act of 1974, as amended
(``ERISA'') or the Internal Revenue Code which would permit the
offset of a participant's benefit against the amount owed to a
plan by the participant as a result of a breach of fiduciary
duty to the plan or criminality involving the plan. Courts were
divided in their interpretation of the prohibition on
assignment or alienation in these cases. Some courts ruled that
there is no exception in ERISA for the offset of a
participant's benefit to make a plan whole in the case of a
fiduciary breach. Other courts reached a different result and
permitted an offset of a participant's benefit for breach of
fiduciary duties.
Reasons for Change
The Congress believed that the assignment and alienation
rules should be clarified by creating a limited exception that
permits participants' benefits under a qualified plan to be
reduced under certain circumstances including the participant's
breach of fiduciary duty to the plan.
Explanation of Provision
The Act permits a participant's benefit in a qualified plan
to be reduced to satisfy liabilities of the participant to the
plan due to (1) the participant being convicted of committing a
crime involving the plan, (2) a civil judgment (or consent
order or decree) entered by a court in an action brought in
connection with a violation of the fiduciary provisions of
ERISA, or (3) a settlement agreement between the Secretary of
Labor or the Pension Benefit Guaranty Corporation and the
participant in connection with a violation of the fiduciary
provisions of ERISA. The court order establishing such
liability must require that the participant's benefit in the
plan be applied to satisfy the liability. If the participant is
married at the time his or her benefit under the plan is offset
to satisfy the liability, spousal consent to such offset is
required unless the spouse is also required to pay an amount to
the plan in the judgment, order, decree or settlement or the
judgment, order, decree or settlement provides a 50-percent
survivor annuity for the spouse. An offset is includible in
income on the date of the offset (except to the extent
attributable to the employee's basis).
Effective Date
The provision is effective for judgments, orders, and
degrees issued, and settlement agreements entered into, on or
after the date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
3. Elimination of paperwork burdens on plans (sec. 1503 of the Act and
sec. 101 of ERISA)
Present and Prior Law
Under present and prior law, employers are required to
prepare summary plan descriptions of employee benefit plans
(``SPDs''), and summaries of material modifications to such
plans (``SMMs''). The SPDs and SMMs generally provide
information concerning the benefits provided by the plan and
the participants' rights and obligations under the plan. The
SPDs and SMMs must be furnished to plan participants and
beneficiaries. Under prior law, SPDs and SMMs had to be filed
with the Secretary of Labor.
Reasons for Change
The Congress believed it was appropriate to alleviate the
cost and burden of paperwork associated with employee benefit
plans.
Explanation of Provision
The Act eliminates the requirement that SPDs and SMMs
automatically be filed with the Secretary of Labor. Employers
are required to furnish these documents to the Secretary of
Labor upon request. A civil penalty may be imposed by the
Secretary of Labor on the plan administrator for failure to
comply with such requests. The penalty is up to $100 per day of
failure, up to a maximum of $1,000 per request. No penalty is
imposed if the failure was due to matters reasonably outside
the control of the plan administrator.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to have no effect on Federal
fiscal year budget receipts.
4. Modification of section 403(b) exclusion allowance to conform to
section 415 modifications (sec. 1504 of the Act and sec. 403(b) of the
Code)
Present and Prior Law
Under present and prior law, annual contributions to a
section 403(b) annuity cannot exceed the exclusion allowance.
In general, the exclusion allowance for a taxable year is the
excess, if any, of (1) 20 percent of the employee's includible
compensation multiplied by his or her years of service, over
(2) the aggregate employer contributions for an annuity
excludable for any prior taxable years.
Alternatively, an employee may elect to have the exclusion
allowance determined under the rules relating to tax-qualified
defined contribution plans (sec. 415). Tax-qualified defined
contribution plans are subject to limitations on annual
additions. In addition, for years beginning before January 1,
2000, an overall limit applies if an employee is a participant
in both a defined contribution plan and defined benefit plan of
the same employer (sec. 415(e)).
Reasons for Change
The exclusion allowance for tax-sheltered annuities should
be modified to reflect recent changes to the corresponding
limits on benefits under tax-qualified plans.
Explanation of Provision
The Act conforms the section 403(b) exclusion allowance to
the section 415 limits by providing that includible
compensation includes elective deferrals (and similar pre-tax
contributions) of the employee.
The Secretary of the Treasury is directed to revise the
regulations regarding the election to have the exclusion
allowance determined under section 415 to reflect the fact that
the overall limit on benefits and contributions is repealed
(sec. 415(e)). The revised regulations are to be effective for
years beginning after December 31, 1999.
Effective Date
The modification to the definition of includible
compensation is effective for years beginning after December
31, 1997. The direction to the Secretary of the Treasury is
effective on the date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $1 million per year for each of
years 1998 through 2007.
5. Permanent moratorium on application of nondiscrimination rules to
State and local governmental plans (sec. 1505 of the Act and
secs. 401 and 403(b) of the Code)
Present and Prior Law
Under present and prior law, the rules applicable to
governmental plans require that such plans satisfy certain
nondiscrimination and minimum participation rules. In general,
the rules require that a plan not discriminate in favor of
highly compensated employees with regard to the contribution
and benefits provided under the plan, participation in the
plan, coverage under the plan, and compensation taken into
account under the plan. The nondiscrimination rules apply to
all governmental plans, qualified retirement plans (including
cash or deferred arrangements (sec. 401(k) plans) in effect
before May 6, 1986) and annuity plans (sec. 403(b) plans).
Elective deferrals under section 401(k) plans are required to
satisfy a special nondiscrimination test called the average
deferral percentage (``ADP'') test. Employer matching and
after-tax employee contributions are subject to a similar test
called the average contribution percentage (``ACP'') test.
For purposes of satisfying the nondiscrimination rules, the
Internal Revenue Service has issued several Notices which
extended the effective date for compliance for governmental
plans. Under the Notices, governmental plans will be required
to comply with the nondiscrimination rules beginning with plan
years beginning on or after the later of January 1, 1999, or 90
days after the opening of the first legislative session
beginning on or after January 1, 1999, of the governing body
with authority to amend the plan, if that body does not meet
continuously. For plan years beginning before the extended
effective date, governmental plans are deemed to satisfy the
nondiscrimination requirements.
Reasons for Change
The Congress believed that, because of the unique
circumstances applicable to governmental plans and the
complexity of compliance, the moratorium on compliance with the
nondiscrimination rules should be made permanent.
Explanation of Provision
The Act provides that State and local governmental plans
are exempt from the nondiscrimination and minimum participation
rules. The exemption from the nondiscrimination and
participation rules includes exemption from the ADP and ACP
tests. A cash or deferred arrangement under a governmental plan
is treated as a qualified cash or deferred arrangement even
though the ADP test is not in fact satisfied. Thus, for
example, elective contributions made by a governmental employer
on behalf of an employee are not treated as distributed or made
available to the employee (in accordance with section 402(e)(3)
of the Code).
Effective Date
The provision is effective for taxable years beginning on
and after the date of enactment (August 5, 1997). A
governmental plan is treated as satisfying the coverage and
nondiscrimination tests for taxable years beginning before the
date of enactment.
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
6. Clarification of certain rules relating to ESOPs of S corporations
(sec. 1506 of the Act and sec. 409 of the Code)
Present and Prior Law
Under present and prior law, an S corporation can have no
more than 75 shareholders. For taxable years beginning after
December 31, 1997, certain tax-exempt organizations, including
employee stock ownership plans (``ESOPs'') can be a shareholder
of an S corporation.
ESOPs are generally required to make distributions in the
form of employer securities. If the employer securities are not
readily tradable, the employee has a right to require the
employer to buy the securities. In the case of an employer
whose bylaws or charter restricts ownership of substantially
all employer securities to employees or a pension plan, the
plan may provide that benefits are distributed in the form of
cash. Such a plan may distribute employer securities, if the
employee has a right to require the employer to purchase the
securities. Under prior law, similar rules did not apply in the
case of an ESOP maintained by an S corporation.
ESOPs are subject to certain prohibited transaction rules
under the Internal Revenue Code and title I of the Employee
Retirement Income Security Act (``ERISA'') which are designed
to prohibit certain transactions between the plan and certain
persons close to the plan. A number of statutory exceptions are
provided to the prohibited transaction rules. Under prior law,
these statutory exceptions did not apply to any transaction in
which a plan (directly or indirectly) (1) lends any part of the
assets of the plan to, (2) pays any compensation for personal
services rendered to the plan to, or (3) acquires for the plan
any property from or sells any property to a shareholder
employee of an S corporation, a member of the family of such a
shareholder employee, or a corporation controlled by the
shareholder employee. An administrative exception from the
prohibited transactions rules may be obtained from the
Secretary of Labor, even if a statutory exception does not
apply.
Reasons for Change
It is possible that an S corporation may lose its status as
such if the ESOP is required to give stock to plan
participants, rather than cash equal to the value of the stock.
Changes to the prohibited transactions rules are appropriate to
facilitate the maintenance of an ESOP by an S corporation.
Explanation of Provision
The Act provides that ESOPs of S corporations may
distribute cash to plan participants. Such a plan may
distribute employer securities, as long as the employee has a
right to require the employer to purchase the securities (as
under the rules applicable to ESOPs generally). In addition,
the Act provides that the statutory exceptions to the
prohibited transaction rules do not fail to apply merely
because a transaction involves the sale of employer securities
to an ESOP maintained by an S corporation by a shareholder
employee, a family member of the shareholder employee, or a
corporation controlled by the shareholder employee. Thus, the
statutory exemptions for such a transaction (including the
exemption for a loan to the ESOP to acquire employer securities
in connection with such a sale or a guarantee of such a loan)
apply.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
7. Modification of 10-percent tax on nondeductible contributions (sec.
1507 of the Act and sec. 4972 of the Code)
Present and Prior Law
Under present and prior law, contributions to qualified
pension plans are deductible within certain limits. In the case
of a single-employer defined benefit plan which has more than
100 participants during the year, the maximum amount deductible
is not less than the plan's unfunded current liability as
determined under the minimum funding rules. Limits are also
imposed on the amount of annual deductible contributions if an
employer sponsors both a defined benefit plan and a defined
contribution plan that covers some of the same employees. Under
the combined plan limitation, the total deduction for all plans
for a plan year is generally limited to the greater of (1) 25
percent of compensation or (2) the contribution necessary to
meet the minimum funding requirements of the defined benefit
plan for the year.
A 10-percent nondeductible excise tax is imposed on
contributions that are not deductible. This excise tax does not
apply to contributions to one or more defined contribution
plans that are nondeductible because they exceed the combined
plan deduction limit to the extent such contributions do not
exceed 6 percent of compensation in the year for which the
contribution is made.
Reasons for Change
The Congress believed that present law unfairly penalizes
employers by imposing an excise tax on employer plan
contributions that are required to be made and that are not
deductible because the employer is fully funding its pension
plan. In particular, the Congress did not believe that the
excise tax on nondeductible contributions should be imposed
when an employer is required to make contributions attributable
to elective deferrals under a section 401(k) plan and employer
matching contributions.
Explanation of Provision
The Act adds an additional exception to the 10-percent
excise tax on nondeductible contributions. Under the provision,
the excise tax does not apply to contributions to one or more
defined contribution plans that are not deductible because they
exceed the combined plan deduction limit to the extent such
contributions do not exceed the amount of the employer's
matching contributions plus the elective deferral contributions
to a section 401(k) plan for the taxable year for which the
contributions are made.
Effective Date
The provision is effective with respect to taxable years
beginning after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $2 million in 1998, and by $3 million per
year in each of 1999 through 2007.
8. Modify funding requirements for certain plans (sec. 1508 of the Act
and sec. 412 of the Code)
Present and Prior Law
Under present and prior law, defined benefit pension plans
are required to meet certain minimum funding rules. Underfunded
plans are required to satisfy certain faster funding
requirements. In general, these additional requirements do not
apply in the case of plans with a funded current liability
percentage of at least 90 percent.
The Pension Benefit Guaranty Corporation (``PBGC'') insures
benefits under most defined benefit pension plans in the event
the plan is terminated with insufficient assets to pay for plan
benefits. The PBGC is funded in part by a flat-rate premium per
plan participant, and a variable rate premium based on plan
underfunding.
Reasons for Change
Certain interstate bus companies have pension plans that
are closed to new participants and the participants in these
plans have demonstrated mortality significantly greater than
that predicted by the mortality tables that the plans are
required to use for minimum funding purposes. As a result, the
sponsors of such plans are required to make contributions that
cause the plan to be substantially overfunded. The Congress
believed it was appropriate to modify the minimum funding
requirements for such plans, while at the same time ensuring
that pension benefits are adequately funded.
Explanation of Provision
The Act modifies the minimum funding requirements in the
case of certain plans. The Act applies in the case of plans
that (1) were not required to pay a variable rate PBGC premium
for the plan year beginning in 1996, (2) do not, in plan years
beginning after 1995 and before 2009, merge with another plan
(other than a plan sponsored by an employer that was a member
of the controlled group of the employer in 1996), and (3) are
sponsored by a company that is engaged primarily in the
interurban or interstate passenger bus service.
The provision treats a plan to which it applies as having a
funded current liability percentage of at least 90 percent for
plan years beginning after 1996 and before 2005. For plan years
beginning after 2004, the funded current liability percentage
will be deemed to be at least 90 percent if the actual funded
current liability percentage is at least at certain specified
levels.
The relief from the minimum funding requirements applies
for the plan year beginning in 2005, 2006, 2007, and 2008 only
if contributions to the plan equal at least the expected
increase in current liability due to benefits accruing during
the plan year.
Effective Date
The provision is effective with respect to plan years
beginning after December 31, 1996.
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
9. Plans not disqualified merely by accepting rollover contributions
(sec. 1509 of the Act and sec. 401(a) of the Code)
Present and Prior Law
Under present and prior law, Treasury regulations provide
that a qualified retirement plan that accepts rollover
contributions from other plans will not be disqualified because
the plan making the distribution is, in fact, not qualified at
the time of the distribution, if, prior to accepting the
rollover, the receiving plan reasonably concluded that the
distributing plan was qualified. The receiving plan can
reasonably conclude that the distributing plan was qualified
if, for example, prior to accepting the rollover, the
distributing plan provided a statement that the distributing
plan had a favorable determination letter issued by the
Internal Revenue Service (``IRS''). The receiving plan is not
required to verify this information.
Reasons for Change
In order to encourage employers to accept rollovers from
other qualified retirement plans, the Congress believed that
the receiving plans should be insulated from disqualification
based on the subsequent qualified status of the distributing
plan.
Explanation of Provision
The Act directs the Secretary of the Treasury to clarify
that, under its regulations protecting plans from
disqualification because they receive invalid rollover
contributions, it is not necessary for a distributing plan to
have a determination letter in order for the administrator of
the receiving plan to reasonably conclude that a contribution
is a valid rollover.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
10. New technologies in retirement plans (sec. 1510 of the Act)
Prior Law
Under prior law, it was not clear if sponsors of employee
benefit plans could use new technologies (telephonic response
systems, computers, email) to satisfy the various ERISA
requirements for notice, election, consent, record keeping, and
participant disclosure.
Reasons for Change
The Congress believed it was appropriate to review existing
guidance for purposes of permitting the use of new technologies
for notice and record keeping requirements for retirement
plans.
Explanation of Provision
The Act directs the Secretaries of the Treasury and Labor
to issue guidance facilitating the use of new technology for
plan purposes. The guidance must be designed to (1) interpret
the notice, election, consent, disclosure, and time
requirements (and related recordkeeping requirements) under the
Internal Revenue Code (the ``Code'') and the Employee
Retirement Income Security Act of 1974, as amended (``ERISA'')
relating to retirement plans as applied to the use of new
technologies by plan sponsors and administrators while
maintaining the protection of the rights of participants and
beneficiaries, and (2) clarify the extent to which writing
requirements under the Code will be interpreted to permit
paperless transactions.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997), and requires that the guidance be issued not
later than December 31, 1998.
Revenue Effect
The provision is estimated to have no effect on Federal
fiscal year budget receipts.
B. Miscellaneous Provisions Relating to Pensions and Other Benefits
1. Increase in full funding limit (sec. 1521 of the Act and sec. 412 of
the Code)
Present and Prior Law
Under present and prior law, defined benefit pension plans
are subject to minimum funding requirements. In addition, there
is a maximum limit on contributions that can be made to a plan,
called the full funding limit. Under prior law, the full
funding limit was generally the lesser of a plan's accrued
liability and 150 percent of current liability. In general,
current liability is all liabilities to plan participants and
beneficiaries. Current liability represents benefits accrued to
date, whereas the accrued liability full funding limit is based
on projected benefits. Under IRS rules, amounts that cannot be
contributed because of the current liability full funding limit
are amortized over 10 years.
Reasons for Change
The 150-percent of full funding limit was enacted to limit
and allocate efficiently the Federal tax revenue associated
with the special tax treatment provided to tax-qualified plans.
However, the Congress believed that the 150-percent of current
liability full funding limit unduly restricts funding and that
the amortization period should be extended.
Explanation of Provision
The Act increases the 150-percent of current liability full
funding limit as follows: 155 percent for plan years beginning
in 1999 or 2000, 160 percent for plan years beginning in 2001
or 2002, 165 percent for plan years beginning in 2003 and 2004,
and 170 percent for plan years beginning in 2005 and
thereafter. In addition, amounts that cannot be contributed due
to the current liability full funding limit are amortized over
20 years. Amounts that could not be contributed because of the
prior-law current liability full funding limit and that have
not been amortized as of the last day of the last plan year
beginning in 1998 are amortized over this 20-year period. With
respect to amortization bases remaining at the end of the 1998
plan year, the 20-year amortization period is reduced by the
number of years since the amortization base had been
established. No amortization is required with respect to
funding methods that do not provide for amortization bases.
Effective Date
The provision is effective for plan years beginning after
December 31, 1998.
Revenue Effect
The provision is estimated is estimated to reduce Federal
fiscal year budget receipts by $4 million in 1999, $12 million
in 2000, $14 million in 2001, $18 million in 2002, $19 million
in 2003, $23 million per year for 2004 and 2005, and $25
million per year for 2006 and 2007.
2. Contributions on behalf of a minister to a church plan (sec.
1522(a)(2) of the Act and sec. 414(e) of the Code)
Present and Prior Law
Under present and prior law, contributions made to
retirement plans by ministers who are self-employed are
deductible to the extent such contributions do not exceed
certain limitations applicable to retirement plans. These
limitations include the limit on elective deferrals, the
exclusion allowance, and the limit on annual additions to a
retirement plan.
Reasons for Change
The Congress believed that the unique characteristics of
church plans and the procedures associated with contributions
made by ministers who are self-employed create particular
problems with respect to plan administration.
Explanation of Provision
The Act provides that in the case of a contribution made to
a church plan on behalf of a minister who is self-employed, the
contribution is excludable from the income of the minister to
the extent that the contribution would be excludable if the
minister was an employee of a church and the contribution was
made to the plan. The provision does not alter present law
under which amounts contributed for a minister in connection
with section 403(b), either by the minister's actual employer
or by any church or convention or association of churches that
is treated as the minister's employer under section 414(e), are
excluded from the minister's income, and amounts contributed in
accordance with section 403(b) by the minister (whether the
minister is an employee or is self-employed) are deductible by
the minister as provided in section 404 taking into account the
other special rules of section 414(e). A minister will not be
entitled to both an exclusion and deduction for the same
contribution.
Effective Date
The provision is effective for years beginning after
December 31, 1997.
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
3. Exclusion of ministers from discrimination testing of certain non-
church retirement plans (sec. 1522(a)(1) of the Act and sec.
414(e) of the Code)
Present and Prior Law
Under present and prior law ministers who are employed by
an organization other than a church are treated as if employed
by the church and may participate in the retirement plan
sponsored by the church. Under prior law, if the organization
also sponsored a retirement plan, such plan did not have to
include the ministers as employees for purposes of satisfying
the nondiscrimination rules applicable to qualified plans
provided the organization was not eligible to participate in
the church plan.
Reasons for Change
The Congress believed it was appropriate to extend the same
relief to other non-church organizations that may be eligible
to participate in a church plan but elect not to do so. Such
organizations will not be required to treat ministers as
employees for purposes of satisfying the nondiscrimination
rules applicable to their retirement plan.
Explanation of Provision
The Act provides that if a minister is employed by an
organization other than a church and the organization is not
otherwise participating in the church plan, then the minister
does not have to be included as an employee under the
retirement plan of the organization for purposes of the
nondiscrimination rules.
Effective Date
The provision is effective for years beginning after
December 31, 1997.
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
4. Repeal application of UBIT to ESOPs of S corporations (sec. 1523 of
the Act and sec. 512 of the Code)
Present and Prior Law
Under present and prior law, for taxable years beginning
after December 31, 1997, certain tax-exempt organizations,
including employee stock ownership plans (``ESOPs'') can be a
shareholder of an S corporation. Under prior law, items of
income or loss of the S corporation flowed through to all
qualified tax-exempt shareholders as unrelated business taxable
income (``UBTI''), regardless of the source of the income.
Reasons for Change
The Congress believed that treating S corporation income as
UBTI is not appropriate because such amounts would be subject
to tax at the ESOP level, and also again when benefits are
distributed to ESOP participants.
Explanation of Provision
The Act repeals the provision treating items of income or
loss of an S corporation as unrelated business taxable income
in the case of an employee stock ownership plan that is an S
corporation shareholder. The repeal of such provision applies
only with respect to employer securities held by an employee
stock ownership plan (as defined in section 4975(e)(7) of the
Code) maintained by an S corporation.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $8 million in 1998, $23 million in 1999, $34
million in 2000, $41 million in 2001, $44 million in 2002, $46
million in 2003, $48 million in 2004, $50 million in 2005, $52
million in 2006, and $54 million in 2007.
5. Diversification in section 401(k) plan investments (sec. 1524 of the
Act and sec. 407(b) of ERISA)
Present and Prior Law
The Employee Retirement Income Security Act of 1974, as
amended (``ERISA'') prohibits certain employee benefit plans
from acquiring securities or real property of the employer who
sponsors the plan if, after the acquisition, the fair market
value of such securities and property exceeds 10 percent of the
fair market value of plan assets. Under prior law, the 10-
percent limitation did not apply to any ``eligible individual
account plans'' that specifically authorized such investments.
Generally, eligible individual account plans were defined
contribution plans, including plans containing a cash or
deferred arrangement (``401(k) plans''). Under prior law, the
assets of such plans could be invested in employer securities
and real property without regard to the 10-percent limitation.
Reasons for Change
Because of the growth of 401(k) plans in recent years and
the fact that these plans serve as a significant source of
pension benefits for many individuals, the Congress was
concerned with protecting and preserving these benefits.
Requiring participant contributions to be invested in employer
securities or real property could have an adverse impact on the
retirement security of the plan participants. In circumstances
where an employer experiences financial distress, including
bankruptcy, participants would be affected by a decrease in the
value of employer securities and real property.
Explanation of Provision
The Act provides that the term ``eligible individual
account plan'' does not include the portion of a plan that
consists of elective deferrals (and earnings on the elective
deferrals) made under section 401(k) if elective deferrals
equal to more than 1 percent of any employee's eligible
compensation are required to be invested in employer securities
and employer real property. Eligible compensation is
compensation that is eligible to be deferred under the plan.
The portion of the plan that consists of elective deferrals
(and earnings thereon) is still treated as an individual
account plan, and the 10-percent limitation does not apply, as
long as elective deferrals (and earnings thereon) are not
required to be invested in employer securities or employer real
property.
The provision does not apply if individual account plans
are a small part of the employer's retirement plans. In
particular, the provision does not apply to an individual
account plan for a plan year if the value of the assets of all
individual account plans maintained by the employer do not
exceed 10 percent of the value of the assets of all pension
plans maintained by the employer (determined as of the last day
of the preceding plan year). Multiemployer plans are not taken
into account in determining whether the value of the assets of
all individual account plans maintained by the employer exceed
10 percent of the value of the assets of all pension plans
maintained by the employer. The provision does not apply to an
employee stock ownership plan as defined in section 4975(e)(7)
of the Internal Revenue Code.
In determining whether individual account plans are a small
part of the employer's total pension plan assets, all assets of
such plans (regardless of when acquired) are taken into
account. Similarly, if the provision applies to the portion of
a plan consisting of elective deferrals and earnings thereon
(so that such portion of a plan is subject to the 10-percent
limitation on employer securities and real property), all
assets of such portion of the plan (regardless of when
acquired) are taken into account in determining whether the 10-
percent limitation is violated.
The effect of the provision is illustrated as follows.
Assume the provision applies to the portion of a plan
consisting of elective deferrals (and earnings thereon), so
that such portion of a plan is treated as a separate plan
subject to the 10-percent limitation on employer securities and
real property, and that more than 10-percent of such separate
plan's assets are invested in employer securities. The separate
plan cannot acquire more employer securities or real property,
unless the participants elect such investment.
Effective Date
The provision is effective with respect to elective
deferrals for plan years beginning after December 31, 1998 (and
earnings thereon). The provision does not apply with respect to
earnings on elective deferrals for plan years beginning before
January 1, 1999.
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
6. Cash or deferred arrangements for irrigation and drainage entities
(sec. 1525 of the Act and sec. 401(k) of the Code)
Present and Prior Law
Under present and prior law, taxable and tax-exempt
employers may maintain qualified cash or deferred arrangements.
Under prior law, all State and local government organizations
generally were prohibited from maintaining qualified cash or
deferred arrangements (``section 401(k) plans''), other than
qualified cash or deferred arrangements adopted by a State or
local government before May 6, 1986.
Mutual irrigation or ditch companies are exempt from tax if
at least 85 percent of the income of the company consists of
amounts collected from members for the sole purpose of meeting
losses and expenses.
Reasons for Change
The Congress believed that all mutual irrigation and ditch
companies and water districts should be permitted to maintain a
qualified cash or deferred arrangement, regardless of whether
the company or district is a tax-exempt or taxable entity or
part of a State or local government.
Explanation of Provision
Under the Act, mutual irrigation or ditch companies and
districts organized under the laws of a State as a municipal
corporation for the purpose of irrigation, water conservation
or drainage (or a national association of such organizations)
are permitted to maintain qualified cash or deferred
arrangements, even if the company or district is a State or
local government organization.
Effective Date
The provision is effective with respect to years beginning
after December 31, 1997.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $1 million in 1998, $1 million per
year in each of 1999 through 2001, $2 million per year in each
of 2002 through 2006, and $3 million in 2007.
7. Portability of permissive service credit under governmental pension
plans (sec. 1526 of the Act and sec. 415 of the Code)
Present and Prior Law
Under present and prior law, limits are imposed on the
contributions and benefits under qualified pension plans (Code
sec. 415).
In the case of a defined contribution plan, the limit on
annual additions is the lesser of $30,000 or 25 percent of
compensation. Annual additions include employer contributions,
as well as after-tax employee contributions. In the case of a
defined benefit pension plan, the limit on the annual
retirement benefit is the lesser of (1) 100 percent of
compensation or (2) $120,000 (indexed for inflation). The 100
percent of compensation limitation does not apply in the case
of State and local governmental pension plans. Certain other
special rules apply in the case of State and local governmental
plans.
Amounts contributed by employees to a State or local
governmental plan are treated as made by the employer if the
employer ``picks up'' the contribution.
Under prior law, there were no special rules applicable to
make-up contributions by State and local government employees.
Reasons for Change
Many State and local government plans facilitate
portability of pension benefits by permitting employees to
purchase credit for service with another governmental employer
and for certain other service as provided in the plan. The
Congress believed it was appropriate to modify the limits on
contributions and benefits to encourage portability of benefits
between governmental plans.
Explanation of Provision
Under the Act, contributions by a participant in a State or
local governmental plan to purchase permissive service credits
are subject to one of two limits. Either (1) the accrued
benefit derived from all contributions to purchase permissive
service credit must be taken into account in determining
whether the defined benefit pension plan limit is satisfied, or
(2) all such contributions must be taken into account in
determining whether the $30,000 limit on annual additions is
met for the year (taking into account any other annual
additions of the participant). Under the first alternative, a
plan will not fail to satisfy the reduced defined benefit
pension plan limit that applies in the case of early retirement
due to the accrued benefit derived from the purchase of
permissive service credits. These limits may be applied on a
participant-by-participant basis. That is, contributions to
purchase permissive service credits by all participants in the
same plan do not have to satisfy the same limit.
Under the Act, permissive service credit means credit for a
period of service recognized by the governmental plan only if
the employee voluntarily contributes to the plan an amount (as
determined by the plan) which does not exceed the amount
necessary to fund the benefit attributable to the period of
service and which is in addition to the regular employee
contributions, if any, under the plan. Section 415 is violated
if more than 5 years of permissive service credit is purchased
for ``nonqualified service''. In addition, section 415 is
violated if nonqualified service is taken into account for an
employee who has less than 5 years of participation under the
plan. Nonqualified service is service other than service (1) as
a Federal, State, or local government employee, (2) as an
employee of an association representing Federal, State or local
government employees, (3) as an employee of an educational
institution which provides elementary or secondary education,
or (4) for military service. Service under (1), (2) or (3) is
not qualified if it enables a participant to receive a
retirement benefit for the same service under more than one
plan.
The Act provides that in the case of any repayment of
contributions and earnings to a governmental plan with respect
to an amount previously refunded upon a forfeiture of service
credit under the plan (or another plan maintained by a State or
local government employer within the same State) any such
repayment shall not be taken into account for purposes of
section 415 and service credit obtained as a result of the
repayment shall not be considered permissive service credit.
The provision is not intended to affect the application of
``pick up'' contributions to purchase permissive service credit
or the treatment of pick up contributions under section 415.
The provision does not apply to purchases of service credit for
qualified military service under the rules relating to
veterans' reemployment rights (sec. 414(u)).
Effective Date
The provision is effective with respect to contributions to
purchase permissive service credits made in years beginning
after December 31, 1997.
The Act provides a transition rule for plans that provided
for the purchase of permissive service credit prior to
enactment of the Act. Under this rule, the defined contribution
limits will not reduce the amount of permissive service credit
of an eligible participant allowed under the terms of the plan
as in effect on the date of enactment. For this purpose an
eligible participant is an individual who first became a
participant in the plan before the first plan year beginning
after the last day of the calendar year in which the next
regular session (following the date of the enactment of this
Act) of the governing body with authority to amend the plan
ends.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $9 million in 1998, $25 million per year in
each of years 1999 and 2000, $26 million per year in each of
years 2001 through 2003, $27 million per year in each of years
2004 through 2006, and $28 million in 2007.
8. Removal of dollar limitation on benefit payments from a defined
benefit plan for police and fire employees (sec. 1527 of the
Act and sec. 415(b)(2) of the Code)
Present and Prior Law
Under present and prior law, limits are imposed on the
contributions and benefits under qualified pension plans.
Certain special rules apply in the case of State and local
governmental plans.
In the case of a defined benefit pension plan, the limit on
the annual retirement benefit is the lesser of (1) 100 percent
of compensation or (2) $125,000 (for 1997, indexed for
inflation). The 100 percent of compensation limitation does not
apply in the case of State and local governmental pension
plans. In general, the dollar limit is reduced if benefits
begin before social security retirement age and increased if
benefits begin after social security retirement age. In the
case of State and local government plans, the dollar limit is
not reduced unless benefits begin before age 62 and in any case
is not less than $75,000, and the dollar limit is increased if
benefits begin after age 65. Under prior law, this rule applied
to police and fire department employees, except that the dollar
limit could not be reduced below $50,000 (indexed), regardless
of the age at which benefits commenced.\312\
---------------------------------------------------------------------------
\312\ This special rule applied to participants (1) in a defined
benefit plan of a State or local government plan, and (2) with respect
to whom the period of service taken into account in determining the
amount of the benefit under such plan includes at least 15 years of
service of the participant as (a) a full-time employee of a police or
fire department organized by a State or political subdivision to
provide police protection, firefighting services, or emergency medical
services or (b) as a member of the Armed Services of the United States.
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that police and fire department
employees who are covered by the special rule should be
excepted from the dollar limit as it applies to the reduction
for early retirement benefits.
Explanation of Provision
The dollar limit on defined benefit plans does not apply to
the reduction for early retirement benefits for individuals who
received the special rule for certain police and fire
department employees under prior law. Thus, the defined benefit
plan dollar limit continues to apply, but is not reduced in the
case of early retirement. As under present law, the dollar
limit is increased for such employees if benefits begin after
age 65.
Effective Date
The provision is effective for years beginning after
December 31, 1996.
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
9. Survivor benefits of public safety officers killed in the line of
duty (sec. 1528 of the Act and sec. 101 of the Code)
Present and Prior Law
Under present and prior law, survivors of military service
personnel (such as those killed in combat) are generally
entitled to survivor benefits (38 U.S.C. sec. 1310). These
survivor benefits are generally exempt from taxation (38 U.S.C.
sec. 5301). ``Survivor'' means the surviving spouse or
surviving dependent child of the military service personnel.
Under prior law, survivor annuity benefits paid under a
governmental retirement plan to a survivor of a law enforcement
officer killed in the line of duty were generally includible in
income except to the extent the benefits are a return of after-
tax employee contributions. Under present and prior law,
survivor benefits paid under a government plan only to
survivors of officers who died as a result of injuries
sustained in the line of duty are in the nature of workers'
compensation and are generally excludable from income.
Reasons for Change
The Congress believed that it was appropriate to apply to
the survivors of public safety officers who are killed in the
line of duty the rules regarding the taxation of certain
survivor benefits provided to survivors of military personnel.
Explanation of Provision
The Act generally provides that an amount paid as a
survivor annuity on account of the death of a public safety
officer who is killed in the line of duty is excludable from
income to the extent the survivor annuity is attributable to
the officer's service as a law enforcement officer. The
survivor annuity must be provided under a governmental plan to
the surviving spouse (or former spouse) of the public safety
officer or to a child of the officer. Public safety officers
include law enforcement officers, firefighters, rescue squad or
ambulance crew. The provision does not apply with respect to
the death of a public safety officer if it is determined by the
appropriate supervising authority that (1) the death was caused
by the intentional misconduct of the officer or by the
officer's intention to bring about the death, (2) the officer
was voluntarily intoxicated at the time of death, (3) the
officer was performing his or her duties in a grossly negligent
manner at the time of death, or (4) the actions of the
individual to whom payment is to be made were a substantial
contributing factor to the death of the officer.
Effective Date
The provision applies to amounts received in taxable years
beginning after December 31, 1996, with respect to individuals
dying after that date.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $500,000 in 1998, $1 million per
year in each of 1999 through 2005, and by $2 million per year
in each of 2006 and 2007.
10. Treatment of certain disability payments to public safety employees
(sec. 1529 of the Act and sec. 104 of the Code)
Present and Prior Law
Under present and prior law, amounts received under a
workmen's compensation act as compensation for personal
injuries or sickness incurred in the course of employment are
excluded from gross income. Compensation received under a
workmen's compensation act by the survivors of a deceased
employee also are excluded from gross income. Under prior law,
no nonoccupational death and disability benefits were
excludable from income as workmen's compensation benefits.
Reasons for Change
The Congress was aware that some State plans were
structured so that the exclusion for workers' compensation
benefits was not applicable, and that some benefit recipients
mistakenly thought the exclusion applied. The Congress believed
it was appropriate to provide relief in such cases.
Explanation of Provision
Under the Act, certain payments made on behalf of full-time
employees of any police or fire department organized and
operated by a State (or any political subdivision, agency, or
instrumentality thereof) are excludable from income. The
provision applies to payments made on account of heart disease
or hypertension of the employee and that were received in 1989,
1990, 1991 pursuant to a State law as amended on May 19, 1992,
which irrebuttably presumed that heart disease and hypertension
are work-related illnesses, but only for employees separating
from service before July 1, 1992.
The Act provides that claims for refund or credit for
overpayment of tax resulting from the provision could be filed
up to 1 year after the date of enactment, without regard to the
otherwise applicable statute of limitations.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $10 million in 1998, and by $1 million in
1999.
11. Gratuitous transfers for the benefit of employees (sec. 1530 of the
Act and sec. 664 of the Code )
Present and Prior Law
Under present and prior law, an employee stock ownership
plan (``ESOP'') is a qualified stock bonus plan or a
combination stock bonus and money purchase pension plan under
which employer securities are held for the benefit of
employees.
Under present and prior law, a deduction is allowed for
Federal estate tax purposes for transfers by a decedent to
charitable, religious, scientific, etc. organizations. In the
case of a transfer of a remainder interest to a charity, the
remainder interest must be in a charitable remainder trust. A
charitable remainder trust generally is a trust that is
required to pay, no less often than annually, a fixed dollar
amount (charitable remainder annuity trust) or a fixed
percentage of the fair market value of the trust's assets
determined at least annually (charitable remainder unitrust) to
noncharitable beneficiaries, and, under prior law, the
remainder of the trust (i.e., after termination of the annuity
or unitrust amounts) to a charitable, religious, scientific,
etc. organization.
Reasons for Change
The Congress believed it was appropriate to encourage
certain transfers of stock to an ESOP.
Explanation of Provision
In general
The Act permits certain limited transfers of qualified
employer securities by charitable remainder trusts to ESOPs
without adversely affecting the status of the charitable
remainder trusts under Code section 664. As a result, the Act
provides that a qualified gratuitous transfer of employer
securities to an ESOP is deductible from the gross estate of a
decedent under Code section 2055 to the extent of the present
value of the remainder interest. In addition, an ESOP will not
fail to be a qualified plan because it complies with the
requirements with respect to a qualified gratuitous transfer.
Qualified gratuitous transfer
In order for a transfer of securities to be a ``qualified
gratuitous transfer,'' the following requirements must be
satisfied, including the following: (1) the securities
transferred to the ESOP must previously have passed from the
decedent to a charitable remainder trust; (2) at the time of
the transfer to the ESOP, family members of the decedent own
(directly or indirectly) no more than 10 percent of the value
of the outstanding stock of the company; (3) immediately after
the transfer to the ESOP, the ESOP owns at least 60 percent
\313\ of the value of outstanding stock of the company; and (4)
the plan meets certain requirements. In order to prevent
erosion of the 60-percent ownership requirements, an excise tax
is imposed on the employer maintaining the ESOP with respect to
certain dispositions of the transferred stock within 3 years of
the transfer.
---------------------------------------------------------------------------
\313\ The 60-percent requirement is determined assuming that
outstanding options have been exercised.
---------------------------------------------------------------------------
The provision applies in cases in which the ESOP was in
existence on August 1, 1996, and the decedent dies on or before
December 31, 1998. The provision does not fail to apply merely
because the ESOP is amended after August 1, 1996, for example,
in order to conform to the requirements of the provision.
Plan requirements
In order for a transfer to qualify as a gratuitous
transfer, the ESOP must contain certain provisions. First, the
plan must provide that plan participants are entitled to direct
the manner in which stock transferred are to be voted (with
respect to all matters). Transferred securities that have not
yet been allocated to participants must be voted by a trustee
that is not a 5-percent owner of the company or a family member
of the decedent.
Second, the plan must provide that participants have the
right to receive distributions in the form of stock and that
the participant can require the employer to repurchase any
shares distributed under a fair valuation formula. For this
purpose, a valuation formula is not considered fair if it takes
into account a discount for minority interests.
Finally, the plan must provide that, if the plan is
terminated before all the transferred stock has been allocated,
the remaining stock is to be transferred to one or more
charitable organizations. The employer is subject to an excise
tax designed to recapture the estate taxes that would have been
due had the transfer to the ESOP not occurred if the plan is
terminated and any unallocated shares are not transferred to
charitable organizations.
Treatment of transferred stock and allocation rules
No deduction is permitted under section 404 of the Code
with respect to securities transferred from the charitable
remainder trust. The nondiscrimination requirements (sec.
401(a)(4)) normally applicable to qualified plans must be
satisfied with respect to the securities transferred. The ESOP
is required to treat the securities transferred as employer
securities, except for purposes of determining the amount of
deductible contributions to the plan otherwise permitted by the
employer. The ESOP is required to allocate the transferred
securities up to the limit on contributions and benefits (sec.
415) after allocating any other employer contributions for the
year; any transferred securities that cannot be allocated
because of the section 415 limits would be held in a suspense
account and allocated in the same manner in subsequent years.
Transferred securities are not taken into account in
determining whether any other contributions satisfy the section
415 limit. Further, securities transferred to an ESOP by a
charitable remainder trust cannot be allocated to the account
of (1) any family member of the decedent, or (2) any employee
owning more than 5 percent of any class of outstanding stock of
the corporation issuing the securities (or a member of a
controlled group of corporations) or the total value of any
class of outstanding stock of any such corporation. The
employer is subject to an excise tax if impermissible
allocations are made.
Definition of qualified employer securities
Qualified employer securities include only employer
securities (within the meaning of sec. 409(l) of the Code),
which are issued by a domestic corporation that has no
outstanding stock that is readily tradable on an established
securities market and that has only one class of stock.
Effective Date
The provision was effective with respect to transfers to an
ESOP after the date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by $8 million in 1998 and by $15 million in
1999.
C. Certain Health Act Provisions
1. Newborns' and mothers' health protection; mental health parity (sec.
1531 of the Act)
Present and Prior Law
The Newborns' and Mothers' Health Protection Act of 1996
amended the Employee Retirement Income Security Act (``ERISA'')
and the Public Health Service Act to impose certain
requirements on group health plans with respect to coverage of
newborns and mothers, including a requirement that a group
health plan cannot restrict benefits for a hospital stay in
connection with childbirth for the mother or newborn to less
than 48 hours following a normal vaginal delivery or less than
96 hours following a cesarean section. These provisions are
effective with respect to plan years beginning on or after
January 1, 1998.
The Mental Health Parity Act of 1996 amended ERISA and the
Public Health Service Act to provide that group health plans
that provide both medical and surgical benefits and mental
health benefits cannot impose aggregate lifetime or annual
dollar limits on mental health benefits that are not imposed on
substantially all medical and surgical benefits. The provisions
of the Mental Health Parity Act are effective with respect to
plan years beginning on or after January 1, 1998, but do not
apply to benefits for services furnished on or after September
30, 2001.
The Internal Revenue Code requires that group health plans
meet certain requirements with respect to limitations on
exclusions of preexisting conditions and that group health
plans not discriminate against individuals based on health
status. An excise tax of $100 per day during the period of
noncompliance is imposed on the employer sponsoring the plan if
the plan fails to meet these requirements. The maximum tax that
can be imposed during a taxable year cannot exceed the lesser
of 10 percent of the employer's group health plan expenses for
the prior year or $500,000. No tax is imposed if the Secretary
determines that the employer did not know, and exercising
reasonable diligence would not have known, that the failure
existed.
Under prior law, the provisions of the Newborns' and
Mothers' Health Protection Act and the Mental Health Parity Act
were not in the Code.
Explanation of Provision
The Act incorporates into the Internal Revenue Code the
provisions of the Newborns' and Mothers' Health Protection Act
of 1996 and the Mental Health Parity Act of 1996 relating to
group health plans. Failures to comply with such provisions are
subject to the excise tax applicable to failures to comply with
present-law group health plan requirements.
Effective Date
The provisions are effective with respect to plan years
beginning on or after January 1, 1998. However, the provisions
relating to the Mental Health Parity Act do not apply to
benefits for services furnished on or after September 30, 2001.
Revenue Effect
The provisions are estimated to have a negligible effect on
Federal fiscal year budget receipts.
2. Church plan exception to prohibition on discrimination against
individuals based on health status (sec. 1532 of the Act)
Present and Prior Law
Under the Health Insurance Portability and Accountability
Act (``HIPAA''), group health plans generally may not establish
rules for eligibility based on any of the following factors
relating to an individual or a dependent of the individual: (1)
health status, (2) medical condition, (3) claims experience,
(4) receipt of health care, (5) medical history, (6) genetic
information, (7) evidence of insurability, or (8) disability.
In addition, a group health plan may not charge an individual a
greater premium based on any of such factors.
An excise tax is imposed on the failure of a group plan to
satisfy the nondiscrimination rule. In general, the excise tax
is imposed on the employer sponsoring the plan and is equal to
$100 per day per individual as long as the plan is not in
compliance.
Under prior law, there were no exceptions to these rules
for church plans.
Explanation of Provision
The Act provides that certain church plans are not treated
as violating HIPAA's health plan eligibility requirements
merely because the plan requires evidence of good health in
order for an individual to enroll in the plan for (1) both any
individual who is an employee of an employer with 10 or fewer
employees and any self-employed individual or (2) any
individual who enrolls after the first 90 days of eligibility
under the plan. The provision applies to a church plan for a
year if the plan included either of such provisions requiring
evidence of good health on July 15, 1997, and at all times
thereafter before the beginning of the year.
Effective Date
The provision is effective as if included in HIPAA.
Revenue Effect
The provision is estimated to have a negligible effect on
Federal fiscal year budget receipts.
D. Date for Adoption of Plan Amendments (sec. 1541 of the Act)
Present and Prior Law
Plan amendments to reflect amendments to the law generally
must be made by the time prescribed by law for filing the
income tax return of the employer for the employer's taxable
year in which the change in law occurs.
Explanation of Provision
The Act provides that any amendments to a plan or annuity
contract required to be made by the Act are not required to be
made before the first day of the first plan year beginning on
or after January 1, 1999. In the case of a governmental plan,
the date for amendments is extended to the first plan year
beginning on or after January 1, 2001. The Act also provides
that if an amendment is made pursuant to the Act (whether or
not the amendment is required) before the date for required
plan amendments, the plan or contract is operated in a manner
consistent with the amendment during a period and the amendment
is effective retroactively to such period (1) the plan or
contract will not fail to be treated as operated in accordance
with its terms for such period merely because it is operated in
a manner consistent with the amendment, and (2) the plan will
not fail to meet the anti-cutback provisions applicable to
qualified retirement plans by reason of such a plan amendment.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to have no effect on Federal
fiscal year budget receipts.
TITLE XVI. TECHNICAL CORRECTIONS PROVISIONS
Except as otherwise provided, the technical corrections
contained in the Act generally are effective as if included in
the originally enacted related legislation.
TECHNICAL CORRECTIONS TO THE SMALL BUSINESS JOB PROTECTION ACT OF 1996
A. Small Business-Related Provisions
1. Returns relating to purchases of fish (sec. 1601(a)(1) of the Act
and sec. 6050R(c)(1) of the Code)
Prior Law
Every person engaged in the trade or business of purchasing
fish for resale must file an informational return reporting its
purchases from any person that is engaged in the trade or
business of catching fish which are in excess of $600 for any
calendar year. Persons filing such an informational return
relating to the purchase of fish must furnish a statement
showing the name and address of the person filing the return,
as well as the amount shown on the return, to each person whose
name is required to be disclosed on the return.
Explanation of Provision
Every person filing an informational return relating to the
purchase of fish must furnish a statement showing the phone
number of the person filing the return, as well as such
person's name, address and the amount shown on the return, to
each person whose name is required to be disclosed on the
return.
2. Charitable remainder trusts not eligible to be electing small
business trusts (sec. 1601(c)(1) of the Act and sec. 1361(c)(1)(B) of
the Code)
Prior Law
An electing small business trust may be a shareholder in an
S corporation. In order to qualify for this treatment, all
beneficiaries of the electing small business trust generally
must be individuals or estates eligible to be S corporation
shareholders. An exempt trust may not qualify as an electing
small business trust.
Explanation of Provision
The provision clarifies that charitable remainder annuity
trusts and charitable remainder unitrusts may not be electing
small business trusts.
3. Clarify the effective date for post-termination transition period
provision (sec. 1601(c)(2) of the Act)
Prior Law
Distributions made by a former S corporation during its
post-termination period are treated in the same manner as if
the distributions were made by an S corporation (e.g., treated
by shareholders as nontaxable distributions to the extent of
the accumulated adjustment account). Distributions made after
the post-termination period are generally treated as made by a
C corporation (i.e., treated by shareholders as taxable
dividends to the extent of earnings and profits).
The ``post-termination period'' is the period beginning on
the day after the last day of the last taxable year of the S
corporation and ending on the later of: (1) a date that is one
year later, or (2) the due date for filing the return for the
last taxable year and the 120-day period beginning on the date
of a determination that the corporation's S corporation
election had terminated for a previous taxable year.
The Small Business Act expanded the post-termination period
to include the 120-day period beginning on the date of any
determination pursuant to an audit of the taxpayer that follows
the termination of the S corporation's election and that
adjusts a subchapter S item of income, loss or deduction of the
S corporation during the S period. In addition, the definition
of ``determination'' was expanded to include a final
disposition of the Secretary of the Treasury of a claim for
refund and, under regulations, certain agreements between the
Secretary and any person, relating to the tax liability of the
person. The Small Business Act provision was effective for
taxable years beginning after December 31, 1996.
Explanation of Provision
The technical correction clarifies that the effective date
for the Small Business Act provision affecting the post-
termination transition period is for determinations after
December 31, 1996, not for determinations with respect to
taxable years beginning after December 31, 1996. However, in no
event will the post-termination transition period expanded by
the Small Business Act end before the end of the 120-day period
beginning after the date of enactment of this Act.
4. Treatment of qualified subchapter S subsidiaries (sec. 1601(c)(3) of
the Act and sec. 1361(b)(3) of the Code)
Prior Law
Pursuant to a provision of the Small Business Act, an S
corporation is allowed to own a qualified subchapter S
subsidiary. The term ``qualified subchapter S subsidiary''
means a domestic corporation that (1) is not an ineligible
corporation (i.e., a corporation that would be eligible to be
an S corporation if the stock of the corporation were held
directly by the shareholders of its parent S corporation) if
100 percent of the stock of the subsidiary were held by its S
corporation parent and (2) which the parent elects to treat as
a qualified subchapter S subsidiary. Under the election, for
all purposes of the Code, the qualified subchapter S subsidiary
is not treated as a separate corporation and all the assets,
liabilities, and items of income, deduction, and credit of the
subsidiary are treated as the assets, liabilities, and items of
income, deduction, and credit of the parent S corporation.
The legislative history of the provision provides that if
an election is made to treat an existing corporation as a
qualified subchapter S subsidiary, the subsidiary will be
deemed to have liquidated under sections 332 and 337
immediately before the election is effective.
Explanation of Provision
The technical correction provides that the Secretary of the
Treasury may provide, by regulations, instances where the
separate corporate existence of a qualified subchapter S
subsidiary may be taken into account for purposes of the Code.
Thus, if an S corporation owns 100 percent of the stock of a
bank (as defined in sec. 581) and elects to treat the bank as a
qualified subchapter S subsidiary, it is expected that Treasury
regulations would treat the bank as a separate legal entity for
purposes of those Code provisions that apply specifically to
banks (e.g., sec. 582).
Treasury regulations also may provide exceptions to the
general rule that the qualified subchapter S subsidiary
election is treated as a deemed section 332 liquidation of the
subsidiary in appropriate cases. In addition, if the effect of
a qualified subchapter S subsidiary election is to invalidate
an election to join in the filing of a consolidated return for
a group of subsidiaries that formerly joined in such filing,
Treasury regulations may provide guidance as to the
consolidated return effects of the S election.
B. Pension Provisions
1. Salary reduction simplified employee pensions (``SARSEPS'') (sec.
1601(d)(1)(B) of the Act and sec. 408(k)(6) of the Code)
Prior Law
SARSEPs were repealed for years beginning after December
31, 1996, unless the SARSEP was established before January 1,
1997. Consequently, an employer was not permitted to establish
a SARSEP after December 31, 1996. SARSEPs established before
January 1, 1997, may continue to receive contributions under
the rules in effect prior to January 1, 1997.
Explanation of Provision
The Act amends Code section 408(k)(6) to clarify that new
employees of an employer hired after December 31, 1996, may
participate in a SARSEP of an employer established before
January 1, 1997.
2. SIMPLE retirement plans (secs. 1601(d)(1)(A) and (d)(1)(C)-(F) and
1601(d)(2) of the Act)
a. Reporting requirements for SIMPLE IRAs (sec.
1601(d)(1)(A) of the Act and sec. 408(i) of the
Code)
Prior Law
A trustee of an individual retirement account and the
issuer of an individual retirement annuity must furnish reports
regarding the account or annuity to the individual for whom the
account or annuity is maintained not later than January 31 of
the calendar year following the year to which the reports
relate. In the case of a SIMPLE IRA, such reports are to be
furnished within 30 days after each calendar year.
Explanation of Provision
The Act conforms the time for providing reports for SIMPLE
IRAs to that for IRA reports generally. Thus, the Act would
provide that the report required to be furnished to the
individual under a SIMPLE IRA would be provided within 31 days
after each calendar year.
b. Notification requirement for SIMPLE IRAs (sec.
1601(d)(1)(C) of the Act and secs. 408(l)(2) and
6693(c) of the Code)
Prior Law
The trustee of any SIMPLE IRA is required to provide the
employer maintaining the arrangement a summary plan description
containing basic information about the plan. At least once a
year, the trustee is also required to furnish an account
statement to each individual maintaining a SIMPLE account. In
addition, the trustee is required to file an annual report with
the Secretary. A trustee who fails to provide any of such
reports or descriptions will be subject to a penalty of $50 per
day until such failure is corrected, unless the failure is due
to reasonable cause.
Explanation of Provision
The Act provides that issuers of annuities for SIMPLE IRAs
have the same reporting requirements as SIMPLE IRA trustees.
c. Maximum dollar limitation for SIMPLE IRAs (sec.
1601(d)(1)(D) of the Act and sec. 408(p) of the
Code)
Prior Law
The Small Business Act created a simplified retirement plan
for small business called the savings incentive match plan for
employees (``SIMPLE'') retirement plan. A SIMPLE plan can be
either an individual retirement arrangement (``IRA'') for each
employee or part of a qualified cash or deferred arrangement
(``a 401(k) plan''). A SIMPLE IRA permits employees to make
elective contributions up to $6,000 per year to their IRA. The
employer is required to satisfy one of two contribution
formulas. Under the matching contribution formula, the employer
generally is required to match employee elective contributions
on a dollar-for-dollar basis up to 3 percent of the employee's
compensation, unless the employer elects a lower percentage
matching contribution (but not less than 1 percent of each
employee's compensation). Alternatively, an employer is
permitted to elect, in lieu of making matching contributions,
to make a 2 percent of compensation nonelective contribution on
behalf of each eligible employee. The employer contribution
amounts are contributed to the employee's IRA. The maximum
contribution limitation to an IRA is $2,000.
Explanation of Provision
The Act provides that in the case of a SIMPLE IRA, the
$2,000 maximum limitation applicable to IRAs is increased to
the limitations in effect for contributions made under a
qualified salary reduction arrangement. This includes employee
elective contributions and required employer contributions.
d. Application of exclusive plan requirement for SIMPLE
IRAs to noncollectively bargained employees (sec.
1601(d)(1)(E) of the Act and sec. 408(p)(2)(D) of
the Code)
Prior Law
A SIMPLE IRA will be treated as a qualified salary
reduction arrangement provided the employer does not maintain a
qualified plan during the same time period the SIMPLE IRA is
maintained. Collectively bargained employees can be excluded
from participation in the SIMPLE IRA and may be covered under a
plan established by the employer as a result of a good faith
bargaining agreement.
Explanation of Provision
The Act provides that an employer who maintains a plan for
collectively bargained employees is permitted to maintain a
SIMPLE IRA for noncollectively bargained employees.
e. Application of exclusive plan requirement for SIMPLE
IRAs in the case of mergers and acquisitions (sec.
1601(d)(1)(F) of the Act and sec. 408(p)(2) of the
Code)
Prior Law
Only employers who employ 100 or fewer employees who
received compensation for the preceding year of at least $5,000
are eligible to establish a SIMPLE IRA. An eligible employer
maintaining a SIMPLE IRA who fails to be an eligible employer
due to an acquisition, disposition or similar transaction is
treated as an eligible employer for the 2 years following the
last year the employer was eligible provided rules similar to
the special coverage rules of section 410(b)(6)(C)(i) apply.
There is no parallel provision with respect to an employer who,
because of an acquisition, disposition or similar transaction,
maintains a qualified plan and a SIMPLE IRA at the same time.
Explanation of Provision
The Act provides that if an employer maintains a qualified
plan and a SIMPLE IRA in the same year due to an acquisition,
disposition or similar transaction the SIMPLE IRA is treated as
a qualified salary reduction arrangement for the year of the
transaction and the following calendar year.
f. Top-heavy exemption for SIMPLE 401(k) arrangements (sec.
1601(d)(2)(A) of the Act and sec. 401(k)(11)(D) of
the Code)
Prior Law
A plan meeting the SIMPLE 401(k) requirements for any year
is not treated as a top-heavy plan under section 416 for the
year. This rule was intended to apply only to SIMPLE 401(k)s,
and not other plans maintained by the employer.
Explanation of Provision
The Act provides that the top-heavy exemption applies to a
plan which permits only contributions required to satisfy the
SIMPLE 401(k) requirements.
g. Cost of living adjustments for SIMPLE 401(k)
arrangements (sec. 1601(d)(2)(B) of the Act and
sec. 401(k)(11) of the Code)
Prior Law
The $6,000 limit on deferrals to a SIMPLE IRA is subject to
a cost-of-living adjustment. There is no parallel provision
applicable to a SIMPLE 401(k) arrangement.
Explanation of Provision
The Act provides that the $6,000 limit on elective
deferrals under a SIMPLE 401(k) arrangement will be adjusted at
the same time and in the same manner as for SIMPLE IRAs.
h. Employer deduction for SIMPLE 401(k) arrangements (sec.
1601(d)(2)(C) of the Act and sec. 404(a)(3) of the
Code)
Prior Law
Contributions paid by an employer to a profit sharing or
stock bonus plan are deductible by the employer for a taxable
year to the extent the contributions do not exceed 15-percent
of the compensation otherwise paid or accrued during the
taxable year to the participants under the plan. Contributions
paid by an employer to a profit sharing or stock bonus plan
that are not deductible because they are in excess of the 15-
percent limitation are subject to a 10-percent excise tax
payable by the employer making the contribution.
Explanation of Provision
The Act provides that to the extent that contributions paid
by an employer to a SIMPLE 401(k) arrangement satisfy the
contribution requirements of section 401(k)(11)(B), such
contributions are deductible by the employer for the taxable
year.
i. Notification and election periods for SIMPLE 401(k)
arrangements (sec. 1601(d)(2)(D) of the Act and
sec. 401(k)(11) of the Code)
Prior Law
An employer maintaining a SIMPLE 401(k) arrangement is
required to make a matching contribution for employees making
elective deferrals of up to 3-percent of compensation (or,
alternatively, elect to make a 2-percent of compensation
nonelective contribution on behalf of all eligible employees).
An employer electing to make a 2-percent nonelective
contribution is required to notify all employees of such
election within a reasonable period of time before the 60th day
before the beginning of the year.
An employer maintaining a SIMPLE IRA is required to notify
each employee of the employee's opportunity to make or modify
salary reduction contributions as well as the contribution
alternative chosen by the employer within a reasonable period
of time before the employee's election period. The employee's
election period is the 60-day period before the beginning of
any year (and the 60-day period before the first day such
employee is eligible to participate).
Explanation of Provision
The Act extends the employer notice and employee election
requirements of SIMPLE IRAs to SIMPLE 401(k) arrangements.
Effective Date
The provision is effective with respect to calendar years
beginning after the date of enactment.
j. Treatment of Indian tribal governments under section
403(b) (sec. 1601(d)(4) of the Act and sec. 403(b)
of the Code)
Prior Law
Any 403(b) annuity contract purchased in a plan year
beginning before January 1, 1995, by an Indian tribal
government is treated as purchased by an entity permitted to
maintain a tax-sheltered annuity plan. Such contracts may be
rolled over into a section 401(k) plan maintained by the Indian
tribal government in accordance with the rollover rules of
section 403(b)(8).
Explanation of Provision
The Act clarifies that an employee participating in a
403(b) annuity contract of the Indian tribal government would
be permitted to roll over amounts from such contract to a
section 401(k) plan maintained by the Indian tribal government
whether or not the annuity contract is terminated.
k. Special rules for chaplains and self-employed ministers
(sec. 1601(d)(6) of the Act and sec. 414(e)(5)(A)
of the Code)
Prior Law
Ministers employed by an employer other than a church may
participate in their denominational plan.
Certain service of a self-employed minister is treated as
years of service for purposes of calculating the exclusion
allowance applicable to section 403(b) annuities.
Explanation of Provision
The provision clarifies that a minister may participate in
the denominational plan, whether or not the minister is
employed by a tax-exempt employer or a taxable employer.
The provision clarifies that the exclusion amount is
determined by taking into account the minister's self-employed
earnings with respect to years of service taken into account in
calculating the exclusion amount.
C. Foreign Provisions
1. Measurement of earnings of controlled foreign corporations (sec.
1601(e) of the Act and section 956 of the Code)
Prior Law
U.S. 10-percent shareholders of a controlled foreign
corporation (CFC) are subject to current U.S. tax on their pro
rata shares of the CFC's earnings invested in United States
property. For this purpose, earnings include both current
earnings and profits (not including a deficit) referred to in
section 316(a)(2) and accumulated earnings and profits referred
to in section 316(a)(1). It could be argued that this
definition of earnings takes current year earnings into account
twice.
Explanation of Provision
The technical correction clarifies that accumulated
earnings and profits of a CFC taken into account under section
956(b)(1)(A) for purposes of determining the CFC's earnings
invested in United States property do not include current
earnings (which are taken into account separately under sec.
956(b)(1)(B)). A similar technical correction to the definition
of earnings for purposes of prior-law section 956A (relating to
a CFC's earnings invested in excess passive assets) was enacted
with the Small Business Job Protection Act of 1996 (section
1703(i)(2)).
2. Transfers to foreign trusts at fair market value (sec. 1601(i)(2) of
the Act and sec. 679 of the Code)
Prior Law
A U.S. person who transfers property to a foreign trust
which has U.S. beneficiaries generally is treated as the owner
of such trust. However, this rule does not apply where the U.S.
person transfers property to a trust in exchange for fair
market value consideration. In determining whether the U.S.
person receives fair market value consideration, obligations of
certain related persons are not taken into account. For this
purpose, related persons include the trust, any grantor or
beneficiary of the trust, and certain persons who are related
to any such grantor or beneficiary.
Explanation of Provision
The technical correction clarifies that, for purposes of
determining whether a U.S. person's transfer to a trust is for
fair market value consideration, the related persons whose
obligations are disregarded include any owner of the trust and
certain persons who are related to any such owner.
3. Treatment of trust as U.S. person (sec. 1601(i)(3) of the Act and
secs. 641 and 7701(a)(30) of the Code)
Prior Law
A trust is considered to be a U.S. person if two criteria
are met. First, a court within the United States must be able
to exercise primary supervision over the administration of the
trust. Second, one or more U.S. fiduciaries must have the
authority to control all substantial decisions of the trust.
These criteria regarding the treatment of a trust as a U.S.
person are effective for taxable years beginning after December
31, 1996. The Internal Revenue Service announced procedures
under which a U.S. trust in existence on August 20, 1996 may
continue to file returns as a U.S. trust for taxable years
beginning after December 31, 1996. To qualify for such
treatment, the trustee (1) must initiate modification of the
trust to conform to the new criteria by the due date for filing
the trust's return for its first taxable year beginning after
1996, (2) must complete the modification within two years of
such date, and (3) must attach the required statement to the
trust returns for the taxable years beginning after 1996.\314\
---------------------------------------------------------------------------
\314\ Notice 96-65, 1996-2 C.B. 232. See Joint Committee on
Taxation, General Explanation of Tax Legislation Enacted in the 104th
Congress (JCS-12-96), December 12, 1996, pp. 277-278.
---------------------------------------------------------------------------
Explanation of Provision
The technical correction clarifies that a trust is treated
as a U.S. person as long as one or more U.S. persons have the
authority to control all substantial decisions of the trust
(and a U.S. court can exercise primary supervision).
Accordingly, the fact that a substantial decision of the trust
is controlled by a U.S. person who is not a fiduciary would not
cause the trust not to be treated as a U.S. person. In
addition, the technical correction clarifies that a trust that
is a foreign trust under these criteria is not considered to be
present or resident in the United States at any time. Finally,
the technical correction provides the Secretary of Treasury
with authority to allow reasonable time for U.S. trusts in
existence on August 20, 1996 to make modifications in order to
comply with the new criteria for treatment of a trust as a U.S.
person.
D. Other Provisions
1. Phaseout and expiration of excise tax on luxury automobiles (sec.
1601(f)(3) of the Act and secs. 4001 and 4003 of the Code)
Prior Law
An excise tax is imposed on the sale of automobiles whose
price exceeds a designated threshold ($36,000 for 1997). The
excise tax is imposed at a rate of 8-percent on the excess of
the sales price above the designated threshold. The 8-percent
rate declines by one percentage point per year until reaching 3
percent in 2002. The $36,000 threshold is indexed for
inflation.
The tax generally applies only to the first retail sale
after manufacture, production, or importation of an automobile.
It does not apply to subsequent sales of taxable automobiles.
However, under section 4003 of the Code, a 10-percent tax was
imposed on the ``separate purchase of vehicle and parts and
accessories therefor'' when the sum of the separate purchases
exceeds the luxury tax threshold. The rate of tax under section
4003 is not determined by reference to section 4001.
The tax under section 4001 applies to sales before January
1, 2003. The tax under section 4003 has no termination date.
Explanation of Provision
The Act clarifies that the phased reduction in luxury
excise tax rates and the expiration date of December 31, 2002,
enacted as part of the Small Business Act, apply both for the
tax imposed on the purchase of new automobiles under section
4001 and for the tax imposed for the separate purchase of
vehicles and parts and accessories therefor under section 4003.
Effective Date
The provision is effective for sales after the date of
enactment of the 1997 Act.
2. Treatment of certain reserves of thrift institutions (sec.
1601(f)(5) of the Act and secs. 593(e) and 1374 of the Code)
Prior Law
A provision of the Small Business Act repealed the
percentage-of-taxable income method for deducting bad debts
applicable to thrift institutions. The portion of the section
481(a) adjustment applicable to pre-1988 reserves of an
institution required to change its method of accounting
generally is not restored to income unless the institution
makes a distribution to which section 593(e) applies. Section
593(e) provides that if a institution makes a nonliquidating
distribution in an amount in excess of its post-1951
accumulated earnings and profits, such excess will be treated
as a distribution of the post-1987 reserve for bad debts,
requiring recapture of such amount.
Another provision of the Small Business Act allows a bank
or a thrift institution to elect to be treated as an S
corporation so long as the entity does not use a reserve method
of accounting for bad debts. The earnings of an S corporation
increase the corporation's accumulated adjustments account, but
do not increase its accumulated earnings and profits (sec.
1368). In addition, any net unrealized built-in gains of a C
corporation that converts to S corporation status that are
recognized during the 10-year period beginning with the date of
such conversion generally are subject to corporate-level tax
(sec. 1374). Section 481(a) adjustments taken into account
during the 10-year period generally are subject to section
1374.
Explanation of Provision
The Act provides rules to clarify the section 593(e)
treatment of pre-1988 bad debt reserves of thrift and former
thrift institutions that become S corporations. The technical
corrections provide that (1) the accumulated adjustments
account of an S corporation would be treated the same as post-
1951 earnings and profits for purposes of section 593(e) and
(2) section 593(e) would apply irrespective of section 1374
(e.g., distributions that trigger section 593(e) would be
subject to corporate-level recapture even if such distributions
occur after the 10-year period of section 1374).
3. ``FASIT'' technical corrections (sec. 1601(f)(6) of the Act and sec.
860L of the Code)
Prior Law
In general
A ``financial asset securitization investment trust''
(``FASIT'') is designed to facilitate the securitization of
debt obligations such as credit card receivables, home equity
loans, and auto loans. A FASIT generally is not taxable; the
FASIT's taxable income or net loss flows through to the owner
of the FASIT.
The ownership interest of a FASIT generally is required to
be entirely held by a single domestic C corporation. In
addition, a FASIT generally must hold only qualified debt
obligations, and certain other specified assets, and is subject
to certain restrictions on its activities. An entity that
qualifies as a FASIT can issue instruments (called ``regular
interests'') that meet certain specified requirements and treat
those instruments as debt for Federal income tax purposes. In
general, those requirements must be met ``after the startup
date.'' Instruments bearing yields to maturity over 5
percentage points above the yield to maturity on specified
United States government obligations (i.e., ``high-yield
interests'') may be held only by domestic C corporations that
are not exempt from income tax.
Income from prohibited transactions
The owner of a FASIT is required to pay a penalty excise
tax equal to 100 percent of net income derived from (1) an
asset that is not a permitted asset, (2) any disposition of an
asset other than a permitted disposition, (3) any income
attributable to loans originated by the FASIT, and (4)
compensation for services (other than fees for a waiver,
amendment, or consent under permitted assets not acquired
through foreclosure). A permitted disposition is any
disposition of any permitted asset (1) arising from complete
liquidation of a class of regular interests (i.e., a qualified
liquidation); \315\ (2) incident to the foreclosure, default,
or imminent default of the asset; (3) incident to the
bankruptcy or insolvency of the FASIT; (4) necessary to avoid a
default on any indebtedness of the FASIT attributable to a
default (or imminent default) on an asset of the FASIT; (5) to
facilitate a clean-up call; (6) to substitute a permitted debt
instrument for another such instrument; or (7) in order to
reduce over-collateralization where a principal purpose of the
disposition was not to avoid recognition of gain arising from
an increase in its market value after its acquisition by the
FASIT.
---------------------------------------------------------------------------
\315\ For this purpose, a ``qualified liquidation'' has the same
meaning as it does purposes of the exemption from the tax on prohibited
transactions of a real estate mortgage investment conduit (``REMIC'')
in section 860F(a)(4).
---------------------------------------------------------------------------
Definition of ``FASIT''
For an entity or arrangement to qualify as a FASIT,
substantially all of its assets must consist of the following
``permitted assets'': (1) cash and cash equivalents; (2)
certain permitted debt instruments; (3) certain foreclosure
property; (4) certain instruments or contracts that represent a
hedge or guarantee of debt held or issued by the FASIT; (5)
contract rights to acquire permitted debt instruments or
hedges; (6) a regular interest in another FASIT; and (7) a
regular interest in a REMIC. A FASIT must meet the asset test
at the 90th day after its formation and at all times
thereafter. Permitted assets may be acquired at any time by a
FASIT, including any time after its formation.
Explanation of Provision
Definition of regular interest
The Act provides that the requirement of a ``regular
interest'' must be met ``on or after the startup date,''
instead of just ``after the startup date.''
Correction of cross reference
The Act corrects an incorrect cross reference in section
860L(d) from section 860I(c)(2) to section 860I(b)(2).
Tax on prohibited transactions
The Act provides that the tax on prohibited transactions
would not apply to dispositions of foreclosure property or
hedges using the similar exception applicable to REMICs.
4. Qualified State tuition programs (sec. 1601(h)(1) of the Act and
sec. 529 of the Code)
Prior Law
Section 529 provides tax-exempt status to certain qualified
State tuition programs and provides rules governing the tax
treatment of distributions from such programs. Section 529 was
effective on the date of enactment of the Small Business Job
Protection Act of 1996, but a special transition rule provides
that if (1) a State maintains (on the date of enactment) a
program under which persons may purchase tuition credits on
behalf of, or make contributions for educational expenses of, a
designated beneficiary, and (2) such program meets the
requirements of a qualified State tuition program before the
later of (a) one year after the date of enactment, or (b) the
first day of the first calendar quarter after the close of the
first regular session of the State legislature that begins
after the date of enactment, then the provisions of the Small
Business Act will apply to contributions (and earnings
allocable thereto) made before the date the program meets the
requirements of a qualified State tuition program, without
regard to whether the requirements of a qualified State tuition
program are satisfied with respect to such contributions and
earnings.
Explanation of Provision
The provision clarifies that, if a State program under
which persons may purchase tuition credits comes into
compliance with the requirements of a ``qualified State tuition
program'' as defined in section 529 within a specified time
period, then such program will be treated as a qualified State
tuition program with respect to any contributions (and earnings
allocable thereto) made pursuant to a contract entered into
under the program before the date on which the program comes
into compliance with the present-law requirements of a
qualified State tuition program under section 529.
5. Adoption credit (sec. 1601(h)(2) of the Act, sec. 1807 of the Small
Business Act, and sec. 23 of the Code)
Prior Law
Taxpayers are allowed a maximum nonrefundable tax credit
against income tax liability of $5,000 per child for qualified
adoption expenses ($6,000 in the case of certain domestic
adoptions) paid or incurred by the taxpayer. Qualified adoption
expenses are reasonable and necessary adoption fees, court
costs, attorneys' fees, and other expenses that are directly
related to the legal adoption of an eligible child.
Otherwise qualified adoption expenses paid or incurred in
one taxable year are not taken into account for purposes of the
credit until the next taxable year unless the expenses are paid
or incurred in the year the adoption becomes final.
Explanation of Provision
The technical correction conforms the treatment of
otherwise qualified adoption expenses paid or incurred in years
after the year the adoption becomes final to the treatment of
expenses paid or incurred in the year the adoption becomes
final. Another technical correction repeals as ``deadwood'' an
ordering rule inadvertently included in the credit.
6. Phaseout of adoption assistance exclusion (sec. 1601(h)(2) of the
Act, sec. 1807 of the Small Business Act, and sec. 137 of the
Code)
Prior Law
The adoption tax credit and the exclusion for employer
provided adoption assistance are generally phased out ratably
for taxpayers with modified adjusted gross income (AGI) above
$75,000, and are fully phased out at $115,000 of modified AGI.
For these purposes modified AGI is computed by increasing the
taxpayer's AGI by the amount otherwise excluded from gross
income under Code sections 911, 931, or 933 (relating to the
exclusion of income of U.S. citizens or residents living
abroad; residents of Guam, American Samoa, and the Northern
Mariana Islands, and residents of Puerto Rico, respectively).
Explanation of Provision
The technical correction conforms the phaseout range of the
adoption assistance exclusion to the phaseout range of the
credit for qualified adoption expenses.
TECHNICAL CORRECTIONS TO THE HEALTH INSURANCE PORTABILITY AND
ACCOUNTABILITY ACT OF 1996
A. Medical Savings Accounts (sec. 1602(a) of the Act and sec. 220 of
the Code)
1. Additional tax on distributions not used for medical purposes
Prior Law
Distributions from a medical savings account (``MSA'') that
are not used for medical expenses are includible in gross
income and subject to a 15-percent additional tax unless the
distribution is after age 65 or death or on account of
disability. A similar additional 10-percent tax is imposed on
early withdrawals from individual retirement arrangements and
qualified pension plans. The 10-percent additional tax on early
withdrawals is not treated as tax liability for purposes of the
minimum tax. No such rule applies to the 15-percent additional
tax applicable to MSAs.
Explanation of Provision
The Act provides that the 15-percent tax on nonmedical
withdrawals from an MSA is not treated as tax liability for
purposes of the minimum tax.
2. Definition of permitted coverage
Prior Law
In order to be eligible to have an MSA an individual must
be covered under a high deductible health plan and no other
health plan, except for plans that provide certain permitted
coverage. Medicare supplemental plans are one of the types of
permitted coverage, even though an individual covered by
Medicare is not eligible to have an MSA.
Explanation of Provision
Under the Act, Medicare supplemental plans would be deleted
from the types of permitted coverage an individual may have and
still qualify for an MSA.
3. Taxation of distributions
Prior Law
In order to be eligible to have a medical savings account
(``MSA'') an individual must be covered under a high deductible
health plan and no other health plan, except for plans that
provide certain permitted coverage and must be either (1) a
self-employed individual, or (2) employed by a small employer.
Distributions from an MSA for the medical expenses of the MSA
account holder and his or her spouse or dependents are
generally excludable from income. However, in any year for
which a contribution is made to an MSA, withdrawals from the
MSA are excludable from income only if the individual for whom
the expenses were incurred was an eligible individual for the
month in which the expenses were incurred. This rule is
designed to ensure that MSAs are used in conjunction with a
high deductible plan and that they are not primarily used by
other individuals who have health plans that are not high
deductible plans.
Explanation of Provision
The Act would clarify that, in any year for which a
contribution is made to an MSA, withdrawals from the MSA are
excludable from income only if the individual for whom the
expenses were incurred was covered under a high deductible
health plan (and no other health plan except for plans that
provide certain permitted coverage) in the month in which the
expenses were incurred. That is, the individual for whom the
expenses were incurred does not have to be self employed or
employed by a small employer in order for a withdrawal for
medical expenses to be excludible.
4. Penalty for failure to provide required reports
Prior Law
Trustees of an MSA are required to provide such reports to
the Secretary and the account holder as the Secretary may
require. A penalty of $50 applies with respect to each failure
to provide a required report. Separate penalties apply to
information returns required by the Code.
Explanation of Provision
The Act provides that the $50 penalty does not apply to
information returns.
B. Definition of Chronically Ill Individual Under a Qualified
Long-Term Care Insurance Contract (sec. 1602(b) of the
Act and sec. 7702B(c)(2) of the Code)
Prior Law
Under the long-term care insurance rules, a chronically ill
individual is one who has been certified within the previous 12
months by a licensed health care practitioner as (1) being
unable to perform (without substantial assistance) at least 2
activities of daily living for at least 90 days due to a loss
of functional capacity, (2) having a level of disability
similar (as determined under regulations prescribed by the
Secretary in consultation with the Secretary of Health and
Human Services) to the level of disability described above, or
(3) requiring substantial supervision to protect the individual
from threats to health and safety due to severe cognitive
impairment. A contract is not treated as a qualified long-term
care insurance contract unless the determination of whether an
individual is a chronically ill individual takes into account
at least 5 of such activities.
Explanation of Provision
The technical correction clarifies that the five-activity
requirement--i.e., that the number of activities of daily
living that are taken into account not be less than five--
applies only for purposes of the first of three alternative
definitions of a chronically ill individual (Code sec.
7702B(c)(2)(A)(i)), that is, by reason of the individual being
unable to perform (without substantial assistance) at least 2
activities of daily living for at least 90 days due to a loss
of functional capacity. Thus, the requirement does not apply to
the determination of whether an individual is a chronically ill
individual either (1) by virtue of severe cognitive impairment,
or (2) if the insured satisfies a standard (if any) that is not
based upon activities of daily living, as determined under
regulations.
C. Deduction for Long-Term Care Insurance of Self-
Employed Individuals (sec. 1602(c) of the Act and
sec. 162(l)(2) of the Code)
Prior Law
The deduction for health insurance expenses of a self-
employed individual is not available for a month for which the
individual is eligible to participate in any subsidized health
plan maintained by any employer of the individual or the
individual's spouse. In the case of a qualified long-term care
insurance contract, only eligible long-term care premiums (as
defined for purposes of the medical expense deduction) are
taken into account in determining the deduction for health
insurance expenses of a self-employed individual.
Explanation of Provision
The technical correction applies the rules for the
deduction for health insurance expenses of a self-employed
individual separately with respect to (1) plans that include
coverage for qualified long-term care services or that are
qualified long-term care insurance contracts, and (2) plans
that do not include such coverage and are not such contracts.
Thus, the provision clarifies that the fact that an individual
is eligible for employer-subsidized health insurance does not
affect the ability of such an individual to deduct long-term
care insurance premiums, so long as the individual is not
eligible for employer-subsidized long-term care insurance.
D. Applicability of Reporting Requirements of Long-Term
Care Contracts and Accelerated Death Benefits
(sec. 1602(d) of the Act and sec. 6050Q of the Code)
Prior Law
Amounts (other than policyholder dividends or premium
refunds) received under a long-term care insurance contract
generally are excludable as amounts received for personal
injuries and sickness, subject to a dollar cap on per diem
contracts only. If the aggregate amount of periodic payments
under all qualified long-term care contracts exceeds the dollar
cap for the period, then the amount of such excess payments is
excludable only to the extent of the individual's costs (that
are not otherwise compensated for by insurance or otherwise)
for long-term care services during the period.
An exclusion from gross income is provided for an amount
paid by reason of the death of an insured for (1) amounts
received under a life insurance contract and (2) amounts
received for the sale or assignment of any portion of the death
benefit under a life insurance contract to a qualified viatical
settlement provider, provided that the insured under the life
insurance contract is either terminally ill or chronically ill
(the accelerated death benefit rules).
A payor of long-term care benefits (defined for this
purpose to include any amount paid under a product advertised,
marketed or offered as long-term care insurance), and a payor
of amounts treated as subject to reporting under the
accelerated death benefit rules, is required to report to the
IRS the aggregate amount of such benefits paid to any
individual during any calendar year, and the name, address and
taxpayer identification number of such individual. A payor is
also required to report the name, address, and taxpayer
identification number of the chronically ill individual on
account of whose condition the amounts are paid, and whether
the contract under which the amount is paid is a per diem-type
contract. A copy of the report must be provided to the payee by
January 31 following the year of payment, showing the name of
the payor and the aggregate amount of benefits paid to the
individual during the calendar year. Failure to file the report
or provide the copy to the payee is subject to the generally
applicable penalties for failure to file similar information
reports.
Explanation of Provision
The technical correction clarifies that the reporting
requirements include the need to report the address and phone
number of the information contact. This conforms these
reporting requirements to the requirements of the Taxpayer Bill
of Rights 2.
E. Consumer Protection Provisions for Long-Term Care
Insurance Contracts (sec. 1602(e) of the Act and
sec. 7702B(g)(4)(b) of the Code)
Prior Law
The long-term care insurance rules include consumer
protection provisions (sec. 7702B(g)). Among these provisions
is a requirement that the issuer of a contract offer to the
policyholder a nonforfeiture provision that meets certain
requirements. The requirements include a rule that the
nonforfeiture provision shall provide for a benefit available
in the event of a default in the payment of any premiums and
the amount of the benefit may be adjusted subsequent to being
initially granted only as necessary to reflect changes in
claims, persistency, and interest as reflected in changes in
rates for premium paying policies approved by the Secretary for
the same contract form.
Explanation of Provision
The technical correction clarifies that the nonforfeiture
provision shall provide for a benefit available in the event of
a default in the payment of any premiums and the amount of the
benefit may be adjusted subsequent to being initially granted
only as necessary to reflect changes in claims, persistency,
and interest as reflected in changes in rates for premium
paying policies approved by the appropriate State regulatory
authority (not by the Secretary) for the same contract form.
F. Insurable Interests Under the COLI Provision (sec. 1602(f)(1) of the
Act and sec. 264(a)(4) of the Code)
Prior Law
No deduction is allowed for interest paid or accrued on any
indebtedness with respect to one or more life insurance
policies or annuity or endowment contracts owned by the
taxpayer covering any individual who is (1) an officer or
employee of, or (2) is financially interested in, any trade or
business carried on by the taxpayer (the COLI rule). An
exception is provided for interest on indebtedness with respect
to life insurance policies covering up to 20 key persons,
subject to an interest rate cap.
Explanation of Provision
The technical correction is intended to prevent unintended
avoidance of the COLI rule by clarifying that the rule relates
to life insurance policies or annuity or endowment contracts
covering any individual who (1) is or was an officer or
employee of, or (2) is or was financially interested in, any
trade or business carried on currently or formerly by the
taxpayer. Thus, for example, the provision would clarify the
treatment of interest on debt with respect to contracts
covering former employees of the taxpayer. As another example,
the provision would clarify the treatment of interest on debt
with respect to a business formerly conducted by the taxpayer
and transferred to an affiliate of the taxpayer. No inference
is intended as the interpretation of this provision under prior
law.
G. Applicable Period for Purposes of Applying the Interest
Rate for a Variable Rate Contract Under the COLI Rules
(sec. 1602(f)(2) of the Act and sec. 264(d)(2)(B)(ii) of the Code)
Prior Law
No deduction is allowed for interest paid or accrued on any
indebtedness with respect to one or more life insurance
policies or annuity or endowment contracts owned by the
taxpayer covering any individual who is (1) an officer or
employee of, or (2) is financially interested in, any trade or
business carried on by the taxpayer. An exception is provided
for interest on indebtedness with respect to life insurance
policies covering up to 20 key persons, subject to an interest
rate cap.
This provision generally does not apply to interest on debt
with respect to contracts purchased on or before June 20, 1986.
If the policy loan interest rate under such a contract does not
provide for a fixed rate of interest, then interest on such a
contract paid or accrued after December 31, 1995, is allowable
only to the extent the rate of interest for each fixed period
selected by the taxpayer does not exceed Moody's Corporate Bond
Yield Average--Monthly Average Corporates, for the third month
preceding the first month of the fixed period. The fixed period
must be 12 months or less.
Explanation of Provision
The technical correction provides that an election of an
applicable period for purposes of applying the interest rate
for a variable rate contract can be made no later than the 90th
date after the date of enactment of the proposal, and applies
to the taxpayer's first taxable year ending on or after October
13, 1995. If no election is made, the applicable period is the
policy year. The policy year is the 12-month period beginning
on the anniversary date of the policy.
H. Definition of 20-Percent Owner for Purposes of Key
Person Exception Under COLI Rule (sec. 1602(f)(3) of the
Act and sec. 264(d)(4) of the Code)
Prior Law
No deduction is allowed for interest paid or accrued on any
indebtedness with respect to one or more life insurance
policies or annuity or endowment contracts owned by the
taxpayer covering any individual who is (1) an officer or
employee of, or (2) is financially interested in, any trade or
business carried on by the taxpayer. An exception is provided
for interest on indebtedness with respect to life insurance
policies covering up to 20 key persons, subject to an interest
rate cap.
A key person is an individual who is either an officer or a
20-percent owner of the taxpayer. The number of individuals
that can be treated as key persons may not exceed the greater
of (1) 5 individuals, or (2) the lesser of 5 percent of the
total number of officers and employees of the taxpayer, or 20
individuals. Employees are to be full-time employees, for this
purpose. A 20-percent owner is an individual who directly owns
20 percent or more of the total combined voting power of the
corporation. If the taxpayer is not a corporation, the statute
states that a 20-percent owner is an individual who directly
owns 20 percent or more of the capital or profits interest of
the employer.
Explanation of Provision
The technical correction clarifies that, in determining a
key person, if the taxpayer is not a corporation, a 20-percent
owner is an individual who directly owns 20 percent or more of
the capital or profits interest of the taxpayer.
I. Effective Date of Interest Rate Cap on Key Persons and
Pre-1986 Contracts Under the COLI Rule (sec. 1602(f)(4)
of the Act and sec. 501(c) of HIPA)
Prior Law
No deduction is allowed for interest paid or accrued on any
indebtedness with respect to one or more life insurance
policies or annuity or endowment contracts owned by the
taxpayer covering any individual who is (1) an officer or
employee of, or (2) is financially interested in, any trade or
business carried on by the taxpayer. An exception is provided
for interest on indebtedness with respect to life insurance
policies covering up to 20 key persons, subject to an interest
rate cap.
This provision generally does not apply to interest on debt
with respect to contracts purchased on or before June 20, 1986.
If the policy loan interest rate under such a contract does not
provide for a fixed rate of interest, then interest on such a
contract paid or accrued after December 31, 1995, is allowable
only to the extent the rate of interest for each fixed period
selected by the taxpayer does not exceed Moody's Corporate Bond
Yield Average--Monthly Average Corporates, for the third month
preceding the first month of the fixed period. The fixed period
must be 12 months or less.
The interest rate cap on key persons and pre-1986 contracts
is effective with respect to interest paid or accrued for any
month beginning after December 31, 1995. Another part of the
provision provides that the interest rate cap on key employees
and pre-1986 contracts applies to interest paid or accrued
after October 13, 1995.
Explanation of Provision
The technical correction clarifies that, under the COLI
rule, the interest rate cap on key persons and pre-1986
contracts applies to interest paid or accrued for any month
beginning after December 31, 1995. This technical correction
eliminates the discrepancy between the October and the December
dates in the grandfather rule for pre-1986 contracts.
J. Clarification of Contract Lapses Under Effective Date
Provisions of the COLI Rule (sec. 1602(f)(5) of the Act
and sec. 501(d)(2) of HIPA)
Prior Law
No deduction is allowed for interest paid or accrued on any
indebtedness with respect to one or more life insurance
policies or annuity or endowment contracts owned by the
taxpayer covering any individual who is (1) an officer or
employee of, or (2) is financially interested in, any trade or
business carried on by the taxpayer. An exception is provided
for interest on indebtedness with respect to life insurance
policies covering up to 20 key persons, subject to an interest
rate cap.
Additional limitations are imposed on the deductibility of
interest with respect to single premium contracts, and interest
on debt incurred or continued to purchase or carry a life
insurance, endowment, or annuity contract pursuant to a plan of
purchase that contemplates the systematic direct or indirect
borrowing of part or all of the increases in the cash value of
the contract. An exception to the latter rule is provided,
permitting deductibility of interest on bona fide debt that is
part of such a plan, if no part of 4 of the annual premiums due
during the first 7 years is paid by means of debt (the ``4-out-
of-7'' rule).
This COLI rule is phased in. In connection with the phase-
in rule, a transition rule provides that any amount included in
income during 1996, 1997, or 1998, that is received under a
contract described in the provision on the complete surrender,
redemption or maturity of the contract or in full discharge of
the obligation under the contract that is in the nature of a
refund of the consideration paid for the contract, is
includable ratably over the first 4 taxable years beginning
with the taxable year the amount would otherwise have been
includable. The lapse of a contract after October 13, 1995, due
to nonpayment of premiums does not cause interest paid or
accrued prior to January 1, 1999, to be nondeductible solely by
reason of (1) failure to meet the 4-out-of-7 rule, or (2)
causing the contract to be treated as a single premium contract
within the meaning of section 264(b)(1). This lapse provision
states that the relief is provided in the following case:
solely by reason of no additional premiums being received by
reason of a lapse.
Explanation of Provision
The technical correction clarifies that, under the
transition relief provided under the COLI rule, the 4-out-of-7
rule and the single premium rule are not to apply solely by
reason of a lapse occurring after October 13, 1995, by reason
of no additional premiums being received under the contract.
K. Requirement of Gain Recognition on Certain Exchanges
(sec. 1602(g) (1) and (2) of the Act, sec. 511 of the Act, and
sec. 877(d)(2) of the Code)
Prior Law
Under the expatriation tax provisions in section 877,
special tax treatment applies to certain former U.S. citizens
and former long-term U.S. residents for 10 years following the
date of loss of U.S. citizenship or U.S. residency status. Gain
recognition is required on certain exchanges of property
following loss of U.S. citizenship or U.S. residency status,
unless a gain recognition agreement is entered into. In
addition, regulatory authority is granted to apply this rule to
the 15-year period beginning 5 years before the loss of U.S.
citizenship or U.S. residency status.
Explanation of Provision
The technical correction clarifies that the period to which
the general rule requiring gain recognition on certain
exchanges applies is the 10-year period that begins on the date
of loss of U.S. citizenship or U.S. residency status. In
addition, the technical correction clarifies that in the case
of an exchange occurring during the 5-year period before the
loss of U.S. citizenship or U.S. residency status, any gain
required to be recognized under regulations is to be recognized
immediately after the date of such loss of U.S. citizenship or
U.S. residency status.
L. Suspension of 10-Year Period in Case of Substantial
Diminution of Risk of Loss (sec. 1602(g)(3) of the Act,
sec. 511 of the Act, and sec. 877(d)(3) of the Code)
Prior Law
Under the expatriation tax provisions in section 877,
special tax treatment applies to certain former U.S. citizens
and former long-term U.S. residents for 10 years following the
date of loss of U.S. citizenship or U.S. residency status. The
running of this period with respect to gain on the sale or
exchange of any property is suspended for any period during
which the individual's risk of loss with respect to the
property is substantially diminished.
Explanation of Provision
The technical correction clarifies that the period to which
the rule suspending such period in the case of a substantial
diminution of risk of loss applies is the 10-year period that
begins on the date of loss of U.S. citizenship or U.S.
residency status.
M. Treatment of Property Contributed to Certain Foreign
Corporations (sec. 1602(g)(4) of the Act, sec. 511 of the Act,
and sec. 877(d)(4) of the Code)
Prior Law
Under the expatriation tax provisions in section 877,
special tax treatment applies to certain former U.S. citizens
and former long-term U.S. residents for 10 years following the
date of loss of U.S. citizenship or U.S. residency status.
Special rules apply in the case of certain contributions of
U.S. property by such an individual to a foreign corporation
during such period.
Explanation of Provision
The technical correction clarifies that the period to which
the rule regarding certain contributions to foreign
corporations applies is the 10-year period that begins on the
date of loss of U.S. citizenship or U.S. residency status. The
technical correction also clarifies that the rule applies in
the case of property the income from which, immediately before
the contribution, was from U.S. sources.
N. Credit for Foreign Estate Tax (sec. 1602(g)(6) of the Act, sec. 511
of the Act, and sec. 2107(c) of the Code)
Prior Law
Under the expatriation tax provisions in section 2107,
special estate tax treatment applies to certain former U.S.
citizens and former long-term U.S. residents who die within 10
years following the date of loss of U.S. citizenship or U.S.
residency status. Special rules provide a credit against the
U.S. estate tax for foreign estate taxes paid with respect to
property that is includible in the decedent's U.S. estate
solely by reason of the expatriation estate tax provisions.
Explanation of Provision
The technical correction clarifies the formula for
determining the amount of the foreign tax credit allowable
against U.S. estate taxes on property includible in the
decedent's U.S. estate solely by reason of the expatriation
estate tax provisions. The credit for the estate taxes paid to
any foreign country generally is limited to the lesser of (1)
the foreign estate taxes attributable to the property
includible in the decedent's U.S. estate solely by reason of
the expatriation estate tax provisions or (2) the U.S. estate
tax attributable to property that is subject to estate tax in
such foreign country and is includible in the decedent's U.S.
estate solely by reason of the expatriation tax provisions. The
amount of taxes attributable to such property is determined on
a pro rata basis.
TECHNICAL CORRECTIONS TO THE TAXPAYER BILL OF RIGHTS 2
A. Reasonable Cause Abatement for First-Tier Intermediate
Sanctions Excise Tax (sec. 1603(a) of the Act and sec. 4962
of the Code)
Present and Prior Law
Section 4958 imposes penalty excise taxes as an
intermediate sanction in cases where organizations exempt from
tax under sections 501(c)(3) or 501(c)(4) (other than private
foundations) engage in an ``excess benefit transaction.'' The
excise tax may be imposed on certain disqualified persons
(i.e., insiders) who improperly benefit from an excess benefit
transaction and on organization managers who participate in
such a transaction knowing that it is improper.
A disqualified person who benefits from an excess benefit
transaction is subject to a first-tier penalty tax equal to 25
percent of the amount of the excess benefit. Organization
managers who participate in an excess benefit transaction
knowing that it is improper are subject to a first-tier penalty
tax of 10 percent of the amount of the excess benefit.
Additional second-tier taxes equal to 200 percent of the amount
of the excess benefit may be imposed on a disqualified person
if there is no correction of the transaction within a specified
time period.
Under section 4962, the IRS has the authority to abate
certain first-tier taxes if the taxable event was due to
reasonable cause and not to willful neglect and the event was
corrected within the applicable correction period. First-tier
taxes which may be abated include, among others, the taxes
imposed under sections 4941 (on acts of self-dealing between
private foundations and disqualified persons), 4942 (for
failure by private foundations to distribute a minimum amount
of income), and 4943 (on private foundations with excess
business holdings).
In enacting the new excise taxes on excess benefit
transactions, Congress explicitly intended to provide the IRS
with abatement authority under section 4962.\316\ However, the
abatement rules of section 4962 applied only to qualified
first-tier taxes imposed by subchapter A or C of Chapter 42.
The section 4958 excise tax is located in subchapter D of
Chapter 42. The failure to cross reference subchapter D in
section 4962 meant that IRS did not have such abatement
authority with respect to the section 4958 excise taxes.
---------------------------------------------------------------------------
\316\ See report of the House Committee on Ways and Means (H. Rept.
104-506) accompanying H.R. 2377, p. 59.
---------------------------------------------------------------------------
Explanation of Provision
The Act amends section 4962(b) to include a cross-reference
to first-tier taxes imposed by subchapter D (i.e., the section
4958 excise taxes on excess benefit transactions). Thus, the
IRS has authority to abate the first-tier excise taxes on
excess benefit transactions in cases where it is established
that the violation was due to reasonable cause and not due to
willful neglect and the transaction at issue was corrected
within the specified period.
B. Reporting by Public Charities With Respect to Intermediate Sanctions
and Certain Other Excise Tax Penalties (sec. 1603(b) of the Act and
sec. 6033 of the Code)
Present and Prior Law
Section 4958 imposes penalty excise taxes as an
intermediate sanction in cases where organizations exempt from
tax under sections 501(c)(3) or 501(c)(4) (other than private
foundations) engage in an ``excess benefit transaction.'' The
excise tax may be imposed on certain disqualified persons
(i.e., insiders) who improperly benefit from an excess benefit
transaction and on organization managers who participate in
such a transaction knowing that it is improper. No tax is
imposed on the organization itself with respect under section
4958.
Section 4911 imposes an excise tax penalty on excess
lobbying expenditures made by public charities. The tax is
imposed on the organization itself. Section 4912 imposes a
penalty excise tax on certain public charities that make
disqualifying lobbying expenditures and section 4955 imposes a
penalty excise tax on political expenditures of section
501(c)(3) organizations. Both of these penalty taxes are
imposed not only on the affected organization, but also on
organization managers who agree to an expenditure knowing that
it is improper.
Under section 4962, the IRS has the authority to abate
certain first-tier taxes if the taxable event was due to
reasonable cause and not to willful neglect and the event was
corrected within the applicable correction period. First-tier
taxes which may be abated include, among others, the taxes
imposed under section 4955.\317\
---------------------------------------------------------------------------
\317\ A separate provision in the Act makes a technical correction
to section 4962(b) to permit the abatement of first-tier penalty excise
taxes imposed under section 4958.
---------------------------------------------------------------------------
Under section 6033(b)(10), 501(c)(3) organizations are
required to report annually on Form 990 any amounts paid by the
organization under section 4911, 4912, and 4955. Thus, although
sections 4912 and 4955 impose excise taxes on organization
managers, organizations technically were not required to report
any such excise taxes paid by such managers.
In addition, under section 6033(b)(11), an organization
exempt from tax under section 501(c)(3) must report on Form 990
any amount of excise tax on excess benefit transactions paid by
the organization, or any disqualified person with respect to
such organization, during the taxable year. The Code did not
explicitly require the reporting of any excess benefit excise
taxes paid by an organization manager solely in his or her
capacity as such (i.e., an organization manager might also be a
disqualified person with respect to an excess benefit
transaction, in which case any tax paid would be reported).
Explanation of Provision
The Act makes the reporting requirements of section
6033(b)(10) and (11) consistent with the excise tax penalty
provisions to which they relate. Thus, section 6033(b)(10) is
amended to require 501(c)(3) organizations to report any
amounts of tax imposed under sections 4911, 4912, and 4955 on
the organization or any organization manager of the
organization. In addition, the Act requires reporting with
respect to any reimbursements paid by an organization with
respect to taxes imposed under sections 4912 or 4955 on any
organization manager of the organization. Section 6033(b)(11)
is amended to require 501(c)(3) organizations to report any
amounts of tax imposed under section 4958 on any organization
manager or any disqualified person, as well as any
reimbursements of section 4958 excise tax liability paid by the
organization to such organization managers or disqualified
persons.
In addition, the Act clarifies that no reporting is
required under sections 6033(b)(10) or (11) in the event a
first-tier penalty excise tax imposed under section 4955 or
section 4958 is abated by the IRS pursuant to its authority
under section 4962.
TECHNICAL CORRECTIONS TO OTHER ACTS
A. Correction of GATT Interest and Mortality Rate Provisions in the
Retirement Protection Act (sec. 1604(b)(3)
of the Act and sec. 1449(a) of the Small Business Act)
Prior Law
The Retirement Protection Act of 1994, enacted as part of
the implementing legislation for the General Agreements on
Tariffs and Trade (``GATT''), modified the actuarial
assumptions that must be used in adjusting benefits and
limitations under section 415. In general, in adjusting a
benefit that is payable in a form other than a straight life
annuity and in adjusting the dollar limitation if benefits
begin before age 62, the interest rate to be used cannot be
less than the greater of 5 percent or the rate specified by the
plan. Under GATT, the benefit is payable in a form subject to
the requirements of section 417(e)(3), then the interest rate
on 30-year Treasury securities is substituted for 5 percent.
Also under GATT, for purposes of adjusting any limit or
benefit, the mortality table prescribed by the Secretary must
be used. This provision of GATT was generally effective as of
the first day of the limitation year beginning in 1995.
The Small Business Act conformed the effective date of
these changes to the effective date of similar changes by
providing generally that, in the case of a plan that was
adopted and in effect before December, 8, 1994, the GATT change
is not effective with respect to benefits accrued before the
earlier of (1) the later of the date a plan amendment applying
the amendments is adopted or made effective or (2) the first
day of the first limitation year beginning after December 31,
1999. The Small Business Act provides that ``Determinations
under section 415(b)(2)(E) before such earlier date are to be
made with respect to such benefits on the basis of such section
as in effect on December 7, 1994 (except that the modification
made by section 1449(b) of the Small Business Job Protection
Act of 1996 shall be taken into account), and the provisions of
the plan as in effect on December 7, 1994, but only if such
provisions of the plan meet the requirements of such section
(as so in effect).''
Explanation of Provision
The provision in the Small Business Act was intended to
permit plans to apply pre-GATT law under section 415(b)(2)(E)
for a transition period. The Act conforms the statute to this
intent by providing that determinations under section
415(b)(2)(E) before such earlier date are to be made with
respect to such benefits on the basis of such section as in
effect on December 7, 1994 and the provisions of the plan as in
effect on December 7, 1994, but only if such provisions of the
plan meet the requirements of such section (as so in effect).
B. Clarify Definition of Indian Reservation Under Section 168(j)(6)
(sec. 1604(c) of the Act and sec 168(j)(6) of the Code)
Prior Law
Section 168(j)(6) provides for accelerated depreciation for
certain property located on Indian reservations. For this
purpose, the term ``Indian reservation'' means a reservation as
defined in either (a) section 3(d) of the Indian Financing Act
of 1974 (25 U.S.C. 1452(d)), or (b) section 4(10) of the Indian
Child Welfare Act of 1978 (25 U.S.C. 1903(10)). In addition,
section 45A (which provides for an incremental Indian
employment credit) incorporates by reference the same
definition of ``Indian reservation'' contained in section
168(j)(6). Section 3(d) of the Indian Financing Act of 1974
includes not only officially designated Indian reservations and
public domain Indian allotments, but also all ``former Indian
reservations in Oklahoma,'' which covers most of the State of
Oklahoma even though parts of such ``former Indian
reservations'' may no longer have a significant nexus to an
Indian tribe.
Explanation of Provision
For purposes of the section 168(j)(6) definition of
``Indian reservation,'' the term ``former reservations in
Oklahoma'' is defined as lands that are (1) within the
jurisdictional area of an Oklahoma Indian tribe as determined
by the Secretary of the Interior, and (2) recognized by such
Secretary as an area eligible for trust land status under 25
C.F.R. Part 151.
Effective Date
The provision generally is effective as if included in the
Omnibus Budget Reconciliation Act of 1993 (i.e., the technical
correction applies to property placed in service and wages paid
on or after January 1, 1994). However, the provision does not
apply to wages claimed on any original return filed prior to
March 18, 1997, nor does it apply to property placed in service
with a 10-year life or less (without regard to section 168(j))
if accelerated depreciation under section 168(j) was claimed
with respect to such property on an original return filed prior
to March 18, 1997.
C. Treatment of ``Cost-Plus'' Contracts Under Section 833 (sec. 1604(d)
of the Act and sec. 833 of the Code)
Prior Law
Section 833 provides a special deduction for eligible
health insurance organizations equal to (1) 25 percent of the
sum of: the claims incurred during the taxable year; and
expenses incurred during the year in connection with the
administration, adjustment, or settlement of claims, less (2)
the adjusted surplus as of the beginning of the year.
Explanation of Provision
The provision clarifies that, for purposes of the section
833 deduction, liabilities incurred during the taxable year
under cost-plus contracts are added to claims incurred under
section 833(b)(1)(A)(i). Similarly, for purposes of the section
833 deduction, expenses incurred during the taxable year in
connection with the administration of cost-plus contracts are
added to expenses incurred under section 833(b)(1)(A)(ii).
D. Related Parties Determined by Reference to Section 267 (sec. 1604(d)
of the Act and sec. 267(f) of the Code)
Prior Law
Section 267 disallows loses arising in transactions between
certain defined related parties. In the case of related
corporations, such losses may be deferred. Several Code
provisions, in defining related parties, often incorporate the
relationships described in section 267 by cross-reference to
such section.
Explanation of Provision
Any provision of the Internal Revenue Code of 1986 that
refers to a relationship that would result in loss disallowance
under section 267 also refers to relationships where loss is
deferred, where such relationship is applicable to the
provision.
TITLE XVII. LIMITED TAX BENEFITS SUBJECT TO THE LINE ITEM VETO ACT
(sec. 1701 of the Act)
Present and Prior Law
The Line Item Veto Act amended the Congressional Budget and
Impoundment Act of 1974 to grant the President the limited
authority to cancel specific dollar amounts of discretionary
budget authority, certain new direct spending, and limited tax
benefits. The Line Item Veto Act provides that the Joint
Committee on Taxation is required to examine any revenue or
reconciliation bill or joint resolution that amends the
Internal Revenue Code of 1986 prior to its filing by a
conference committee in order to determine whether or not the
bill or joint resolution contains any limited tax benefits and
to provide a statement to the conference committee that either
(1) identifies each limited tax benefit contained in the bill
or resolution, or (2) states that the bill or resolution
contains no limited tax benefits. The conferees determine
whether or not to include the Joint Committee's statement in
the conference report. If the conference report includes the
information from the Joint Committee on Taxation identifying
provisions that are limited tax benefits, then the President
may cancel one or more of those, but only those, provisions
that have been identified. If such a conference report contains
a statement from the Joint Committee on Taxation that none of
the provisions in the conference report are limited tax
benefits, then the President has no authority to cancel any of
the specific tax provisions, because there are no tax
provisions that are eligible for cancellation under the Line
Item Veto Act.
Explanation of Provision
The Act contains a list of provisions that were identified
by the Joint Committee on Taxation as limited tax benefits
within the meaning of the Line Item Veto Act. These provisions
are listed below.
(1) Sec. 101(c) (relating to high risk pools permitted to
cover dependents of high risk individuals)
(2) Sec. 222 (relating to limitation on qualified 501(c)(3)
bonds other than hospital bonds)
(3) Sec. 224 (relating to contributions of computer
technology and equipment for elementary or secondary school
purposes)
(4) Sec. 312(a) (relating to treatment of remainder
interests for purposes of provision relating to gain from sale
of principal residence)
(5) Sec. 501(b) (relating to indexing of alternative
valuation of certain farm, etc., real property)
(6) Sec. 504 (relating to extension of treatment of certain
rents under section 2032A to lineal descendants)
(7) Sec. 505 (relating to clarification of judicial review
of eligibility for extension of time for payment of estate tax)
(8) Sec. 508 (relating to treatment of land subject to
qualified conservation easement)
(9) Sec. 511 (relating to expansion of exception from
generation-skipping transfer tax for transfers to individuals
with deceased parents)
(10) Sec. 601 (relating to the research tax credit)
(11) Sec. 602 (relating to contributions of stock to
private foundations)
(12) Sec. 603 (relating to the work opportunity tax credit)
(13) Sec. 604 (relating to orphan drug tax credit)
(14) Sec. 701 (relating to incentives for revitalization of
the District of Columbia) to the extent it amends the Internal
Revenue Code of 1986 to create sections 1400 and 1400A
(relating to tax-exempt economic development bonds)
(15) Sec. 701 (relating to incentives for revitalization of
the District of Columbia) to the extent it amends the Internal
Revenue Code of 1986 to create section 1400C (relating to
first-time homebuyer credit for District of Columbia)
(16) Sec. 801 (relating to incentives for employing long-
term family assistance recipients)
(17) Sec. 904(b) (relating to uniform rate of tax on
vaccines) as it relates to any vaccine containing pertussis
bacteria, extracted or partial cell bacteria, or specific
pertussis antigens
(18) Sec. 904(b) (relating to uniform rate of tax on
vaccines) as it relates to any vaccine against measles
(19) Sec. 904(b) (relating to uniform rate of tax on
vaccines) as it relates to any vaccine against mumps
(20) Sec. 904(b) (relating to uniform rate of tax on
vaccines) as it relates to any vaccine against rubella
(21) Sec. 905 (relating to operators of multiple retail
gasoline outlets treated as wholesale distributors for refund
purposes)
(22) Sec. 906 (relating to exemption of electric and other
clean-fuel motor vehicles from luxury automobile
classification)
(23) Sec. 907(a) (relating to rate of tax on liquified
natural gas determined on basis of BTU equivalency with
gasoline)
(24) Sec. 907(b) (relating to rate of tax on methanol from
natural gas determined on basis of BTU equivalency with
gasoline)
(25) Sec. 908 (relating to modification of tax treatment of
hard cider)
(26) Sec. 914 (relating to mortgage financing for
residences located in disaster areas)
(27) Sec. 962 (relating to assignment of workmen's
compensation liability eligible for exclusion relating to
personal injury liability assignments)
(28) Sec. 963 (relating to tax-exempt status for certain
State worker's compensation act companies)
(29) Sec. 967 (relating to additional advance refunding of
certain Virgin Island bonds)
(30) Sec. 968 (relating to nonrecognition of gain on sale
of stock to certain farmers' cooperatives)
(31) Sec. 971 (relating to exemption of the incremental
cost of a clean fuel vehicle from the limits on depreciation
for vehicles)
(32) Sec. 974 (relating to clarification of treatment of
certain receivables purchased by cooperative hospital service
organizations)
(33) Sec. 975 (relating to deduction in computing adjusted
gross income for expenses in connection with service performed
by certain officials) with respect to taxable years beginning
before 1991
(34) Sec. 977 (relating to elective carryback of existing
carryovers of National Railroad Passenger Corporation)
(35) Sec. 1005(b)(2)(B) (relating to transition rule for
instruments described in a ruling request submitted to the
Internal Revenue Service on or before June 8, 1997)
(36) Sec. 1005(b)(2)(C) (relating to transition rule for
instruments described on or before June 8, 1997, in a public
announcement or in a filing with the Securities and Exchange
Commission) as it relates to a public announcement
(37) Sec. 1005(b)(2)(C) (relating to transition rule for
instruments described on or before June 8, 1997, in a public
announcement or in a filing with the Securities and Exchange
Commission) as it relates to a filing with the Securities and
Exchange Commission
(38) Sec. 1011(d)(2)(B) (relating to transition rule for
distributions made pursuant to the terms of a tender offer
outstanding on May 3, 1995)
(39) Sec. 1011(d)(3) (relating to transition rule for
distributions made pursuant to the terms of a tender offer
outstanding on September 13, 1995)
(40) Sec. 1012(d)(3)(B) (relating to transition rule for
distributions pursuant to an acquisition described in section
355(e)(2)(A)(ii) of the Internal Revenue Code of 1986 described
in a ruling request submitted to the Internal Revenue Service
on or before April 16, 1997)
(41) Sec. 1012(d)(3)(C) (relating to transition rule for
distributions pursuant to an acquisition described in section
355(e)(2)(A)(ii) of the Internal Revenue Code of 1986 described
in a public announcement or filing with the Securities and
Exchange Commission) as it relates to a public announcement
(42) Sec. 1012(d)(3)(C) (relating to transition rule for
distributions pursuant to an acquisition described in section
355(e)(2)(A)(ii) of the Internal Revenue Code of 1986 described
in a public announcement or filing with the Securities and
Exchange Commission) as it relates to a filing with the
Securities and Exchange Commission
(43) Sec. 1013(d)(2)(B) (relating to transition rule for
distributions or acquisitions after June 8, 1997, described in
a ruling request submitted to the Internal Revenue Service
submitted on or before June 8, 1997)
(44) Sec. 1013(d)(2)(C) (relating to transition rule for
distributions or acquisitions after June 8, 1997, described in
a public announcement or filing with the Securities and
Exchange Commission on or before June 8, 1997) as it relates to
a public announcement
(45) Sec. 1013(d)(2)(C) (relating to transition rule for
distributions or acquisitions after June 8, 1997, described in
a public announcement or filing with the Securities and
Exchange Commission on or before June 8, 1997) as it relates to
a filing with the Securities and Exchange Commission
(46) Sec. 1014(f)(2)(B) (relating to transition rule for
any transaction after June 8, 1997, if such transaction is
described in a ruling request submitted to the Internal Revenue
Service on or before June 8, 1997)
(47) Sec. 1014(f)(2)(C) (relating to transition rule for
any transaction after June 8, 1997, if such transaction is
described in a public announcement or filing with the
Securities and Exchange Commission on or before June 8, 1997)
as it relates to a public announcement
(48) Sec. 1014(f)(2)(C) (relating to transition rule for
any transaction after June 8, 1997, if such transaction is
described in a public announcement or filing with the
Securities and Exchange Commission on or before June 8, 1997)
as it relates to a filing with the Securities and Exchange
Commission
(49) Sec. 1042(b) (relating to special rules for provision
terminating certain exceptions from rules relating to exempt
organizations which provide commercial-type insurance)
(50) Sec. 1081(a) (relating to termination of suspense
accounts for family corporations required to use accrual
accounting) as it relates to the repeal of Internal Revenue
Code section 447(i)(3)
(51) Sec. 1089(b)(3) (relating to reformations)
(52) Sec. 1089(b)(5)(B)(i) (relating to persons under a
mental disability)
(53) Sec.1171 (relating to treatment of computer software
as FSC export property)
(54) Sec. 1175 (relating to exemption for active financing
income)
(55) Sec. 1204 (relating to travel expenses of Federal
employees doing criminal investigations)
(56) Sec. 1236 (relating to extension of time for filing a
request for administrative adjustment)
(57) Sec. 1243 (relating to special rules for
administrative adjustment request with respect to bad debts or
worthless securities)
(58) Sec. 1251 (relating to clarification on limitation on
maximum number of shareholders)
(59) Sec. 1253 (relating to attribution rules applicable to
tenant ownership)
(60) Sec. 1256 relating to modification of earnings and
profits rules for determining whether REIT has earnings and
profits from non-REIT years)
(61) Sec. 1257 (relating to treatment of foreclosure
property)
(62) Sec. 1261 (relating to shared appreciation mortgages)
(63) Sec. 1302 (relating to clarification of waiver of
certain rights of recovery)
(64) Sec. 1303 (relating to transitional rule under section
2056A)
(65) Sec. 1304 (relating to treatment for estate tax
purposes of short-term obligations held by nonresident alien)
(66) Sec. 1311 (relating to clarification of treatment of
survivor annuities under qualified terminable interest rules)
(67) Sec. 1312 (relating to treatment of qualified domestic
trust rules of forms of ownership which are not trusts)
(68) Sec. 1313 (relating to opportunity to correct failures
under section 2032A)
(69) Sec. 1414 (relating to fermented material from any
brewery may be received at a distilled spirits plant)
(70) Sec. 1417 (relating to use of additional ameliorating
material in certain wines)
(71) Sec. 1418 (relating to domestically produced beer may
be withdrawn free of tax for use of foreign embassies,
legations, etc.)
(72) Sec. 1421 (relating to transfer to brewery of beer
imported in bulk without payment of tax)
(73) Sec. 1422 (relating to transfer to bonded wine cellars
of wine imported in bulk without payment of tax)
(74) Sec. 1506 (relating to clarification of certain rules
relating to employee stock ownership plans of S corporations)
(75) Sec. 1507 (relating to modification of 10 percent tax
for nondeductible contributions)
(76) Sec. 1523 (relating to repeal of application of
unrelated business income tax to ESOPs)
(77) Sec. 1530 (relating to gratuitous transfers for the
benefit of employees)
(78) Sec. 1532 (relating to special rules relating to
church plans)
(79) Sec. 1604(c)(2) (relating to amendment related to
Omnibus Budget Reconciliation Act of 1993)
Line Item Veto Action
Pursuant to the authority under the Line Item Veto Act, the
President canceled the following from the above listed items:
item (30) Sec. 968 (relating to nonrecognition of gain on sale
of stock to certain farmers' cooperatives) and item (54) Sec.
1175 (relating to exemption for active financing
income).317a
---------------------------------------------------------------------------
\317a\ See House Document 105-116, Cancellation of Limited Tax
Benefit, Message from the President of the United States. A bill that
would restore and modify these canceled provisions, H.R. 2513, was
reported by the House Committee on Ways and Means (Rept. 105-318 Part
1) on October 9, 1997, and passed by the House on November 8, 1997.
PART THREE: REVENUE PROVISIONS OF THE BALANCED BUDGET ACT OF 1997 (H.R.
2015) \318\
A. Taxation of Medicare+Choice Medical Savings Accounts (sec. 4006 of
the Act and new sec. 138 of the Code)
Present and Prior Law
Under present and prior law, the value of Medicare coverage
and benefits is not includible in taxable income.
---------------------------------------------------------------------------
\318\ P.L. 105-33; August 5, 1997. H.R. 2015 was reported by the
House Committee on the Budget on June 24, 1997 (H. Rept. 105-149). The
Committee on Ways and Means approved its health and human resources
reconciliation provisions on June 9 and 10, 1997, respectively, which
were incorporated in H.R. 2015 as reported. The bill, as amended, was
passed by the House on June 25, 1997.
S. 947 was reported by the Senate Committee on the Budget on June
20, 1997 (no written report). S. 947 included the health and human
resources reconciliation provisions as approved by the Committee on
Finance on June 18, 1997. S. 947 was considered by the Senate on June
23 and 24, 1997, and was passed, as amended, on June 25, 1997.
H.R. 2015, as amended by the Senate provisions of S. 947, was
passed by the Senate on June 25, 1997. A conference report was filed in
the House on July 30, 1997 (H. Rept. 105-217); the House agreed to the
conference report on July 30, 1997; and the Senate agreed to the
conference report on July 31, 1997. H.R. 2015 was signed by the
President on August 5, 1997.
H.R. 2015, as enacted, includes the revenue-related provisions
described in this Part.
---------------------------------------------------------------------------
Individuals who itemize deductions may deduct amounts paid
during the taxable year (if not reimbursed by insurance or
otherwise) for medical expenses of the taxpayer and the
taxpayer's spouse and dependents (including expenses for
insurance providing medical care) to the extent that the total
of such expenses exceeds 7.5 percent of the taxpayer's adjusted
gross income (``AGI'').
Within limits, contributions to a medical savings account
(``MSA'') are deductible in determining AGI if made by an
eligible individual and are excludable from gross income and
wages for employment tax purposes if made by the employer of an
eligible individual.\319\ Under prior law, individuals covered
under Medicare were not eligible to have an MSA.
---------------------------------------------------------------------------
\319\ The number of MSAs which can be established is subject to a
cap.
---------------------------------------------------------------------------
Earnings on amounts in an MSA are not currently includible
in income. Distributions from an MSA for medical expenses of
the MSA account holder and his or her spouse or dependents are
not includible in income. For this purpose, medical expenses
are defined as under the itemized deduction for medical
expenses, except that medical expenses do not include any
insurance premiums other than premiums for long-term care
insurance, continuation coverage (so-called ``COBRA
coverage''), or premiums for coverage while an individual is
receiving unemployment compensation. Distributions not used for
medical expenses are subject to an additional 15-percent tax
unless the distribution is made after age 65, death, or
disability.
Under prior law, there were no tax provisions for
Medicare+Choice medical savings accounts (``Medicare+Choice
MSAs'').
Explanation of Provision
In general
Under the Act, individuals who are eligible for Medicare
are permitted to choose either the traditional Medicare program
or a Medicare+Choice MSA plan.\320\ To the extent an individual
chooses such a plan, the Secretary of Health and Human Services
makes a specified contribution directly into a Medicare+Choice
MSA designated by such individual. Only contributions by the
Secretary of Health and Human Services can be made to a
Medicare+Choice MSA and such contributions are not included in
the taxable income of the Medicare+Choice MSA holder. Income
earned on amounts held in a Medicare+Choice MSA are not
currently includible in taxable income. Withdrawals from a
Medicare+Choice MSA are excludable from taxable income if used
for the qualified medical expenses of the Medicare+Choice MSA
holder. Medical expenses of the account holder's spouse or
dependents are not treated as qualified medical expenses.
Withdrawals from a Medicare+Choice MSA that are not used for
the qualified medical expenses of the account holder are
includible in income and may be subject to an additional tax
(described below).
---------------------------------------------------------------------------
\320\ As under prior law, individuals who are eligible for Medicare
are not eligible for an MSA that is not a Medicare+Choice MSA.
---------------------------------------------------------------------------
Definition of Medicare+Choice MSAs
In general, a Medicare+Choice MSA is an MSA that is
designated as Medicare+Choice MSA and to which the only
contributions that can be made are those by the Secretary of
Health and Human Services.\321\ Thus, a Medicare+Choice MSA is
a tax-exempt trust (or a custodial account) created exclusively
for the purpose of paying the qualified medical expenses of the
account holder that meets requirements similar to those
applicable to individual retirement arrangements
(``IRAs'').\322\ The trustee of a Medicare+Choice MSA can be a
bank, insurance company, or other person that demonstrates to
the satisfaction of the Secretary of the Treasury that the
manner in which such person will administer the trust will be
consistent with applicable requirements.
---------------------------------------------------------------------------
\321\ Medicare+Choice MSAs are not taken into account for purposes
of the cap on non-Medicare+Choice MSAs, nor are they subject to that
cap.
\322\ For example, no Medicare+Choice MSA assets could be invested
in life insurance contracts, Medicare+Choice MSA assets can not be
commingled with other property except in a common trust fund or common
investment fund, and an account holder's interest in a Medicare+Choice
MSA would be nonforfeitable. In addition, if an account holder engages
in a prohibited transaction with respect to a Medicare+Choice MSA or
pledges assets in a Medicare+Choice MSA, rules similar to those for
IRAs would apply, and any amounts treated as distributed to the account
holder under such rules would be treated as not used for qualified
medical expenses.
---------------------------------------------------------------------------
A Medicare+Choice MSA trustee is required to make such
reports as may be required by the Secretary of the Treasury. A
$50 penalty is imposed for each failure to file without
reasonable cause.
Taxation of distributions from a Medicare+Choice MSA
Distributions from a Medicare+Choice MSA that are used to
pay the qualified medical expenses of the account holder are
excludable from taxable income regardless of whether the
account holder is enrolled in the Medicare+Choice MSA plan at
the time of the distribution.\323\ Qualified medical expenses
are defined as under the rules relating to the itemized
deduction for medical expenses. However, for this purpose,
qualified medical expenses do not include any insurance
premiums other than premiums for long-term care insurance,
continuation insurance (so-called ``COBRA coverage''), or
premium for coverage while an individual is receiving
unemployment compensation. Distributions from a Medicare+Choice
MSA that are excludable from gross income under the provision
can not be taken into account for purposes of the itemized
deduction for medical expenses.
---------------------------------------------------------------------------
\323\ Under the provision, medical expenses of the account holder's
spouse or dependents are not treated as qualified medical expenses.
---------------------------------------------------------------------------
Distributions for purposes other than qualified medical
expenses are includible in taxable income. An additional tax of
50 percent applies to the extent the total distributions for
purposes other than qualified medical expenses in a taxable
year exceed the amount by which the value of the
Medicare+Choice MSA as of December 31, of the preceding year
exceeds 60 percent of the deductible of the plan under which
the individual is covered on January 1 of the current year. The
additional tax does not apply to distributions on account of
the disability or death of the account holder.
Following is an example of how the amount available to be
withdrawn from a Medicare+Choice MSA without penalty is
calculated.\324\
---------------------------------------------------------------------------
\324\ The numbers are provided for illustrative purposes only.
------------------------------------------------------------------------
Year 1 Year 2 Year 3 Year 4
------------------------------------------------------------------------
1. Deductible....................... $3,000 $3,000 $3,000 $3,000
2. 60% of deductible................ 1,800 1,800 1,800 1,800
3. Contributions.................... 1,300 1,300 1,300 1,300
4. Earnings......................... 130 200 300 400
5. Total withdrawals................ 600 500 600 600
6. Closing balance (Dec. 31 of
current year)...................... 830 1,830 2,830 3,930
7. Amount available for nonmedical
withdrawal without penalty (6. from
prior year--2., or 0 if less than
0)................................. 0 0 30 1,030
------------------------------------------------------------------------
Direct trustee-to-trustee transfers can be made from one
Medicare+Choice MSA to another Medicare+Choice MSA without
income inclusion.
The provision includes a correction mechanism so that if
contributions for a year are erroneously made by the Secretary
of Health and Human Services, such erroneous contributions can
be returned to the Secretary of Health and Human Services
(along with any attributable earnings) from the Medicare+Choice
MSA without tax consequence to the account holder.
Treatment of Medicare+Choice MSA at death
Upon the death of the account holder, if the beneficiary of
the Medicare+Choice MSA is the account holder's surviving
spouse, the surviving spouse may continue the Medicare+Choice
MSA, but no new contributions could be made. Distributions from
the Medicare+Choice MSA are subject to the rules applicable to
MSAs that are not Medicare+Choice MSAs. Thus, earnings on the
account balance are not currently includible in income.
Distributions from the account for the qualified medical
expenses of the spouse or the spouse's dependents (or
subsequent spouse) are not includible in income. Distributions
not for such medical expenses are includible in income, and
subject to a 15-percent excise tax unless the distribution is
made after the surviving spouse attains age 65, dies, or
becomes disabled.
If the beneficiary of a Medicare+Choice MSA is not the
account holder's spouse, the Medicare+Choice MSA is no longer
treated as a Medicare+Choice MSA and the value of the
Medicare+Choice MSA on the account holder's date of death is
included in the taxable income of the beneficiary for the
taxable year in which the death occurred (under the rules
applicable to MSAs generally). If the account holder fails to
name a beneficiary, the value of the Medicare+Choice MSA on the
account holder's date of death is to be included in the taxable
income of the account holder's final income tax return (under
the rules applicable to MSAs generally).
In all cases, the value of the Medicare+Choice MSA is
included in the account holder's gross estate for estate tax
purposes.
Effective Date
The provision is effective with respect to taxable years
beginning after December 31, 1998.
Revenue Effect
The provision is estimated to have a negligible effect on
fiscal year budget receipts.
B. Tax Treatment of Hospitals Which Participate in
Provider-Sponsored Organizations (sec. 4041 of the Act
and new sec. 501(o) of the Code)
Present and Prior Law
To qualify as a charitable tax-exempt organization
described in section 501(c)(3), an organization must be
organized and operated exclusively for religious, charitable,
scientific, testing for public safety, literary, or educational
purposes, or to foster international sports competition, or for
the prevention of cruelty to children or animals. Although
section 501(c)(3) does not specifically mention furnishing
medical care and operating a nonprofit hospital, such
activities have long been considered to further charitable
purposes, provided that the organization benefits the community
as a whole.
No part of the net earnings of a 501(c)(3) organization may
inure to the benefit of any private shareholder or individual.
No substantial part of the activities of a 501(c)(3)
organization may consist of carrying on propaganda, or
otherwise attempting to influence legislation, and such
organization may not participate in, or intervene in, any
political campaign on behalf of (or in opposition to) any
candidate for public office. In addition, under section 501(m),
an organization described in section 501(c)(3) or 501(c)(4) is
exempt from tax only if no substantial part of its activities
consists of providing commercial-type insurance.
A tax-exempt organization may, subject to certain
limitations, enter into a joint venture or partnership with a
for-profit organization without affecting its tax-exempt
status. Under current ruling practice, the IRS examines the
facts and circumstances of each arrangement to determine (1)
whether the venture itself and the participation of the tax-
exempt organization therein furthers a charitable purpose, and
(2) whether the sharing of profits and losses or other aspects
of the arrangement entail improper private inurement or more
than incidental private benefit.\325\
---------------------------------------------------------------------------
\325\ See IRS General Counsel Memorandum 39862; Announcement 92-83,
1992-22 I.R.B. 59 (IRS Audit Guidelines for Hospitals). Even where no
prohibited private inurement exists, however, more than incidental
private benefit conferred on individuals may result in the organization
not being operated ``exclusively'' for an exempt purpose. See, e.g.,
American Campaign Academy v. Commissioner, 92 T.C. 1053 (1989).
---------------------------------------------------------------------------
Explanation of Provision
The provision provides that an organization does not fail
to be treated as organized and operated exclusively for a
charitable purpose for purposes of Code section 501(c)(3)
solely because a hospital which is owned and operated by such
organization participates in a provider-sponsored organization
(``PSO'') (as defined in section 1845(a)(1) of the Social
Security Act), whether or not such PSO is exempt from tax.
Thus, participation by a hospital in a PSO (whether taxable or
tax-exempt) is deemed to satisfy the first part of the inquiry
under current IRS ruling practice.\326\
---------------------------------------------------------------------------
\326\ The qualification of a hospital as a tax-exempt charitable
organization under section 501(c)(3) is determined as under present
law. See Rev. Rul. 69-545, 1969-2 C.B. 117.
---------------------------------------------------------------------------
The provision does not change present-law restrictions on
private inurement and private benefit. However, the provision
provides that any person with a material financial interest in
such a PSO shall be treated as a private shareholder or
individual with respect to the hospital for purposes of
applying the private inurement prohibition in Code section
501(c)(3). Accordingly, the facts and circumstances of each PSO
arrangement are evaluated to determine whether the arrangement
entails impermissible private inurement or more than incidental
private benefit (e.g., where there is a disproportionate
allocation of profits and losses to the non-exempt partners,
the tax-exempt partner makes loans to the joint venture that
are commercially unreasonable, the tax-exempt partner provides
property or services to the joint venture at less than fair
market value, or a non-exempt partner receives more than
reasonable compensation for the sale of property or services to
the joint venture).
The provision does not change present-law restrictions on
lobbying and political activities. In addition, the
restrictions of Code section 501(m) on the provision of
commercial-type insurance continue to apply.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to have a negligible revenue
effect on Federal fiscal year budget receipts in each of 1997
through 2007.
C. Provision of Employer Identification Numbers by Medicare Providers
(sec. 4313 of the Act)
Present Law
Entities participating in Medicare, Medicaid and the
Maternal and Child Health Block Grant programs are required to
provide certain information regarding the identity of each
person with an ownership or control interest in the entity or
in any subcontractor in which the entity has a direct or
indirect 5 percent or more ownership interest. Providers under
part B of Medicare also are required to provide information
regarding persons with an ownership or control interest in a
provider or any subcontractor in which the provider has a
direct or indirect 5 percent or more ownership interest.
Explanation of Provision
The Act requires that all Medicare providers supply the
Secretary of HHS with the employer identification number
(``EIN'') of each disclosing entity, each person with an
ownership or control interest, and any subcontractor in which
the entity has a direct or indirect 5 percent or more ownership
interest. The Secretary of HHS is required to transmit to the
Secretary of the Treasury the EIN's received, and the Secretary
of the Treasury is directed to verify or correct the EINs. The
Secretary of HHS is to reimburse the Secretary of the Treasury
for the costs incurred in performing the verification and
correction.
Effective Date
The provision is effective 90 days after the Secretary of
HHS submits to the Congress a report on the steps taken to
ensure the confidentiality of social security account numbers
required to be provided to the Secretary of HHS.
Revenue Effect
The provision is estimated to have a negligible effect on
fiscal year budget receipts in each of 1997 through 2007.
D. Disclosure of Tax Return Information for Verification
of Employment Status of Medicare Beneficiaries and
the Spouse of a Medicare Beneficiary (sec. 4631(c) of the
Act and sec. 6103(l)(12) of the Code)
Present Law
The Internal Revenue Code prohibits disclosure of tax
returns and return information, except to the extent
specifically authorized by the Internal Revenue Code (sec.
6103). Unauthorized disclosure is a felony punishable by a fine
not exceeding $5,000 or imprisonment of not more than five
years, or both (sec. 7213). An action for civil damages also
may be brought for unauthorized disclosure (sec. 7431). No tax
information may be furnished by the Internal Revenue Service
(``IRS'') to another agency unless the other agency establishes
procedures satisfactory to the IRS for safeguarding the tax
information it receives (sec. 6103(p)).
Among the disclosures permitted under the Code is
disclosure of taxpayer filing status and identity information
for the purpose of verifying the employment status of Medicare
beneficiaries and the spouse of a Medicare beneficiary.
The Medicare disclosure provision was generally scheduled
to expire after September 30, 1998.
Explanation of Provision
The Act permanently extends the Medicare disclosure
provision.
Effective Date
The provision is effective on the date of enactment (August
5, 1997).
Revenue Effect
The provision is estimated to have no effect on Federal
fiscal year budget receipts.
E. Unemployment Tax Provisions
1. Exemption from service performed by election workers from the
Federal Unemployment Tax (sec. 5405 of the Act and sec. 3309(b)
of the Code)
Present Law
The Federal Unemployment Tax Act (``FUTA'') generally
requires States to cover under their unemployment compensation
laws service performed in the employ of a State or local
government. Only certain enumerated exceptions are allowed.
Reasons for Change
The Congress believes that short-term employment as an
election official or election worker should not form the basis
for participation in the unemployment compensation system.
Explanation of Provision
The Act exempts from FUTA service performed as an election
official or election worker. This exemption applies only if the
annual wages received by the individual for such service are
less than $1,000. These persons are also ineligible to claim
unemployment benefits with respect to such wages.
Effective Date
The provision was effective with respect to service
performed after the date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $1 million in 1998 and have a negligible
effect on Federal fiscal year budget receipts thereafter.
2. Treatment of certain services performed by inmates (sec. 5406 of the
Act and sec. 3306 of the Code)
Present and Prior Law
The Federal Unemployment Tax Act (``FUTA'') imposes a 6.2-
percent gross tax rate on the first $7,000 of wages paid
annually by covered employers to each employee. Generally,
wages are defined to include all remuneration for employment
unless specifically exempted. Under prior law, there was no
exemption for wages paid to persons committed to penal
institutions who earn wages through private-sector jobs.
Reasons for Change
The Congress believed that employment while committed to
penal institutions should not form the basis for participation
in the unemployment compensation system.
Explanation of Provision
The Act exempts wages paid to persons committed to penal
institutions from the definition of wages for FUTA tax
purposes. These persons are also ineligible to claim
unemployment benefits with respect to such wages.
Effective Date
The provision was effective with respect to service
performed after January 1, 1994.
Revenue Effect
The provision is estimated to reduce Federal fiscal year
budget receipts by less than $500,000 a year.
3. Exemption of service performed for an elementary or secondary school
operated primarily for religious purposes from the Federal
unemployment tax (sec. 5407 of the Act and sec. 3309(b) of the
Code)
Present and Prior Law
The Federal Unemployment Tax Act (``FUTA'') requires States
to cover under their unemployment compensation laws certain
nonprofit organizations designated under FUTA that are not
subject to the FUTA tax. These nonprofit organizations
generally must elect whether to pay State unemployment taxes or
reimburse the State unemployment insurance agency for the
benefits provided to its former employees. However, FUTA
exempts from coverage under State unemployment compensation
laws service performed in the employ of: (1) a church or
convention or association of churches, or (2) an organization
which is operated primarily for religious purposes and which is
operated, supervised, controlled, or principally supported by a
church or convention or association of churches. Under prior
law, services provided by individuals who are in the employ of
entities with a religious orientation which are not affiliated
with a particular church, or convention or association of
churches were not exempt from State unemployment compensation
laws.
Reasons for Change
The Congress believed that employees of certain schools
with a religious orientation should be treated similarly for
FUTA tax purposes regardless of the school's affiliation, or
lack thereof, with a particular church, or convention, or
association of churches.
Explanation of Provision
The Act exempts from FUTA requirements of coverage under
State unemployment compensation laws service performed in an
elementary or secondary school which is operated primarily for
religious purposes. This exemption is available to such schools
even though they are not operated, supervised, controlled, or
principally supported by a church or convention or association
of churches. Persons performing such service are also
ineligible to claim unemployment benefits with respect to such
wages
Effective Date
The provision was effective with respect to service
performed after the date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by $2 million in fiscal year 1998 and have a
negligible revenue effect thereafter.
F. Earned Income Credit Provision
1. Authorization of appropriations for enforcement initiatives related
to the earned income credit (sec. 5702)
Present Law
Certain eligible low-income workers are entitled to claim a
refundable earned income credit on their income tax return. A
refundable credit is a credit that not only reduces an
individual's tax liability but allows refunds to the individual
in excess of income tax liability. The amount of the credit an
eligible individual may claim depends upon whether the
individual has one, more than one, or no qualifying children,
and is determined by multiplying the credit rate by the
individual's earned income up to an earned income amount. The
maximum amount of the credit is the product of the credit rate
and the earned income amount. The credit is reduced by the
amount of the alternative minimum tax (``AMT'') the taxpayer
owes for the year. The credit is phased out above certain
income levels.
The Taxpayer Relief Act of 1997 modified the Code to
include several earned income credit compliance initiatives.
Prior to fiscal year 1998 however, there was no explicit
authorization of appropriations for the enforcement of the
earned income credit.
Reasons for Change
The Congress believes that this provision will lead to
better enforcement of the earned income credit.
Explanation of Provision
The Act authorizes to be appropriated to the Secretary of
the Treasury for improved application of the earned income
credit, the following amounts: $138 million in FY 1998, $143
million in FY 1999, $144 million in FY 2000, $145 million in FY
2001, and $146 million in FY 2002.
Effective Date
The provision was effective on the date of enactment
(August 5, 1997).
Revenue Effect
The provision is estimated to have no effect on Federal
fiscal year budget receipts.
G. Increase in Excise Tax on Tobacco Products (sec. 9302 of the Act,
sec. 1604(f)(3) of the Taxpayer Relief Act of 1997, and sec. 5701 of
the Code)
Present Law
The following is a listing of the Federal excise tax rates
imposed on tobacco products under present law (through December
31, 1999):
------------------------------------------------------------------------
Article Tax rate
------------------------------------------------------------------------
Cigars:
Small cigars................. $1.125 per thousand.
Large cigars................. 12.75% of manufacturer's price, up to
$30 per thousand.
Cigarettes:
Small cigarettes............. $12.00 per thousand (24 cents per
pack of 20 cigarettes).
Large cigarettes............. $25.20 per thousand.
Cigarette papers................. $0.0075 per 50 papers.
Cigarette tubes.................. $0.15 per 50 tubes.
Chewing tobacco.................. $0.12 per pound.
Snuff............................ $0.36 per pound.
Pipe tobacco..................... $0.675 per pound.
------------------------------------------------------------------------
Reasons for Change
The Congress determined that it is appropriate to increase
excise taxes on tobacco products, and to extend the tax to
``roll-your-own'' tobacco. Raising such taxes will have the
positive effect of discouraging smoking, particularly by
children and teenagers.
Explanation of Provision
In general
The Act increases the current excise tax rates on all
tobacco products, including cigarettes, cigars, chewing
tobacco, snuff, and pipe tobacco, effective in two stages:
January 1, 2000 and January 1, 2002. Excise tax is also imposed
on ``roll-your-own'' tobacco, beginning in 2000. Floor stocks
taxes are imposed on tobacco products at the time of the rate
increases (including tobacco products in foreign trade zones).
The Act also includes expanded compliance measures designed to
prevent diversion of non-tax-paid tobacco products nominally
destined for export to use within the United States.
Specific tax rate increases
Tax rates for 2000 and 2001
The following table shows the specific tobacco excise tax
rates under the Act in effect for the period, January 1, 2000-
December 31, 2001:
------------------------------------------------------------------------
Tax rate (January 1, 2000-December
Article 31, 2001)
------------------------------------------------------------------------
Cigars:
Small cigars................. $1.594 per thousand.
Large cigars................. 18.063% of manufacturer's price, up
to $42.50 per thousand.
Cigarettes:
Small cigarettes............. $17.00 per thousand (34 cents per
pack of 20 cigarettes).
Large cigarettes............. $35.70 per thousand.
Cigarette papers................. $0.0106 per 50 papers.
Cigarette tubes.................. $0.0213 per 50 tubes.
Chewing tobacco.................. $0.17 per pound.
Snuff............................ $0.51 per pound.
Pipe tobacco..................... $0.9567 per pound.
Roll-your-own tobacco............ $0.9567 per pound.
------------------------------------------------------------------------
Tax rates for 2002 and thereafter
The following table shows the specific tobacco excise tax
rates in effect for 2002 and thereafter:
------------------------------------------------------------------------
Article Tax rate (2002 and thereafter)
------------------------------------------------------------------------
Cigars:
Small cigars................. $1.828 per thousand.
Large cigars................. 20.719% of manufacturers price, up to
$48.75 per thousand.
Cigarettes:
Small cigarettes............. $19.50 per thousand (39 cents per
pack of 20 cigarettes).
Large cigarettes............. $40.95 per thousand.
Cigarette papers................. $0.0122 per 50 papers.
Cigarette tobacco................ $0.0244 per 50 tubes.
Chewing tobacco.................. $0.19 cents per pound.
Snuff............................ $0.585 cents per pound.
Pipe tobacco..................... $1.0969 per pound.
Roll-your-own tobacco............ $1.0969 per pound.
------------------------------------------------------------------------
Coordination with tobacco industry settlement agreement
Section 1604(f)(3) of the Taxpayer Relief Act of 1997
provided that the increase in tobacco excise taxes collected as
a result of the above increases are to be ``credited against
the total payments made by parties pursuant to Federal
legislation implementing the tobacco industry settlement
agreement of June 20, 1997.'' \327\
---------------------------------------------------------------------------
\327\ This provision was repealed under section 519 of the Fiscal
Year 1998 Appropriations for Labor, Health and Human Resources (H.R.
2264) as passed by the Congress and signed by the President (P.L. 105-
78, November 13, 1997).
---------------------------------------------------------------------------
Effective Date
The provision generally is effective on January 1, 2000.
Revenue Effect
The provision is estimated to increase fiscal year budget
receipts by $1,175 million in 2000, $1,720 million in 2001,
$2,272 million in 2002, $2,280 million in 2003, $2,290 million
in 2004, $2,300 million in 2005, $2,310 million in 2006, and
$2,320 million in 2007.
H. Identification of Limited Tax Benefits Subject to Line Item Veto
(sec. 9304 of the Act)
Present and Prior Law
The Line Item Veto Act amended the Congressional Budget and
Impoundment Act of 1974 to grant the President the limited
authority to cancel specific dollar amounts of discretionary
budget authority, certain new direct spending, and limited tax
benefits. The Line Item Veto Act provides that the Joint
Committee on Taxation is required to examine any revenue or
reconciliation bill or joint resolution that amends the
Internal Revenue Code of 1986 prior to its filing by a
conference committee in order to determine whether or not the
bill or joint resolution contains any limited tax benefits and
to provide a statement to the conference committee that either
(1) identifies each limited tax benefit contained in the bill
or resolution, or (2) states that the bill or resolution
contains no limited tax benefits. The conferees determine
whether or not to include the Joint Committee's statement in
the conference report. If the conference report includes the
information from the Joint Committee on Taxation identifying
provisions that are limited tax benefits, then the President
may cancel one or more of those, but only those, provisions
that have been identified. If such a conference report contains
a statement from the Joint Committee on Taxation that none of
the provisions in the conference report are limited tax
benefits, then the President has no authority to cancel any of
the specific tax provisions, because there are no tax
provisions that are eligible for cancellation under the Line
Item Veto Act.
Explanation of Provision
The Balanced Budget Act of 1997 contains a provision that
has been identified by the Joint Committee on Taxation as a
limited tax benefit within the meaning of the Line Item Veto
Act. The provision is section 5406 of the Balanced Budget Act,
relating to treatment of certain services performed by inmates.
PART FOUR: TAXPAYER BROWSING PROTECTION ACT (H.R. 1226) \328\
---------------------------------------------------------------------------
\328\ P.L. 105-35; August 5, 1997. H.R. 1226 was reported by the
House Committee on Ways and Means on April 14, 1997 (H. Rept. 105-51).
The bill, as amended, passed the House on April 15, 1997, and was
passed by the Senate on July 23, 1997. H.R. 1226 was signed by the
President on August 5, 1997.
---------------------------------------------------------------------------
Present and Prior Law
The Internal Revenue Code prohibits disclosure of tax
returns and return information, except to the extent
specifically authorized by the Internal Revenue Code (sec.
6103). Unauthorized willful disclosure is a felony punishable
by a fine not exceeding $5,000 or imprisonment of not more than
five years, or both (sec. 7213). An action for civil damages
also may be brought for unauthorized disclosure (sec. 7431).
There is no explicit criminal penalty in the Internal
Revenue Code for unauthorized inspection (absent subsequent
disclosure) of tax returns and return information. Such
inspection is, however, explicitly prohibited by the Internal
Revenue Service (``IRS'').\329\ In a recent case, an individual
was convicted of violating the Federal wire fraud statute (18
U.S.C. 1343 and 1346) and a Federal computer fraud statute (18
U.S.C. 1030) for unauthorized inspection. However, the U.S.
First Circuit Court of Appeals overturned this conviction.\330\
Unauthorized inspection of information of any department or
agency of the United States (including the IRS) via computer
was made a crime under 18 U.S.C. 1030 by the Economic Espionage
Act of 1996.\331\ This provision does not apply to unauthorized
inspection of paper documents.
---------------------------------------------------------------------------
\329\ IRS Declaration of Privacy Principles, May 9, 1994.
\330\ U.S. v. Czubinski, DTR 2/25/97, p. K-2.
\331\ P.L. 104-294, sec. 201 (October 11, 1996).
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that it is important to have a
criminal penalty in the Internal Revenue Code to punish this
type of behavior. The Congress also believed that it is
appropriate to provide for civil damages for unauthorized
inspection parallel to civil damages for unauthorized
disclosure.
Explanation of Provisions
Criminal penalties (sec. 2 of the Act and new sec. 7213A of the Code)
The Act creates a new criminal penalty in the Internal
Revenue Code. The penalty is imposed for willful inspection
(except as authorized by the Code) of any tax return or return
information by any Federal employee or IRS contractor. The
penalty also applies to willful inspection (except as
authorized) by any State employee or other person who acquired
the tax return or return information under specific provisions
of section 6103. Upon conviction, the penalty is a fine in any
amount not exceeding $1,000,\332\ or imprisonment of not more
than 1 year, or both, together with the costs of prosecution.
In addition, upon conviction, an officer or employee of the
United States would be dismissed from office or discharged from
employment.
---------------------------------------------------------------------------
\332\ Pursuant to 18 U.S.C. sec. 3571 (added by the Sentencing
Reform Act of 1984), the amount of the fine is not more than the
greater of the amount specified in this new Code section or $100,000.
---------------------------------------------------------------------------
The Congress viewed any unauthorized inspection of tax
returns or return information as a very serious offense; this
new criminal penalty reflects that view. The Congress also
believed that unauthorized inspection warrants very serious
personnel sanctions against IRS employees who engage in
unauthorized inspection, and that it is appropriate to fire
employees who do this.
Civil damages (sec. 3 of the Act and sec. 7431 of the Code)
The Act amends the provision providing for civil damages
for unauthorized disclosure by also providing for civil damages
for unauthorized inspection. Damages are available for
unauthorized inspection that occurs either knowingly or by
reason of negligence. Accidental or inadvertent inspection that
may occur (such as, for example, by making an error in typing
in a TIN) would not be subject to damages because it would not
meet this standard. The Act also provides that no damages are
available to a taxpayer if that taxpayer requested the
inspection or disclosure.
The Act also requires that, if any person is criminally
charged by indictment or information with inspection or
disclosure of a taxpayer's return or return information in
violation of section 7213 (a) or (b), new section 7213A (as
added by the Act), or 18 USC section 1030(a)(2)(B), the
Secretary notify that taxpayer as soon as practicable of the
inspection or disclosure.
Effective Date
The Act is effective for violations occurring on or after
the date of enactment (August 5, 1997).
Revenue Effect
The provision is estimated to increase Federal fiscal year
budget receipts by less than $1 million per year in 1997
through 2007.
PART FIVE: EXTENSION OF HIGHWAY TRUST FUND
(S. 1519) \333\
(Sec. 9 of S. 1519 and secs. 9503, 9504(c) and 9511(c) of the Code)
Prior Law
Under prior law, the Internal Revenue Code (sec. 9503)
authorized expenditures (subject to appropriations) to be made
from the Highway Trust Fund through September 30, 1997, for
purposes provided in specified authorizing legislation as in
effect on the date of enactment of the most recent authorizing
Act (the Intermodal Surface Transportation Efficiency Act of
1991).\334\
---------------------------------------------------------------------------
\333\ P.L. 105-130; December 1, 1997 (Section 9 of the Surface
Transportation Extension Act of 1997). S. 1519 was passed by the Senate
on November 10, 1997, and by the House on November 12, 1997. The Act
was signed by the President on December 1, 1997.
\334\ The other authorizing Acts referenced in the Highway Trust
Fund are the Highway Revenue Act of 1956, Titles I and II of the
Surface Transportation Assistance Act of 1982, and the Surface
Transportation and Uniform Relocation Act of 1987.
---------------------------------------------------------------------------
Highway Trust Fund provisions also provided for transfer of
11.5 cents per gallon of the revenues from the excise tax
imposed on motor fuels used in motorboats and off-highway
recreational vehicles. Those revenues were transferred from the
Highway Trust Fund to the Boat Safety Account of the Aquatic
Resources Trust Fund (up to $70 million per year), the Land and
Water Conservation Fund ($1 million per year), and the National
Recreational Trails Trust Fund, respectively, through September
30, 1997.\335\ Revenues from the gasoline tax used in small
engines were transferred to the Sport Fish Restoration Account
of the Aquatic Resources Trust Fund through September 30, 1997.
Expenditures were and are authorized from the Boat Safety
Account of the Aquatic Resources Trust Fund through March 31,
1998. Expenditures were authorized from the National
Recreational Trails Trust Fund through September 30, 1997.
---------------------------------------------------------------------------
\335\ No amounts have actually been transferred yet to the National
Recreational Trails Trust Fund because no obligations have been made
for that Trust Fund.
---------------------------------------------------------------------------
Reasons for Change
The Congress extended Highway Trust Fund program
authorizations for 6 months in this Act (``Surface
Transportation Extension Act of 1997''), and determined that
the Highway Trust Fund expenditure authority needed to be
extended and updated to reflect the expenditure purposes
authorized under this Act during fiscal year 1998.
Explanation of Provision
The Act extends the authority to make expenditures (subject
to appropriations) from the Highway Trust Fund through
September 30, 1998. The Act also updates the Highway Trust Fund
cross reference to authorizing legislation to include
expenditure purposes in this Act as in effect on the date of
enactment.
In addition, the Act extends the deadline for the transfer
from the Highway Trust Fund of revenues from the tax on
gasoline and special motor fuels used in motorboats, gasoline
used in small engines, and motor fuels used in off-highway
recreational vehicles through September 30, 1998. Further, the
Act extends the expenditure authority from the Boat Safety
Account of the Aquatic Resources Trust Fund for 6 months,
through September 30, 1998, and extends the expenditure
authority from the National Recreational Trails Trust Fund
through September 30, 1998.\336\
---------------------------------------------------------------------------
\336\ This Act includes an authorization from the Highway Trust
Fund for the National Recreational Trails Program.
---------------------------------------------------------------------------
Effective Date
The provision was effective on October 1, 1997.
Revenue Effect
The provision has no effect on Federal fiscal year budget
receipts.
=======================================================================
A P P E N D I X
=======================================================================
APPENDIX:
ESTIMATED BUDGET EFFECTS OF TAX LEGISLATION ENACTED IN 1997
Fiscal Years 1997-2007
[Millions of dollars]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Provision Effective 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1997-07
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
PART ONE: AIRPORT AND AIRWAY TRUST FUND
1. Extension of Airport and Airway Trust Fund
excise taxes through 9/30/97................ tp 7 data
DOE 2,730 -54 ......... ......... ......... ......... ......... ......... ......... ......... ......... 2,676
------------------------------------------------------------------------------------------------------------------------------------
Subtotal: H.R. 668...................... 2,730 -54 ......... ......... ......... ......... ......... ......... ......... ......... ......... 2,676
====================================================================================================================================
PART TWO: TAXPAYER RELIEF ACT OF 1997 (H.R.
2014)
Title I. Child Tax Credit
A. Tax Credit for Children Under Age 17 ($400
in 1998, and $500 thereafter: $75,000/
$110,000 AGI phaseout for credit;
nonrefundable for small families, refundable
and limited to tax plus employee FICA minus
EIC for large families) (\1\)(\2\)........... tyba
12/31/97 ......... -2,710 -18,119 -21,549 -21,401 -21,258 -20,901 -20,430 -19,702 -18,997 -18,317 -183,384
B. Expand Definition of High-Risk Individuals
with Respect to Tax-Exempt State-Sponsored
Organizations Providing Health Coverage...... tyba
12/31/97 ......... -1 -2 -2 -2 -2 -2 -2 -2 -2 -2 -17
Title II. Education Tax Incentives
A. Tax Benefits Relating to Education Expenses
1. HOPE credit, 100% credit for first $1,000
of eligible expenses, 50% credit for next
$1,000, 20% credit for third and fourth
year students for up to $5,000 of expenses;
for years after 2002, expenses are
increased to $10,000 (effective date of the
20% credit is 7/1/98); eligible expenses
for HOPE credit are indexed in 2001; income
limits for both credits indexed in 2001.... pma &
tyba
12/31/97 ......... -2,083 -6,469 -7,393 -7,907 -7,707 -8,620 -8,754 -8,893 -9,035 -9,180 -76,041
2. Deduction for student loan interest:
$1,000 above-the-line deduction in 1998,
$1,500 in 1999, $2,000 in 2000, $2,500 in
2001 and thereafter; phaseout $40,000--
$55,000 single filers ($60,000--$75,000
joint filers); income limits indexed
beginning in 2003.......................... poida
12/31/97 ......... -18 -69 -122 -204 -277 -308 -326 -346 -368 -391 -2,429
3. Penalty-free withdrawals from IRAs for
undergraduate, post-secondary vocational,
and graduate education expenses............ da
12/31/97 ......... -78 -201 -181 -175 -177 -179 -182 -184 -186 -189 -1,732
4. Expand State-sponsored prepaid tuition
and State savings programs to include room
and board (\3\)............................ tyba
12/31/97 ......... -36 -107 -118 -130 -143 -157 -173 -190 -209 -230 -1,491
5. Education IRA--permit contributions to
Education IRA for a child under age 18;
annual contributions limited to $500 per
child; impose phaseout range of $95,000-
$110,000 for single filers and $150,000-
$160,000 for joint filers (\4\)............ tyba
12/31/97 ......... -156 -644 -912 -1,060 -1,126 -1,448 -1,752 -2,054 -2,360 -2,680 -14,193
B. Other Education-Related Tax Provisions
1. Extend employer-provided education
assistance for undergraduates through 5/31/
00 (\1\)................................... tyba
12/31/96 ......... -534 -369 -250 ......... ......... ......... ......... ......... ......... ......... -1,153
2. Repeal $150 million limit on tax-exempt
section 501(c)(3) bonds for new capital
expenditures............................... bia
DOE ......... -6 -45 -75 -89 -99 -106 -115 -125 -138 -162 -962
3. Raise small issuer arbitrage rebate
exception for governmental bonds used to
finance education facilities from $5
million to $10 million..................... bia
12/31/97 ......... -1 -4 -7 -11 -14 -27 -30 -33 -36 -38 -199
4. Enhanced deduction for corporate
contributions of computer technology and
equipment for grades K-12; sunset after 3
years...................................... tyba
12/31/97 ......... -46 -48 -77 -49 -5 -1 ......... ......... ......... ......... -227
5. Treatment of cancellation of certain
student loans.............................. Doia
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
6. Tax credit for holders of qualified
education bonds (limited to $400 million
per year in loans); 2-year sunset.......... qza bia
12/31/97 ......... -8 -27 -43 -47 -47 -47 -47 -47 -47 -47 -408
Title III. Savings and Investment Tax
Incentives
A. Individual Retirement Arrangements--
Increase deductible IRA income limits by
$10,000 for joint filers in 1998 ($5,000 for
single filers in 1998) and by $1,000 per year
through 2002; in 2003 increase to $40,000 for
single filers and $60,000 for joint filers
and by $5,000 per year thereafter until
limits are $50,000-$60,000 for single filers
and $80,000-$100,000 for joint filers (phase
out range increases to $20,000 when lower
limit reaches $100,000); penalty-free
withdrawals for educational purposes and
first-time home purchase only; create Roth
IRA; impose phase-out range of $95,000-
$110,000 for single filers and $150,000-
$160,000 for joint filers; impose $150,000-
$160,000 income phase-out for spousal IRAs;
provide that aggregate contributions to
deductible and nondeductible retirement IRAs
may not exceed $2,000........................ tyba
12/31/97 ......... -367 -345 86 -346 -860 -1,830 -3,292 -3,482 -4,424 -5,004 -20,225
B. Capital Gains Provisions: (a) 20%/10% rate
structure; (b) retain 28%/15% for
collectibles, includible gain from small
business stock, and assets held more than 1
year but not more than 18 months; (c) 25%
maximum rate for unrecaptured section 1250
gain; (d) 18%/8% for assets held more than 5
years after 2000, with mark-to-market in
2001; assets qualify for 18% only if
purchased after 2000; (e) symmetric AMT
rates; (f) exclusion of gain on personal
residences (including remainder interests);
(g) no information reporting on sales of
principal residences less than $250,000 or
$500,000 (married filing joint return); (h)
tax-free rollover of qualified small business
stock held more than 6 months by individuals;
and (i) corporate alternative rate limited to
taxable income............................... various
(\5\) 1,254 6,371 171 -2,954 -2,934 -1,785 -3,742 -3,981 -4,179 -4,424 -4,958 -21,161
Title IV. Alternative Minimum Tax Provisions
A. Repeal Alternative Minimum Tax for Small
Businesses and Modify the Depreciation
Adjustment
1. Repeal of the alternative minimum tax for
small corporations......................... tyba
12/31/97 ......... -97 -171 -131 -100 -77 -59 -45 -34 -26 -20 -762
2. Conform AMT depreciation lives to the
regular tax................................ ppisa
12/31/98 ......... ......... -580 -1,653 -2,230 -2,358 -2,561 -2,622 -2,350 -2,044 -1,920 -18,317
B. Repeal AMT Installment Method Adjustment
for Farmers.................................. di tyba
12/31/87 -8 -157 -158 -167 -164 -157 -148 22 22 21 21 -872
Title V. Estate, Gift, and Generation-Skipping
Tax Provisions
A. Estate and Gift Tax Provisions
1. Increase unified estate and gift tax
credit to $625,000 in 1998; $650,000 in
1999; $675,000 in 2000 and 2001; $700,000
in 2002 and 2003, $850,000 in 2004,
$950,000 in 2005; $1 million in 2006 and
thereafter; and index other provisions
beginning in 1999; cap family owned
business exclusion with unified credit at
$1.3 million annually (exclude $675,000 in
1998, $650,000 in 1999, $625,000 in 2000,
$625,000 in 2001, $600,000 in 2002 and
2003, $450,000 in 2004, $350,000 in 2005;
$300,000 in 2006 and thereafter)........... dda
12/31/97 ......... ......... -843 -1,259 -1,816 -2,013 -2,596 -2,997 -5,656 -7,279 -8,638 -33,097
2. Reduce section 6601(j) interest rate to
2% for first $1 million of taxable closely-
held business interests, remainder subject
to tax at 45% of present-law interest
rates, and all interest under section 6166
made nondeductible......................... dda
12/31/97 ......... ......... -9 -17 -25 -33 -41 -47 -53 -58 -65 -349
3. Extension of treatment of certain rents
under section 2032A to lineal descendants.. roa
12/31/76 ......... -25 -2 -2 -2 -2 -2 -2 -2 -2 -2 -43
4. Clarification of judicial review of
eligibility for extension of time for
payment of estate tax...................... dda
DOE ......... ......... -15 -15 -15 -15 -15 -15 -14 -12 -11 -127
5. Gifts may not be revalued for estate tax
purposes after expiration of statute of
limitations................................ gma
DOE ......... ......... -16 -18 -21 -26 -32 -38 -45 -53 -61 -310
6. Repeal certain throwback rules applicable
to domestic trusts; exclude pre-1984
multiple trusts from repeal................ Dmi tyba
DOE ......... ......... -11 -11 -11 -11 -11 -11 -11 -11 -11 -99
7. Provide up to $500,000 estate tax
exclusion (phasein by $100,000 annually
beginning in 1998) for treatment of land
subject to a qualified conservation
easement coordinated with exclusion of
family farms and business relief (with
expanded treatment of land with severed
mineral rights)............................ dda
12/31/97 ......... ......... -7 -15 -25 -35 -48 -51 -56 -60 -64 -361
B. Generation-Skipping Tax Provision
1. Expand exception from generation-skipping
transfer tax for transfers to individuals
with deceased parents...................... gsta
12/31/97 ......... ......... -4 -4 -4 -4 -4 -5 -5 -5 -6 -41
Title VI. Extension of Certain Expiring Tax
Provisions
A. Research Tax Credit (through 6/30/98)..... 6/1/97 -161 -820 -639 -294 -204 -123 -33 ......... ......... ......... ......... -2,274
B. Contributions of Appreciated Stock to
Private Foundations (through 6/30/98)........ 6/1/97 ......... -99 -9 -4 ......... ......... ......... ......... ......... ......... ......... -112
C. Work Opportunity Tax Credit (through 6/30/
98 (\6\)).................................... wpoifhma
9/30/97 ......... -140 -131 -73 -28 -11 -2 ......... ......... ......... ......... -385
D. Orphan Drug Tax Credit (permanent)......... epoia
5/31/97 ......... -29 -28 -30 -32 -34 -35 -37 -39 -40 -42 -346
Title VII. District of Columbia Tax Incentives
1. Designate existing D.C. enterprise
community and census tracts with greater than
20% poverty (with revised residency
requirement) as the D.C. Enterprise Zone,
eligible for modified present-law empowerment
zone incentives (20% wage credit, increased
179 expensing, and expanded tax-exempt
financing); sunset 12/31/02.................. 1/1/98 ......... -71 -110 -113 -118 -127 -45 3 2 (\7\) -2 -582
2. Provide 0% capital gains rate on enterprise
zone business property in D.C. census tracts
with greater than 10% poverty held for at
least 5 years; sunset 12/31/02............... 1/1/98 ......... -1 -5 -12 -21 -33 -48 -85 -90 -99 -107 -502
3. $5,000 tax credit for first-time homebuyer
in D.C., with phaseout of $110,000-$130,000
for joint filers ($70,000-$90,000 for single
filers), and sunset 12/31/00................. po/a
DOE ......... -10 -21 -27 -16 (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) -74
Title VIII. Welfare-To-Work Tax Credit
1. Administration's welfare-to-work tax
credit, as modified:
(a) wage credit is 35% on first $10,000 of
wages in the first year of employment, and
50% on $10,000 of wages in the second year of
employment; (b) effective for hires made
through 4/30/99.............................. wpoifhma
12/31/97 ......... -13 -31 -29 -15 -10 -4 -2 -1 ......... ......... -106
Title IX. Miscellaneous Provisions
A. Excise Tax Provisions
1. Transfer of General Fund highway fuels
tax revenues to the Highway Trust Fund:
a. Transfer the 4.3 cents/gallon
transportation motor fuels tax on highway
motor fuels to the Highway Trust Fund.... 10/1/97 ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
b. Modify excise tax deposit rules for
gasoline and special motor fuels, diesel
fuel and kerosene, aviation fuels, and
air cargo taxes to suspend deposits due 8/
1/98 to 9/30/98 until 10/5/98............ DOE ......... -6,359 6,359 ......... ......... ......... ......... ......... ......... ......... ......... ..........
2. Repeal excise tax on recreational
motorboat diesel fuel...................... fsa
12/31/97 ......... -4 -5 -5 -1 -1 -1 -1 -1 -1 -1 -22
3. Modify excise tax on imported halons..... DOE (\8\) (\8\) (\8\) (\8\) (\8\) (\8\) (\8\) (\8\) (\8\) (\8\) (\8\) 1
4. Uniform excise tax on vaccines; add 3 new
vaccines ($0.75 per dose).................. SaDOE ......... -16 -15 -15 -15 -14 -14 -14 -14 -14 -14 -146
5. Treat certain gasoline retailers as
wholesale distributors under gasoline tax
refund rules............................... DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
6. Exemption for electric and clean-fuel
vehicles from luxury excise tax............ saia
DOE (\7\) -1 -1 (\7\) (\7\) (\7\) (\7\) ......... ......... ......... ......... -2
7. Equalize the excise tax rates among
alternative motor fuels except CNG......... fsoua
9/30/97 -2 -15 -16 -16 -17 -18 -19 -20 -21 -22 -23 -186
8. Reduce excise tax rate on draft cider to
the small producer beer rate............... 10/1/97 ......... -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -7
9. Study feasibility of moving collection
point for distilled spirits excise tax..... DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
10. Codify Treasury Department regulations
regulating wine labels..................... DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
B. Disaster Relief Provisions
1. Disaster losses--postponement of IRS
deadlines; permit extension of statute of
limitations................................ aoty ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
2. Use of certain appraisals to establish
amount of disaster loss.................... DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
3. Modify tax treatment of livestock sold on
account of certain weather-related
conditions................................. sea
12/31/96 ......... -12 -2 -2 -2 -1 -1 -1 -1 -1 -1 -23
4. Loosen mortgage revenue bond requirements
in Presidentially declared disaster areas
for 2 years; permit 2-year period to place
mortgages.................................. (\9\) ......... -3 -7 -8 -8 -7 -6 -6 -5 -4 -4 -58
5. Abatement of interest on underpayments by
taxpayers in Presidentially declared
disaster areas (1997 disaster areas only).. 1/1/97 -5 ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... -5
C. Provisions Relating to Employment Taxes
1. Worker classification of securities
brokers for income and employment tax
purposes................................... spa
12/31/97 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
2. Clarification of SECA tax treatment of
termination payments received by former
insurance agents........................... pa
12/31/97 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
D. Provisions Relating to Small Businesses
1. Delay penalties for failure to make
payments through EFTPS until after 6/30/98. DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
2. Home office deduction: definition of
principal place of business................ tyba
12/31/98 ......... ......... -119 -244 -253 -263 -274 -285 -295 -306 -318 -2,358
3. 3-year income averaging for farmers...... (\10\) -1 -10 -53 -54 -50 ......... ......... ......... ......... ......... ......... -168
4. Increase deduction for health insurance
expenses of self-employed individuals: 50%
in 2000 and 2001, 60% in 2002, 80% in 2003
through 2005; 90% in 2006, and 100% in 2007
and thereafter............................. tyba
12/31/96 ......... ......... ......... -39 -120 -224 -605 -882 -601 -404 -604 -3,479
5. Impose moratorium on issuance of Treasury
regulations relating to self-employment tax
(SECA) treatment of limited partners
through 6/30/98............................ DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
E. Expense ``Brownfields'' redevelopment costs
in empowerment zones, enterprise communities
and EPA demonstration sites; add census
tracts with greater than 20% poverty; 3-year
sunset....................................... (\11\) ......... -57 -132 -165 -63 (\8\) 2 9 17 19 18 -352
F. Empowerment Zones and Enterprise
Communities
1. Designate 20 new urban empowerment zones
with modified incentives (\12\)............ DOE ......... -82 -121 -121 -99 -79 -56 -44 -41 -38 -25 -706
2. Designate 2 supplemental empowerment
zones as regular empowerment zones, with
present-law incentives (phaseout of wage
credit beginning in 2004).................. 1/1/00 ......... ......... ......... -38 -86 -92 -98 -78 -53 -26 -13 -483
3. Modification of empowerment zone and
enterprise community criteria in the event
of future designations of additional zones
and communities............................ DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
G. Other Provisions
1. Shrinkage allowance for inventory
accounting................................. tyea
DOE ......... -7 -21 -23 -25 -27 -29 -31 -33 -35 -37 -268
2. Include liability to pay compension under
workmen's compensation acts within rules
relating to certain personal liability
assignments................................ cfa
DOE ......... -1 -2 -5 -8 -12 -17 -23 -29 -32 -36 -164
3. Clarify tax-exempt status of certain
State workmen's compensation funds......... tyba
12/31/97 ......... (\7\) (\7\) -1 -1 -1 -1 -1 -1 -1 -1 -6
4. Election for 1987 partnerships to
continue exception from treatment of
publicly traded partnerhsips as
corporations............................... tyba
12/31/97 ......... ......... ......... .........
(3)Revenue Neutral ........... ......... ......... .........
5. Exclusion from UBIT for certain corporate
sponsorship payments....................... psora
12/31/97 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
6. Allow timeshare associations to elect to
be taxed as homeowner associations at 32%
rate and modify definition of property for
timeshares................................. tyba
12/31/96 ......... -1 -1 -1 -1 -2 -2 -2 -2 -2 -2 -17
7. Modification of advance refunding rules
for certain tax-exempt bonds issued by the
Virgin Islands (\13\)...................... DOE ......... -2 -4 -5 -5 -5 -3 -1 -3 -4 -4 -37
8. Deferral of gain on sales of stock in
farm product refining firms to farm coops
which supply the firm with raw farm
products for refining (\14\)............... Sa
12/31/97 ......... -2 -68 -5 -5 -4 -4 -4 -4 -4 -4 -104
9. Increase the business meals deduction to
80% in 5% increments every other year for
persons subject to Federal hours of service
limitation, with clarification of section
119 meals.................................. tyba
12/31/97 ......... -8 -17 -27 -37 -49 -62 -76 -91 -108 -125 -600
10. Modify limits on depreciation of luxury
automobiles for certain clean-burning fuel
and electric vehicles...................... ppisa
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
11. Suspend 100% net income limitation with
respect to percentage depletion on oil and
gas property for marginal producers for 2
years...................................... DOE ......... -21 -35 -14 ......... ......... ......... ......... ......... ......... ......... -70
12. Raise the charitable mileage rate from
12 cents/mile to 14 cents/mile; no indexing tyba
12/31/97 ......... -8 -56 -58 -61 -64 -68 -71 -75 -78 -82 -621
13. Purchasing of receivables by tax-exempt
hospital cooperative service organizations. tyba
12/31/96 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
14. Provide an above-the-line deduction for
certain State and local official's expenses tyba
12/31/86 ......... -10 -4 -4 -4 -5 -5 -6 -6 -7 -7 -58
15. Combined employment tax reporting
demonstration project (5-year
demonstration)............................. DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
16. Elective carryback of existing net
operating losses of the National Railroad
Passenger Corporation (Amtrak)............. (\15\) ......... -1,162 -1,162 ......... ......... ......... ......... ......... ......... ......... ......... -2,323
H. Extension of Duty-Free Treatment Under the
Generalized System of Preferences (through 6/
30/98) (\16\)................................ DOE -378 ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... -378
Title X. Revenue-Increase Provisions
A. Financial Products
1. Require recognition of gain on certain
appreciated positions in personal property;
election of mark-to-market for securities
traders and for traders and dealers in
commodities; limitation on exception for
investment companies under section 351..... csa
6/8/97 ......... 367 121 68 73 79 85 94 111 118 127 1,243
2. Gains or losses from certain terminations
with respect to property................... 30da
DOE ......... 15 27 25 25 25 25 25 25 25 25 242
3. Determination of original issue discount
where pooled debt obligations subject to
acceleration............................... tyba
DOE ......... 76 275 358 319 283 100 105 109 114 118 1,857
4. Deny interest deduction on certain debt
instruments................................ iia
6/8/97 ......... 5 16 29 43 55 62 63 64 65 67 469
B. Corporate Organizations and Reorganizations
1. Require gain recognition for certain
extraordinary dividends.................... da
5/3/95+
9/13/95 ......... 44 -93 -54 -10 45 77 81 89 95 101 375
2. Require gain recognition on certain
distributions of controlled corporation
stock...................................... da
4/16/97 ......... 301 243 216 187 158 130 101 73 46 10 1,465
3. Reform tax treatment of certain corporate
stock transfers............................ doaa
6/8/97 ......... 10 10 5 5 5 5 5 5 5 5 60
4. Treat certain preferred stock treated as
``boot''................................... ta
6/8/97 ......... 35 37 39 41 43 10 10 11 11 12 248
5. Modify holding period for dividends-
received deduction with 2-year transition
period..................................... droaa
30da
DOE ......... 11 13 15 16 16 16 17 17 17 18 156
C. Administrative Provisions
1. Reporting of certain payments made to
attorneys.................................. pma
12/31/97 ......... ......... 3 3 3 3 3 4 4 4 4 31
2. Information reporting on persons
receiving contract payments from certain
Federal agencies........................... rd 90da
DOE ......... ......... 7 8 9 10 11 11 12 12 13 93
3. Disclosure of tax return information for
administration of certain Veterans'
programs (\16\)............................ DOE ......... ......... 22 27 31 36 36 ......... ......... ......... ......... 152
4. Establish IRS continuous levy and improve
debt collections........................... lia
DOE ......... 332 327 256 213 157 117 102 86 82 78 1,750
5. Consistency rule for beneficiaries of
trusts and estates......................... rfa
DOE ......... 3 3 3 3 3 3 4 4 4 4 34
6. Registration of confidential corporate
tax shelters and substantial understatement
penalty.................................... tsoaiTg ......... 15 37 38 39 41 42 43 44 46 47 392
D. Excise and Employment Tax Provisions
1. Extension and modification of Airport and
Airway Trust Fund excise taxes:
a. Extend domestic air passenger ticket
tax: reduce tax rate from 10% to 9% of
ticket price and impose an additional tax
of $1.00 per flight segment for 10/1/97
through 9/30/98; 8% and $2.00/segment for
10/1/98 through 9/30/99; and 7.5% after 9/
30/99 with additional tax of $2.25/
segment for 10/1/99 through 12/31/99,
$2.50/segment in 2000, $2.75/segment in
2001, and $3.00/segment in 2002, and in
years thereafter index the $3.00/segment
tax to changes in the CPI (first indexing
adjustment on 1/1/03).................... 10/1/97 ......... 4,633 4,859 5,031 5,433 5,870 6,275 6,684 7,117 7,580 8,059 61,542
b. Modify airline ticket tax deposit rule
to suspend deposits due 8/15/97 to 9/30/
97 until 10/10/97, and suspend deposits
due 8/15/98 to 9/30/98 until 10/5/98..... DOE -1,017 -199 1,216 ......... ......... ......... ......... ......... ......... ......... ......... ..........
c. Reduce air passenger ticket tax to 7.5%
of ticket price (and omit segment tax)
for flight segment to/from certain rural
airports (\17\).......................... 10/1/97 ......... -26 -27 -26 -27 -27 -28 -30 -31 -32 -33 -289
d. Extend international departure tax:
increase tax from $6.00 to $12/passenger,
tax arrivals at the same rate, and index
the $12 tax to changes in the CPI (first
indexing adjustment on 1/1/99), but
retain present-law $6.00/passenger
departure tax for domestic flights to/
from Alaska and Hawaii, and index the
$6.00 departure tax to changes in the CPI
(first indexing adjustment on 1/1/99).... 10/1/97 ......... 788 879 948 1,026 1,114 1,209 1,307 1,411 1,526 1,653 11,859
e. Impose 7.5% tax rate on cash payments
to airlines for air travel under credit
card and similar programs................ 10/1/97 ......... 65 73 77 82 87 92 98 104 110 116 904
f. Extend current air cargo excise tax.... 10/1/97 ......... 304 347 377 409 443 481 522 567 615 667 4,732
g. Extend current taxes on noncommercial
aviation gasoline and noncommercial jet
fuel..................................... 10/1/97 ......... 84 87 89 91 93 95 97 99 102 104 943
h. Dedicate 4.3 cents/gallon of tax on
aviation fuel to the Airport and Airway
Trust Fund............................... 10/1/97 ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
2. Extend diesel fuel excise tax rules to
kerosene................................... 7/1/98 ......... 44 43 49 46 44 43 44 47 49 52 461
3. Reinstate LUST excise tax and extend
through 3/31/05............................ 10/1/97 ......... 129 129 128 129 131 134 136 67 ......... ......... 983
4. Apply 3% telephone excise tax to certain
prepaid phone cards and cash payments to
service providers under credit card
arrangements............................... 11/1/97 ......... 19 28 38 49 60 71 83 101 113 124 684
5. Extend FUTA surtax and increase the
statutory limit on the FUA Trust Fund from
.25% of covered wages to .50% (\16\)....... lpo/a
1/1/99 ......... ......... 1,063 1,763 1,797 1,733 661 -73 -71 -74 -73 6,726
E. Provisions Relating to Tax-Exempt
Organizations
1. Modify control test and include
attribution rules to determine UBIT
consequences of certain payments from
subsidiaries of tax-exempt organizations... tyba
12/31/98
& tyba
2ya
DOE ......... (\8\) (\8\) (\8\) 3 5 5 4 4 4 4 29
2. Repeal grandfather rule with respect to
pension business of certain insurers....... tyba
12/31/97 ......... (\8\) 82 116 124 128 133 140 149 160 174 1,208
F. Foreign Provisions
1. Inclusion of income from notional
principal contracts and stock lending
transactions under Subpart F............... tyba
DOE ......... 9 20 21 21 21 21 22 22 22 23 202
2. Restrict like-kind exchanges involving
foreign personal property.................. ea
6/8/97 ......... 4 8 11 13 15 17 19 21 23 25 156
3. Impose holding period requirement for
claiming foreign tax credits with respect
to dividends............................... dpoaa
30da
DOE ......... 23 48 50 53 56 58 61 64 68 71 552
4. Limitation on treaty benefits for
payments to hybrid entities................ DOE ......... 1 1 1 1 1 1 1 1 1 1 10
5. Interest on underpayment reduced by
foreign tax credit carrybacks.............. ftpoa
tyba
DOE ......... 8 10 2 1 1 1 1 1 1 1 27
6. Determination of period of limitations
relating to foreign tax credits............ ftpoa
tyba
DOE ......... 1 2 1 1 1 1 1 1 1 1 11
7. Repeal special exception which permits
certain companies to eliminate their AMT
liability.................................. tyba
DOE ......... 2 5 5 5 5 5 5 5 5 5 47
G. Partnership Provisions
1. Allocation of basis of properties
distributed to a partner by a partnership.. pda
DOE ......... 26 52 55 57 59 61 64 66 69 72 581
2. Eliminate the substantial appreciation
requirement for inventory on sale of
partnership interest....................... sepda
DOE &
efbcieo
6/8/97 ......... 30 66 69 73 77 80 84 89 93 98 760
3. Extension of time for taxing
precontribution gain....................... pcpa
6/8/97 ......... ......... ......... ......... ......... 2 10 11 11 12 12 58
H. Pension and Employee Benefit Provisions
1. Increase involuntary cash out amount from
$3,500 to $5,000 (no indexing of dollar
amount).................................... pyba
DOE (\8\) 2 6 7 7 7 8 8 9 9 10 73
2. Election to receive taxable cash
compensation in lieu of nontaxable parking
benefits (\18\)............................ tyba
12/31/97 ......... 3 8 11 12 12 13 14 14 15 16 118
3. Repeal of 15% excess distribution and
excess retirement accumulation taxes....... dra & dda
12/31/96 ......... -18 -19 -7 18 18 16 16 14 13 11 62
4. Increase in prohibited transactions
excise tax................................. ptoa
DOE ......... 2 4 4 4 4 4 4 4 4 4 34
5. Modify basis recovery rules.............. aba
12/31/97 ......... 1 3 6 9 11 15 18 21 24 27 133
I. Other Revenue-Increase Provisions
1. Termination of suspense accounts for
family farm corporations required to use
accrual method of accounting (\19\)........ (\20\) ......... 29 33 35 36 37 39 40 41 43 44 377
2. 2-year carryback and 20-year carryforward
for net operating losses with an exception
related to Presidentially declared disaster
areas...................................... NOLgi
tyba
DOE ......... 42 303 361 256 179 136 112 100 93 90 1,672
3. Limit carryback period for general
business credits to 1 year; extend
carryforward period to 20 years............ cai tyba
12/31/97 ......... 182 300 81 -60 -32 -9 5 15 21 25 527
4. Modification of treatment of company-
owned life insurance--disallowance of
certain interests and premiums; pro rata
disallowance of interest on debt to fund
life insurance............................. cia
6/8/97 ......... 20 53 93 140 193 247 299 349 399 447 2,240
5. Earned income Credit (``EIC'') compliance
provisions:
a. Deny EIC eligibility for prior acts of
recklessness or fraud; recertification
required when EIC denied in past; and due
diligence requirement for paid preparers. tyba
12/31/96 ......... (\8\) 18 25 24 21 21 21 21 21 21 193
b. For the purpose of EIC phaseout,
include in AGI nontaxable distributions
of IRA, pensions, and annuities, and tax-
exempt interest; and addback 75% of
business losses (\21\)................... tyba
12/31/97 ......... (\8\) 72 75 79 85 89 92 94 99 102 788
6. Provide that workfare payments do not
qualify as earned income for the purposes
of the earned income credit................ DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
7. Restrict income forecast method and allow
3-year MACRS for rent-to-own property; with
clarification for home computers and
cellular phones............................ ppisa
DOE ......... 29 41 62 78 38 27 25 17 17 18 352
8. Expansion of requirement that
involuntarily converted property be
replaced with property acquired from an
unrelated person........................... icoa
6/8/97 ......... 1 4 6 8 11 13 15 17 19 21 115
9. Repeal of exception for certain sales by
manufacturers to dealers................... tyb1ya
DOE ......... ......... 44 97 106 106 64 21 22 23 24 507
10. Limitation on charitable remainder trust
annual payouts; require charitable
remainders to have a minimum value of 10%
of trust................................... Ta
6/18/97 ......... 6 6 6 6 6 6 6 6 6 6 60
11. Expanded SSA records for tax enforcement
(\22\)..................................... 180da
DOE ......... ......... 10 10 10 10 10 10 10 10 10 90
12. Using Federal case registry of child
support orders for tax enforcement purposes
(\22\)..................................... 10/1/98 ......... ......... ......... ......... 10 20 30 40 60 85 105 350
13. Prior year estimated tax safe harbor
(100% in 1998, 105% in 1999 through 2001,
and 112% in 2002).......................... DOE ......... -7,400 4,000 ......... ......... 4,400 -1,000 ......... ......... ......... ......... ..........
Title XI. Foreign Tax Provisions
A. General Provisions
1. Simplify foreign tax credit limitation
for individuals............................ tyba
12/31/97 ......... (\23\) -1 -1 -1 -1 -1 -1 -1 -1 -1 -9
2. Simplify translation of foreign taxes.... ftpo
tyba
12/31/97 ......... (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\)
3. Election to use simplified foreign tax
credit limitation for alternative minimum
tax purposes............................... tyba
12/31/97 ......... (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) -2
4. Simplify treatment of personal
transactions in foreign currency........... tyba
12/31/97 ......... (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) -2
5. Simplify foreign tax credit limitation
for dividends from 10/50 companies to
provide look-through starting in 2003...... tyba
12/31/02 ......... ......... ......... ......... ......... ......... -57 -241 -215 -227 -242 -982
B. General Provisions Affecting Treatment of
Controlled Foreign Corporations.............. various
(\5\) ......... -2 -5 -7 -9 -10 -10 -11 -12 -13 -14 -93
C. Modification of Passive Foreign Investment
Company Provisions to Eliminate Overlap With
Subpart F, to Allow Mark-to-Market Election,
and to Require Measurement Based on Value for
PFIC Asset Test.............................. tyba
12/31/97 ......... -24 -23 -24 -26 -27 -28 -29 -31 -33 -35 -280
D. Simplify Formation and Operation of
International Joint Ventures................. various
(\5\) ......... (\7\) (\7\) -1 -1 -1 -1 -1 -1 -1 -2 -9
E. Modification of Reporting Threshold for
Stock Ownership of a Foreign Corporation..... toa
12/31/97 ......... (\23\) -1 -2 -2 -2 -2 -2 -3 -3 -3 -20
F. Other Foreign Simplification Provisions
1. Transition rule for certain trusts....... tyba
12/31/96 ......... -1 -3 -5 -5 -5 -5 -5 -5 -5 -5 -44
2. Simplify application of the stock and
securities trading safe harbor............. tyba
12/31/97 ......... (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\)
3. Clarification of determination of foreign
taxes deemed paid.......................... DOE ......... (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\)
4. Clarification of foreign tax credit
limitation for financial services income... DOE ......... (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\)
G. Other Foreign Provisions
1. Eligibility of licenses of computer
software for foreign sales corporation
benefits................................... gra
12/31/97 ......... -27 -42 -146 -173 -180 -191 -202 -227 -252 -277 -1,717
2. Increase dollar limitation on section 911
exclusion and index after 2007............. tyba
12/31/97 ......... -15 -30 -50 -67 -82 -97 -103 -111 -119 -127 -801
3. Exception from U.S. property definition
under subpart F for certain securities
positions.................................. tyba
12/31/97 ......... -1 -2 -2 -2 -2 -2 -2 -2 -2 -2 -19
4. Treat service income of nonresident alien
individuals earned on foreign ships as
foreign source income and disregard the
U.S. presence of such individuals.......... tyba
12/31/97 ......... -2 -4 -3 -3 -3 -3 -3 -3 -3 -3 -30
5. Exemption from subpart F for active
financing income (\14\).................... tybi
1998 ......... -23 -68 -3 ......... ......... ......... ......... ......... ......... ......... -94
Title XII. Simplification Provisions Relating
to Individuals and Businesses
A. Provisions Relating to Individuals
1. Deduction attributable to unearned income
of dependent filers: greater of (a) present
law; or (b) earned income plus $250; delink
dependent AMT from parent's AMT position... tyba
12/31/97 ......... -2 -38 -35 -35 -35 -35 -35 -38 -37 -36 -327
2. Increase de minimis threshold for
estimated tax to $1,000 for individuals.... tyba
12/31/97 ......... -134 -17 -18 -19 -20 -21 -22 -24 -25 -26 -326
3. Treatment of certain reimbursed expenses
for rural mail carriers' vehicles.......... tyba
12/31/97 ......... (\7\) -1 -1 -1 -1 -1 -1 -1 -1 -1 -11
4. Treatment of travel expenses of certain
Federal employees participating in a
Federal criminal investigation............. apoii
tyea
DOE ......... (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) -2
5. Permit payment of taxes by any
commercially acceptable means; and prohibit
payment of fees by Treasury................ 9ma
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
B. Provisions Relating to Businesses Generally
1. Modifications to look-back method for
long-term contracts........................ cci tyea
DOE ......... -1 -2 -3 -4 -4 -4 -4 -5 -5 -5 -37
2. Minimum tax treatment of certain property
and casualty insurance companies........... tyba
12/31/97 ......... -1 -2 -3 -3 -3 -3 -3 -3 -3 -3 -27
3. Treatment of construction allowances
provided to lessees........................ leia
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
C. Partnership Simplification Provisions
1. General provisions:
a. Simplified reporting to partners....... tyba
12/31/97 ......... 6 8 8 8 8 9 9 9 9 9 83
b. Simplified audit procedure for large
partnerships............................. tyba
12/31/97 ......... (\8\) (\8\) (\8\) 1 1 1 1 1 1 1 8
c. Due date for furnishing information to
partners of large partnerships........... tyba
12/31/97 ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
d. Returns required on magnetic media for
partnerships with 100 partners or more... tyba
12/31/97 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
e. Treatment for partnership items of
individual retirement arrangements....... tyba
12/31/97 ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
2. Other partnership audit rules............ various
(\5\) ......... -2 (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) -5
3. Closing partnership taxable year with
respect to deceased partner................ tyba
12/31/97 ......... (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) -1
D. Modifications of Rules for Real Estate
Investment Trusts
1. Alternative penalty for failure to
request information from shareholders...... tyba
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
2. De minimis rule for tenant services
income..................................... tyba
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
3. Attribution rules applicable to tenant
ownership.................................. tyba
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
4. Credit for tax paid by REIT on retained
capital gains.............................. tyba
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
5. Repeal 30% gross income requirment....... tyba
DOE ......... -4 -5 -5 -6 -7 -7 -8 -9 -10 -11 -72
6. Modification of earnings and profits
rules for determining whether REIT has
earnings and profits from non-REIT year.... tyba
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
7. Treatment of foreclosure property........ tyba
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
8. Payments under hedging instruments....... tyba
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
9. Excess noncash income.................... tyba
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
10. Prohibited transaction safe harbor...... tyba
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
11. Shared appreciation mortgages........... tyba
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
12. Wholly owned subsidiaries............... tyba
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
E. Repeal 30% Gross Income Limitation for
Regulated Investment Companies............... tyba
DOE ......... -17 -23 -27 -33 -38 -45 -53 -61 -71 -82 -450
F. Taxpayer Protections
1. Provide reasonable cause exception for
additional penalties....................... tyba
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
2. Clarification of period for filing claims
for refunds................................ tyea
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
3. Repeal authority to disclose whether a
prospective juror has been audited......... pca
DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
4. Clarify statute of limitations for items
from pass-through entities................. tyba
DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
5. Awarding of administrative costs and
attorneys fees............................. aca
DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
Title XIII. Estate, Gift, and Trust
Simplification Provisions
1. Eliminate gift tax filing requirements
for gifts to charities of over $10,000..... gma
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
2. Clarification of waiver of certain rights
of recovery of estate tax from QTIP trust.. dda
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
3. Transitional rule under section 2056A.... aiii
OBRA'90 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
4. Estate and gift tax treatment of short-
term OID instruments....................... dda
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
5. Certain revocable trusts treated as part
of estate.................................. dda
DOE ......... -3 -3 -3 -3 -3 -3 -3 -3 -3 -3 -30
6. Distributions during first 65 days of
taxable year of estate..................... tyba
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
7. Separate share rules available to estates dda
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
8. Executor of estate and beneficiaries
treated as related persons for disallowance
of losses.................................. tyba
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
9. Simplified taxation of earnings of pre-
need funeral trusts........................ tyea
DOE ......... 2 2 2 2 2 2 2 2 2 2 20
10. Adjustments for certain gifts within 3
years of decedent's death.................. dda
DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
11. Clarification of treatment of survivor
annuities under qualified terminable
interest rules............................. dda
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
12. Treatment under qualified domestic trust
rules of forms of ownership which are not
trusts..................................... dda
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
13. Opportunity to correct certain failures
under section 2032A........................ DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
14. Authority to waive requirement of United
States trustee for qualified domestic
trusts..................................... dda
DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
Title XIV. Excise Tax and Other Simplification
Provisions
A. Excise Tax Simplification Provisions
1. Increase de minimis limit for after-
market alterations for heavy truck and
luxury automobile excise taxes............. ia
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
2. Replace truck excise tax deduction for
tire value with tax credit for excise tax
paid on tires.............................. Sa
12/31/97 ......... 66 94 96 97 99 101 102 105 108 110 979
3. Simplification of excise taxes on
distilled spirits, wine, and beer:
a. Credit or refund for imported bottled
distilled spirits returned to distilled
spirits plant............................ fcq
DOE +
180 days ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
b. Authority to cancel or credit export
bonds without submission of records...... fcq
DOE +
180 days ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
c. Repeal of required maintenance of
records on premises of distilled spirits
plant.................................... fcq
DOE +
180 days ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
d. Fermented material from any brewery may
be received at a distilled spirits plant. fcq
DOE +
180 days ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
e. Repeal of requirement for wholesale
dealers in liquors to post sign.......... DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
f. Refund of tax to wine returned to bond
not limited to unmerchantable wine....... fcq
DOE +
180 days ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
g. Use of additional ameliorating material
in certain wines......................... fcq
DOE +
180 days ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
h. Domestically produced beer may be
withdrawn free of tax for use of foreign
embassies, legations, etc................ fcq
DOE +
180 days ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
i. Beer may be withdrawn free of tax for
destruction.............................. fcq
DOE +
180 days ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
j. Authority to allow drawback on exported
beer without submission of records....... fcq
DOE +
180 days ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
k. Imported beer or wine transferred in
bulk to brewery or winery without payment
of tax................................... fcq
DOE +
180 days ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
4. Authority for IRS to grant exemption from
excise tax registration requirements....... wia
DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
5. Repeal of excise tax ``deadwood''
provisions................................. DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
6. Move taxation of arrows from tax on
assembled arrows to tax on component parts
of 12.4%................................... Csa
9/30/97 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
7. Modifications to heavy highway vehicle
retail excise tax:
a. Exemption from truck excise tax for
certain wrecked truck fixups and truck
modifications............................ 1/1/98 ......... -5 -8 -8 -8 -9 -9 -10 -10 -11 -11 -89
b. Repeal registration requirement for tax-
free sales of trucks for resale.......... 1/1/98 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
8. Treatment of skydiving flights as
noncommerical aviation..................... 10/1/97 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
9. Eliminate double taxation for certain
purchases of aviation fuel from ``fixed-
based operators''.......................... 10/1/97 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
B. Tax-Exempt Bond Provisions
1. Repeal $100,000 limitation on unspent
proceeds from tax-exempt bond issues under
year exception from rebate................. bia
DOE ......... (\7\) -2 -3 -5 -6 -8 -9 -10 -11 -12 -65
2. Exclusion from arbitrage rebate for
earnings on bona fide debt service fund
under construction bond rules.............. bia
DOE ......... (\7\) -1 -2 -3 -3 -4 -5 -6 -6 -7 -37
3. Repeal of debt service-based limitation
on investment in certain nonpurpose
investments................................ bia
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
4. Repeal of expired student loan bond
arbitrage rebate provisions................ bia
DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
C. Tax Court Procedures
1. Overpayment determinations of Tax Court.. DOE ......... -3 -3 -3 -3 -3 -3 -3 -3 -3 -3 -30
2. Redetermination of interest pursuant to
motion..................................... DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
3. Application of net worth requirements for
awards of administrative or litigation
costs; $4 million for joint returns........ pca
DOE ......... -1 -2 -2 -2 -2 -2 -2 -2 -2 -2 -19
4. Tax Court jurisdiction for determination
of employment status....................... DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
D. Other Provisions
1. Due date for first quarter estimated tax
by private foundations..................... tyba
DOE ......... -2 (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) -3
2. Withholding of Commonwealth income taxes
from wages of Federal employees............ 1/1/98 ......... -2 -3 -1 -1 -1 -1 -1 -1 -1 -1 -13
3. Certain notices disregarded under
provision increasing interest rate on large
corporate underpayments.................... Pa
12/31/97 ......... -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -10
Title XV. Pension and Employee Benefit
Provisions
A. Pension Simplification Provisions
1. Matching contributions for self-employed
individuals not treated as elective
deferrals.................................. yba
12/31/97 ......... (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\24\)
2. Modification of prohibition on assignment
or alienation.............................. DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
3. Eliminate paperwork burdens on plans..... DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
4. Modifications to section 403(b) exclusion
allowance to conform to section 415
modifications.............................. yba
12/31/97 ......... ......... (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\23\) (\24\)
5. Permanent moratorium on nondiscrimination
rules to State and local governmental plans tybo/a
DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
6. Clarification of certain rules relating
to employee stock ownership plans of S
corporation................................ tyba
12/31/97 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
7. Modification of 10% tax on nondeductible
contributions.............................. tyba
12/31/97 ......... -2 -3 -3 -3 -3 -3 -3 -3 -3 -3 -29
8. Modify funding requirements for certain
plans...................................... pyba
12/31/96 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
9. Plans not disqualified merely by
accepting rollover contributions........... DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
10. New technologies in retirement plans.... DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
B. Miscellaneous Provisions Relating to
Pensions and Other Benefits
1. Increase in full funding limit with 20-
year amortization.......................... pyba
12/31/98 ......... ......... -4 -12 -14 -18 -19 -23 -23 -25 -25 -164
2. Deduction for contributions made by
ministers to retirement plans.............. yba
12/31/97 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
3. Exclusion of ministers from
discrimination testing of certain non-
church retirement plans.................... yba
12/31/97 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
4. Repeal UBIT on income from an S
corporation to an ESOP..................... tyba
12/31/97 ......... -8 -23 -34 -41 -44 -46 -48 -50 -52 -54 -400
5. Diversification of section 401(k) plan
investments................................ 1/1/99 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
6. Water districts made eligible for 401(k)
plans even if State or local entity........ yba
12/31/97 ......... (\23\) -1 -1 -1 -2 -2 -2 -2 -2 -3 -15
7. Modify section 415 limits for permissive
service credits under State and local plans yba
12/31/97 ......... -9 -25 -25 -26 -26 -26 -27 -27 -27 -28 -246
8. Removal of dollar limitation on benefits
payments from a defined benefit plan for
police and fire employees.................. yba
12/31/96 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
9. Exclude from gross income certain
survivor benefits attributable to a public
safety officer who is killed in the line of
duty....................................... (\25\) ......... (\7\) -1 -1 -1 -1 -1 -1 -1 -2 -2 -12
10. Treatment of certain disability benefits
to public safety employees................. DOE ......... -10 -1 ......... ......... ......... ......... ......... ......... ......... ......... -11
11. Gratuitous transfers for the benefit of
employees.................................. Ta
DOE ......... -8 -15 ......... ......... ......... ......... ......... ......... ......... ......... -23
C. Certain Health Act Provisions
1. Excise tax penalties for failure of group
health plan to provide certain maternity
and mental health benefits................. pybo/a
1/1/98 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
2. Church plan exception to prohibition on
discrimination against individuals based on
health status.............................. aiii
HIPAA ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
D. Date for Adoption of Plan Amendments....... DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
Title XVI. Technical Corrections Provisions
1. Oklahoma technical on Indian wage credits
and development incentives for property with
10-year lives or less........................ dwcorfpt
3/18/97 ......... -10 -2 1 2 2 1 1 1 1 1 -2
2. Luxury tax clarification................... Sa
DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
------------------------------------------------------------------------------------------------------------------------------------
Subtotal: H.R. 2014..................... 60 -9,483 -9,887 -27,937 -29,329 -23,865 -34,966 -36,611 -38,652 -39,809 -41,551 -292,045
====================================================================================================================================
PART THREE: REVENUE PROVISIONS OF THE BALANCED
BUDGET ACT OF 1997 (H.R. 2015)
A. Treatment of Medicare+Choice Medical
Savings Accounts............................. tyba
12/31/98 ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
B. Tax Treatment of Hospitals Which
Participate in Provider-Sponsored
Organizations................................ DOE ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
C. Provision of Employer Identification
Numbers by Medicare Providers................ (\26\) ......... ......... ......... .........
(3)Negligible Revenue Effect ........... ......... ......... .........
D. Disclosure of Tax Return Information for
Verification of Employment Status of Medicare
Beneficiaries and Spouses of Medicare
Beneficiaries (\27\)......................... DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
E. Unemployment Tax Provisions--Miscellaneous
FUTA provisions (\16\)....................... various
(\5\) ......... 3 (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) (\7\) ..........
F. Earned Income Tax Credit Provision--
Authorization of appropriations for
enforcement initiatives related to the earned
income credit (\22\)......................... DOE ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
G. Increase in Excise Tax on Tobacco Products--
Increase small cigarettes tax by $0.10 per
pack in 2000 and 2001, and $0.15 per pack in
2002 and thereafter with proportionate
increase in other tobacco products excise
taxes; extend tax to ``roll-your-own''
tobacco...................................... 1/1/00 ......... ......... ......... 1,175 1,720 2,272 2,280 2,290 2,300 2,310 2,320 16,667
------------------------------------------------------------------------------------------------------------------------------------
Subtotal: H.R. 2015..................... ......... 3 (\7\) 1,175 1,720 2,272 2,280 2,290 2,300 2,310 2,320 16,667
====================================================================================================================================
PART FOUR: TAXPAYER BROWSING PROTECTION ACT
(H.R. 1226)
1. Civil damages for unauthorized inspection
of tax returns or tax return information;
notification of unlawful inspection or
disclosure................................... voo/a
DOE (\28\) (\28\) (\28\) (\28\) (\28\) (\28\) (\28\) (\28\) (\28\) (\28\) (\28\) (\28\)
------------------------------------------------------------------------------------------------------------------------------------
Subtotal: H.R. 1226..................... (\28\) (\28\) (\28\) (\28\) (\28\) (\28\) (\28\) (\28\) (\28\) (\28\) (\28\) (\28\)
====================================================================================================================================
PART FIVE: HIGHWAY TRUST FUND EXTENSION (S.
1519)
1. Extend Highway Trust Fund expenditure and
revenue transfer authority through 9/30/98;
extend Boat Safety Account and National
Recreational Trails Trust Fund expenditure
authority through 9/30/98.................... 10/1/97 ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
------------------------------------------------------------------------------------------------------------------------------------
Subtotal: S. 1519....................... ......... ......... ......... .........
(3)No Revenue Effect ........... ......... ......... .........
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Joint Committee on Taxation.
NOTE: Details may not add to totals due to rounding.
Legend for ``Effective'' column:
aba=annuities beginning after fcq DOE + 180 days=first day of the rfa=returns filed after
calendar
aca=actions commenced after quarter that begins at least 180 days roa=rentals occurring
after (for
aiii HIPAA=as if included in the Health after date of enactment returns open on date of
first
Insurance Portability and fsa=fuels sold after committee action)
Accountability
Act fsoua=fuels sold or used after Sa=sales after
aiii OBRA'90=as if included in the ftpoa=foreign taxes paid or accrued in saia=sales and
Omnibus installations after
Budget Reconciliation Act of 1990 gma=gifts made after sea=sales or exchanges
after
aoty=all open taxable years gra=gross receipts after sepda=sales and
exchanges, and certain
apoii=amounts paid or incurred in gsta=generation skipping transfers after partnership
distributions after
bia=bonds issued after ia=installations after spa=services performed
after
cai=credits arising in icoa=involuntary conversions occurring ta=transactions after
after
cci=contracts completed in iia=instruments issued after Ta=transfers after
cfa=claims filed after leia=leases entered into after toa=transactions
occurring after
cia=contracts issued after lia=levies issued after tp7data=tickets purchased
7 days after date of
csa=constructive sales after lpo/a=labor performed on or after enactment for travel 7
days after
Csa=components sold after NOLgi=net operating losses generated in tsoaiTg=tax shelters
offered after issuance
of
da=distributions after pa=payments after Treasury guidance
dda=decedents dying after Pa=periods after tyba=taxable years
beginning after
di=dispositions in pca=proceedings commenced after tyb1ya=taxable years
beginning 1 year after
Dmi=distributions made in pcpa=property contributed to partnership tybo/a=taxable years
after beginning on or after
doaa=distributions or acquisitions after pda=partnership distributions after tybi=taxable years
beginning in
DOE=date of enactment pma=payments made after tyea=taxable years ending
after
Doia=discharges of indebtedness after po/a=purchases on or after voo/a=violations
occurring on or after
dpoaa=dividends paid or accrued after poida=payments of interest due after wia=waivers issued after
dra=distributions received after ppisa=property placed in service after wpoifhma=wages paid or
incurred for hires
droaa=dividends received or accrued psora=payments solicited or received made after
after after
dwcorfpt=depreciation and wages claimed ptoa=prohibited transactions occurring yba=years beginning after
on after
returns filed prior to pyba=plans years beginning after 30da=30 days after
ea=exchanges after pybo/a=plans years beginning on or after 90da=90 days after
efbcieo=exception for binding contracts qza=qualified zone academy 180da=180 days after
in effect on
epoia=expenses paid or incurred after rd=returns due 9ma=9 months after
2ya=2 years after
Footnotes for Appendix:
\1\ Estimate considers interaction with HOPE tax credit proposal.
\2\ The estimate includes a refundable portion of the child credit equal to $4,281 million for fiscal years 1998-
2002 and $10,022 million for fiscal years 1998-2007.
\3\ Estimate includes interaction with estate and gift taxes.
\4\ Considers interaction with IRA PLUS proposal.
\5\ For complete breakout of the effective date, refer to the body of the text.
\6\ Estimate includes interaction with Welfare-to-Work tax credit.
\7\ Loss of less than $500,000.
\8\ Gain of less than $500,000.
\9\ Effective for bonds issued after 12/31/96 and bonds issued before 1/1/99.
\10\ Effective for taxable years beginning after 12/31/97 and before 1/1/01.
\11\ Effective for expenses in taxable years ending after date of enactment and before 1/1/01.
\12\ Estimate includes interaction with Brownfields provision.
\13\ Assumes prior or concurrent passage of legislation to allow Virgin Island financing on parity basis.
\14\ Provision was cancelled by the President pursuant to the Line Item Veto Act of 1996.
\15\ The provision became effective on 12/2/97, upon enactment of the Amtrak Reform and Accountability Act of
1997.
\16\ Estimate provided by the Congressional Budget Office.
\17\ Rural airports are defined as (1) airports receiving ``essential air service'' assistance on date of
enactment and having fewer than 100,000 enplanements in the previous calendar year, and (2) other airports
having fewer than 100,000 passenger enplanements in the previous calendar year, excluding those within 75
miles of airports having more than 100,000 passenger enplanements in the previous year.
\18\ Estimate does not include increase in receipts to Social Security trust fund ($21 million for fiscal years
1997-2002; $51 million for fiscal years 1997-2007).
\19\ The provision also eliminates the present-law requirement that a portion of the suspense account be
restored to income whenever the gross receipts of the corporation decline.
\20\ Provision is effective for taxable years ending after 6/8/97 for new suspense accounts, and taxable years
beginning after that date for existing accounts. Balances in new accounts are included in income over a 10-
year period, and balances in existing accounts over a 20-year period. For existing accounts, the amounts
included in income in any year may not exceed 50% of the taxable income of the taxpayer before the inclusion.
\21\ Estimate includes outlay reductions of $254 million for 1997-2002 and $650 million for 1997-2007.
\22\ Estimate does not include effect on outlays. Outlays will be provided by the Congressional Budget Office.
\23\ Loss of less than $1 million.
\24\ Loss of less than $10 million.
\25\ Effective for payments received in taxable years beginning after 12/31/96 with respect to individuals dying
after such date.
\26\ Effective 90 days after the Secretary of HHS submits to the Congress a report on the steps taken to ensure
the confidentiality of social security account numbers required to be provided to the Secretary of HHS.
\27\ Revenue estimate does not include outlay effects of the provision.
\28\ Gain of less than $1 million.