[Senate Report 104-281]
[From the U.S. Government Publishing Office]
Calendar No. 438
104th Congress Report
SENATE
2d Session 104-281
_______________________________________________________________________
SMALL BUSINESS JOB PROTECTION ACT OF 1996
_______
June 18, 1996.--Ordered to be printed
_______________________________________________________________________
Mr. Roth, from the Committee on Finance, submitted the following
R E P O R T
[To accompany H.R. 3448]
[Including cost estimate of the Congressional Budget Office]
The Committee on Finance, to which was referred the bill
(H.R. 3448) to provide tax relief for small businesses, to
protect jobs, to create opportunities, to increase the take
home pay of workers, to amend the Portal-to-Portal Act of 1947
relating to the payment of wages to employees who use employer
owned vehicles, and to amend the Fair Labor Standards Act of
1938 to increase the minimum wage rate and to prevent job loss
by providing flexibility to employers in complying with minimum
wage and overtime requirements under that Act, having
considered the same, reports favorably thereon with an
amendment and recommends that the bill as amended do pass.
CONTENTS
Page
I. Legislative Background...........................................6
II. Explanation of the Bill (Title I)................................6
Small Business and Other Tax Provisions.................. 6
A. Small Business Provisions............................. 6
1. Increase in expensing for small businesses (sec.
1111)............................................ 6
2. Tax credit for Social Security taxes paid with
respect to employee cash tips (sec. 1112)........ 7
3. Treatment of dues paid to agricultural or
horticultural organizations (sec. 1113).......... 9
4. Clarify employment tax status of certain
fishermen (sec. 1114)............................ 10
5. Modify rules governing issuance of tax-exempt
bonds for first-time farmers (sec. 1115)......... 11
6. Clarify treatment of newspaper distributors and
carriers as direct sellers (sec. 1116)........... 12
7. Application of involuntary conversion rules to
property damaged as a result of Presidentially
declared disasters (sec. 1117)................... 14
8. Establish 15-year recovery period for retail
motor fuel outlet stores (sec. 1118)............. 14
9. Treatment of leasehold improvements (sec. 1119).. 16
10. Increase deductibility of business meal expenses
for certain seafood processing facilities (sec.
1120)............................................ 18
11. Provide a lower rate of excise tax on certain
hard ciders (sec. 1121).......................... 19
12. Modifications to section 530 of the Revenue Act
of 1978 (sec. 1122).............................. 20
B. Extension of Certain Expiring Provisions.............. 28
1. Work opportunity tax credit (sec. 1201).......... 28
2. Employer-provided educational assistance (sec.
1202)............................................ 36
3. Research and experimentation tax credit (sec.
1203)............................................ 38
4. Orphan drug tax credit (sec. 1204)............... 41
5. Contributions of stock to private foundations
(sec. 1205)...................................... 42
6. Tax credit for producing fuel from a
nonconventional source (sec. 1206)............... 43
7. Suspend imposition of diesel fuel tax on
recreational motorboats (sec. 1207).............. 44
C. Provisions Relating to S Corporations................. 45
1. S corporations permitted to have 75 shareholders
(sec. 1301)...................................... 45
2. Electing small business trusts (sec. 1302)....... 46
3. Expansion of post-death qualification for certain
trusts (sec. 1303)............................... 48
4. Financial institutions permitted to hold safe
harbor debt (sec. 1304).......................... 48
5. Rules relating to inadvertent terminations and
invalid elections (sec. 1305).................... 49
6. Agreement to terminate year (sec. 1306).......... 50
7. Expansion of post-termination transition period
(sec. 1307)...................................... 50
8. S corporations permitted to hold subsidiaries
(sec. 1308)...................................... 51
9. Treatment of distributions during loss years
(sec. 1309)...................................... 53
10. Treatment of S corporations under subchapter C
(sec. 1310)...................................... 55
11. Elimination of certain earnings and profits (sec.
1311)............................................ 56
12. Carryover of disallowed losses and deductions
under at-risk rules allowed (sec. 1312).......... 57
13. Adjustments to basis of inherited S stock to
reflect certain items of income (sec. 1313)...... 58
14. S corporations eligible for rules applicable to
real property subdivided for sale by noncorporate
taxpayers (sec. 1314)............................ 59
15. Certain financial institutions as eligible
corporations (sec. 1315)......................... 59
16. Certain tax-exempt entities allowed to be
shareholders (sec. 1316)......................... 60
17. Reelection of subchapter S status (sec. 1317(b)). 61
Pension Simplification Provisions........................ 62
A. Simplified Distribution Rules (secs. 1401-1404)....... 62
B. Increased Access to Retirement Savings Plans.......... 66
1. Establish SIMPLE retirement plans for small
employers (secs. 1421-1422)...................... 66
2. Tax-exempt organizations eligible under section
401(k) (sec. 1426)............................... 71
3. Spousal IRAs (sec. 1427)......................... 72
C. Nondiscrimination Provisions.......................... 73
1. Definition of highly compensated employees and
repeal of family aggregation rules (sec. 1431)... 73
2. Modification of additional participation
requirements (sec. 1432)......................... 75
3. Nondiscrimination rules for qualified cash or
deferred arrangements and matching contributions
(sec. 1433)...................................... 76
4. Definition of compensation for purposes of the
limits on contributions and benefits (sec. 1434). 80
D. Miscellaneous Pension Simplification.................. 80
1. Plans covering self-employed individuals (sec.
1441)............................................ 80
2. Elimination of special vesting rule for
multiemployer plans (sec. 1442).................. 81
3. Distributions under rural cooperative plans (sec.
1443)............................................ 82
4. Treatment of governmental plans under section 415
(sec. 1444)...................................... 82
5. Uniform retirement age (sec. 1445)............... 83
6. Contributions on behalf of disabled employees
(sec. 1446)...................................... 84
7. Treatment of deferred compensation plans of State
and local governments and tax-exempt
organizations (sec. 1447)........................ 84
8. Trust requirement for deferred compensation plans
of State and local governments (sec. 1448)....... 85
9. Correction of GATT interest and morality rate
provisions in the Retirement Protection Act (sec.
1449)............................................ 86
10. Multiple salary reduction agreements permitted
under section 403(b) (sec. 1450(a)).............. 87
11. Treatment of Indian tribal governments under
section 403(b) (sec. 1450(b)).................... 88
12. Application of elective deferral limit to section
403(b) contracts (sec. 1450(c)).................. 89
13. Waiver of minimum waiting period for qualified
plan distributions (sec. 1451)................... 90
14. Repeal of combined plan limit (sec. 1452)........ 91
15. Tax on prohibited transactions (sec. 1453)....... 92
16. Treatment of leased employees (sec. 1454)........ 92
17. Uniform penalty provisions to apply to certain
pension reporting requirements (sec. 1455)....... 95
18. Retirement benefits of ministers not subject to
tax on net earnings from self-employment (sec.
1456)............................................ 95
19. Treasury to provide model forms for spousal
consent and qualified domestic relations orders
(sec. 1457)...................................... 96
20. Treatment of length of service awards for certain
volunteers under section 457 (sec. 1458)......... 97
21. Date for adoption of plan amendments (sec. 1459). 98
Other Provisions......................................... 99
A. Miscellaneous Revenue Provisions...................... 99
1. Exempt Alaska from diesel dyeing requirement
while Alaska is exempt from similar Clean Air Act
dyeing requirement (sec. 1801)................... 99
2. Application of common paymaster rules to certain
agency accounts at State universities (sec. 1802) 100
3. Modifications to excise tax on ozone-depleting
chemicals........................................ 101
a. Exempt imported recycled halons from the
excise tax on ozone-depleting chemicals (sec.
1803)........................................ 101
b. Exempt chemicals used in metered-dose inhalers
from the excise tax on ozone-depleting
chemicals (sec. 1803)........................ 102
4. Tax-exempt bonds for the sale of Alaska Power
Administration facility (sec. 1804).............. 103
5. Allow bank common trust funds to transfer assets
to regulated investment companies without
taxation (sec. 1805)............................. 104
6. Treatment of qualified State tuition programs
(sec. 1806)...................................... 105
Revenue Offsets.......................................... 108
1. Modifications of the Puerto Rico and possession
tax credit (sec. 1601)........................... 108
2. Repeal 50-percent interest income exclusion for
financial institution loans to ESOPs (sec. 1602). 114
3. Taxation of punitive damages received on account
of personal injury sickness (sec. 1603).......... 115
4. Extension and phaseout of excise tax on luxury
automobiles (sec. 1604).......................... 116
5. Allow certain persons engaged in the local
furnishing of electricity or gas to elect not to
be eligible for future tax-exempt bond financing
(sec. 1605)...................................... 117
6. Repeal of financial institution transition rule
to interest allocation rules (sec. 1606)......... 118
7. Reinstate Airport and Airway Trust Fund excise
taxes (sec. 1607)................................ 119
8. Modify basis adjustment rules under section 1033
(sec. 1608)...................................... 120
9. Extension of withholding to certain gambling
winnings (sec. 1609)............................. 122
10. Treatment of certain insurance contracts on
retired lives (sec. 1610)........................ 122
11. Treatment of contributions in aid of construction
for water utilities (sec. 1611(a))............... 123
12. Require water utility property to be depreciated
over 25 years (sec. 1611(b))..................... 124
13. Treatment of financial asset securitization
investment trusts (``FASITs'') (sec. 1621)....... 125
14. Revision of expatriation tax rules (secs. 1631-
1633)............................................ 133
Tax Technical Corrections Provisions..................... 148
A. Technical Corrections to the Revenue Reconciliation
Act of 1990.......................................... 149
1. Excise tax provisions............................ 149
a. Application of the 2.5-cents-per-gallon tax on
fuel used in rail transportation to States
and local governments (sec. 1702(b)(2))...... 149
b. Small winery production credit and bonding
requirements (secs. 1702(b) (5), (6), and
(7))......................................... 149
2. Other revenue-increase provisions of the 1990 Act 150
a. Deposits of Railroad Retirement Tax Act taxes
(sec. 1702(c)(3))............................ 150
b. Treatment of salvage and subrogation of
property and casualty insurance companies
(sec. 1702(c)(4))............................ 150
c. Information with respect to certain foreign-
owned or foreign corporations: Suspension of
statute of limitations during certain
judicial proceedings (sec. 1702(c)(5))....... 151
d. Rate of interest for large corporate
underpayments (secs. 1702(c)(6) and (7))..... 152
3. Research credit provision: Effective date for
repeal of special proration rule (sec.
1702(d)(1))...................................... 153
4. Energy tax provision: Alternative minimum tax
adjustment based on energy preferences (secs.
1702(e)(1) and (4)).............................. 153
5. Estate tax freezes (sec. 1702(f))................ 155
6. Miscellaneous provisions......................... 158
a. Conforming amendments to the repeal of the
General Utilities doctrine (secs. 1702(g) (1)
and (2))..................................... 158
b. Prohibited transaction rules (sec. 1702(g)(3)) 159
c. Effective date of LIFO adjustment for purposes
of computing adjusted current earnings (sec.
1702(g)(4)).................................. 160
d. Low-income housing tax credit (sec.
1702(g)(5)).................................. 160
7. Expired or obsolete provisions (``deadwood
provisions'') (sec. 1702(h) (1)-(18))............ 161
B. Technical Corrections to the Revenue Reconciliation
Act of 1993.......................................... 161
1. Treatment of full-time students under the low-
income housing credit (sec. 1703(b)(1)).......... 161
2. Indexation of threshold applicable to excise tax
on luxury automobiles (sec. 1703(c))............. 162
3. Indexation of the limitation based on modified
adjusted gross income for income from United
States savings bonds used to pay higher education
tuition and fees (sec. 1703(d)).................. 162
4. Reporting and notification requirements for
lobbying and political expenditures of tax-exempt
organizations (sec. 1703(g))..................... 162
5. Estimated tax rules for certain tax-exempt
organizations (sec. 1703(h))..................... 163
6. Current taxation of certain earnings of
controlled foreign corporations--application of
foreign tax credit limitations (sec. 1703(i)(1)). 164
7. Current taxation of certain earnings of
controlled foreign corporations--measurement of
accumulated earnings (sec. 1703(i)(2))........... 165
8. Current taxation of certain earnings of
controlled foreign corporations--aggregation and
look-through rules (sec. 1703(i)(3))............. 165
9. Treatment of certain leased assets for PFIC
purposes (sec. 1703(i)(5))....................... 166
10. Expiration date of special ethanol blender refund
(sec. 1703(k))................................... 167
11. Amortization of goodwill and certain other
intangibles (sec. 1703(l))....................... 167
12. Empowerment zones and eligibility of small farms
for tax incentives (sec. 1703(m))................ 168
C. Other Tax Technical Corrections....................... 168
1. Hedge bonds (sec. 1704(b))....................... 168
2. Withholding on distributions from U.S. real
property holding companies (sec. 1704(c))........ 169
3. Treatment of credits attributable to working
interests in oil and gas properties (sec.
1704(d))......................................... 171
4. Clarification of passive loss disposition rule
(sec. 1704(e))................................... 171
5. Estate tax unified credit allowed nonresident
aliens under twenty (sec. 1704(f)(1))............ 172
6. Limitation on deduction for certain interest paid
by corporation to related persons (sec.
1704(f)(2)(A))................................... 173
7. Interaction between passive activity loss rules
and earnings stripping rules (sec. 1704(f)(2)(B)
and (C))......................................... 175
8. Branch-level interest tax (sec. 1704(f)(3))...... 176
9. Determination of source in case of sales of
inventory property (sec. 1704(f)(4))............. 177
10. Repeal of obsolete provisions (sec. 1704(f)(5)).. 179
11. Clarification of a certain stadium bond
transition rule in Tax Reform Act of 1986 (sec.
1704(g))......................................... 179
12. Health care continuation rules (sec. 1704(h)).... 180
13. Taxation of excess inclusions of a residual
interest in a REMIC for taxpayers subject to
alternative minimum tax with net operating losses
(sec. 1704(i))................................... 180
14. Application of harbor maintenance tax to Alaska
and Hawaii ship passengers (sec. 1704(j))........ 181
15. Modify effective date provision relating to the
Energy Policy Act of 1992 (sec. 1704(k))......... 182
16. Treat qualified football coaches plan as
multiemployer pension plan for purposes of the
Internal Revenue Code (sec. 1704(l))............. 182
17. Determination of unrecovered investment in
annuity contract (sec. 1704(m)).................. 183
18. Election by parent to claim unearned income of
certain children on parent's return (sec.
1704(n))......................................... 184
19. Treatment of certain veterans' reemployment
rights (sec. 1704(o))............................ 184
20. Reporting of real estate transactions (sec.
1704(p))......................................... 186
21. Clarification of denial of deduction for stock
redemption expenses (sec. 1704(q))............... 187
22. Definition of passive income in determining
passive foreign investment company status (sec.
1704(s))......................................... 188
23. Exclusion from income for combat zone
compensation (sec. 1704(t)(4))................... 188
III. Budget Effects of the Bill.....................................189
A. Committee Estimates................................... 189
B. Budget Authority and Tax Expenditures................. 196
C. Consultation with Congressional Budget Office......... 196
IV. Votes of the Committee.........................................199
V. Regulatory Impact and Other Matters............................199
A. Regulatory Impact..................................... 199
B. Information Relating to Unfunded Mandates............. 200
VI. Changes in Existing Law Made by the Bill, as Reported..........202
I. LEGISLATIVE BACKGROUND
H.R. 3448 (``Small Business Job Protection Act of 1996'')
was passed by the House of Representatives on May 22, 1996. On
May 23, the House combined H.R. 3448 (revenue provisions as
Title I) with the minimum wage and other provisions (as Title
II) from H.R. 1227 as passed by the House on May 23.
H.R. 3448 was referred to the Senate Committee on Finance
on June 6, 1996. On June 12, 1996, the Senate Committee on
Finance marked up a committee amendment as a substitute for the
revenue provisions of H.R. 3448 (Title I) as passed by the
House. The Committee on Finance approved the committee
amendment by unanimous voice vote. The Committee on Finance did
not consider Title II of the bill. References to ``the bill''
in the ``Explanation of the Bill'' (Part II of this report) are
to the Title I revenue provisions.
Most of the provisions in the committee amendment to Title
I of H.R. 3448 were previously approved in the Balanced Budget
Act of 1995 (H.R. 2491) as passed by the Senate or in the
conference agreement to H.R. 2491, which was vetoed by the
President.
II. EXPLANATION OF THE BILL (TITLE I)
Small Business and Other Tax Provisions
A. Small Business Provisions
1. Increase in expensing for small businesses (sec. 1111 of the bill
and sec. 179 of the Code)
Present law
In lieu of depreciation, a taxpayer with a sufficiently
small amount of annual investment may elect to deduct up to
$17,500 of the cost of qualifying property placed in service
for the taxable year (sec. 179).1 In general, qualifying
property is defined as depreciable tangible personal property
that is purchased for use in the active conduct of a trade or
business. The $17,500 amount is reduced (but not below zero) by
the amount by which the cost of qualifying property placed in
service during the taxable year exceeds $200,000. In addition,
the amount eligible to be expensed for a taxable year may not
exceed the taxable income of the taxpayer for the year that is
derived from the active conduct of a trade or business
(determined without regard to this provision). Any amount that
is not allowed as a deduction because of the taxable income
limitation may be carried forward to succeeding taxable years
(subject to similar limitations).
---------------------------------------------------------------------------
\1\ The amount permitted to be expensed under Code section 179 is
increased by up to an additional $20,000 for certain property placed in
service by a business located in an empowerment zone (sec. 1397A).
---------------------------------------------------------------------------
Reasons for change
The Committee believes that section 179 expensing provides
two important benefits for small businesses. First, it lowers
the cost of capital for tangible property used in a trade or
business. Second, it eliminates depreciation recordkeeping
requirements with respect to expensed property. In order to
increase the value of these benefits, the Committee would,
after a phase-in period, increase the amount allowed to be
expensed under section 179 to $25,000.
The Committee also believes that horses should qualify as
section 179 property. The Committee believes that horses are
similar to other tangible personal property for which expensing
is allowed and that any potential tax shelter abuses inherent
in allowing the cost of a horse to be expensed are better
addressed by the phase-out and taxable income limitations of
section 179, the hobby loss rules of section 183, and the
passive loss rules of section 469. Thus, the Committee bill
does not adopt a technical correction that would deny section
179 expensing for horses.
Explanation of provision
The provision increases the $17,500 amount of qualified
property allowed to be expensed under Code section 179 to
$25,000. The increase is phased in as follows:
Taxable year beginning in-- Maximum expensing
1997.......................................................... $18,000
1998.......................................................... 18,500
1999.......................................................... 19,000
2000.......................................................... 20,000
2001.......................................................... 24,000
2002.......................................................... 24,000
2003 and thereafter........................................... 25,000
The bill clarifies the present-law provision that horses
are qualified property for purposes of section 179.
Effective date
The provision increasing the amount allowed to be expensed
under section 179 is effective for property placed in service
in taxable years beginning after December 31, 1996, subject to
the phase-in schedule set forth above.
2. Tax credit for Social Security taxes paid with respect to employee
cash tips (sec. 1112 of the bill and sec. 45B of the Code)
Present law
Employee tip income is treated as employer-provided wages
for purposes of the Federal Insurance Contributions Act
(``FICA''). Employees are required to report to the employer
the amount of tips received. The Omnibus Budget Reconciliation
Act of 1993 (``OBRA 1993'') provided a business tax credit with
respect to certain employer FICA taxes paid with respect to
tips treated as paid by the employer. The credit applies to
tips received from customers in connection with the provision
of food or beverages for consumption on the premises of an
establishment with respect to which the tipping of employees is
customary. OBRA 1993 provided that the FICA tip credit is
effective for taxes paid after December 31, 1993. Temporary
Treasury regulations provide that the tax credit is available
only with respect to tips reported by the employee. The
temporary regulations also provide that the credit is effective
for FICA taxes paid by an employer after December 31, 1993,
with respect to tips received for services performed after
December 31, 1993.
Reasons for change
The Committee believes it appropriate to clarify the
effective date and scope of the credit for FICA taxes paid on
employer cash tips. Despite the statutory language, there has
been some confusion regarding the effective date. The FICA tip
credit was included in the Senate version of H.R. 4210, the Tax
Fairness and Economic Growth Act of 1992, and was included in
the conference agreement of H.R. 4210 as passed by the 102d
Congress and vetoed by President Bush. The effective date of
that provision would have applied to ``tips received and wages
paid after the date of enactment.'' The FICA tip credit was
also included in the House and Senate versions of H.R. 11, the
Revenue Act of 1992, as considered by the 102d Congress. The
effective date of both those provisions was the same as in H.R.
4210, specifically tips received and wages paid after the date
of enactment. The provision was included in the conference
agreement of H.R. 11, as adopted by the Congress and vetoed by
President Bush; however, the effective date of that provision
was modified to apply to ``taxes paid after'' December 31,
1992, i.e., no limitation with respect to tips earned after
December 31, 1992, was included.
In 1993, the House and Senate versions of the Omnibus
Budget Reconciliation Act of 1993 (``OBRA 1993'') did not
contain the FICA tip provision, but it was included in the
conference agreement. The FICA tip provision as included in
OBRA 1993 has the same effective date as the provision in the
conference agreement for H.R. 11, except that the date was
moved one year, to taxes paid after December 31, 1993. The
Committee believes that the legislative history of this
provision indicates intent to change the effective date, and
that the Treasury's interpretation of that date is not
consistent with the provision as finally adopted.
The Committee also believes it appropriate to apply the
credit to all persons who provide food and beverages, whether
for consumption on or off the premises.
Explanation of provision
The provision clarifies the credit with respect to employer
FICA taxes paid on tips by providing that the credit is (1)
available whether or not the employee reported the tips on
which the employer FICA taxes were paid pursuant to section
6053(a), and (2) effective with respect to taxes paid after
December 31, 1993, regardless of when the services with respect
to which the tips are received were performed.
The provision also modifies the credit so that it applies
with respect to tips received from customers in connection with
the delivery or serving of food or beverages, regardless of
whether the food or beverages are for consumption on the
premises of the establishment.
Effective date
The clarifications relating to the effective date and
nonreported tips are effective as if included in OBRA 1993. The
provision expanding the tip credit to the provision of food or
beverages not for consumption on the premises of the
establishment is effective with respect to FICA taxes paid on
tips received with respect to services performed after December
31, 1996.
3. Treatment of dues paid to agricultural or horticultural
organizations (sec. 1113 of the bill and sec. 512 of the Code)
Present law
Tax-exempt organizations generally 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). Dues payments made to a
membership organization generally are not subject to the UBIT.
However, several courts have held that, with respect to postal
labor organizations, dues payments were subject to the UBIT
when received from individuals who were not postal workers, but
who became ``associate'' members for the purpose of obtaining
health insurance available to members of the organization. See
National League of Postmasters of the United States v.
Commissioner, No. 8032-93, T.C. Memo (May 11, 1995); American
Postal Workers Union, AFL-CIO v. United States, 925 F.2d 480
(D.C. Cir. 1991); National Association of Postal Supervisors v.
United States, 944 F.2d 859 (Fed. Cir. 1991).
In Rev. Proc. 95-21 (issued March 23, 1995), the IRS set
forth its position regarding when associate member dues
payments received by an organization described in section
501(c)(5) will be treated as subject to the UBIT. The IRS
stated that dues payments from associate members will not be
treated as subject to UBIT unless, for the relevant period,
``the associate member category has been formed or availed of
for the principal purpose of producing unrelated business
income.'' Thus, under Rev. Proc. 95-21, the focus of the
inquiry is upon the organization's purposes in forming the
associate member category (and whether the purposes of that
category of membership are substantially related to the
organization's exempt purposes other than through the
production of income) rather than upon the motive of the
individuals who join as associate members.
Reasons for change
In order to reduce uncertainty and legal disputes involving
the UBIT treatment of certain associate member dues, the
Committee believes that it is appropriate to provide a special
rule exempting from the UBIT annual dues not exceeding $100
paid to a tax-exempt agricultural or horticultural
organization.
Explanation of provision
Under the provision, if an agricultural or horticultural
organization described in section 501(c)(5) requires annual
dues not exceeding $100 to be paid in order to be a member of
such organization, then in no event will any portion of such
dues be subject to the UBIT by reason of any benefits or
privileges to which members of such organization are entitled.
For taxable years beginning after 1995, the $100 amount will be
indexed for inflation. The term ``dues'' is defined as ``any
payment (whether or not designated as dues) which is required
to be made in order to be recognized by the organization as a
member of the organization.'' Thus, if a person is recognized
as a member of an organization by virtue of having paid annual
dues for his or her membership, then any subsequent payments
made by that person during the year to purchase another
membership in the same organization will not be within the
scope of the provision.
Effective date
The provision applies to taxable years beginning after
December 31, 1994. 2
---------------------------------------------------------------------------
2 The Committee intends that, with respect to dues payments
received prior to the effective date of the provision, general UBIT
rules under prior law will be applied in a manner consistent with the
provision.
---------------------------------------------------------------------------
4. Clarify employment tax status of certain fishermen (sec. 1114 of the
bill and sec. 3121(b)(20) of the Code)
Present law
Under present law, service as a crew member on a fishing
vessel is generally excluded from the definition of employment
for purposes of income tax withholding on wages and for
purposes of the Federal Insurance Contributions Act (``FICA'')
and the Federal Unemployment Tax Act (``FUTA'') taxes if the
operating crew of the boat normally consists of fewer than 10
individuals, the individual receives a share of the catch based
on the total catch, and the individual does not receive cash
remuneration other than proceeds from the sale of the
individual's share of the catch. If a crew member receives any
other cash, e.g., payment for services as an engineer, the
exemption from FICA and FUTA taxes does not apply. Crew members
to which the exemption applies are subject to self-employment
taxes. Special reporting requirements apply to the operators of
boats on which exempt crew members serve.
Reasons for change
The Committee believes that providing a statutory
definition for determining whether the crew of a fishing boat
normally consists of fewer than 10 individuals would make the
provision easier to apply and administer. Providing that the
exemption continues to apply even if an individual receives, in
addition to a share of the catch, a small amount of cash for
certain duties performed would recognize long-standing industry
practice.
Explanation of provision
The operating crew of a boat is treated as normally made up
of fewer than 10 individuals if the average size of the
operating crew on trips made during the preceding 4 calendar
quarters consisted of fewer than 10 individuals. In addition,
the exemption still applies even if the crew member receives
certain cash payments. The cash payments cannot exceed $100 per
trip, must be contingent on a minimum catch, and must be paid
solely for additional duties (e.g., as mate, engineer, or cook)
for which additional cash remuneration is customary.
Effective date
The provision applies to remuneration paid after December
31, 1994. It is intended that, with respect to years before the
effective date, the Secretary apply the exemption in a manner
consistent with the proposal.
5. Modify rules governing issuance of tax-exempt bonds for first-time
farmers (sec. 1115 of the bill and sec. 147 of the Code)
Present law
Interest on bonds issued by States and local governments to
finance governmental activities carried out and paid for by
those entities is exempt from the regular corporate and
individual income taxes. Interest on bonds issued by the
governments to provide financing to private persons is taxable
unless an exception is provided in the Internal Revenue Code.
One such exception allows States and local governments to issue
bonds to finance loans to first-time farmers for the
acquisition of farm land (and limited amounts of related
depreciable farm property) if the purchasers will be the
principal user of the property and will materially participate
in the farming operation in which the property is to be used.
The amount of financing provided under this exception may
not exceed $1 million per farmer (and related parties). The $1
million limit is increased to $10 million if all capital
expenditures by the purchaser in the same county (or
incorporated municipality) within a prescribed six-year period
are aggregated. Aggregate depreciable farm property financing
for any purchaser may not exceed $250,000, of which no more
than $62,500 may be for used property.
A first-time farmer is defined as an individual who has at
no time owned farm land in excess of 15 percent of the median
size of a farm in the county in which such land is located, and
the fair market value of the land has not at any time when held
by the individual exceeded $125,000.
Under the general rules governing issuance of tax-exempt
bonds, bonds for private persons generally may only be issued
for acquisition or construction of property (i.e., may not be
issued for working capital costs). Use of bond proceeds to
finance purchases from related parties is precluded as a
working capital financing.
Reasons for change
The Committee determined that minor modifications to the
rules governing tax-exempt financing for first-time farmers are
appropriate to enable easier utilization of this exception
allowing private activity tax-exempt financing by persons
desiring to enter that occupation, including entry by younger
generations purchasing family farming operations.
Explanation of provision
The bill makes two modifications to the rules governing
issuance of tax-exempt bonds for first-time farmers. First, the
amount of farm land that an individual may own and still be
considered a first-time farmer is doubled, from 15 percent of
the median farm size in the county where the land is located to
30 percent of the median farm size.
Second, proceeds of these tax-exempt bonds are permitted to
be used to finance farm purchases by individuals from related
parties (e.g., a parent or grandparent), provided that the
price paid reflects the fair market value of the property and
that the seller has no financial interest in the farming
operation conducted on the land after the bond-financed sale
occurs.
Effective date
The provision is effective for financing provided with
bonds issued after the date of enactment.
6. Clarify treatment of newspaper distributors and carriers as direct
sellers (sec. 1116 of the bill and sec. 3508 of the Code)
Present law
For Federal tax purposes, there are two classifications of
workers: a worker is either an employee of the service
recipient or an independent contractor. Significant tax
consequences result from the classification of a worker as an
employee or independent contractor. These differences relate to
withholding and employment tax requirements, as well as the
ability to exclude certain types of compensation from income or
take tax deductions for certain expenses. Some of these
consequences favor employee status, while others favor
independent contractor status. For example, an employee may
exclude from gross income employer-provided benefits such as
pension, health, and group-term life insurance benefits. On the
other hand, an independent contractor can establish his or her
own pension plan and deduct contributions to the plan. An
independent contractor also has greater ability to deduct work-
related expenses.
Under present law, the determination of whether a worker is
an employee or an independent contractor is generally made
under a common-law facts and circumstances test that seeks to
determine whether the service provider is subject to the
control of the service recipient, not only as to the nature of
the work performed, but the circumstances under which it is
performed. Under a special safe harbor rule (sec. 530 of the
Revenue Act of 1978), a service recipient may treat a worker as
an independent contractor for employment tax purposes even
though the worker is an employee under the common-law test if
the service recipient has a reasonable basis for treating the
worker as an independent contractor and certain other
requirements are met.
In addition to the common-law test, there are also some
persons who are treated by statute as either employees or
independent contractors. For example, ``direct sellers'' are
deemed to be independent contractors. A direct seller is a
person engaged in the trade or business of selling consumer
products in the home or otherwise than in a permanent retail
establishment, if substantially all the remuneration for the
performance of the services is directly related to sales or
other output rather than to the number of hours worked, and the
services performed by the person are performed pursuant to a
written contract between such person and the service recipient
and such contract provides that the person will not be treated
as an employee for Federal tax purposes.
The newspaper industry has generally taken the position
that newspaper distributors and carriers should be treated as
direct sellers for income and employment tax purposes. The
Internal Revenue Service has generally taken the position that
the direct seller rules do not apply to newspaper distributors
and carriers operating under an agency distribution system
(i.e., where the publisher retains title to the newspapers).
Reasons for change
The Committee recognizes that there are presently numerous
disputes between newspaper distributors and carriers and the
Internal Revenue Service regarding the treatment of newspaper
distributors and carriers as direct sellers. The Committee
believes that in the vast majority of these cases the newspaper
distributors and carriers should properly be treated as direct
sellers. Consequently, in order to avoid further disputes, the
Committee wishes to clarify the treatment of qualifying
newspaper distributors and carriers as direct sellers.
Explanation of provision
The bill clarifies the treatment of qualifying newspaper
distributors and carriers as direct sellers. Under the bill, a
person engaged in the trade or business of the delivery or
distribution of newspapers or shopping news (including any
services that are directly related to such trade or business
such as solicitation of customers or collection of receipts)
qualifies as a direct seller, provided substantially all the
remuneration for the performance of the services is directly
related to sales or other output rather than to the number of
hours worked, and the services performed by the person are
performed pursuant to a written contract between such person
and the service recipient and such contract provides that the
person will not be treated as an employee for Federal tax
purposes. The bill is intended to apply to newspaper
distributors and carriers whether or not they hire others to
assist in the delivery of newspapers. The bill also applies to
newspaper distributors and carriers operating under either a
buy-sell distribution system (i.e., where the newspaper
distributors or carriers purchase the newspapers from the
publisher) or an agency distribution system. For example,
newspaper distributors and carriers operating under an agency
distribution system who are paid based on the number of papers
delivered and have an appropriate written agreement qualify as
direct sellers. The status of newspaper distributors and
carriers who do not qualify as direct sellers under the bill
continue to be determined under present-law rules. No inference
is intended with respect to the employment status of newspaper
distributors and carriers prior to the effective date of the
bill. Further, the provision is intended to clarify the worker
classification issue for income and employment taxes only. The
Committee does not intend the provision to have any impact
whatsoever on the interpretation or applicability of Federal,
State, or local labor laws.
Effective date
The provision is effective with respect to services
performed after December 31, 1995.
7. Application of involuntary conversion rules to property damaged as a
result of Presidentially declared disasters (sec. 1117 of the
bill and sec. 1033(h) of the Code)
Present law
A taxpayer may elect not to recognize gain with respect to
property that is involuntarily converted if the taxpayer
acquires within an applicable period property similar or
related in service or use. If the taxpayer does not replace the
converted property with property similar or related in service
or use, then gain generally is recognized.
Reasons for change
The property damage in a Presidentially declared disaster
may be so great that businesses are forced to suspend
operations for a substantial time. During that hiatus, valuable
markets and customers may be lost. If this suspension causes
the business to fail, and the owners of the business wish to
reinvest their capital in a new business venture, the
involuntary conversion rules will force them to recognize gain
when they buy replacement property that is needed for the new
business but not similar to that used in the failed business.
This provision will offer relief to such businesses by allowing
them to reinvest their funds in any tangible business property
without being forced to recognize gain. No such deferral of
gain is available, however, if the taxpayer decides not to
reinvest in tangible business property.
Explanation of provision
Any tangible property acquired and held for productive use
in a business is treated as similar or related in service or
use to property that (1) was held for investment or for
productive use in a business and (2) was involuntarily
converted as a result of a Presidentially declared disaster.
Effective date
The provision is effective for disasters for which a
Presidential declaration is made after December 31, 1994, in
taxable years ending after that date.
8. Establish 15-year recovery period for retail motor fuels outlet
stores (sec. 1118 of the bill and sec. 168 of the Code)
Present law
Under present law, property used in the retail gasoline
trade is depreciated under section 168 using a 15-year recovery
period and the 150-percent declining balance method.
Nonresidential real property (such as a grocery store) is
depreciated using a 39-year recovery period and the straight-
line method. It is understood that taxpayers generally have
taken the position that convenience stores and other buildings
installed at retail motor fuels outlets have a 15-year recovery
period. The Internal Revenue Service (``IRS''), in a position
described in a recent Coordinated Issues Paper, generally
limits the application of the 15-year recovery period to
instances where the structure: (1) is 1,400 square feet or less
or (2) meets a 50-percent test. The 50-percent test is met if:
(1) 50 percent or more of the gross revenues that are generated
from the building are derived from petroleum sales, and (2) 50
percent or more of the floor space in the building is devoted
to petroleum marketing sales.
Reasons for changes
The Committee believes that the position taken by the IRS
with respect to certain structures installed at motor fuel
retail outlets is contrary to the historical treatment of such
property. The Committee seeks to clarify (and restore) the
treatment of such property.
Explanation of provision
The provision provides that 15-year property includes any
section 1250 property (generally, depreciable real property)
that is a retail motor fuels outlet (whether or not food or
other convenience items are sold at the outlet). A retail motor
fuels outlet does not include any facility related to petroleum
or natural gas trunk pipelines or to any section 1250 property
used only to an insubstantial extent in the retail marketing of
petroleum or petroleum products. In addition, the provision
provides a 20-year class life for retail motor fuels outlets
for purposes of the alternative depreciation system of section
168(g).
The Committee wishes to clarify what types of property
qualify as a retail motor fuels outlet. Section 1250 property
will so qualify if it meets a 50-percent test. The 50-percent
test is met if: (1) 50 percent or more of the gross revenues
that are generated from the property are derived from petroleum
sales, or (2) 50 percent or more of the floor space in the
property is devoted to petroleum marketing sales. The Committee
intends that the determination of whether either prong of this
test is met will be made pursuant to the recent Coordinated
Issue Paper. Property not meeting the test will not qualify as
a retail motor fuels outlet. For property placed in service in
taxable years that end after the date of enactment, the
determination of whether the property meets the 50-percent test
generally will be made in the year the property is placed in
service. However, the test may be applied in the subsequent
taxable year if the property is placed in service near the end
of the taxable year and the use of the property during such
short period is not representative of the subsequent use of the
property. The Committee intends that, with respect to property
placed in service in taxable years that ended before the date
of enactment of the provision, the determination of whether the
property meets the 50-percent test generally will be made in a
manner consistent with the manner in which the 50-percent test
of the Coordinated Issues Paper is applied (but by using the
disjunctive test intended by the Committee rather than the
conjunctive test of the Paper). The Committee also intends that
if property initially meets (or fails to meet) the disjunctive
50-percent test but subsequently fails to meet (or meets) such
test for more than a temporary period, such failure (or
qualification) may be treated as a change in the use of
property to which section 168(i)(5) applies.
In addition, property the size of which is 1,400 square
feet or less also will qualify if such property would have
qualified under the current Coordinated Issues Paper.
Effective date
The provision is effective for property placed in service
on or after the date of enactment. The taxpayer may elect to
apply the provision for any property to which the amendments
made by section 201 of the Tax Reform Act of 1986 apply (i.e.,
property subject to the modified Accelerated Cost Recovery
System of sec. 168) and which was placed in service prior to
the date of enactment. This election shall be made in a manner
prescribed by the Secretary of the Treasury. The Secretary of
the Treasury may treat such election as a change in the
taxpayer's method of accounting for such property and may
provide rules similar to those provided in Rev. Proc. 96-31,
1996-20 I.R.B. 11, May 13, 1996.
9. Treatment of leasehold improvements (sec. 1119 of the bill and sec.
168 of the Code)
Present law
Depreciation of leasehold improvements
Depreciation allowances for property used in a trade or
business generally is 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)).3 This rule applies regardless whether
the lessor or lessee places the leasehold improvements in
service.4 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 (i)(6)).5
---------------------------------------------------------------------------
\3\ Prior to the adoption of the Accelerated Cost Recovery System
(``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 Tax Reform
Act of 1986.
\4\ 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 Tax Reform Act of 1986.
\5\ If the improvement is characterized as tangible personal
property, ACRS depreciation is calculated using the shorter recovery
periods and accelerated methods applicable to such property. The
determination of whether certain improvements are characterized as
tangible personal property or as nonresidential real property often
depends on whether or not the improvements constitute a ``structural
component'' of a building (as defined by Treas. Reg. sec. 1.48-
1(e)(1)). See, for example, Metro National Corp., 52 TCM 1440 (1987);
King Radio Corp., 486 F.2d 1091 (10th Cir., 1973); Mallinckrodt, Inc.,
778 F.2d 402 (8th Cir., 1985) (with respect various leasehold
improvements).
---------------------------------------------------------------------------
Treatment of dispositions of leasehold improvements
A taxpayer generally recovers the adjusted basis of
property for purposes of determining gain or loss upon the
disposition of the property. Upon the termination of a lease,
the adjusted basis of leasehold improvements that were made,
but are not retained, by a lessee are taken into account to
compute gain or loss by the lessee.6 The proper treatment
of the adjusted basis of improvements made by a lessor upon
termination of a lease is less clear. Proposed Treasury
regulation section 1.168-2(e)(1) provides that the unadjusted
basis of a building's structural components must be recovered
as a whole. In addition, proposed Treasury regulation sections
1.168-2(l)(1) and 1.168-6(b) provide that ``disposition'' does
not include the retirement of a structural component of real
property if there is no disposition of the underlying
building.7 Thus, it appears that it is the position of the
Internal Revenue Service that leasehold improvements made by a
lessor that constitute structural components of a building must
be continued to be depreciated in the same manner as the
underlying real property, even if such improvements are retired
at the end of the lease term.8 Some lessors, on the other
hand, may be taking the position that a leasehold improvement
is a property separate and distinct from the underlying
building and that an abandonment loss under section 165 is
allowable at the end of the lease term for the adjusted basis
of the property. In addition, lessors may argue that even if a
leasehold improvement constitutes a structural component of a
building, proposed Treasury regulation section 1.168-2(l)(1)
(that seemingly denies the deduction at the end of the lease
term) applies only to retirements, but not abandonments or
demolitions, of such property.9 Thus, it appears that some
lessors take the position that, at least in certain
circumstances, the adjusted basis of leasehold improvements may
be recovered at the end of the term of the lease to which the
improvements relate even if there is no disposition of the
underlying building.
---------------------------------------------------------------------------
\6\ See, Report of the Committee on Ways and Means on H.R. 3838 (H.
Rept. 99-426), p. 158, and Senate Finance Committee Report on H.R. 3838
(S. Rept. 99-313), p. 105 (Tax Reform Act of 1986, 99th Cong.).
\7\ For example, if a taxpayer places a new roof on building
subject to ACRS, the taxpayer must continue to depreciate the allocable
cost of the old roof as part of the cost of the underlying building.
(Prop. Treas. reg. sec. 1.168-6(b)(1)) See, also, Joint Committee on
Taxation, General Explanation of the Economic Recovery Tax Act of 1981
(97th Cong.), p. 86.
\8\ See, IRS General Information Letter, dated Sept. 17, 1992.
\9\ Compare the second and fourth sentences of proposed Treasury
regulation section 1.168-2(l)(1).
---------------------------------------------------------------------------
Reasons for change
The Committee believes that costs that relate to the
leasing of property should not be recovered beyond the term of
the lease to the extent the costs do not provide a future
benefit beyond such term. The Committee also believes that the
proper present-law treatment of leasehold improvements disposed
of at the end of the term of a lease is unclear. Thus, the
Committee provides that the unrecovered costs of leasehold
improvements that were placed in service by a lessor with
respect to a lease and are irrevocably disposed of at the end
of the lease term should be taken into account at that time.
Explanation of provision
Under the provision, a lessor of leased property that
disposes of a leasehold improvement which 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. The provision thus conforms the treatment of lessors
and lessees with respect to leasehold improvements disposed of
at the end of a term of lease.
For purposes of applying the provision, it is expected that
a lessor must be able to separately account for the adjusted
basis of the leasehold improvement that is irrevocably disposed
of or abandoned. In addition, the Secretary of the Treasury may
provide guidance, as necessary, regarding the determination of
when a leasehold improvement is made for a lessee and when such
property is irrevocably abandoned or disposed of.
Effective date
The provision is effective for leasehold improvements
disposed of after June 12, 1996. No inference is intended as to
the proper treatment of such dispositions before June 13, 1996.
10. Increase deductibility of business meal expenses for certain
seafood processing facilities (sec. 1120 of the bill and sec.
274 of the Code)
Present law
In general, 50 percent of meal and entertainment expenses
incurred in connection with a trade or business that are
ordinary and necessary (and not lavish or extravagant) are
deductible (sec. 274). Food or beverage expenses are fully
deductible provided that they are (1) required by Federal law
to be provided to crew members of a commercial vessel, (2)
provided to crew members of similar commercial vessels not
operated on the oceans, or (3) provided on certain oil or gas
platforms or drilling rigs.
Reasons for change
The Committee believes that it is appropriate to treat
remote seafood processing facilities in the same way that
remote oil or gas platforms and drilling rigs are treated for
purposes of the deductibility of business meal expenses.
Explanation of provision
The provision adds remote seafood processing facilities
located in the United States north of 53 degrees north latitude
to the present-law list of entities not subject to the 50
percent limitation on the deductibility of business meals.
Consequently, these expenses are fully deductible. A seafood
processing facility is remote when there are insufficient
eating facilities in the vicinity of the employer's
premises.10
---------------------------------------------------------------------------
\10\ See Treas. Reg. sec. 1.119-1(a)(2)(ii)(c) and 1.119-1(f)
(Example 7).
---------------------------------------------------------------------------
Effective date
The provision applies to taxable years beginning after
December 31, 1996.
11. Provide a lower rate of tax on certain hard ciders (sec. 1121 of
the bill and sec. 5041 of the Code)
Present law
Under present 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. Higher rates of tax are provided for wines with
greater alcohol content and for sparkling 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. Certain small
breweries pay a reduced excise tax of $7.00 per barrel
(approximately 22.6 cents per gallon) on the first 60,000
barrels (1,860,000 gallons) of beer produced annually.
Apple cider containing alcohol is classified and taxed as
wine.
Reasons for change
The Committee understands that as an alcoholic beverage,
hard cider competes more as a substitute for beer than as a
substitute for 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 Committee also understands that producers of hard
cider generally are small businesses and has 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 bill adjusts the tax rate on apple cider having an
alcohol content of no more than seven percent to 22.6 cents per
gallon. Apple cider production will continue to be counted in
determining whether other production of a producer qualifies
for the tax credit for small producers. The bill does not
change the classification of qualifying apple cider as wine.
Effective date
The provision is effective for apple cider removed after
December 31, 1996.
12. Modifications to section 530 of the Revenue Act of 1978 (sec. 1122
of the bill and sec. 530 of the Revenue Act of 1978)
Present law
In general
For Federal tax purposes, there are two classifications of
workers: a worker is either an employee of the service
recipient or an independent contractor. Significant tax
consequences result from the classification of a worker as an
employee or independent contractor. These differences relate to
withholding and employment tax requirements, as well as the
ability to exclude certain types of compensation from income or
to take tax deductions for certain expenses. Some of these
consequences favor employee status, while others favor
independent contractor status. For example, an employee may
exclude from gross income employer-provided benefits such as
pension, health, and group-term life insurance benefits. On the
other hand, an independent contractor can establish his or her
own pension plan and deduct contributions to the plan. An
independent contractor also has greater ability to deduct work-
related expenses.
In general, the determination of whether an employer-
employee relationship exists for Federal tax purposes is made
under a common-law test. Treasury regulations provide that an
employer-employee relationship generally exists if the person
contracting for services has the right to control not only the
result of the services, but also the means by which that result
is accomplished. In other words, an employer-employee
relationship generally exists if the person providing the
services ``is subject to the will and control of the employer
not only as to what shall be done but how it shall be done.''
11 Under the Treasury regulations, it is not necessary
that the employer actually control the manner in which the
services are performed, rather it is sufficient that the
employer have a right to control. Whether the requisite control
exists is determined based on all the relevant facts and
circumstances.12 The Internal Revenue Service (``IRS'')
recently issued a draft training guide for field agents that
provides current IRS views regarding worker classification
issues.13
---------------------------------------------------------------------------
\11\ Treas. Reg. sec. 31.3401(c)-(1)(b).
\12\ The Internal Revenue Service (``IRS'') has developed a list of
20 factors that may be examined in determining whether an employer-
employee relationship exists Rev. Rul. 87-41, 1987-1 C.B. 296.
\13\ Employee or Independent Contractor?, (Draft, February 28,
1996)(hereinafter the ``IRS Draft Training Guide'')
---------------------------------------------------------------------------
Section 530
In general
With increased enforcement of the employment tax laws
beginning in the late 1960s, controversies developed between
the IRS and taxpayers as to whether businesses had correctly
classified certain workers as self employed rather than as
employees. In some instances when the IRS prevailed in
reclassifying workers as employees under the common-law test,
the employing business became liable for substantial portions
of its employees' employment and income tax liabilities (that
the employer had failed to withhold and pay over) and the
employer's portion of such tax liabilities, although the
employees might have fully paid their liabilities for self-
employment and income taxes.
In response to this problem, the Congress enacted section
530 of the Revenue Act of 1978 (``section 530'').14 That
provision generally allows a taxpayer to treat a worker as not
being an employee for employment tax purposes (but not income
tax purposes), regardless of the individual's actual status
under the common-law test, unless the taxpayer has no
reasonable basis for such treatment. Section 530 was initially
scheduled to terminate at the end of 1979 to give the Congress
time to resolve the many complex issues regarding worker
classification. It was extended through the end of 1980 by P.L.
96-167 and through June 30, 1982, by P.L. 96-541. The provision
was extended permanently by the Tax Equity and Fiscal
Responsibility Act of 1982.15
---------------------------------------------------------------------------
\14\ P.L. 95-600.
\15\ P.L. 97-248.
---------------------------------------------------------------------------
Under section 530, a reasonable basis for treating a worker
as an independent contractor is considered to exist if the
taxpayer reasonably relied on (1) published rulings or judicial
precedent, (2) past IRS audit practice with respect to the
taxpayer, (3) long-standing recognized practice of a
significant segment of the industry of which the taxpayer is a
member, or (4) if the taxpayer has any ``other reasonable
basis'' for treating a worker as an independent contractor. The
legislative history states that section 530 is to be
``construed liberally in favor of taxpayers.'' 16
---------------------------------------------------------------------------
\16\ H. Rept. No. 1748 (95th Cong., 2d Sess., 5 (1978)). The
conference agreement to the Revenue Act of 1978 adopted the provisions
of the House bill and therefore incorporates this legislative history.
---------------------------------------------------------------------------
The relief under section 530 is available with respect to
an individual only if certain additional requirements are
satisfied. The taxpayer must not have treated the individual as
an employee for any period, and for periods since 1978 all
Federal tax returns, including information returns, must have
been filed on a basis consistent with treating such individual
as an independent contractor. Further, the taxpayer (or a
predecessor) must not have treated any individual holding a
substantially similar position as an employee for purposes of
employment taxes for any period beginning after 1977.
Under section 1706 of the Tax Reform Act of 1986, section
530 does not apply in the case of an individual who, pursuant
to an arrangement between the taxpayer and another person,
provides services for such other person as an engineer,
designer, drafter, computer programmer, systems analyst, or
other similarly skilled worker engaged in a similar line of
work. Thus, the determination of whether such individuals are
employees or self employed is made in accordance with the
common-law test.
Section 530 also prohibits the issuance of Treasury
regulations and revenue rulings on common-law employment
status. Taxpayers may, however, obtain private letter rulings
from the IRS regarding the status of workers as employees or
independent contractors.
Status of worker
There is no explicit statement in the language of section
530 requiring that there first be a determination that a worker
is an employee under the common-law test before the relief
under section 530 becomes available. It is the position of the
IRS, based on legislative history, that section 530 can only
apply after such a determination is made. 17 The IRS does
not require the taxpayer to concede or agree to a determination
that the worker is an employee. 18
---------------------------------------------------------------------------
\17\ IRS Draft Training Guide, at 3-4.
\18\ IRS Draft Training Guide, at 3-5 and 3-6; TAM 9443002
(December 3, 1993).
---------------------------------------------------------------------------
Several courts that have explicitly considered the question
have held that section 530 relief is available irrespective of
whether there has been an initial determination of worker
classification under the common law. 19 Courts in the
cases cited in the IRS Draft Training Guide in support of the
IRS' position did determine worker status before applying
section 530. However, it is unclear whether such determination
was made because the court believed a threshold determination
was required or merely as a natural consequence of the court's
disposition of the case (i.e., the taxpayers first argued that
the workers were not employees under the common law test, or in
the alternative, section 530 provided relief). 20
---------------------------------------------------------------------------
\19\ See e.g., Lambert's Nursery and Landscaping, Inc. v. U.S., 894
F.2d 154 (5th Cir. 1990)(``It is not necessary to determine whether
[taxpayer's] workers were independent contractors or employees for
employment tax purposes.''); J & J Cab Service, Inc. v. U.S., 75 AFTR2d
No. 95-618 (W.D. N.C. 1995)(``Section 530 relief may be granted
irrespective of whether individuals were incorrectly treated as other
than employees''); Queensgate Dental Family Practice, Inc. v. U.S., 91-
2 USTC No. 50,536 (M.D. Pa. 1991)(disagreeing with the IRS' contention
that the court must first determine worker classification before
applying section 530).
\20\ See e.g., Overeen v. U.S., 91-2 USTC No. 50, 459 (W.D. Okla.
1991); Galbraith and Green, Inc. v. U.S., 80-2 USTC No. 9,629 (Az.
1980).
---------------------------------------------------------------------------
Judicial or administrative precedent safe harbor
Under section 530, reliance on judicial precedent,
published rulings, technical advice with respect to the
taxpayer, or a letter ruling to the taxpayer is deemed a
reasonable basis for treating a worker as an independent
contractor. If a taxpayer relies on this safe harbor, the IRS
will look to see whether the facts of the judicial precedent or
published ruling are sufficiently similar to the taxpayer's
facts.21
---------------------------------------------------------------------------
\21\ See e.g., TAM 9443002 (December 3, 1993); TAM 9330007 (April
28, 1993).
---------------------------------------------------------------------------
Prior audit safe harbor
Under the prior-audit safe harbor, reasonable reliance is
generally found to exist if the IRS failed to raise an
employment tax issue on audit, even though the audit was not
related to employment tax matters. A taxpayer can also rely on
a prior audit in which an employment tax issue was raised, but
was resolved in favor of the taxpayer. According to the IRS, an
``audit'' must involve an examination of the taxpayer's books
and records; mere inquiries from an IRS service center or a
``compliance check'' to determine whether a taxpayer has filed
all returns will not suffice.22 In order to rely on a
prior audit, the IRS requires that the taxpayer must have
treated the workers at issue as independent contractors during
the period covered by the prior audit.23
---------------------------------------------------------------------------
\22\ IRS Draft Training Guide, at 3-17.
\23\ IRS Draft Training Guide, at 3-19.
---------------------------------------------------------------------------
Industry practice safe harbor
A taxpayer is also treated as having a reasonable basis for
treating a worker as an independent contractor under section
530 if the taxpayer reasonably relied on long-standing
recognized practice of a significant segment of the industry in
which the taxpayer is engaged. In applying this safe harbor, a
number of issues arise including the definition of: (1) a long-
standing practice, (2) the taxpayer's industry, and (3) a
significant segment of the industry.
Section 530 does not specify a period of time in order for
a practice to be long standing. The IRS Draft Training Guide
provides that a practice is most clearly long standing if the
industry has treated workers as independent contractors since
1978.24 According to the IRS Draft Training Guide, the
safe harbor is not met if the industry only recently began to
treat workers as independent contractors. One court has held
that seven years qualifies as long standing.25
---------------------------------------------------------------------------
\24\ IRS Draft Training Guide, at 3-23.
\25\ REAG, Inc. v. U.S., 801 F.Supp. 494 (W.D. Okla. 1992).
---------------------------------------------------------------------------
The IRS Draft Training Guide recognizes that a taxpayer may
use the industry practice safe harbor even if it began business
after 1978.26 However, the IRS Draft Training Guide
provides that if the industry practice changed by the time the
taxpayer joined the industry, the taxpayer cannot rely on the
former practice. The IRS position with respect to whether a new
industry (i.e., one beginning after 1978) can take advantage of
the industry practice safe harbor is unclear; the IRS Draft
Training Guide is silent on this issue. However, given the IRS
position with respect to new taxpayers, the IRS may take a
similar position with respect to new industries.
---------------------------------------------------------------------------
\26\ IRS Draft Training Guide, at 3-23.
---------------------------------------------------------------------------
A taxpayer's industry generally consists of businesses
competing for the same customers and providing the same or a
similar product or service.27 Further, what constitutes
the taxpayer's industry generally will be determined by
reference to the geographic or metropolitan area in which the
taxpayer conducts its business.28
---------------------------------------------------------------------------
\27\ See Sanderson III v. U.S., 862 F.Supp. 196 (N.D. Ohio 1994)
(court held that relevant industry was owner-operated truckers rather
than trucking industry as a whole); IRS Draft Training Guide, at 3-22.
\28\ See General Investment Corp. v. U.S., 823 F.2d 337 (9th Cir.
1987) (court held the taxpayer's industry consisted of small mining
business located in the taxpayer's county, rather than all mining
businesses throughout the county); TAM 9443002 (December 3, 1993).
---------------------------------------------------------------------------
Neither section 530, nor the legislative history, provides
a clear standard as to what constitutes a significant segment
of a taxpayer's industry. The IRS Draft Training Guide provides
that the determination will be based on the facts and
circumstances, including the percentage of employers and
workers subject to the practice.29 A few courts have
addressed this issue. In one case, the IRS argued that a
significant segment of the industry means more than 50 percent
of the industry.30 However, that court held that a
significant segment is less than a majority of the firms in an
industry. Another court held that 15 out of 84 industry
respondents (18 percent) treating workers as independent
contractors would constitute a significant segment of an
industry.31
---------------------------------------------------------------------------
\29\ IRS Draft Training Guide, at 3-24.
\30\ In re Bentley, 73 AFTR2d No. 94-667 (Bkrtcy. E.D. Tenn. 1994).
\31\ REAG, Inc. v. U.S., 801 F.Supp. 494 (W.D. Okla. 1992).
---------------------------------------------------------------------------
Even if a taxpayer can establish a long-standing recognized
practice of a significant segment of the industry, the IRS
requires the taxpayer to show that it had knowledge of the
practice at the time it began treating workers as independent
contractors.32 For instance, the IRS Draft Training Guide
states that ``[i]f the taxpayer relied on a survey, the survey
must focus on the treatment of the workers at the time the
taxpayer started treating its workers as independent
contractors, not the treatment of workers at the time of the
examination.'' 33
---------------------------------------------------------------------------
\32\ TAM 9619001 (January 29, 1996).
\33\ IRS Draft Training Guide, at 3-26.
---------------------------------------------------------------------------
Other reasonable basis
Even if a taxpayer is unable to rely on one of the three
safe harbors described above, a taxpayer may still be entitled
to relief under section 530 if the taxpayer has any other
reasonable basis for treating a worker as an independent
contractor.
Under case law, reliance on the advice of an attorney or an
accountant may constitute a reasonable basis for treating a
worker as an independent contractor.34 The IRS appears to
agree with this position, provided there is a showing that the
attorney or accountant was knowledgeable about the law and the
facts in rendering the advice.35
---------------------------------------------------------------------------
\34\ See e.g., Smoky Mountain Secrets, Inc. v. U.S., 910 F.Supp.
1316 (E.D. 1995); In re Arndt, 72 AFTR2d No. 93-5325 (Bkrtcy. M.D. Fl.
1993).
\35\ IRS Draft Training Guide, at 3-28; see also In re McAtee, 66
AFTR2d No. 94-667 (Bkrtcy. N.D. Iowa 1990)(taxpayer could not rely on
advice of accountant where it is not established accountant had
expertise in employment tax matters).
---------------------------------------------------------------------------
Taxpayers generally have argued successfully that reliance
on the common-law test can constitute a reasonable basis for
purposes of applying section 530.36 However, the IRS does
not concur with this view.37
---------------------------------------------------------------------------
\36\ See e.g., Critical Care Register Nursing, Inc. v. U.S., 776
F.Supp. 1025 (E.D. Pa. 1991); American Institute of Family Relations v.
U.S., 79-1 USTC No. 9,364 (C.D. Cal. 1979).
\37\ IRS Draft Training Guide, at 3-29.
---------------------------------------------------------------------------
Reporting consistency
To be entitled to relief under section 530, the taxpayer
must not have treated the worker as an employee for any period,
and, for periods since 1978, all Federal tax returns, including
information returns, must have been filed on a basis consistent
with treating such worker as an independent contractor. For
example, withholding income and employment taxes from a
worker's remuneration would not be consistent with treatment as
an independent contractor, and the taxpayer must file a Form
1099 (if required) with respect to the worker as opposed to a
Form W-2.38 If a taxpayer does not file the required
information return for a period it will not be entitled to
section 530 relief for such period.39 Further, the courts
have generally held that since 1978 (or such shorter period as
the taxpayer has been in business), Federal tax reporting with
respect to the worker (and all similarly situated workers) must
have been consistent with independent contractor
treatment.40 The filing of consistent Federal tax returns
for the period of examination will not be sufficient.
---------------------------------------------------------------------------
\38\ Rev. Proc. 85-18, 1985-1 C.B. 518.
\39\ General Investment Corp. v. U.S., 823 F.2d 337 (9th Cir.
1987); Rev. Rul. 81-224, 1981-2 C.B. 197.
\40\ Henry v. U.S., 793 F.2d 289 (Fed.Cir. 1986); In re McAtee, 66
AFTR2d No. 94-667 (Bkrtcy. N.D. Iowa 1990).
---------------------------------------------------------------------------
Consistency among workers with substantially similar
positions
In order for section 530 to apply, the taxpayer (or a
predecessor) must not have treated any worker holding a
substantially similar position as an employee for purposes of
employment taxes for any period beginning after 1977. Whether
workers are similarly situated is dependent on the facts and
circumstances. The IRS Draft Training Guide states that a
``substantially similar position exists if the job functions,
duties, and responsibilities are substantially similar and the
control and supervision of those duties and responsibilities is
substantially similar.'' 41
---------------------------------------------------------------------------
\41\ IRS Draft Training Guide, at 3-10.
---------------------------------------------------------------------------
There have been a few court decisions addressing this
issue. For example, in REAG, Inc. v. U.S.,42 the court
held that the position of appraisers who were owner-officers of
the business was not substantially similar to appraisers who
were not owners since the owner-officers had managerial
responsibilities. By contrast, in Lowen Corp. v. U.S.,43
the court found that all workers engaged in the business of
selling real estate signs had substantially similar positions
even though some were salaried and had to file daily reports
while others were paid by commission and did not have to file
such reports.
---------------------------------------------------------------------------
\42\ 801 F.Supp. 494 (W.D. Okla. 1992). The IRS has nonacquiesced.
IRS Draft Training Guide, at 3-13.
\43\ 785 F.Supp. 913 (D. Kan. 1992).
---------------------------------------------------------------------------
Burden of proof
The IRS Draft Training Guide states that the burden of
proof is on the taxpayer to demonstrate that it had a
reasonable basis for treating a worker as an independent
contractor.44 However, in light of the Congressional
instruction in the legislative history to construe section 530
liberally,45 courts appear to be split as to how stringent
a burden to apply.
---------------------------------------------------------------------------
\44\ IRS Draft Training Guide, at 3-25.
\45\ H. Rept. No. 1748 (95th Cong., 2d Sess., 5 (1978)). The
conference agreement to the Revenue Act of 1978 adopted the provisions
of the House bill and therefore incorporates this legislative history.
---------------------------------------------------------------------------
In McClellan v. U.S.,46 the court held that section
530 requires the ``taxpayer to come forward with an explanation
and enough evidence to establish prima facie grounds for a
finding of reasonableness. . . . [T]his threshold burden is
relatively low, and can be met with any reasonable showing.
Once the taxpayer has made this prima facie showing, the burden
then shifts to the IRS to verify or refute the taxpayer's
explanation.'' By contrast, in Boles Trucking, Inc., v.
U.S.,47 the court held that the burden is on the taxpayer
to show, based on a preponderance of the evidence, that it had
a reasonable basis for treating workers as independent
contractors.
---------------------------------------------------------------------------
\46\ 900 F.Supp. 101 (E.D. Mich. 1995). See also REAG, Inc. V.
U.S., 801 F.Supp. 494 (W.D. Okla. 1992)(a taxpayer need only show a
substantial rational basis for its decision to treat the workers as
independent contractors).
\47\ 77 F.3d 236 (8th Cir. 1996). See also Springfield v. U.S., 873
F.Supp.1403 (S.D. Cal. 1994)(taxpayer has the burden to show it
satisfies the requirements of section 530).
---------------------------------------------------------------------------
Reasons for change
The Committee recognizes that the IRS and taxpayers
continue to have disputes over the proper classification of
workers, particularly with respect to the application of
section 530. Many of these disputes involve small businesses
without adequate resources to challenge the IRS position.
Accordingly, the Committee believes it is appropriate to make
certain clarifications of and modifications to section 530
which are designed to provide both the IRS and taxpayers with
clearer uniform standards. The Committee believes these clearer
standards will reduce the number of disputes between the IRS
and taxpayers over the application of section 530 and will
reduce unnecessary and costly litigation. Further, in light of
the unique nature of the legislative history to section 530
which provides that it should be construed liberally in favor
of taxpayers, the Committee believes that the burden of proof
should generally be on the IRS once the taxpayer establishes a
prima facie case that it was reasonable not to treat the worker
as an employee and provided the taxpayer fully cooperates with
reasonable requests for information by the IRS.
Explanation of provision
The bill makes several clarifications of and modifications
to section 530. First, under the bill, a worker does not have
to otherwise be an employee of the taxpayer in order for
section 530 to apply. The provision is intended to reverse the
IRS position, as stated in the IRS Draft Training Guide, that
there first must be a determination that the worker is an
employee under the common law standards before application of
section 530.
The bill modifies the prior audit safe harbor so that
taxpayers may not rely on an audit commencing after December
31, 1996, unless such audit included an examination for
employment tax purposes of whether the worker involved (or any
worker holding a position substantially similar to the position
held by the worker involved) should be treated as an employee
of the taxpayer. The provision does not affect the ability of
taxpayers to rely on prior audits that commenced before January
1, 1997, even though the audit was not related to employment
tax matters, as under present law.
Under the bill, section 530 will not apply with respect to
a worker unless the taxpayer and the worker sign a statement
(at such time and in such manner as the Secretary may
prescribe) which provides that the worker will not be treated
as an employee for employment tax purposes. Also, the bill
provides that an officer or employee of the IRS must, at (or
before) the commencement of an audit involving worker
classification issues, provide the taxpayer with written notice
of the provisions of section 530.
The bill makes a number of changes to the industry practice
safe harbor. First, the bill provides that a significant
segment of the taxpayer's industry under the industry practice
safe harbor does not require a reasonable showing of the
practice of more than 25 percent of an industry (determined
without taking into account the taxpayer). The provision is
intended to be a safe harbor; a lower percentage may constitute
a significant segment of the taxpayer's industry based on the
particular facts and circumstances.
The bill also provides that an industry practice need not
have continued for more than 10 years in order for the industry
practice to be considered long standing. As with the
significant segment safe harbor, this provision is intended to
be a safe harbor; an industry practice in existence for a
shorter period of time may be considered long standing based on
the particular facts and circumstances. In addition, the bill
clarifies that an industry practice will not fail to be treated
as long standing merely because such practice began after 1978.
Consequently, the provision clarifies that new industries can
take advantage of section 530.
The bill modifies the burden of proof in section 530 cases
by providing that if a taxpayer establishes a prima facie case
that it was reasonable not to treat a worker as an employee for
purposes of section 530,48 the burden of proof shifts to
the IRS with respect to such treatment.49 In order for the
shift in burden of proof to occur, the taxpayer must fully
cooperate with reasonable requests by the IRS for information
relevant to the taxpayer's treatment of the worker as an
independent contractor under section 530. The Committee intends
that a request by the IRS will not be treated as reasonable if
complying with the request would be impracticable given the
particular circumstances and the relative costs involved. The
shift in the burden of proof does not apply for purposes of
determining whether the taxpayer had any other reasonable basis
for treating the worker as an independent contractor, but does
apply to all other aspects of section 530. So, for example,
provided the taxpayer establishes its prima facie case and
fully cooperates with the IRS' reasonable requests, the burden
of proof shifts to the IRS with respect to all other aspects of
section 530, including whether the taxpayer had a reasonable
basis for treating the worker as an independent contractor
under the judicial or administrative precedent, prior audit, or
long-standing industry practice safe harbors, whether the
taxpayer filed all Federal tax returns on a basis consistent
with treating the worker as an independent contractor, and
whether the taxpayer treated any worker holding a substantially
similar position as an employee. No inference is intended with
respect to the application of the burden of proof in section
530 cases prior to the effective date of this provision.
---------------------------------------------------------------------------
\48\ For example, the taxpayer must establish a prima facie case
that it reasonably satisfies the requirements of section 530 for not
treating the worker as an employee, including the reporting consistency
and consistency among workers with substantially similar positions
requirements, and the requirement that the taxpayer have a reasonable
basis for not treating the worker as an employee.
\49\ The provision is generally intended to codify the holding in
McClellan v. U.S., discussed above, with respect to the burden of proof
in section 530 cases.
---------------------------------------------------------------------------
Effective date
The provisions generally apply to periods after December
31, 1996. The provision regarding the burden of proof applies
to disputes with respect to periods after December 31, 1996. In
the case of workers engaged to perform services for a taxpayer
before January 1, 1997, the provision requiring a written
statement that such workers are not employees for employment
tax purposes is effective for periods after December 31, 1997
(unless the taxpayer elects to apply the provision earlier).
The provision requiring the IRS to notify taxpayers of the
provisions of section 530 applies to audits commencing after
December 31, 1996.
B. Extension of Certain Expiring Provisions
1. Work opportunity tax credit (sec. 1201 of the bill and sec. 51 of
the Code)
Prior law
General rules
Prior to January 1, 1995, the targeted jobs tax credit was
available on an elective basis for employers hiring individuals
from one or more of nine targeted groups. The credit generally
was equal to 40 percent of qualified first-year wages.
Qualified first-year wages consisted of wages attributable to
service rendered by a member of a targeted group during the
one-year period beginning with the day the individual began
work for the employer. For a vocational rehabilitation
referral, however, the period began the day the individual
began work for the employer on or after the beginning of the
individual's vocational rehabilitation plan.
No more than $6,000 of wages during the first year of
employment were permitted to be taken into account with respect
to any individual. Thus, the maximum credit per individual was
$2,400.
With respect to economically disadvantaged summer youth
employees, the credit was equal to 40 percent of up to $3,000
of qualified first-year wages, for a maximum credit of $1,200.
The deduction for wages was reduced by the amount of the
credit.
Certification of members of targeted groups
In general, an individual was not treated as a member of a
targeted group unless certification that the individual was a
member of such a group was received or requested in writing by
the employer from the designated local agency on or before the
day on which the individual began work for the employer. In the
case of a certification of an economically disadvantaged youth
participating in a cooperative education program, this
requirement was satisfied if the certification was requested or
received from the participating school on or before the day on
which the individual began work for the employer. The
``designated local agency'' was the State employment security
agency.
If a certification was incorrect because it was based on
false information provided as to the employee's membership in a
targeted group, the certification was revoked. Wages paid after
the revocation notice was received by the employer were not
treated as qualified wages.
The U.S. Employment Service, in consultation with the
Internal Revenue Service, was directed to take whatever steps
necessary to keep employers informed of the availability of the
credit.
Targeted groups eligible for the credit
The nine groups eligible for the credit were either
recipients of payments under means-tested transfer programs,
economically disadvantaged (as measured by family income), or
disabled individuals.
(1) Vocational rehabilitation referrals
Vocational rehabilitation referrals were those individuals
who had a physical or mental disability that constituted a
substantial handicap to employment and who had 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 was provided by the designated local employment
agency upon assurances from the vocational rehabilitation
agency that the employee had met the above conditions.
(2) Economically disadvantaged youths
Economically disadvantaged youths were individuals
certified by the designated local employment agency as (1)
members of economically disadvantaged families and (2) at least
age 18 but not age 23 on the date they were hired by the
employer. An individual was determined to be a member of an
economically disadvantaged family if, during the six months
immediately preceding the earlier of the month in which the
determination occurred or the month in which the hiring date
occurred, the individual's family income was, on an annual
basis, not more than 70 percent of the Bureau of Labor
Statistics' lower living standard. A determination that an
individual was a member of an economically disadvantaged family
was valid for 45 days from the date on which the determination
was made.
Except as otherwise noted below, a determination of whether
an individual was a member of an economically disadvantaged
family was made on the same basis and was subject to the same
45-day limitation, where required in connection with the four
other targeted groups that excluded individuals who were not
economically disadvantaged.
(3) Economically disadvantaged Vietnam-era veterans
The third targeted group was Vietnam-era veterans certified
by the designated local employment agency as members of
economically disadvantaged families. For these purposes, a
Vietnam-era veteran was an individual who had served on active
duty (other than for training) in the Armed Forces for more
than 180 days, or who had been discharged or released from
active duty in the Armed Forces for a service-connected
disability, but in either case, the active duty must have taken
place after August 4, 1964, and before May 8, 1975. However,
any individual who had served for a period of more than 90 days
during which the individual was on active duty (other than for
training) was 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 was
intended to prevent employers who hired current members of the
armed services (or those departed from service within the last
60-days) from receiving the credit.
(4) SSI recipients
The fourth targeted group was individuals receiving either
Supplemental Security Income (``SSI'') under Title XVI of the
Social Security Act or State supplements described in section
1616 of that Act or section 212 of P.L. 93-66. To be an
eligible employee, the individual must have received SSI
payments during at least a one-month period ending during the
60-day period that ended on the date the individual was hired
by the employer. The designated local agency was to issue the
certification after a determination by the agency making the
payments that these conditions had been fulfilled.
(5) General assistance recipients
General assistance recipients were individuals who received
general assistance for a period of not less than 30 days if
that period ended within the 60-day period ending on the date
the individual was hired by the employer. General assistance
programs were State and local programs that provided
individuals with money payments, vouchers, or scrip based on
need. These programs were referred to by a wide variety of
names, including home relief, poor relief, temporary relief,
and direct relief. Because of the wide variety of such
programs, Congress provided that a recipient was an eligible
employee only after the program had been designated by the
Secretary of the Treasury as a program that provided money
payments, vouchers, or scrip to needy individuals.
Certification was performed by the designated local agency.
(6) Economically disadvantaged former convicts
The sixth targeted group included any individual who was
certified by the designated local employment agency as (1)
having at some time been convicted of a felony under State or
Federal law, (2) being a member of an economically
disadvantaged family, and (3) having been hired within five
years of the later of release from prison or date of
conviction.
(7) Economically disadvantaged cooperative education
students
The seventh targeted group was youths who (1) actively
participated in qualified cooperative education programs, (2)
had attained age 16 but had not attained age 20, (3) had not
graduated from high school or vocational school, and (4) were
members of economically disadvantaged families. The definitions
of a qualified cooperative education program and a qualified
school were similar to those used in the Vocational Education
Act of 1963. Thus, a qualified cooperative education program
meant a program of vocational education for individuals who,
through written cooperative arrangements between a qualified
school and one or more employers, received instruction,
including required academic instruction, by alternation of
study in school with a job in any occupational field, but only
if these two experiences were planned and supervised by the
school and the employer so that each experience contributed to
the student's education and employability.
For this purpose, a qualified school was (1) a specialized
high school used exclusively or principally for the provision
of vocational education to individuals who were available for
study in preparation for entering the labor market, (2) the
department of a high school used exclusively or principally for
providing vocational education to individuals who were
available for study in preparation for entering the labor
market, or (3) a technical or vocational school used
exclusively or principally for the provision of vocational
education to individuals who had completed or left high school
and who were available for study in preparation for entering
the labor market. In order for a nonpublic school to be a
qualified school, it must have been exempt from income tax
under section 501(a) of the Code.
The certification was performed by the school participating
in the cooperative education program. After initial
certification, an individual remained a member of the targeted
group only while meeting the program participation, age, and
degree status requirements of (a), (b), and (c), above.
(8) AFDC recipients
The eighth targeted group included any individual who was
certified by the designated local employment agency as being
eligible for Aid to Families with Dependent Children (``AFDC'')
and as having continually received such aid during the 90 days
before being hired by the employer.
(9) Economically disadvantaged summer youth employees
The ninth targeted group included youths who performed
services during any 90-day period between May 1 and September
15 of a given year and who were certified by the designated
local agency as (1) being 16 or 17 years of age on the hiring
date and (2) a member of an economically disadvantaged family.
A youth must not have been an employee of the employer prior to
that 90-day period. With respect to any particular employer, an
employee could qualify only one time for this summer youth
credit. If, after the end of the 90-day period, the employer
continued 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 took into account wages paid to the
youth while a qualified summer youth employee.
Definition of wages
In general, wages eligible for the credit were defined by
reference to the definition of wages under the Federal
Unemployment Tax Act (FUTA) in section 3306(b) of the Code,
except that the dollar limits did not apply. Because wages paid
to economically disadvantaged cooperative education students
and to certain agricultural and railroad employees were not
FUTA wages, special rules were provided for these wages.
Wages were taken into account for purposes of the credit
only if more than one-half of the wages paid during the taxable
year to an employee were for services in the employer's trade
or business. The test as to whether more than one-half of an
employee's wages were for services in a trade or business was
applied to each separate employer without treating related
employers as a single employer.
Other rules
In order to prevent taxpayers from eliminating all tax
liability by reason of the credit, the amount of the credit
could not exceed 90 percent of the taxpayer's income tax
liability. Furthermore, the credit was allowed only after
certain other nonrefundable credits had been taken. If, after
applying these other credits, 90 percent of an employer's
remaining tax liability for the year was less than the targeted
jobs tax credit, the excess credit could be carried back three
years and carried forward 15 years.
All employees of all corporations that were members of a
controlled group of corporations were to be treated as if they
were employees of the same corporation for purposes of
determining the years of employment of any employee and wages
for any employee up to $6,000. Generally, under the controlled
group rules, the credit allowed the group was the same as if
the group were a single company. A comparable rule was provided
in the case of partnerships, sole proprietorships, and other
trades or businesses (whether or not incorporated) that were
under common control, so that all employees of such
organizations generally were to be treated as if they were
employed by a single person. The amount of targeted jobs tax
credit allowable to each member of the controlled group was its
proportionate share of the wages giving rise to the credit.
No credit was available for the hiring of certain related
individuals (primarily dependents or owners of the taxpayer).
The credit was also not available for wages paid to an
individual who was employed by the employer at any time during
which the individual was not a certified member of a targeted
group.
No credit was available for wages paid by an employer to an
individual for services that were the same as, or substantially
similar to, those services performed by employees participating
in, or affected by, a strike or lockout during the period of
such strike or lockout. This rule applied to wages paid to
individuals whose principal place of employment was a plant or
facility where there was a strike or lockout.
No credit was allowed for wages paid unless the eligible
individual was either (1) employed by the employer for at least
90 days (14 days in the case of economically disadvantaged
summer youth employees) or (2) had completed at least 120 hours
(20 hours for summer youth) of services performed for the
employer.
Reasons for change
While the prior-law targeted jobs tax credit was the
subject of some criticism, the Committee believes that a tax
credit mechanism can provide an important incentive for
employers to undertake the expense of providing jobs and
training to economically disadvantaged individuals, many of
whom are underskilled and/or undereducated. The bill creates a
new program whose design will focus on individuals with poor
workplace attachments, streamline administrative burdens,
promote longer-term employment, and thereby reduce costs
relative to the prior-law program. The Committee intends that
this short-term program will provide the Congress and the
Treasury and Labor Departments an opportunity to assess fully
the operation and effectiveness of the new credit as a hiring
incentive.
Explanation of provision
General rules
The bill replaces the targeted jobs tax credit with the
``work opportunity tax credit.'' 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.
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 a vocational rehabilitation referral,
however, the period will begin on the day the individual begins
work for the employer on or after the beginning of the
individual's vocational rehabilitation plan as under prior law.
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.
Certification of members of targeted groups
In general, an individual is not to be treated as a member
of a targeted group unless: (1) on or before the day the
individual begins work for the employer, the employer received
in writing a certification from the designated local agency
that the individual is a member of a specific targeted group,
or (2) on or before the day the individual is offered work with
the employer, a pre-screening notice is completed with respect
to that individual by the employer and within 21 days after the
individual begins work for the employer, the employer submits
such notice, signed by the employer and the individual under
penalties of perjury, to the designated local agency as part of
a written request for certification. The pre-screening notice
will contain the information provided to the employer by the
individual that forms the basis of the employer's belief that
the individual is a member of a targeted group.
If a certification is incorrect because it is based on
false information provided as to the individual's membership in
a targeted group, the certification will be revoked. No credit
will be allowed on wages paid after receipt by the employer of
the revocation notice.
If a designated local agency rejects a certification
request it will have to provide a written explanation of the
basis of the rejection.
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 receiving benefits under AFDC or its successor program
for a period of at least nine months part of which is during
the nine-month period ending on the hiring date. For these
purposes, each member of the family receiving such assistance
is treated as receiving such assistance and therefore is
treated as an eligible recipient.
(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 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 will not 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.
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 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 three months ending on the hiring date. For these
purposes, each member of the family receiving such assistance
is treated as receiving such assistance and therefore is
treated as an eligible recipient.
Definition of wages and other rules
In general, wages eligible for the credit are defined by
reference to the definition of wages under the Federal
Unemployment Tax Act (``FUTA'') in section 3306(b) of the Code,
except that the dollar limits do not apply.
Wages are taken into account for purposes of the credit
only if more than one-half of the wages paid during the taxable
year to an employee are for services in the employer's trade or
business. The test as to whether more than one-half of an
employee's wages are for services in a trade or business are
applied to each separate employer without treating related
employers as a single employer.
In order to prevent taxpayers from eliminating all tax
liability by reason of the credit, the amount of the credit may
not exceed 90 percent of the taxpayer's income tax liability.
Furthermore, the credit is allowed only after certain other
nonrefundable credits had been taken. If, after applying these
other credits, 90 percent of an employer's remaining tax
liability for the year is less than the targeted jobs tax
credit, the excess credit can be carried back three years and
carried forward 15 years.
All employees of all corporations that are members of a
controlled group of corporations are treated as if they were
employees of the same corporation for purposes of determining
the years of employment of any employee and wages for any
employee up to $6,000. Generally, under the controlled group
rules, the credit allowed the group is the same as if the group
were a single company. A comparable rule is provided in the
case of partnerships, sole proprietorships, and other trades or
businesses (whether or not incorporated) that are under common
control, so that all employees of such organizations generally
are treated as if they was employed by a single person. The
amount of the credit allowable to each member of the controlled
group is its proportionate share of the wages giving rise to
the credit.
No credit is available for the hiring of certain related
individuals (primarily dependents or owners of the taxpayer).
The credit is also not available for wages paid to an
individual who is employed by the employer at any time during
which the individual is not a certified member of a targeted
group.
No credit is available for wages paid by an employer to an
individual for services that are the same as, or substantially
similar to, those services performed by employees participating
in, or affected by, a strike or lockout during the period of
such strike or lockout. This rule applies to wages paid to
individuals whose principal place of employment is a plant or
facility where there is a strike or lockout.
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
375 hours (120 hours in the case of a qualified summer youth
employee).
Effective date
The 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.
2. Employer-provided educational assistance (sec. 1202 of the bill and
sec. 127 of the Code)
Present and prior law
For taxable years beginning before January 1, 1995, an
employee's gross income and wages did not include amounts paid
or incurred by the employer for educational assistance provided
to the employee if such amounts were paid or incurred pursuant
to an educational assistance program that met certain
requirements. This exclusion, which expired for taxable years
beginning after December 31, 1994, was limited to $5,250 of
educational assistance with respect to an individual during a
calendar year. The exclusion applied whether or not the
education was job related. In the absence of this exclusion,
educational assistance is excludable from income only if it is
related to the employee's current job.
Reasons for change
The section 127 exclusion for employer-provided educational
assistance was first established on a temporary basis by the
Revenue Act of 1978 (through 1983). It subsequently was
extended, again on a temporary basis, by Public Law 98-611
(through 1985), by the Tax Reform Act of 1986 (through 1987),
by the Technical and Miscellaneous Revenue Act of 1988 (through
1988), by the Omnibus Budget Reconciliation Act of 1989
(through September 30, 1990), by the Omnibus Budget
Reconciliation Act of 1990 (through 1991), by the Tax Extension
Act of 1991 (through June 30, 1992), and by the Omnibus Budget
Reconciliation Act of 1993 (through December 31, 1994). Public
Law 98-611 adopted a $5,000 annual limit on the exclusion; this
limit was subsequently raised to $5,250 in the Tax Reform Act
of 1986. The Technical and Miscellaneous Revenue Act of 1988
made the exclusion inapplicable to graduate-level courses. The
restriction on graduate-level courses was repealed by the
Omnibus Budget Reconciliation Act of 1990, effective for
taxable years beginning after December 31, 1990.
The Committee believes that the exclusion for employer-
provided educational assistance should be extended because it
provides needed assistance to workers and aids U.S.
competitiveness by encouraging a better-educated work force.
The need to balance the Federal budget necessitates limiting
the exclusion (as other expiring tax provisions) to a temporary
extension.
Explanation of provision
The provision extends the exclusion for employer-provided
educational assistance (including the application of the
exclusion to graduate education) for taxable years beginning
after December 31, 1994, and before January 1, 1997.
To the extent employers have previously filed Forms W-2
reporting the amount of educational assistance provided as
taxable wages, present Treasury regulations require the
employer to file Forms W-2c (i.e., corrected Forms W-2) with
the Internal Revenue Service.50 It is intended that
employers also be required to provide copies of Form W-2c to
affected employees.
---------------------------------------------------------------------------
\50\ Treasury regulation section 31.6051-1(c).
---------------------------------------------------------------------------
The Secretary is directed to establish expedited procedures
for the refund of any overpayment of taxes paid on excludable
educational assistance provided in 1995 and 1996, including
procedures for waiving the requirement that an employer obtain
an employee's signature if the employer demonstrates to the
satisfaction of the Secretary that any refund collected by the
employer on behalf of the employee will be paid to the
employee.
Because the exclusion is extended, no interest and
penalties should be imposed if an employer failed to withhold
income and employment taxes on excludable educational
assistance or failed to report such educational assistance.
Further, it is intended that the Secretary establish expedited
procedures for refunding any interest and penalties relating to
educational assistance previously paid.
Effective date
The provision is effective with respect to taxable years
beginning after December 31, 1994, and before January 1, 1997.
3. Research and experimentation tax credit (sec. 1203 of the bill and
sec. 41 of the Code)
Present and prior law
General rule
Prior to July 1, 1995, section 41 of the Internal Revenue
Code 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 does not apply
to amounts paid or incurred after June 30, 1995.
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.51
---------------------------------------------------------------------------
\51\ The Omnibus Budget Reconciliation Act of 1993 included a
special rule 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 (i.e., any taxpayer that did not have
gross receipts in at least three years during the 1984-1988 period)
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 June 30, 1995 expiration date, a start-up
firm's fixed-base 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-base 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, research expenditures and gross receipts of
the taxpayer are aggregated with research expenditures and
gross receipts of certain related persons for purposes of
computing any allowable credit (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
or 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)).
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'').
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 Committee believes
that, in order to encourage research activities, it is
appropriate to reinstate the research tax credit and to modify
certain rules for computing the credit.
Explanation of provision
The bill extends the research tax credit (including the
university basic research credit) for the period July 1, 1996,
through June 30, 1997.
The bill also expands 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 1983.52
---------------------------------------------------------------------------
\52\ In applying the start-up firm rules, the test is whether a
taxpayer, in fact, both incurred research expenses (which under the
present-law rules would be qualified research expenses) and had gross
receipts in a particular year, not whether the taxpayer claimed a
research tax credit for that year.
---------------------------------------------------------------------------
In addition, the bill allows taxpayers 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 such an election applies to
that taxable year and all subsequent years unless revoked with
the consent of the Secretary of the Treasury.
The bill also provides for a special rule for payments made
to certain nonprofit research consortia. Under this special
rule, 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 present-law section 41(b)(3) rule 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.
Effective date
Extension of the research tax credit is effective for
expenditures paid or incurred during the period July 1, 1996,
through June 30, 1997. The modification to the definition of
``start-up firms'' is effective for taxable years ending after
June 30, 1996. Taxpayers may elect the alternative research
credit regime (with lower fixed-base percentages and lower
credit rates) for taxable years beginning after June 30, 1996.
The rule that treats 75 percent of qualified research
consortium payments as qualified research expenses is effective
for taxable years beginning after June 30, 1996.
4. Orphan drug tax credit (sec. 1204 of the bill and secs. 28 and 39
and new sec. 45C of the Code)
Present and prior law
Prior to January 1, 1995, 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).
Under prior law, the orphan drug tax credit could be
claimed by a taxpayer only to the extent that its regular tax
liability for the year the credit was earned exceeded its
tentative minimum tax for that year, after regular tax was
reduced by nonrefundable personal credits and the foreign tax
credit.53 Unused credits could not be carried back or
carried forward to reduce taxes in other years.
---------------------------------------------------------------------------
\53\ To the extent that the orphan drug tax credit could not be
used by reason of the minimum tax limitation, the taxpayer's minimum
tax credit was increased (sec. 53(d)(1)(B)(iii)).
---------------------------------------------------------------------------
The orphan drug tax credit expired after December 31, 1994.
Reasons for change
The Committee believes that it is appropriate to reinstate
the orphan drug tax credit.
Explanation of provision
The bill extends the orphan drug tax credit for the period
July 1, 1996, through June 30, 1997.
In addition, the bill allows taxpayers to carry back unused
credits to three years preceding the year the credit is earned
and to carry forward unused credits to 15 years following the
year the credit is earned.
Effective date
The provision applies to qualified clinical testing
expenses paid or incurred during the period July 1, 1996,
through June 30, 1997. The provision allowing for the carry
back and carry forward of unused credits is effective for
taxable years ending after June 30, 1996. No portion of the
unused business credit that is attributable to the orphan drug
credit may be carried back under section 39 to a taxable year
ending before July 1, 1996.
5. Contributions of stock to private foundations (sec. 1205 of the bill
and sec. 173(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.54
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.55
---------------------------------------------------------------------------
\54\ 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)).
\55\ 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 were allowed a deduction equal to the fair
market value of ``qualified appreciated stock'' contributed to
a private foundation prior to January 1, 1995. Qualified
appreciated stock was defined as publicly traded stock which is
capital gain property. The fair-market-value deduction for
qualified appreciated stock donations applied only to the
extent that total donations made by the donor to private
foundations of stock in a particular corporation did not exceed
10 percent of the outstanding stock of that corporation. For
this purpose, an individual was treated as making all
contributions that were made by any member of the individual's
family. This special rule contained in section 170(e)(5)
expired after December 31, 1994.
Reasons for change
The Committee believes that, to encourage donations to
charitable private foundations, it is appropriate to reinstate
the special rule that allowed a fair-market-value deduction for
certain gifts of appreciated stock to private foundations.
Explanation of provision
The bill extends the special rule contained in section
170(e)(5) for contributions of qualified appreciated stock made
to private foundations for contributions made during the period
July 1, 1996, through June 30, 1997.56
---------------------------------------------------------------------------
\56\ If, during this period, a taxpayer contributes qualified
appreciated stock as defined in section 170(e)(5) and the amount of
such contribution exceeds the percentage limitation under section
170(b)(1)(D), the excess may be carried over to succeeding taxable
years. See, e.g., LTR 9444029, LTR 9424020.
---------------------------------------------------------------------------
Effective date
The provision is effective for contributions of qualified
appreciated stock to private foundations made during the period
July 1, 1996, through June 30, 1997.
6. Tax credit for producing fuel from a nonconventional source (sec.
1206 of the bill and sec. 29 of the Code)
Present law
Certain fuels produced from ``nonconventional sources'' and
sold to unrelated parties are eligible for an income tax credit
equal to $3 (generally adjusted for inflation) per barrel or
BTU oil barrel equivalent (sec. 29) (referred to as the
``section 29 credit''). Qualified fuels must be produced within
the United States. Qualified fuels include:
(1) oil produced from shale and tar sands;
(2) gas produced from geopressured brine, Devonian shale,
coal seams, tight formations (``tight sands''), or biomass; and
(3) liquid, gaseous, or solid synthetic fuels produced from
coal (including lignite).
In general, the credit is available only with respect to
fuels produced from wells drilled or facilities placed in
service after December 31, 1979, and before January 1, 1993. An
exception extends the January 1, 1993 expiration date for
facilities producing gas from biomass and synthetic fuel from
coal if the facility producing the fuel is placed in service
before January 1, 1997, pursuant to a binding contract entered
into before January 1, 1996.
The credit may be claimed for qualified fuels produced and
sold before January 1, 2003 (in the case of nonconventional
sources subject to the January 1, 1993 expiration date) or
January 1, 2008 (in the case of biomass gas and synthetic fuel
facilities eligible for the extension period).
Reasons for change
The Committee believes that a short-term extension of the
section 29 credit is appropriate to allow projects currently in
negotiation or under development to be placed in service in a
more orderly manner than is possible under the present-law
scheduled expiration.
Explanation of provision
The binding contract date for facilities producing
synthetic fuels from coal and gas from biomass is extended
until the date which is six months after the date of the
provision's enactment, and the placed in service date is
extended for one year. The present sunset on production
qualifying for the credit is not changed. Under the provision,
synthetic fuels from coal and gas from biomass produced from a
facility placed in service before January 1, 1998, pursuant to
a binding contract entered into before the date which is six
months after the date of the provision's enactment, will be
eligible for the tax credit if produced before January 1, 2008.
Effective date
The provision is effective upon enactment.
7. Suspend imposition of diesel fuel tax on recreational motorboats
(sec. 1207 of the bill and sec. 6427 of the Code)
Present law
Diesel fuel used in recreational motorboats is subject to a
24.4 cents-per-gallon excise tax through December 31, 1999.
This 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.
The diesel fuel tax is imposed on removal of the fuel from
a registered terminal facility (i.e., at the ``terminal
rack''). Present law provides that tax is imposed on all diesel
fuel removed from terminal facilities unless the fuel is
destined for a nontaxable use and is indelibly dyed pursuant to
Treasury Department regulations. If fuel on which tax is paid
at the terminal rack (i.e., undyed diesel fuel) ultimately is
used in a nontaxable use, a refund is allowed. Depending on the
aggregate amount of tax to be refunded, this refund may be
claimed either by a direct filing with the Internal Revenue
Service or as a credit against income tax.
Dyed diesel fuel (fuel on which no tax is paid) may not be
used in a taxable use. Present law imposes a penalty equal to
the greater of $10 per gallon or $1,000 on persons found to be
violating this prohibition.
Reasons for change
The Committee understands that market conditions in the
marine industry have produced shortages of diesel fuel for
recreational boat use in some areas. This is reported to have
occurred because some marinas primarily serve commercial
vessels that burn nontaxable, dyed diesel fuel, and have
resisted installing supplemental fuel tanks for the taxable,
undyed diesel fuel required for recreational boats. The
Committee believes, therefore, that a temporary suspension of
this tax is appropriate to allow review of possible alternative
collection regimes, and to allow marinas additional time in
which to adapt to the requirements of the present-law rules, if
satisfactory alternatives are not found.
Explanation of provision
No tax will be imposed on diesel fuel used in recreational
motorboats during the period July 1, 1996, through June 30,
1997.
This exemption will temporarily address current supply
problems. The Committee requests the Treasury Department to
study possible alternatives to the current collection regime
for motorboat diesel fuel that will provide comparable
compliance with the law, and to report to the Senate Committee
on Ways and Means and the Senate Committee on Finance no later
than April 1, 1997.
Effective date
The provision is effective on July 1, 1996.
C. Provisions Relating to S Corporations
1. S corporations permitted to have 75 shareholders (sec. 1301 of the
bill and sec. 1361 of the Code)
Present law
The taxable income or loss of an S corporation is taken
into account by the corporation's shareholders, rather than by
the entity, whether or not such income is distributed. A small
business corporation may elect to be treated as an S
corporation. A ``small business corporation'' is defined as a
domestic corporation which is not an ineligible corporation and
which does not have (1) more than 35 shareholders, (2) as a
shareholder, a person (other than certain trusts or estates)
who is not an individual, (3) a nonresident alien as a
shareholder, and (4) more than one class of stock. For purposes
of the 35-shareholder limitation, a husband and wife are
treated as one shareholder.
Reasons for change
The Committee believes that increasing the maximum number
of shareholders of an S corporation will facilitate corporate
ownership by additional family members, employees and capital
investors.
Explanation of provision
The provision increases the maximum number of shareholders
from 35 to 75.
Effective date
The provision applies to taxable years beginning after
December 31, 1996.
2. Electing small business trusts (sec. 1302 of the bill and sec. 1361
of the Code)
Present law
Under present law, trusts other than grantor trusts, voting
trusts, certain testamentary trusts and ``qualified subchapter
S trusts'' may not be shareholders in an S corporation. A
``qualified subchapter S trust'' is a trust which, under its
terms, (1) is required to have only one current income
beneficiary (for life), (2) any corpus distributed during the
life of the beneficiary must be distributed to the beneficiary,
(3) the beneficiary's income interest must terminate at the
earlier of the beneficiary's death or the termination of the
trust, and (4) if the trust terminates during the beneficiary's
life, the trust assets must be distributed to the beneficiary.
All the income (as defined for local law purposes) must be
currently distributed to that beneficiary. The beneficiary is
treated as the owner of the portion of the trust consisting of
the stock in the S corporation.
Reasons for change
The Committee believes that a trust that provides for
income to be distributed to (or accumulated for) a class of
individuals should be allowed to hold S corporation stock. This
would allow an individual to establish a trust to hold S
corporation stock and ``spray'' income among family members (or
others) who are beneficiaries of the trust. The Committee
believes allowing such an arrangement will facilitate family
financial planning.
Explanation of provision
In general
The provision allows stock in an S corporation to be held
by certain trusts (``electing small business trusts''). In
order to qualify for this treatment, all beneficiaries of the
trust must be individuals or estates eligible to be S
corporation shareholders, except that charitable organizations
may hold contingent remainder interests.57 No interest in
the trust may be acquired by purchase. For this purpose,
``purchase'' means any acquisition of property with a cost
basis (determined under sec. 1012). Thus, interests in the
trust must be acquired by reason of gift, bequest, etc.
---------------------------------------------------------------------------
\57\ For taxable years beginning after 1997, charitable
organizations may hold current interests in a trust.
---------------------------------------------------------------------------
A trust must elect to be treated as an electing small
business trust. An election applies to the taxable year for
which made and could be revoked only with the consent of the
Secretary of the Treasury or his delegate.
Each potential current beneficiary of the trust is counted
as a shareholder for purposes of the proposed 75 shareholder
limitation (or if there were no potential current
beneficiaries, the trust would be treated as the shareholder).
A potential current income beneficiary means any person, with
respect to the applicable period, who is entitled to, or at the
discretion of any person may receive, a distribution from the
principal or income of the trust. Where the trust disposes of
all the stock in an S corporation, any person who first became
so eligible during the 60 days before the disposition is not
treated as a potential current beneficiary.
A qualified subchapter S trust with respect to which an
election is in effect or an exempt trust is not eligible to
qualify as an electing small business trust.
Treatment of items relating to S corporation stock
The portion of the trust which consists of stock in one or
more S corporations is treated as a separate trust for purposes
of computing the income tax attributable to the S corporation
stock held by the trust. The trust is taxed at the highest
individual rate (currently, 39.6 percent on ordinary income and
28 percent on net capital gain) on this portion of the trust's
income. The taxable income attributable to this portion
includes (1) the items of income, loss, or deduction allocated
to it as an S corporation shareholder under the rules of
subchapter S, (2) gain or loss from the sale of the S
corporation stock, and (3) to the extent provided in
regulations, any state or local income taxes and administrative
expenses of the trust properly allocable to the S corporation
stock. Otherwise allowable capital losses are allowed only to
the extent of capital gains.
In computing the trust's income tax on this portion of the
trust, no deduction is allowed for amounts distributed to
beneficiaries, and no deduction or credit is allowed for any
item other than the items described above. This income is not
included in the distributable net income of the trust, and thus
is not included in the beneficiaries' income. No item relating
to the S corporation stock could be apportioned to any
beneficiary.
On the termination of all or any portion of an electing
small business trust the loss carryovers or excess deductions
referred to in section 642(h) is taken into account by the
entire trust, subject to the usual rules on termination of the
entire trust.
Treatment of remainder of items held by trust
In determining the tax liability with regard to the
remaining portion of the trust, the items taken into account by
the subchapter S portion of the trust are disregarded. Although
distributions from the trust are deductible in computing the
taxable income on this portion of the trust, under the usual
rules of subchapter J, the trust's distributable net income
does not include any income attributable to the S corporation
stock.
Termination of trust and conforming amendment applicable to all trusts
Where the trust terminates before the end of the S
corporation's taxable year, the trust takes into account its
pro rata share of S corporation items for its final year. The
provision makes a conforming amendment applicable to all trusts
and estates clarifying that this is the present-law treatment
of trusts and estates that terminate before the end of the S
corporation's taxable year.
Effective date
The provision applies to taxable years beginning after
December 31, 1996.
3. Expansion of post-death qualification for certain trusts (sec. 1303
of the bill and sec. 1361 of the Code)
Present law
Under present law, trusts other than grantor trusts, voting
trusts, certain testamentary trusts and ``qualified subchapter
S trusts'' may not be shareholders in an S corporation. A
grantor trust may remain an S corporation shareholder for 60
days after the death of the grantor. The 60-day period is
extended to 2 years if the entire corpus of the trust is
includible in the gross estate of the deemed owner. In
addition, a trust may be an S corporation shareholder for 60
days after the transfer of the S corporation stock pursuant to
a will.
Reasons for change
The Committee believes that the 60-day holding period
applicable to certain testamentary trusts should be expanded to
facilitate estate administration.
Explanation of provision
The provision expands the post-death holding period to 2
years for all testamentary trusts.
Effective date
The provision applies to taxable years beginning after
December 31, 1996.
4. Financial institutions permitted to hold safe harbor debt (sec. 1304
of the bill and sec. 1361 of the Code)
Present law
A small business corporation eligible to be an S
corporation may not have more than one class of stock. Certain
debt (``straight debt'') is not treated as a second class of
stock so long as such debt is an unconditional promise to pay
on demand or on a specified date a sum certain in money if: (1)
the interest rate (and interest payment dates) are not
contingent on profits, the borrower's discretion, or similar
factors; (2) there is no convertibility (directly or
indirectly) into stock, and (3) the creditor is an individual
(other than a nonresident alien), an estate, or certain
qualified trusts.
Reasons for change
The Committee believes that bona fide debt that is held by
a financial institution should be able to satisfy the
``straight debt'' safe harbor.
Explanation of provision
The definition of ``straight debt'' is expanded to include
debt held by creditors, other than individuals, that are
actively and regularly engaged in the business of lending
money.
Effective date
The provision applies to taxable years beginning after
December 31, 1996.
5. Rules relating to inadvertent terminations and invalid elections
(sec. 1305 of the bill and sec. 1362 of the Code)
Present law
Under present law, if the Internal Revenue Service
(``IRS'') determines that a corporation's Subchapter S election
is inadvertently terminated, the IRS can waive the effect of
the terminating event for any period if the corporation timely
corrects the event and if the corporation and shareholders
agree to be treated as if the election had been in effect for
that period. Such waivers generally are obtained through the
issuance of a private letter ruling. Present law does not grant
the IRS the ability to waive the effect of an inadvertent
invalid Subchapter S election.
In addition, under present law, a small business
corporation must elect to be an S corporation no later than the
15th day of the third month of the taxable year for which the
election is effective. The IRS may not validate a late
election.
Reasons for change
The Committee believes that the Secretary of the Treasury
should have the same authority to validate inadvertently
defective subchapter S elections as it has for inadvertent
subchapter S terminations.
Explanation of provision
Under the provision, the authority of the IRS to waive the
effect of an inadvertent termination is extended to allow the
IRS to waive the effect of an invalid election caused by an
inadvertent failure to qualify as a small business corporation
or to obtain the required shareholder consents (including
elections regarding qualified subchapter S trusts), or both.
The provision also allows the IRS to treat a late Subchapter S
election as timely where the IRS determines that there was
reasonable cause for the failure to make the election timely.
The IRS may exercise this authority in cases where the taxpayer
never filed an election. It is intended that the IRS be
reasonable in exercising this authority and apply standards
that are similar to those applied under present law to
inadvertent subchapter S terminations and other late or invalid
elections.
Effective date
The provision applies to taxable years beginning after
December 31, 1982.58
---------------------------------------------------------------------------
\58\ This is the effective date of the present-law provision
regarding inadvertent terminations.
---------------------------------------------------------------------------
6. Agreement to terminate year (sec. 1306 of the bill and sec. 1377 of
the Code)
Present law
In general, each item of S corporation income, deduction
and loss is allocated to shareholders on a per-share, per-day
basis. However, if any shareholder terminates his or her
interest in an S corporation during a taxable year, the S
corporation, with the consent of all its shareholders, may
elect to allocate S corporation items by closing its books as
of the date of such termination rather than applying the per-
share, per-day rule.
Reasons for change
The Committee believes that the election to close the books
of an S corporation does not need the consent of shareholders
whose tax liability is unaffected by the election.
Explanation of provision
The provision provides that, under regulations to be
prescribed by the Secretary of the Treasury, the election to
close the books of the S corporation upon the termination of a
shareholder's interest is made by all affected shareholders and
the corporation, rather than by all shareholders. The closing
of the books applies only to the affected shareholders. For
this purpose, ``affected shareholders'' means any shareholder
whose interest is terminated and all shareholders to whom such
shareholder has transferred shares during the year. If a
shareholder transferred shares to the corporation, ``affected
shareholders'' includes all persons who were shareholders
during the year.
Effective date
The provision applies to taxable years beginning after
December 31, 1996.
7. Expansion of post-termination transition period (sec. 1307 of the
bill and secs. 1377 and 6037 of the Code)
Present law
Distributions made by a former S corporation during its
post-termination transition 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 transition 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 transition 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.
In addition, the audit procedures adopted by the Tax Equity
and Fiscal Responsibility Act of 1982 (``TEFRA'') with respect
to partnerships also apply to S corporations. Thus, the tax
treatment of items is determined at the corporate, rather than
individual level.
Reasons for change
The Committee believes that the current scope of the
``post-termination transition period'' is insufficient under
present law. In addition, the Committee believes that the TEFRA
audit procedures should be inapplicable to entities with a
limited number of owners.
Explanation of provision
The present-law definition of ``post-termination transition
period'' is expanded 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'' is 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.
In addition, the provision repeals the TEFRA audit
provisions applicable to S corporations and would provide other
rules to require consistency between the returns of the S
corporation and its shareholders.
Effective date
The provision applies to taxable years beginning after
December 31, 1996.
8. S corporations permitted to hold subsidiaries (sec. 1308 of the bill
and secs. 1361 and 1362 of the Code)
Present law
A small business corporation may not be a member of an
affiliated group of corporations (other than by reason of
ownership in certain inactive corporations). Thus, an S
corporation may not own 80 percent or more of the stock of
another corporation (whether an S corporation or a C
corporation).
In addition, a small business corporation may not have as a
shareholder another corporation (whether an S corporation or a
C corporation).
Reasons for change
The Committee understands that there are situations where
taxpayers may wish to separate different trades or businesses
in different corporate entities. The Committee believes that,
in such situations, shareholders should be allowed to arrange
these separate corporate entities under parent-subsidiary
arrangements as well as brother-sister arrangements.
Explanation of provision
C corporation subsidiaries
An S corporation is allowed to own 80 percent or more of
the stock of a C corporation. The C corporation subsidiary
could elect to join in the filing of a consolidated return with
its affiliated C corporations. An S corporation is not allowed
to join in such election. Dividends received by an S
corporation from a C corporation in which the S corporation has
an 80 percent or greater ownership stake are not treated as
passive investment income for purposes of sections 1362 and
1375 to the extent the dividends are attributable to the
earnings and profits of the C corporation derived from the
active conduct of a trade or business.
S corporation subsidiaries
In addition, an S corporation is allowed to own a qualified
subchapter S subsidiary. The term ''qualified subchapter S
subsidiary'' means a domestic corporation that 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 (1) 100 percent of the stock of the subsidiary
were held by its S corporation parent and (2) the parent elects
to treat the subsidiary as a qualified subchapter S subsidiary.
If a subsidiary ceases to be a qualified subchapter S
subsidiary (either because the subsidiary fails to qualify or
the parent revokes the election) another such election may not
be made for the subsidiary by the parent for five years without
the consent of the Secretary of the Treasury.
Under the election, the qualified subchapter S subsidiary
is not treated as a separate corporation and all the assets,
liabilities, and items of income, deduction, loss, and credit
of the subsidiary are treated as the assets, liabilities, and
items of income, deduction, loss, and credit of the parent S
corporation. Thus, transactions between the S corporation
parent and qualified subchapter S subsidiary are not taken into
account and items of the subsidiary (including accumulated
earnings and profits, passive investment income, built-in
gains, etc.) are considered to be items of the parent. In
addition, if a subsidiary ceases to be a qualified subchapter S
subsidiary (e.g., fails to meet the wholly-owned requirement),
the subsidiary will be treated as a new corporation acquiring
all of its assets (and assuming all of its liabilities)
immediately before such cessation from the parent S corporation
in exchange for its stock.59
---------------------------------------------------------------------------
\59\ Similar rules apply with respect to wholly owned subsidiaries
of real estate investment trusts (``REITs'') under section 856(i) of
present law.
---------------------------------------------------------------------------
Under the provision, if an election is made to treat an
existing corporation (whether or not its stock was acquired
from another person or previously held by the S 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. The built-in
gains tax under section 1374 and the LIFO recapture tax under
section 1363(d) may apply where the subsidiary was previously a
C corporation. Where the stock of the subsidiary was acquired
by the S corporation in a qualified stock purchase, an election
under section 338 with respect to the subsidiary may be made.
Because the parent and each subsidiary corporation that is
a qualified subchapter S subsidiary are treated for Federal
income tax purposes as a single corporation, debt issued by a
subsidiary to a shareholder of the parent corporation will be
treated as debt of the parent for purposes of determining the
amount of losses that may flow through to shareholders of the
parent corporation under section 1366(d)(1)(B). The Secretary
of the Treasury may prescribe rules as to the order that losses
pass through where debt of both the parent and subsidiary
corporations are held by shareholders of the parent. To the
extent a shareholder of the parent S corporation is not at-risk
with respect to losses of a subsidiary, the at-risk rules of
section 465 may cause losses of the subsidiary to be suspended.
Effective date
The provision applies to taxable years beginning after
December 31, 1996.
9. Treatment of distributions during loss years (sec. 1309 of the bill
and secs. 1366 and 1368 of the Code)
Present law
Under present law, the amount of loss an S corporation
shareholder may take into account for a taxable year cannot
exceed the sum of the shareholder's adjusted basis in his or
her stock of the corporation and the adjusted basis in any
indebtedness of the corporation to the shareholder. Any excess
loss is carried forward.
Any distribution to a shareholder by an S corporation
generally is tax-free to the shareholder to the extent of the
shareholder's adjusted basis of his or her stock. The
shareholder's adjusted basis is reduced by the tax-free amount
of the distribution. Any distribution in excess of the
shareholder's adjusted basis is treated as gain from the sale
or exchange of property.
Under present law, income (whether or not taxable) and
expenses (whether or not deductible) serve, respectively, to
increase and decrease an S corporation shareholder's basis in
the stock of the corporation. These rules require that the
adjustments to basis for items of both income and loss for any
taxable year apply before the adjustment for distributions
applies.60
---------------------------------------------------------------------------
\60\ See section 1368(d)(1); H. Rept. 97-826, p. 17; S. Rept. 97-
640, p. 18; Treas. reg. sec. 1.1367-1(e).
---------------------------------------------------------------------------
These rules limiting losses and allowing tax-free
distributions up to the amount of the shareholder's adjusted
basis are similar in certain respects to the rules governing
the treatment of losses and cash distributions by partnerships.
Under the partnership rules (unlike the S corporation rules),
for any taxable year, a partner's basis is first increased by
items of income, then decreased by distributions, and finally
is decreased by losses for that year.61
---------------------------------------------------------------------------
\61\ Treas. reg. sec. 1.704-1(d)(2); Rev. Rul. 66-94, 1966-1 C.B.
166.
---------------------------------------------------------------------------
In addition, if the S corporation has accumulated earnings
and profits,62 any distribution in excess of the amount in
an ``accumulated adjustments account'' will be treated as a
dividend (to the extent of the accumulated earnings and
profits). A dividend distribution does not reduce the adjusted
basis of the shareholder's stock. The ``accumulated adjustments
account'' generally is the amount of the accumulated
undistributed post-1982 gross income less deductions.
---------------------------------------------------------------------------
\62\ An S corporation may have earnings and profits from years
prior to its subchapter S election or from pre-1983 subchapter S years.
---------------------------------------------------------------------------
Reasons for change
The Committee believes that the rules regarding the
treatment of distributions by S corporations during loss years
should be the same as the rules applicable to partnerships.
Explanation of provision
The provision provides that the adjustments for
distributions made by an S corporation during a taxable year
are taken into account before applying the loss limitation for
the year. Thus, distributions during a year reduce the adjusted
basis for purposes of determining the allowable loss for the
year, but the loss for a year does not reduce the adjusted
basis for purposes of determining the tax status of the
distributions made during that year.
The provision also provides that in determining the amount
in the accumulated adjustment account for purposes of
determining the tax treatment of distributions made during a
taxable year by an S corporation having accumulated earnings
and profits, net negative adjustments (i.e., the excess of
losses and deductions over income) for that taxable year are
disregarded.
The following examples illustrate the application of these
provisions:
Example 1.--X is the sole shareholder of corporation A, a
calendar year S corporation with no accumulated earnings and
profits. X's adjusted basis in the stock of A on January 1,
1998, is $1,000 and X holds no debt of A. During 1998, A makes
a distribution to X of $600, recognizes a capital gain of $200
and sustains an operating loss of $900. Under the provision,
X's adjusted basis in the A stock is increased to $1,200
($1,000 plus $200 capital gain recognized) pursuant to section
1368(d) to determine the effect of the distribution. X's
adjusted basis is then reduced by the amount of the
distribution to $600 ($1,200 less $600) to determine the
application of the loss limitation of section 1366(d)(1). X is
allowed to take into account $600 of A's operating loss, which
reduces X's adjusted basis to zero. The remaining $300 loss is
carried forward pursuant to section 1366(d)(2).
Example 2.--The facts are the same as in Example 1, except
that on January 1, 1998, A has accumulated earnings and profits
of $500 and an accumulated adjustments account of $200. Under
the provision, because there is a net negative adjustment for
the year, no adjustment is made to the accumulated adjustments
account before determining the effect of the distribution under
section 1368(c).
As to A, $200 of the $600 distribution is a distribution of
A's accumulated adjustments account, reducing the accumulated
adjustments account to zero. The remaining $400 of the
distribution is a distribution of accumulated earnings and
profits (``E&P'') and reduces A's E&P to $100. A's accumulated
adjustments account is then increased by $200 to reflect the
recognized capital gain and reduced by $900 to reflect the
operating loss, leaving a negative balance in the accumulated
adjustment account on January 1, 1999, of $700 (zero plus $200
less $900).
As to X, $200 of the distribution is applied against X's
adjusted basis of $1,200 ($1,000 plus $200 capital gain
recognized), reducing X's adjusted basis to $1,000. The
remaining $400 of the distribution is taxable as a dividend and
does not reduce X's adjusted basis. Because X's adjusted basis
is $1,000, the loss limitation does not apply to X, who may
deduct the entire $900 operating loss. X's adjusted basis is
then decreased to reflect the $900 operating loss. Accordingly,
X's adjusted basis on January 1, 1999, is $100 ($1,000 plus
$200 less $200 less $900).
Effective date
The provision applies to taxable years beginning after
December 31, 1996.
10. Treatment of S corporations under subchapter C (sec. 1310 of the
bill and sec. 1371 of the Code)
Present law
Present law contains several provisions relating to the
treatment of S corporations as corporations generally for
purposes of the Internal Revenue Code.
First, under present law, the taxable income of an S
corporation is computed in the same manner as in the case of an
individual (sec. 1363(b)). Under this rule, the provisions of
the Code governing the computation of taxable income which are
applicable only to corporations, such as the dividends received
deduction, do not apply to S corporations.
Second, except as otherwise provided by the Internal
Revenue Code and except to the extent inconsistent with
subchapter S, subchapter C (i.e., the rules relating to
corporate distributions and adjustments) applies to an S
corporation and its shareholders (sec. 1371(a)(1)). Under this
second rule, provisions such as the corporate reorganization
provisions apply to S corporations. Thus, a C corporation may
merge into an S corporation tax-free.
Finally, an S corporation in its capacity as a shareholder
of another corporation is treated as an individual for purposes
of subchapter C (sec. 1371(a)(2)). In 1988, the IRS took the
position that this rule prevents the tax-free liquidation of a
C corporation into an S corporation because a C corporation
cannot liquidate tax-free when owned by an individual
shareholder.63 In 1992, the IRS reversed its position,
stating that the prior ruling was incorrect.64
---------------------------------------------------------------------------
\63\ PLR 8818049 (Feb. 10, 1988).
\64\ PLR 9245004, (July 28, 1992).
---------------------------------------------------------------------------
Reasons for change
The Committee wishes to clarify that the position taken by
the IRS in 1992 that allows the tax-free liquidation of a C
corporation into an S corporation represents the proper policy.
Explanation of provision
The provision repeals the rule that treats an S corporation
in its capacity as a shareholder of another corporation as an
individual. Thus, the provision clarifies that the liquidation
of a C corporation into an S corporation will be governed by
the generally applicable subchapter C rules, including the
provisions of sections 332 and 337 allowing the tax-free
liquidation of a corporation into its parent corporation.
Following a tax-free liquidation, the built-in gains of the
liquidating corporation may later be subject to tax under
section 1374 upon a subsequent disposition. An S corporation
also will be eligible to make a section 338 election (assuming
all the requirements are otherwise met), resulting in immediate
recognition of all the acquired C corporation's gains and
losses (and the resulting imposition of a tax).
The repeal of this rule does not change the general rule
governing the computation of income of an S corporation. For
example, it does not allow an S corporation, or its
shareholders, to claim a dividends received deduction with
respect to dividends received by the S corporation, or to treat
any item of income or deduction in a manner inconsistent with
the treatment accorded to individual taxpayers.
Effective date
The provision applies to taxable years beginning after
December 31, 1996.
11. Elimination of certain earnings and profits (sec. 1311 of the bill
and secs. 1362 and 1375 of the Code)
Present law
Under present law, the accumulated earnings and profits of
a corporation are not increased for any year in which an
election to be treated as an S corporation is in effect.
However, under the subchapter S rules in effect before revision
in 1982, a corporation electing subchapter S for a taxable year
increased its accumulated earnings and profits if its earnings
and profits for the year exceeded both its taxable income for
the year and its distributions out of that year's earnings and
profits. As a result of this rule, a shareholder may later be
required to include in his or her income the accumulated
earnings and profits when it is distributed by the corporation.
The 1982 revision to subchapter S repealed this rule for
earnings attributable to taxable years beginning after 1982 but
did not do so for previously accumulated S corporation earnings
and profits.
Reasons for change
The Committee believes that the existence of pre-1983
earnings and profits of an S corporation unnecessarily
complicates corporate recordkeeping and constitutes a potential
trap for the unwary.
Explanation of provision
The provision provides that if a corporation is an S
corporation for its first taxable year beginning after December
31, 1996, the accumulated earnings and profits of the
corporation as of the beginning of that year is reduced by the
accumulated earnings and profits (if any) accumulated in any
taxable year beginning before January 1, 1983, for which the
corporation was an electing small business corporation under
subchapter S. Thus, such a corporation's accumulated earnings
and profits are solely attributable to taxable years for which
an S election was not in effect. This rule is generally
consistent with the change adopted in 1982 limiting the S
shareholder's taxable income attributable to S corporation
earnings to his or her share of the taxable income of the S
corporation.
Effective date
The provision applies to taxable years beginning after
December 31, 1996.
12. Carryover of disallowed losses and deductions under at-risk rules
allowed (sec. 1312 of the bill and sec. 1366 of the Code)
Present law
Under section 1366, the amount of loss an S corporation
shareholder may take into account cannot exceed the sum of the
shareholder's adjusted basis in his or her stock of the
corporation and the unadjusted basis in any indebtedness of the
corporation to the shareholder. Any disallowed loss is carried
forward to the next taxable year. Any loss that is disallowed
for the last taxable year of the S corporation may be carried
forward to the post-termination transition period. The ``post-
termination transition 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.
In addition, under section 465, a shareholder of an S
corporation may not deduct losses that are flowed through from
the corporation to the extent the shareholder is not ``at-
risk'' with respect to the loss. Any loss not deductible in one
taxable year because of the at-risk rules is carried forward to
the next taxable year.
Reasons for change
The Committee believes that losses suspended by the at-risk
rules should be conformed to the treatment of losses suspended
by the subchapter S basis rules.
Explanation of provision
Losses of an S corporation that are suspended under the at-
risk rules of section 465 are carried forward to the S
corporation's post-termination transition period.
Effective date
The provision applies to taxable years beginning after
December 31, 1996.
13. Adjustments to basis of inherited S stock to reflect certain items
of income (sec. 1313 of the bill and sec. 1367 of the Code)
Present law
Income in respect to a decedent (``IRD'') generally
consists of items of gross income that accrued during the
decedent's lifetime but were not includible in the decedent's
income before his or her death under his or her method of
accounting. IRD is includible in the income of the person
acquiring the right to receive such item. A deduction for the
estate tax attributable to an item of IRD is allowed to such
person (sec. 691(c)). The cost or basis of property acquired
from a decedent is its fair market value at the date of death
(or alternate valuation date if that date is elected for estate
tax purposes). This basis is often referred to as a ``stepped-
up basis.'' Property that constitutes a right to receive IRD
does not receive a stepped-up basis.
The basis of a partnership interest or corporate stock
acquired from a decedent generally is stepped-up at death.
Under Treasury regulations, the basis of a partnership interest
acquired from a decedent is reduced to the extent that its
value is attributable to items constituting IRD (Treas. reg.
sec. 1.742-1). This rule insures that the items of IRD held by
a partnership are not later offset by a loss arising from a
stepped-up basis. Although an S corporation and its
shareholders generally are taxed in a manner similar to the
taxation of a partnership and its partners, no comparable
regulation requires a reduction in the basis of stock in an S
corporation acquired from a decedent where the S corporation
holds items of IRD.
Reasons for change
The Committee believes that the present-law treatment of
IRD items of an S corporation is unclear and that the treatment
of such items should be similar to the treatment of identical
items held by a partnership.
Explanation of provision
The provision provides that a person acquiring stock in an
S corporation from a decedent would treat as IRD his or her pro
rata share of any item of income of the corporation that would
have been IRD if that item had been acquired directly from the
decedent. Where an item is treated as IRD, a deduction for the
estate tax attributable to the item generally will be allowed
under the provisions of section 691(c). The stepped-up basis in
the stock in an S corporation acquired from a decedent is
reduced by the extent to which the value of the stock is
attributable to items consisting of IRD. This basis rule is
comparable to the present-law partnership rule.
Effective date
The provision applies with respect to decedents dying after
the date of enactment.
14. S corporations eligible for rules applicable to real property
subdivided for sale by noncorporate taxpayers (sec. 1314 of the
bill and sec. 1237 of the Code)
Present law
Under present-law section 1237, a lot or parcel of land
held by a taxpayer other than a corporation generally is not
treated as ordinary income property solely by reason of the
land being subdivided if (1) such parcel had not previously
been held as ordinary income property and if in the year of
sale, the taxpayer did not hold other real property; (2) no
substantial improvement has been made on the land by the
taxpayer, a related party, a lessee, or a government; and (3)
the land has been held by the taxpayer for five years.
Reasons for change
The Committee believes that rules generally applicable to
individuals should be applicable to S corporations.
Explanation of provision
The provision allows the present-law capital gains
presumption in the case of land held by an S corporation. It is
expected that rules similar to the attribution rules for
partnerships will apply to S corporation (Treas. reg. sec.
1.1237-1(b)(3)).
Effective date
The provision is effective for sales in taxable years
beginning after December 31, 1996.
15. Certain financial institutions as eligible corporations (sec. 1315
of the bill and sec. 1361 of the Code)
Present law
A small business corporation may elect to be treated as an
S corporation. A ``small business corporation'' is defined as a
domestic corporation which is not an ineligible corporation and
which meets certain other requirements. An ``ineligible
corporation'' means any corporation which is a member of an
affiliated group, certain depository financial institutions
(i.e., banks, domestic savings and loan associations, mutual
savings banks, and certain cooperative banks), certain
insurance companies, a section 936 corporation, or a DISC or
former DISC.
Reasons for change
The Committee believes that any otherwise eligible
corporation should be allowed to elect to be treated as an S
corporation regardless of the type of trade or business
conducted by the corporation, so long as special corporate tax
benefits provided to such trades or businesses do not flow
through to individual taxpayers.
Explanation of provision
A bank (as defined in sec. 581) is allowed to be an
eligible small business corporation unless such institution
uses a reserve method of accounting for bad debts. Thus, a
large bank (as defined by sec. 585(c)(2)) that meets all the
subchapter S eligibility requirements may elect to be treated
as an S corporation. An otherwise qualified small bank may
elect to be treated as an S corporation if it uses the specific
charge-off method of section 166 to account for its bad debts.
Effective date
The provision applies to taxable years beginning after
December 31, 1996.
16. Certain tax-exempt entities allowed to be shareholders (sec. 1316
of the bill and secs. 404, 512, 1042, and 1361 of the Code)
Present law
A small business corporation may elect to be treated as an
S corporation. A ``small business corporation'' is defined as a
domestic corporation which is not an ineligible corporation and
which does not have (1) more than 35 shareholders; (2) as a
shareholder, a person (other than certain trusts or estates)
who is not an individual; (3) a nonresident alien as a
shareholder; and (4) more than one class of stock. Thus, a tax-
exempt organization described in section 401(a) (relating to
qualified retirement plan trusts) or section 501(c)(3)
(relating to certain charitable organizations) cannot be a
shareholder in an S corporation.
A tax-exempt organization may be a partner in a
partnership. If the partnership carries on a trade or business
that is an unrelated trade or business with respect to the tax-
exempt organization, the tax-exempt partner is required to
include its distributed share of income from such trade or
business as unrelated business taxable income (``UBTI'') (sec.
512(c)).
Reasons for change
The Committee believes that the present-law prohibition of
certain tax-exempt organizations being S corporation
shareholders may inhibit employee ownership of closely-held
businesses, frustrate estate planning, discourage charitable
giving, and restrict sources of capital for closely-held
businesses. The Committee seeks to lift these barriers by
allowing certain tax-exempt organizations to be shareholders in
S corporations. However, the provisions of subchapter S were
enacted in 1958 and substantially modified in 1982 on the
premise that all income of the S corporation (including all
gains on the sale of the stock) would be subject to a
shareholder-level income tax. This underlying premise allows
the rules governing S corporations to be relatively simple (in
contrast, for example, to the partnership rules of subchapter
K) because of the lack of concern about ``transferring'' income
to non-taxpaying persons. Consistent with this underlying
premise of subchapter S, the provision treats all the income
flowing through to a tax-exempt shareholder, and gains and
losses from the disposition of the stock, as unrelated business
taxable income.
Explanation of provision
Tax-exempt organizations described in Code sections 401(a)
and 501(c)(3) (``qualified tax-exempt shareholders'') are
allowed to be shareholders in S corporations. For purposes of
determining the number of shareholders of an S corporation, a
qualified tax-exempt shareholder will count as one shareholder.
Items of income or loss of an S corporation will flow-
through to qualified tax-exempt shareholders as UBTI,
regardless of the source or nature of such income (e.g.,
passive income of an S corporation will flow through to the
qualified tax-exempt shareholders as UBTI.) In addition, gain
or loss on the sale or other disposition of stock of an S
corporation by a qualified tax-exempt shareholder will be
treated as UBTI. If a qualified tax-exempt shareholder has gain
on the sale of the stock in a C corporation that once was an S
corporation while held by the shareholder, the tax-exempt
shareholder will treat as UBTI the amount of gain that the
shareholder would have recognized had it sold the stock for its
fair market value as of the last day of the corporation's last
taxable year as an S corporation.
In addition, certain special tax rules relating to employee
stock ownership plans (``ESOPs'') will not apply with respect
to S corporation stock held by the ESOP. These rules include
rules relating to certain contributions to ESOPs (sec.
404(a)(9)), the deduction for dividends paid on employer
securities (sec. 404(k)), and the rollover of gain on the sale
of stock to an ESOP (sec. 1042).
Effective date
The provision applies to taxable years beginning after
December 31, 1997.
17. Reelection of subchapter S status (sec. 1317(b) of the bill and
sec. 1362 of the Code)
Present law
A small business corporation that terminates its subchapter
S election (whether by revocation or otherwise) may not make
another election to be an S corporation for five taxable years
unless the Secretary of the Treasury consents to such election.
Reasons for change
The Committee believes that, given the changes made by the
Committee to subchapter S, it is appropriate to allow
corporations that terminated their elections under subchapter S
within the last five years to re-elect subchapter S status
without requiring the consent of the Secretary.
Explanation of provision
For purposes of the five-year rule, any termination of
subchapter S status in effect immediately before the date of
enactment of the provision is not be taken into account. Thus,
any small business corporation that had terminated its S
corporation election within the five-year period before the
date of enactment may re-elect subchapter S status upon
enactment of the provision without the consent of the Secretary
of the Treasury.
Effective date
The provision is effective for terminations occurring in a
taxable year beginning before January 1, 1997.
Pension Simplification Provisions
A. Simplified Distribution Rules (secs. 1401-1404 of the bill and secs.
72(d), 101(b), 401(a)(9), and 402(d) of the Code)
Present law
In general, a distribution of benefits from a tax-favored
retirement arrangement (i.e., a qualified plan, a qualified
annuity plan, and a tax-sheltered annuity contract (sec. 403(b)
annuity)) generally is includible in gross income in the year
it is paid or distributed under the rules relating to the
taxation of annuities.
Lump-sum distributions
Lump-sum distributions from qualified plans and qualified
annuity plans are eligible for special 5-year forward
averaging. In general, a lump-sum distribution is a
distribution within one taxable year of the balance to the
credit of an employee that becomes payable to the recipient
first, on account of the death of the employee, second, after
the employee attains age 59\1/2\, third, on account of the
employee's separation from service, or fourth, in the case of
self-employed individuals, on account of disability. Lump-sum
treatment is not available for distributions from a tax-
sheltered annuity.
A taxpayer is permitted to make an election with respect to
a lump-sum distribution received on or after the employee
attains age 59\1/2\ to use 5-year forward income averaging
under the tax rates in effect for the taxable year in which the
distribution is made. In general, this election allows the
taxpayer to pay a separate tax on the lump-sum distribution
that approximates the tax that would be due if the lump-sum
distribution were received in 5 equal installments. If the
election is made, the taxpayer is entitled to deduct the amount
of the lump-sum distribution from gross income. Only one such
election on or after age 59\1/2\ may be made with respect to
any employee.
Under the Tax Reform Act of 1986 (the ``1986 Act''),
individuals who attained age 50 by January 1, 1986, can elect
to use 10-year averaging (under the rates in effect prior to
the 1986 Act) in lieu of 5-year averaging. In addition, such
individuals may elect to retain capital gains treatment with
respect to the pre-1974 portion of a lump sum distribution.
$5,000 exclusion for employer-provided death benefits
Under present law, the beneficiary or estate of a deceased
employee generally can exclude up to $5,000 in benefits paid by
or on behalf of an employer by reason of the employee's death
(sec. 101(b)).
Recovery of basis
Amounts received as an annuity under a qualified plan
generally are includible in income in the year received, except
to the extent they represent the return of the recipient's
investment in the contract (i.e., basis). Under present law, a
pro-rata basis recovery rule generally applies, so that the
portion of any annuity payment that represents nontaxable
return of basis is determined by applying an exclusion ratio
equal to the employee's total investment in the contract
divided by the total expected payments over the term of the
annuity.
Under a simplified alternative method provided by the IRS,
the taxable portion of qualifying annuity payments is
determined under a simplified exclusion ratio method.
In no event can the total amount excluded from income as
nontaxable return of basis be greater than the recipient's
total investment in the contract.
Required distributions
Present law provides uniform minimum distribution rules
generally applicable to all types of tax-favored retirement
vehicles, including qualified plans and annuities, IRAs, and
tax-sheltered annuities.
Under present law, a qualified plan is required to provide
that the entire interest of each participant will be
distributed beginning no later than the participant's required
beginning date (sec. 401(a)(9)). The required beginning date is
generally April 1 of the calendar year following the calendar
year in which the plan participant or IRA owner attains age
70\1/2\. In the case of a governmental plan or a church plan,
the required beginning date is the later of first, such April
1, or second, the April 1 of the year following the year in
which the participant retires.
Reasons for change
In almost all cases, the responsibility for determining the
tax liability associated with a distribution from a qualified
plan, tax-sheltered annuity, or IRA rests with the individual
receiving the distribution. Under present law, this task can be
burdensome. Among other things, the taxpayer must consider (1)
whether special tax rules apply that reduce the tax that
otherwise would be paid, (2) the amount of the taxpayer's basis
in the plan, annuity, or IRA and the rate at which such basis
is to be recovered, and (3) whether or not a portion of the
distribution is excludable from income as a death benefit.
The number of special rules for taxing pension
distributions makes it difficult for taxpayers to determine
which method is best for them and also increases the likelihood
of error. In addition, the specifics of each of the rules
create complexity. For example, the present-law rules for
determining the rate at which a participant's basis in a
qualified plan is recovered often entail calculations that the
average participant has difficulty performing. These rules
require a fairly precise estimate of the period over which
benefits are expected to be paid. The IRS publication on
taxation of pension distributions (Publication 939) contains
over 60 pages of actuarial tables used to determine total
expected payments.
The original intent of the income averaging rules for
pension distributions was to prevent a bunching of taxable
income because a taxpayer received all of the benefits in a
qualified plan in a single taxable year. Liberalization of the
rollover rules in the Unemployment Compensation Amendments of
1992 increased taxpayers' ability to determine the time of the
income inclusion of pension distributions, and eliminates the
need for special rules such as 5-year forward income averaging
to prevent bunching of income.
It is inappropriate to require all participants to commence
distributions by age 70\1/2\ without regard to whether the
participant is still employed by the employer. However, the
accrued benefit of employees who retire after age 70\1/2\
generally should be actuarially increased to take into account
the period after age 70\1/2\ in which the employee was not
receiving benefits.
Explanation of provisions
Lump-sum distributions
The bill repeals 5-year averaging for lump-sum
distributions from qualified plans. Thus, the bill repeals the
separate tax paid on a lump-sum distribution and also repeals
the deduction from gross income for taxpayers who elect to pay
the separate tax on a lump-sum distribution. The bill preserves
the transition rules adopted in the Tax Reform Act of 1986
(i.e., 10-year averaging and capital gains treatment for the
pre-1974 portion of the lump-sum distribution), but not 5-year
averaging, with respect to lump-sum distributions to
individuals eligible for such transition rules.
$5,000 exclusion for employer-provided death benefits
The bill repeals the $5,000 exclusion for employer-provided
death benefits.
Recovery of basis
The bill provides that basis recovery on payments from
qualified plans generally is determined under a method similar
to the present-law simplified alternative method provided by
the IRS. The portion of each annuity payment that represents a
return of basis equals to the employee's total basis as of the
annuity starting date, divided by the number of anticipated
payments under the following table:
Age Number of Payments:
Not more than 55.................................................. 360
56-60............................................................. 310
61-65............................................................. 260
66-70............................................................. 210
More than 70...................................................... 160
Required distributions
The bill modifies the rule that requires all participants
in qualified plans to commence distributions by age 70\1/2\
without regard to whether the participant is still employed by
the employer and generally replaces it with the rule in effect
prior to the Tax Reform Act of 1986. Under the bill,
distributions generally are required to begin by April 1 of the
calendar year following the later of first, the calendar year
in which the employee attains age 70\1/2\ or second, the
calendar year in which the employee retires. However, in the
case of a 5-percent owner of the employer, distributions are
required to begin no later than the April 1 of the calendar
year following the year in which the 5-percent owner attains
age 70\1/2\.
In addition, in the case of an employee (other than a 5-
percent owner) who retires in a calendar year after attaining
age 70\1/2\, the bill generally requires the employee's accrued
benefit to be actuarially increased to take into account the
period after age 70\1/2\ in which the employee was not
receiving benefits under the plan. Thus, under the bill, the
employee's accrued benefit is required to reflect the value of
benefits that the employee would have received if the employee
had retired at age 70\1/2\ and had begun receiving benefits at
that time.
The actuarial adjustment rule and the rule requiring 5-
percent owners to begin distributions after attainment of age
70\1/2\ does not apply, under the bill, in the case of a
governmental plan or church plan.
Effective date
Lump-sum distributions
The provision is effective for taxable years beginning
after December 31, 1999.
$5,000 exclusion for employer-provided death benefits
The provision applies with respect to decedents dying after
date of enactment.
Recovery of basis
The provision is effective with respect to annuity starting
dates beginning 90 days after the date of enactment.
Required distributions
The provision is effective for years beginning after
December 31, 1996. If a participant is currently receiving
distributions, but does not have to under the provision, the
Committee intends that a plan (or annuity contract) could (but
would not be required to) permit the participant to stop
receiving distributions until such distributions are required
under the provision.
B. Increased Access to Retirement Savings Plans
1. Establish SIMPLE retirement plans for small employers (secs. 1421-
1422 of the bill and secs. 401(k) and 408(p) of the Code)
Present law
Present law does not contain rules relating to SIMPLE
retirement plans. However, present law does provide a number of
ways in which individuals can save for retirement on a tax-
favored basis. These include employer-sponsored retirement
plans that meet the requirements of the Internal Revenue Code
(a ``qualified plan'') and individual retirement arrangements
(``IRAs''). Employees can earn significant retirement benefits
under employer-sponsored retirement plans. However, in order to
receive tax-favored treatment, such plans must comply with a
variety of rules, including complex nondiscrimination and
administrative rules (including top-heavy rules). Such plans
are also subject to certain requirements under the labor law
provisions of the Employee Retirement Income Security Act of
1974 (``ERISA'').
IRAs are not subject to the same rules as qualified plans,
but the amount that can be contributed in any year is
significantly less. The maximum deductible IRA contribution for
a year is limited to $2,000. Distributions from IRAs and
employer-sponsored retirement plans are generally taxable when
made. In addition, distributions prior to age 59\1/2\ generally
are subject to an additional 10-percent early withdrawal tax.
Contributions to an IRA can also be made by an employer at
the election of an employee under a salary reduction simplified
employee pension (``SARSEP''). Under SARSEPs, which are not
qualified plans, employees can elect to have contributions made
to the SARSEP or to receive the contributions in cash. The
amount the employee elects to have contributed to the SARSEP is
not currently includible in income. The annual amount an
employee can elect to contribute to a SARSEP is limited to
$9,500 for 1996. This dollar limit is indexed for inflation in
$500 increments. The election to have amounts contributed to a
SARSEP or received in cash is available only if at least 50
percent of the eligible employees of the employer elect to have
amounts contributed to the SARSEP. In addition, such election
is available for a taxable year only if the employer
maintaining the SARSEP had 25 or fewer eligible employees at
all times during the prior taxable year. Elective deferrals
under SARSEPs are subject to a special nondiscrimination test.
Under one type of qualified plan that can be maintained by
an employer, employees can elect to reduce their taxable
compensation and have nontaxable contributions made to the
plan. Such contributions are called elective deferrals, and the
plans which allow such contributions are called qualified cash
or deferred arrangements (or ``401(k) plans''). Like SARSEPs,
the maximum annual amount of elective deferrals that can be
made by an individual is $9,500 for 1996. A special
nondiscrimination test applies to elective deferrals. An
employer may make contributions based on an employee's elective
contributions. Such contributions are called matching
contributions, and are subject to a special nondiscrimination
test similar to the special nondiscrimination test applicable
to elective deferrals.
Reasons for Change
Retirement plan coverage is lower among small employers
than among medium and large employers. The Committee believes
that one of the reasons small employers do not establish tax-
qualified retirement plans is the complexity of rules relating
to such plans and the cost of complying with such rules. The
Committee believes it is appropriate to encourage small
employers to adopt retirement plans by providing a simplified
retirement plan that is not subject to the complex rules
applicable to tax-qualified plans.
Among the rules applicable to tax-qualified plans are
nondiscrimination rules that help to ensure that plans cover a
broad range of employees, not just an employer's highly
compensated employees. The Committee believes that the goal of
the nondiscrimination rules, broad pension coverage, is an
important one. Unfortunately, the complicated nature of these
rules may prevent small employers from establishing any plan.
The Committee believes that the purposes of the
nondiscrimination rules will be served in the case of small
employers if all full-time employees are given the opportunity
to participate in the plan, the employer is required to match
employee contributions, and there are limits on the total
contributions that can be made.
The Committee believes that employees should be encouraged
to save for retirement, and thus believes a penalty should be
imposed on amounts withdrawn within a short period after the
retirement plan is adopted.
Explanation of provision
In general
The bill creates a simplified retirement plan for small
business called the savings incentive match plan for employees
(``SIMPLE'') retirement plan. SIMPLE plans can be adopted by
employers who employed 100 or fewer employees earning at least
$5,000 in compensation for the preceding year and who do not
maintain another employer-sponsored retirement plan. A SIMPLE
plan can be either an IRA for each employee or part of a
qualified cash or deferred arrangement (``401(k) plan''). If
established in IRA form, a SIMPLE plan is not subject to the
nondiscrimination rules generally applicable to qualified plans
(including the top-heavy rules) and simplified reporting
requirements apply. Within limits, contributions to a SIMPLE
plan are not taxable until withdrawn.
A SIMPLE plan can also be adopted as part of a 401(k) plan.
In that case, the plan does not have to satisfy the special
nondiscrimination tests applicable to 401(k) plans and is not
subject to the top-heavy rules. The other qualified plan rules
continue to apply.
SIMPLE retirement plans in IRA form
In general
A SIMPLE retirement plan allows employees to make elective
contributions to an IRA. Employee contributions have to be
expressed as a percentage of the employee's compensation, and
cannot exceed $6,000 per year. The $6,000 dollar limit is
indexed for inflation in $500 increments.
Under the bill, 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. Under a special rule,
the employer could elect a lower percentage matching
contribution for all employees (but not less than 1 percent of
each employee's compensation). In order for the employer to
lower the matching percentage for any year, the employer has to
notify employees of the applicable match within a reasonable
time before the 60-day election period for the year (described
below). In addition, a lower percentage cannot be elected for
more than 2 out of any 5 years.
Alternatively, for any year, 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 with at least $5,000 in compensation for
such year. If such an election were made, the employer has to
notify eligible employees of the change within a reasonable
period before the 60-day election period for the year
(described below). No contributions other than employee
elective contributions and required employer matching
contributions (or, alternatively, required employer nonelective
contributions) can be made to a SIMPLE account.
Only employers who employed 100 or fewer employees earning
at least $5,000 in compensation for the preceding year and who
do not currently maintain a qualified plan can establish SIMPLE
retirement accounts for their employees. Under a special rule,
employers are given a 2-year grace period to maintain a SIMPLE
plan once they are no longer eligible.
Each employee of the employer who received at least $5,000
in compensation from the employer during any 2 prior years and
who is reasonably expected to receive at least $5,000 in
compensation during the year must be eligible to participate in
the SIMPLE plan. Nonresident aliens and employees covered under
a collective bargaining agreement do not have to be eligible to
participate in the SIMPLE plan. Self-employed individuals can
participate in a SIMPLE plan.
All contributions to an employee's SIMPLE account have to
be fully vested.
Distributions from a SIMPLE plan generally are taxed as
under the rules relating to IRAs, except that an increased
early withdrawal tax (25 percent) applies to distributions
within the first 2 years the employee first participates in the
SIMPLE plan.
Tax treatment of SIMPLE accounts, contributions, and
distributions
Contributions to a SIMPLE account generally are deductible
by the employer. In the case of matching contributions, the
employer will be allowed a deduction for a year only if the
contributions are made by the due date (including extensions)
for the employer's tax return. Contributions to a SIMPLE
account are excludable from the employee's income. SIMPLE
accounts, like IRAs, are not subject to tax. Distributions from
a SIMPLE retirement account generally are taxed under the rules
applicable to IRAs. Thus, they are includible in income when
withdrawn. Tax-free rollovers can be made from one SIMPLE
account to another. A SIMPLE account can be rolled over to an
IRA on a tax-free basis after a two-year period has expired
since the individual first participated in the SIMPLE plan. To
the extent an employee is no longer participating in a SIMPLE
plan (e.g., the employee has terminated employment), the
employee's SIMPLE account will be treated as an IRA.
Early withdrawals from a SIMPLE account generally are be
subject to the 10-percent early withdrawal tax applicable to
IRAs. However, withdrawals of contributions during the 2-year
period beginning on the date the employee first participated in
the SIMPLE plan are subject to a 25-percent early withdrawal
tax (rather than 10 percent).
Employer matching or nonelective contributions to a SIMPLE
account are not treated as wages for employment tax purposes.
Administrative requirements
Each eligible employee can elect, within the 60-day period
before the beginning of any year (or the 60-day period before
first becoming eligible to participate), to participate in the
SIMPLE plan (i.e., to make elective deferrals), and to modify
any previous elections regarding the amount of contributions.
An employer is required to contribute employees' elective
deferrals to the employee's SIMPLE account within 30 days after
the end of the month to which the contributions relate.
Employees must be allowed to terminate participation in the
SIMPLE plan at any time during the year (i.e., to stop making
contributions). The plan can provide that an employee who
terminates participation cannot resume participation until the
following year. A plan can permit (but is not required to
permit) an individual to make other changes to his or her
salary reduction contribution election during the year (e.g.,
reduce contributions). An employer is permitted to designate a
SIMPLE account trustee to which contributions on behalf of
eligible employees are made.
The bill also amend parts 1 and 4, Subtitle B, Title I of
ERISA so that only simplified reporting requirements apply to
SIMPLE plans and so that the employer (and any other plan
fiduciary) will not be subject to fiduciary liability resulting
from the employee (or beneficiary) exercising control over the
assets in the SIMPLE account. For this purpose, an employee (or
beneficiary) will be treated as exercising control over the
assets in his or her account upon the earlier of (1) an
affirmative election with respect to the initial investment of
any contributions, (2) a rollover contribution (including a
trustee-to-trustee transfer) to another SIMPLE account or IRA,
or (3) one year after the SIMPLE account is established. The
Committee intends that once an employee (or beneficiary) is
treated as exercising control over his or her SIMPLE account,
the relief from fiduciary liability would extend to the period
prior to when the employee (or beneficiary) was deemed to
exercise control.
Reporting requirements
Trustee requirements.--The trustee of a SIMPLE account is
required each year to prepare, and provide to the employer
maintaining the SIMPLE plan, a summary description containing
the following basic information about the plan: the name and
address of the employer and the trustee; the requirements for
eligibility; the benefits provided under the plan; the time and
method of making salary reduction elections; and the procedures
for and effects of, withdrawals (including rollovers) from the
SIMPLE account. 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.
Employer reports.--The employer maintaining a SIMPLE plan
is required to notify each employee of the employee's
opportunity to make salary reduction contributions under the
plan as well as the contribution alternative chosen by the
employer immediately before the employee becomes eligible to
make such election. This notice must include a copy of the
summary description prepared by the trustee. An employer who
fails to provide such notice will be subject to a penalty of
$50 per day on which such failure continues, unless the failure
is due to reasonable cause.
Definitions
For purposes of the rules relating to SIMPLE plans,
compensation means compensation required to be reported by the
employer on Form W-2, plus any elective deferrals of the
employee. In the case of a self-employed individual,
compensation means net earnings from self-employment. The
$150,000 compensation limit (sec. 401(a)(17)) applies only for
purposes of the 2 percent of compensation nonelective
contribution formula.65 The term employer includes the
employer and related employers. Related employers includes
trades or businesses under common control (whether incorporated
or not), controlled groups of corporations, and affiliated
service groups. In addition, the leased employee rules apply.
---------------------------------------------------------------------------
\65\ So, for example, the maximum employer contribution that can be
made on behalf of any single eligible employee under the 2 percent of
compensation nonelective contribution formula is $3,000. By contrast,
the maximum employer contribution that can be made on behalf of any
single eligible employee under the matching contribution formula is
$6,000.
---------------------------------------------------------------------------
For purposes of the rule prohibiting an employer from
establishing a SIMPLE plan, if the employer has another
qualified plan, an employer is treated as maintaining a
qualified plan if the employer (or a predecessor employer)
maintained a qualified plan with respect to which contributions
were made, or benefits were accrued, with respect to service
for any year in the period beginning with the year the SIMPLE
plan became effective and ending with the year for which the
determination is being made. A qualified plan includes a
qualified retirement plan, a qualified annuity plan, a
governmental plan, a tax-sheltered annuity, and a simplified
employee pension.
SIMPLE 401(k) plans
In general, under the bill, a cash or deferred arrangement
(i.e., 401(k) plan), will be deemed to satisfy the special
nondiscrimination tests applicable to employee elective
deferrals and employer matching contributions if the plan
satisfies the contribution requirements applicable to SIMPLE
plans. In addition, the plan is not subject to the top-heavy
rules for any year for which this safe harbor is satisfied. The
plan is subject to the other qualified plan rules.
The safe harbor is satisfied if, for the year, the employer
does not maintain another qualified plan and (1) employee's
elective deferrals are limited to no more than $6,000, (2) the
employer matches employees' elective deferrals up to 3 percent
of compensation (or, alternatively, makes a 2 percent of
compensation nonelective contribution on behalf of all eligible
employees with at least $5,000 in compensation), and (3) no
other contributions are made to the arrangement. Contributions
under the safe harbor have to be 100 percent vested. The
employer cannot reduce the matching percentage below 3 percent
of compensation.
Repeal of SARSEPs
Under the bill, the present-law rules permitting SARSEPs no
longer apply after December 31, 1996, unless the SARSEP was
established before January 1, 1997. Consequently, an employer
is not permitted to establish a SARSEP after December 31, 1996.
SARSEPs established before January 1, 1997, can continue to
receive contributions under present-law rules, and new
employees of the employer hired after December 31, 1996, can
participate in the SARSEP in accordance with such rules.
Effective date
The provisions relating to SIMPLE plans are effective for
years beginning after December 31, 1996.
2. Tax-exempt organizations eligible under section 401(k) (sec. 1426 of
the bill and sec. 401(k) of the Code)
Present law
Under present law, tax-exempt and State and local
government organizations are generally prohibited from
establishing qualified cash or deferred arrangements (sec.
401(k) plans). Qualified cash or deferred arrangements (1) of
rural cooperatives, (2) adopted by State and local governments
before May 6, 1986, or (3) adopted by tax-exempt organizations
before July 2, 1986, are not subject to this prohibition.
There is no specific statutory provision governing the
Federal income tax liability of Indian tribes.66 However,
the Internal Revenue Service (``IRS'') has long taken the
position that Indian tribal governments, as well as wholly-
owned tribal corporations chartered under Federal law, are not
taxable entities and, thus, are immune from Federal income
taxes.67 More recently, the IRS has ruled that any income
earned by an unincorporated Indian tribal government or
Federally chartered tribal corporation is not subject to
Federal income tax, regardless of whether the activities that
produced the income are conducted on or off the tribe's
reservation.68
---------------------------------------------------------------------------
\66\ Section 7871 provides that Indian tribal governments are
treated as States for certain limited tax purposes, such as the
issuance of certain tax-exempt bonds, certain excise tax exemptions,
and for eligibility to receive deductible charitable contributions.
Section 7871 also treats Indian tribal governments as States for
purposes of the provision that permits State and local government
educational organizations to maintain tax-sheltered annuity plans (sec.
403(b)). However, section 7871 does not treat Indian tribal governments
as States or State governments for purposes of section 401(k).
\67\ See Rev. Rul. 67-284, 1967-2 C.B. 55; Rev. Rul. 81-295, 1981-2
C.B. 15.
\68\ See Rev. Rul. 94-16, 1994-1 C.B. 19; Rev. Rul. 94-65, 1994-2
C.B. 14.
---------------------------------------------------------------------------
Reasons for change
Nongovernmental tax-exempt entities should be permitted to
maintain qualified cash or deferred arrangements for their
employees on the same basis as other employers.
Explanation of provision
The bill allows tax-exempt organizations (including, for
this purpose, Indian tribal governments, a subdivision of an
Indian tribal government, an agency or instrumentality of an
Indian tribal government or subdivision thereof, or a
corporation chartered under Federal, State, or tribal law which
is owned in whole or in part by any of such entities) to
maintain qualified cash or deferred arrangements. The bill
retains the present-law prohibition against the maintenance of
cash or deferred arrangements by State and local governments,
except to the extent it may apply to Indian tribal governments.
Effective date
The provision is effective for plan years beginning after
December 31, 1996. The Committee intends no inference with
respect to whether Indian tribal governments are permitted to
maintain qualified cash or deferred arrangements under present
law.
3. Spousal IRAs (sec. 1427 of the bill and sec. 219 of the Code)
Present law
Within limits, an individual is allowed a deduction for
contributions to an individual retirement account or an
individual retirement annuity (an ``IRA''). 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.
Under present law, the maximum deductible contribution that
can be made to an IRA generally is the lesser of $2,000 or 100
percent of an individual's compensation (earned income in the
case of a self-employed individual). In the case of a married
individual whose spouse has no compensation (or elects to be
treated as having no compensation), the $2,000 limit on IRA
contributions is increased to $2,250.
Reasons for change
The Committee is concerned about the national savings rate,
and believes that individuals should be encouraged to save. The
Committee believes that the ability to make deductible
contributions to an IRA is a significant savings incentive.
However, this incentive is not available to all taxpayers under
present law. The Committee believes that the present-law rules
relating to deductible IRAs penalize American homemakers. The
Committee believes that IRA contributions should be permitted
for both spouses even though only one spouse works.
Explanation of provision
The bill modifies the present-law rules relating to
deductible IRAs by permitting deductible IRA contributions of
up to $2,000 to be made for each spouse (including, for
example, a homemaker who does not work outside the home) if the
combined compensation of both spouses is at least equal to the
contributed amount.
Effective date
The provision is effective for taxable years beginning
after December 31, 1996.
C. nondiscrimination provisions
1. Definition of highly compensated employees and repeal of family
aggregation rules (sec. 1431 of the bill and secs. 401(a)(17),
404(l), and 414(g) of the Code)
Present law
Definition of highly compensated employee
An employee, including a self-employed individual, is
treated as highly compensated if, at any time during the year
or the preceding year, the employee (1) was a 5-percent owner
of the employer, (2) received more than $100,000 (for 1996) in
annual compensation from the employer, (3) received more than
$66,000 (for 1996) in annual compensation from the employer and
was one of the top-paid 20 percent of employees during the same
year, or (4) was an officer of the employer who received
compensation in excess of $60,000 (for 1996). If, for any year,
no officer has compensation in excess of the threshold, then
the highest paid officer of the employer is treated as a highly
compensated employee.
Family aggregation rules
A special rule applies with respect to the treatment of
family members of certain highly compensated employees for
purposes of the nondiscrimination rules applicable to qualified
plans. Under the special rule, if an employee is a family
member of either a 5-percent owner or 1 of the top-10 highly
compensated employees by compensation, then any compensation
paid to such family member and any contribution or benefit
under the plan on behalf of such family member is aggregated
with the compensation paid and contributions or benefits on
behalf of the 5-percent owner or the highly compensated
employee in the top-10 employees by compensation. Therefore,
such family member and employee are treated as a single highly
compensated employee. An individual is considered a family
member if, with respect to an employee, the individual is a
spouse, lineal ascendant or descendant, or spouses of a lineal
ascendant or descendant of the employee.
Similar family aggregation rules apply with respect to the
$150,000 (for 1996) limit on compensation that may be taken
into account under a qualified plan (sec. 401(a)(17)) and for
deduction purposes (sec. 404(1)). However, under such
provisions, only the spouse of the employee and lineal
descendants of the employee who have not attained age 19 are
taken into account.
Reasons for change
Under present law, the administrative burden on plan
sponsors to determine which employees are highly compensated
can be significant. The various categories of highly
compensated employees require employers to perform a number of
calculations that for many employers have largely duplicative
results.
The family aggregation rules impose undue restrictions on
the ability of a family-owned small business to provide
adequate retirement benefits for all members of the family
working for the business. In addition, the complexity of the
calculations required under the family aggregation rules
appears to be unnecessary in light of the numerous other
provisions that ensure that qualified pension plans do not
disproportionately favor highly compensated employees.
Explanation of provisions
Definition of highly compensated employee
Under the bill, an employee is treated as highly
compensated if the employee (1) was a 5-percent owner of the
employer at any time during the year or the preceding year or
(2) had compensation for the preceding year in excess of
$80,000 (indexed for inflation). The bill also repeals the rule
requiring the highest paid officer to be treated as a highly
compensated employee.
Family aggregation rules
The bill repeals the family aggregation rules.
Effective date
The provisions are effective for years beginning after
December 31, 1996.
2. Modification of additional participation requirements (sec. 1432 of
the bill and sec. 401(a)(26) of the Code)
Present law
Under present law, a plan is not a qualified plan unless it
benefits no fewer than the lesser of (a) 50 employees of the
employer or (b) 40 percent of all employees of the employer
(sec. 401(a)(26)). This requirement may not be satisfied by
aggregating comparable plans, but may be applied separately to
different lines of business of the employer. A line of business
of the employer does not qualify as a separate line of business
unless it has at least 50 employees.
Reasons for change
The minimum participation rule was adopted in the Tax
Reform Act of 1986 because the Congress believed that it was
inappropriate to permit an employer to maintain multiple plans,
each of which covered a very small number of employees.
Although plans that are aggregated for nondiscrimination
purposes are required to satisfy comparability requirements
with respect to the amount of contributions or benefits, such
an arrangement may still discriminate in favor of highly
compensated employees.
However, it is appropriate to better target the minimum
participation rule by limiting the scope of the rule to defined
benefit pension plans and increasing the minimum number of
employees required to be covered under very small plans.
Also, the arbitrary requirement that a line of business
must have at least 50 employees requires application of the
minimum participation rule on an employer-wide basis in some
cases in which the employer truly has separate lines of
business.
Explanation of provision
The bill provides that the minimum participation rule
applies only to defined benefit pension plans. In addition, the
bill provides that a defined benefit pension plan does not
satisfy the rule unless it benefits no fewer than the lesser of
(1) 50 employees or (2) the greater of (a) 40 percent of all
employees of the employer or (b) 2 employees (1 employee if
there is only 1 employee).
The bill provides that the requirement that a line of
business has at least 50 employees does not apply in
determining whether a plan satisfies the minimum participation
rule on a separate line of business basis.
Effective date
The provision is effective for years beginning after
December 31, 1996.
3. Nondiscrimination rules for qualified cash or deferred arrangements
and matching contributions (sec. 1433 of the bill and secs.
401(k) and 401(m) of the Code)
Present law
Under present law, a special nondiscrimination test applies
to qualified cash or deferred arrangements (sec. 401(k) plans).
The special nondiscrimination test is satisfied if the actual
deferral percentage (``ADP'') for eligible highly compensated
employees for a plan year is equal to or less than either (1)
125 percent of the ADP of all nonhighly compensated employees
eligible to defer under the arrangement or (2) the lesser of
200 percent of the ADP of all eligible nonhighly compensated
employees or such ADP plus 2 percentage points.
Employer matching contributions and after-tax employee
contributions under qualified defined contribution plans are
subject to a special nondiscrimination test (the actual
contribution percentage (``ACP'') test) similar to the special
nondiscrimination test applicable to qualified cash or deferred
arrangements. Employer matching contributions that satisfy
certain requirements can be used to satisfy the ADP test, but,
to the extent so used, such contributions cannot be considered
when calculating the ACP test.
A plan that would otherwise fail to meet the special
nondiscrimination test for qualified cash or deferred
arrangements is not treated as failing such test if excess
contributions (with allocable income) are distributed to the
employee or, in accordance with Treasury regulations,
recharacterized as after-tax employee contributions. For
purposes of this rule, in determining the amount of excess
contributions and the employees to whom they are allocated, the
elective deferrals of highly compensated employees are reduced
in the order of their actual deferral percentage beginning with
those highly compensated employees with the highest actual
deferral percentages. A similar rule applies to employer
matching contributions.
Reasons for change
The sources of complexity generally associated with the
nondiscrimination requirements for qualified cash or deferred
arrangements and matching contributions are the recordkeeping
necessary to monitor employee elections, the calculations
involved in applying the tests, and the correction mechanism,
i.e., what to do if the plan fails the tests.
The Committee believes that the complexity of
nondiscrimination requirements, particularly after the Tax
Reform Act of 1986 changes that imposed a dollar cap on
elective deferrals ($9,500 in 1996), is not justified by the
marginal additional participation of rank-and-file employees
that might be achieved by the operation of these requirements.
The result that the nondiscrimination rules are intended to
produce can also be achieved by creating an incentive for
employers to provide certain matching contributions or
nonelective contributions on behalf of rank-and-file employees.
Such contributions should create a sufficient inducement to
rank-and-file employee participation. Thus, the Committee
believes it is appropriate to provide a design-based safe
harbor for qualified cash or deferred arrangements. Plans that
satisfy the safe harbors would not have to satisfy the
nondiscrimination tests for cash or deferred arrangements.
In addition, the significant simplification that a design-
based safe harbor test achieves may reduce the complexity of
the qualified cash or deferred arrangement requirements enough
to encourage additional employers to establish such plans,
thereby expanding employee access to voluntary retirement
savings arrangements. The adoption of a nondiscrimination safe
harbor that eliminates the testing of actual plan contributions
removes a significant administrative burden that may act as a
deterrent to employers who would not otherwise set up such a
plan. Thus, the adoption of a simpler nondiscrimination test
may encourage more employers, particularly small employers, who
do not now provide any tax-favored retirement plan for their
employees, to set up such plans.
A design-based nondiscrimination test provides certainty to
an employer and plan participants that does not exist under
present law. Under such a test, an employer will know at the
beginning of each plan year whether the plan satisfies the
nondiscrimination requirements for the year.
Simplifying the nondiscrimination tests will also reduce
administrative burdens for those plans that do not utilize the
safe harbor.
Explanation of provisions
Prior-year data
The bill modifies the special nondiscrimination tests
applicable to elective deferrals and employer matching and
after-tax employee contributions to provide that the maximum
permitted actual deferral percentage (and actual contribution
percentage) for highly compensated employees for the year is
determined by reference to the actual deferral percentage (and
actual contribution percentage) for nonhighly compensated
employees for the preceding, rather than the current, year. A
special rule applies for the first plan year.
Alternatively, under the bill, an employer is allowed to
elect to use the current year actual deferral percentage (and
actual contribution percentage). Such an election can be
revoked only as provided by the Secretary.
Safe harbor for cash or deferred arrangements
The bill provides that a cash or deferred arrangement
satisfies the special nondiscrimination tests if the plan
satisfies one of two contribution requirements and satisfies a
notice requirement.
A plan satisfies the contribution requirements under the
safe harbor rule for qualified cash or deferred arrangements if
the plan either first, satisfies a matching contribution
requirement or second, the employer makes a nonelective
contribution to a defined contribution plan of at least 3
percent of an employee's compensation on behalf of each
nonhighly compensated employee who is eligible to participate
in the arrangement without regard to whether the employee makes
elective contributions under the arrangement.
A plan satisfies the matching contribution requirement if,
under the arrangement: first, the employer makes a matching
contribution on behalf of each nonhighly compensated employee
that is equal to (a) 100 percent of the employee's elective
contributions up to 3 percent of compensation and (b) 50
percent of the employee's elective contributions from 3 to 5
percent of compensation; and second, the rate of match with
respect to any elective contribution for highly compensated
employees is not greater than the rate of match for nonhighly
compensated employees.
Alternatively, if the rate of matching contribution with
respect to any rate of elective contribution requirement is not
equal to the percentages described in the preceding paragraph,
the matching contribution requirement will be deemed to be
satisfied if first, the rate of an employer's matching
contribution does not increase as an employee's rate of
elective contribution increases and second, the aggregate
amount of matching contributions at such rate of elective
contribution at least equals the aggregate amount of matching
contributions that would be made if matching contributions
satisfied the above percentage requirements. For example, the
alternative test will be satisfied if an employer matches 125
percent of an employee's elective contributions up to the first
3 percent of compensation, 25 percent of elective deferrals
from 3 to 4 percent of compensation, and provides no match
thereafter. However, the alternative test will not be satisfied
if an employer matches 80 percent of an employee's elective
contributions up to the first 5 percent of compensation. The
former example satisfies the alternative test because the
employer match does not increase and the aggregate amount of
matching contributions at any rate of elective contribution is
at least equal to the aggregate amount of matching
contributions required under the general safe harbor rule.
Employer matching and nonelective contributions used to
satisfy the contribution requirements of the safe harbor rules
are required to be nonforfeitable and are subject to the
restrictions on withdrawals that apply to an employee's
elective deferrals under a qualified cash or deferred
arrangement (sec. 401(k)(2)(B) and (C)). It is intended that
employer matching and nonelective contributions used to satisfy
the contribution requirements of the safe harbor rules can be
used to satisfy other qualified retirement plan
nondiscrimination rules (except the special nondiscrimination
test applicable to employer matching contributions (the ACP
test)). So, for example, a cross-tested defined contribution
plan that includes a qualified cash or deferred arrangement can
consider such employer matching and nonelective contributions
in testing.69
---------------------------------------------------------------------------
69 The Committee intends that if two plans which include qualified
cash or deferred arrangements are treated as one plan for purposes of
the nondiscrimination and coverage rules, such qualified cash or
deferred arrangements will be treated as one qualified cash or deferred
arrangement for purposes of the safe harbor rules. In such a case,
unless both qualified cash or deferred arrangements satisfied the safe
harbor, both qualified cash or deferred arrangements tested together
will have to satisfy the ADP and ACP tests.
---------------------------------------------------------------------------
The notice requirement is satisfied if each employee
eligible to participate in the arrangement is given written
notice, within a reasonable period before any year, of the
employee's rights and obligations under the arrangement.
Alternative method of satisfying special nondiscrimination test for
matching contributions
The bill provides a safe harbor method of satisfying the
special nondiscrimination test applicable to employer matching
contributions (the ACP test). Under this safe harbor, a plan is
treated as meeting the special nondiscrimination test if first,
the plan meets the contribution and notice requirements
applicable under the safe harbor method of satisfying the
special nondiscrimination requirement for qualified cash or
deferred arrangements, and second, the plan satisfies a special
limitation on matching contributions.
The limitation on matching contributions is satisfied if:
first, the employer matching contributions on behalf of any
employee may not be made with respect to employee contributions
or elective deferrals in excess of 6 percent of compensation;
second, the rate of an employer's matching contribution does
not increase as the rate of an employee's contributions or
elective deferrals increases; and third, the matching
contribution with respect to any highly compensated employee at
any rate of employee contribution or elective deferral is not
greater than that with respect to an employee who is not highly
compensated.
Any after-tax employee contributions made under the
qualified cash or deferred arrangement will continue to be
tested under the ACP test. Employer matching and nonelective
contributions used to satisfy the safe harbor rules for
qualified cash or deferred arrangements cannot be considered in
calculating such test. However, employer matching and
nonelective contributions in excess of the amount required to
satisfy the safe harbor rules for qualified cash or deferred
arrangements can be taken into account in calculating such
test.
Distribution of excess contributions and excess aggregate contributions
The bill provides that the total amount of excess
contributions (and excess aggregate contributions) is
determined as under present law, but the distribution of excess
contributions (and excess aggregate contributions) are required
to be made on the basis of the amount of contribution by, or on
behalf of, each highly compensated employee. Thus, excess
contributions (and excess aggregate contributions) are deemed
attributable first to those highly compensated employees who
have the greatest dollar amount of elective deferrals.
Effective date
The provisions relating to use of prior-year data and the
distribution of excess contributions and excess aggregate
contributions are effective for years beginning after December
31, 1996. The provisions providing for a safe harbor for
qualified cash or deferred arrangements and the alternative
method of satisfying the special nondiscrimination test for
matching contributions are effective for years beginning after
December 31, 1998.
4. Definition of compensation for purposes of the limits on
contributions and benefits (sec. 1434 of the bill and sec. 415
of the Code)
Present law
Present law imposes limits on contributions and benefits
under qualified plans based on the type of plan. For purposes
of these limits, present law provides that the definition of
compensation generally does not include elective employee
contributions to certain employee benefit plans.
Reasons for change
The Committee believes that not treating employee elective
contributions as compensation for purposes of the limits on
benefits and contributions under qualified plans unduly
restricts the amount that employees, particularly employees who
are not highly compensated, can earn under qualified plans.
Explanation of provision
The bill provides that elective deferrals to section 401(k)
plans and similar arrangements, elective contributions to
nonqualified deferred compensation plans of tax-exempt
employers and State and local governments (sec. 457 plans), and
salary reduction contributions to a cafeteria plan are
considered compensation for purposes of the limits on
contributions and benefits.
Effective date
The provision is effective for years beginning after
December 31, 1997.
D. Miscellaneous Pension Simplification
1. Plans covering self-employed individuals (sec. 1441 of the bill and
sec. 401(d) of the Code)
Present law
Prior to the Tax Equity and Fiscal Responsibility Act of
1982 (``TEFRA''), different rules applied to retirement plans
maintained by incorporated employers and unincorporated
employers (such as partnerships and sole proprietors). In
general, plans maintained by unincorporated employers were
subject to special rules in addition to the other qualification
requirements of the Code. Most, but not all, of this disparity
was eliminated by TEFRA. Under present law, certain special
aggregation rules apply to plans maintained by owner employees
of unincorporated businesses that do not apply to other
qualified plans (sec. 401(d)(1) and (2)).
Reasons for change
The remaining special aggregation rules for plans
maintained by unincorporated employers are unnecessary and
should be eliminated. Applying the same set of rules to all
types of plans would make the qualification standards easier to
apply and administer.
Explanation of provision
The bill eliminates the special aggregation rules that
apply to plans maintained by self-employed individuals that do
not apply to other qualified plans.
Effective date
The provision is effective for years beginning after
December 31, 1996.
2. Elimination of special vesting rule for multiemployer plans (sec.
1442 of the bill and sec. 411(a) of the Code)
Present law
Under present law, except in the case of multiemployer
plans, a plan is not a qualified plan unless a participant's
employer-provided benefit vests at least as rapidly as under
one of two alternative minimum vesting schedules. A plan
satisfies the first schedule if a participant acquires a
nonforfeitable right to 100 percent of the participant's
accrued benefit derived from employer contributions upon the
participant's completion of 5 years of service. A plan
satisfies the second schedule if a participant has a
nonforfeitable right to at least 20 percent of the
participant's accrued benefit derived from employer
contributions after 3 years of service, 40 percent at the end
of 4 years of service, 60 percent at the end of 5 years of
service, 80 percent at the end of 6 years of service, and 100
percent at the end of 7 years of service.
In the case of a multiemployer plan, a participant's
accrued benefit derived from employer contributions is required
to be 100-percent vested no later than upon the participant's
completion of 10 years of service. This special rule applies
only to employees covered by the plan pursuant to a collective
bargaining agreement.
Reasons for change
The present-law vesting rules for multiemployer plans add
to complexity because there are different vesting schedules for
different types of plans, and different vesting schedules for
persons within the same multiemployer plan. In addition, the
present-law rule prevents some workers from earning a pension
under a multiemployer plan. Conforming the multiemployer plan
rules to the rules for other plans would mean that workers
could earn additional benefits.
Explanation of provision
The bill conforms the vesting rules for multiemployer plans
to the rules applicable to other qualified plans.
Effective date
The provision is effective for plan years beginning on or
after the earlier of (1) the later of January 1, 1997, or the
date on which the last of the collective bargaining agreements
pursuant to which the plan is maintained terminates, or (2)
January 1, 1999, with respect to participants with an hour of
service after the effective date.
3. Distributions under rural cooperative plans (sec. 1443 of the bill
and sec. 401(k)(7) of the Code)
Present law
A qualified cash or deferred arrangement can permit
withdrawals of employee elective deferrals only after the
earlier of (1) the participant's separation from service,
death, or disability, (2) termination of the arrangement, or
(3) in the case of a profit-sharing or stock bonus plan, the
attainment of age 59\1/2\ or the occurrence of a hardship of
the participant. In the case of a money purchase pension plan,
including a rural cooperative plan, withdrawals by participants
cannot occur upon attainment of age 59\1/2\ or upon hardship.
Reasons for change
It is appropriate to permit qualified cash or deferred
arrangements of rural cooperatives to permit distributions to
plan participants under the same circumstances as other
qualified cash or deferred arrangements. It is also appropriate
to clarify that certain public utility districts and a national
association of rural cooperatives should be treated as rural
cooperatives for this purpose.
Explanation of provision
The bill provides that a rural cooperative plan that
includes a cash or deferred arrangement may permit
distributions to plan participants after the attainment of age
59\1/2\ or on account of hardship. In addition, the definition
of a rural cooperative is expanded to include certain public
utility districts.
Effective date
The provision generally is effective for distributions
after the date of enactment. The modifications to the
definition of a rural cooperative apply to plan years beginning
after December 31, 1996.
4. Treatment of governmental plans under section 415 (sec. 1444 of the
bill and secs. 415 and 457 of the Code)
Present law
Present law imposes limits on contributions and benefits
under qualified plans based on the type of plan (sec. 415).
Certain special rules apply to State and local governmental
plans under which such plans may provide benefits greater than
those permitted by the limits on benefits applicable to plans
maintained by private employers.
In the case of defined benefit pension plans, the limit on
the annual retirement benefit is the lesser of (1) 100 percent
of compensation or (2) $120,000 (indexed for inflation). The
dollar limit is reduced in the case of early retirement or if
the employee has less than 10 years of plan participation.
Reasons for change
The limits on contributions and benefits create unique
problems for plans maintained by public employers.
Explanation of provision
The bill makes the following modifications to the limits on
contributions and benefits as applied to governmental plans:
(1) the 100 percent of compensation limitation on defined
benefit pension plan benefits would not apply; and
(2) the early retirement reduction and the 10-year phase-in
of the defined benefit pension plan dollar limit would not
apply to certain disability and survivor benefits.
The bill also permits State and local government employers
to maintain excess benefit plans without regard to the limits
on unfunded deferred compensation arrangements of State and
local government employers (sec. 457).
Effective date
The provision is effective for years beginning after
December 31, 1994. No inference is intended with respect to
whether a governmental plan complies with the requirements of
section 415 with respect to years beginning before January 1,
1995. With respect to such years, the Secretary is directed to
enforce the requirements of section 415 consistent with the
provision.
5. Uniform retirement age (sec. 1445 of the bill and sec. 401(a)(5) of
the Code)
Present law
A qualified plan generally must provide that payment of
benefits under the plan must begin no later than 60 days after
the end of the plan year in which the participant reaches age
65. Also, for purpose of the vesting and benefit accrual rules,
normal retirement age generally can be no later than age 65.
For purposes of applying the limits on contributions and
benefits (sec. 415), Social Security retirement age is
generally used as retirement age. The Social Security
retirement age as used for such purposes is presently age 65,
but is scheduled to gradually increase.
Reasons for change
Many plans base benefits on social security retirement age
so that the benefits under the plan complement social security.
Under present law, plans that do so may fail applicable
nondiscrimination tests. It is believed that the social
security retirement age is an appropriate age for use under
plans maintained by private employers.
Explanation of provision
The bill provides that for purposes of the general
nondiscrimination rules (sec. 401(a)(4)) the Social Security
retirement age (as defined in sec. 415) is a uniform retirement
age and that subsidized early retirement benefits and joint and
survivor annuities are not treated as not being available to
employees on the same terms merely because they are based on an
employee's Social Security retirement age (as defined in sec.
415).
Effective date
The provision is effective for years beginning after
December 31, 1996.
6. Contributions on behalf of disabled employees (sec. 1446 of the bill
and sec. 415(c)(3) of the Code)
Present law
Under present law, an employer may elect to continue
deductible contributions to a defined contribution plan on
behalf of an employee who is permanently and totally disabled.
For purposes of the limit on annual additions (sec. 415(c)),
the compensation of a disabled employee is deemed to be equal
to the annualized compensation of the employee prior to the
employee's becoming disabled. Contributions are not permitted
on behalf of disabled employees who were officers, owners, or
highly compensated before they became disabled.
Reasons for change
It is appropriate to facilitate the provision of benefits
for disabled employees, if it is done on a nondiscriminatory
basis.
Explanation of provision
The bill provides that the special rule for contributions
on behalf of disabled employees is applicable without an
employer election and to highly compensated employees if the
defined contribution plan provides for the continuation of
contributions on behalf of all participants who are permanently
and totally disabled.
Effective date
The provision is effective for years beginning after
December 31, 1996.
7. Treatment of deferred compensation plans of State and local
governments and tax-exempt organizations (sec. 1447 of the bill
and sec. 457(e) of the Code)
Present law
Under a section 457 plan, an employee who elects to defer
the receipt of current compensation is taxed on the amounts
deferred when such amounts are paid or made available. The
maximum annual deferral under such a plan is the lesser of (1)
$7,500 or (2) 33\1/3\ percent of compensation (net of the
deferral).
Amounts deferred under a section 457 plan may not be made
available to an employee before the earliest of (1) the
calendar year in which the participant attains age 70\1/2\, (2)
when the participant is separated from the service with the
employer, or (3) when the participant is faced with an
unforeseeable emergency.
Benefits under a section 457 plan are not treated as made
available if the participant may elect to receive a lump sum
payable after separation from service and within 60 days of the
election. This exception is available only if the total amount
payable to the participant under the plan does not exceed
$3,500 and no additional amounts may be deferred under the plan
with respect to the participant.
Reasons for change
It is appropriate to index the dollar limits on deferrals
under section 457 plans to maintain the value of the deferral
and to provide two additional exceptions to the principle of
constructive receipt with respect to distributions from such
plans.
Explanation of provision
The bill makes three changes to the rules governing section
457 plans.
The bill: (1) permits in-service distributions of accounts
that do not exceed $3,500 under certain circumstances; (2)
increases the number of elections that can be made with respect
to the time distributions must begin under the plan, and (3)
provides for indexing (in $500 increments) of the dollar limit
on deferrals.
Effective date
The provision is effective for taxable years beginning
after December 31, 1996.
8. Trust requirement for deferred compensation plans of State and local
governments (sec. 1448 of the bill and sec. 457 of the Code)
Present law
Until deferrals under a section 457 plan are made available
to a plan participant, such amounts deferred, all property and
rights purchased with such amounts, and all income attributable
to such amounts, property, or rights must remain solely the
property and rights of the employer, subject only to the claims
of the employer's general creditors.
Reasons for change
The Committee is concerned about the potential for
employees of certain State and local governments to lose
significant portions of their retirement savings because their
employer has chosen to provide benefits through an unfunded
deferred compensation plan rather than a qualified pension
plan. Therefore, the Committee finds it appropriate to require
that benefits under a section 457 plan of a State and local
government should be held in a trust (or custodial account or
annuity contract) to insulate the retirement benefits of
employees from the claims of the employer's creditors.
Explanation of provision
Under the bill, all amounts deferred under a section 457
plan maintained by a State and local governmental employer have
to be held in trust (or custodial account or annuity contract)
for the exclusive benefit of employees. The trust (or custodial
account or annuity contract) is provided tax-exempt status.
Amounts will not be considered made available merely because
they are held in a trust, custodial account, or annuity
contract.70
---------------------------------------------------------------------------
\70\ So, for example, the constructive receipt rules contained in
the Code (secs. 83 and 402(b)) do not apply to amounts deferred under
the section 457 plan and contributed to the trust.
---------------------------------------------------------------------------
Effective date
The provision generally is effective with respect to
amounts held on or after the date of enactment. In the case of
plans in existence on the date of enactment, a trust will not
need to be established by reason of the provision until January
1, 1999.
9. Correction of GATT interest and mortality rate provisions in the
Retirement Protection Act (sec. 1449 of the bill and sec. 767
of the General Agreement on Tariffs and Trade)
Present law
The Retirement Protection Act of 1994, enacted as part of
the implementing legislation for the General Agreement on
Tariffs and Trade (``GATT''), modified the actuarial
assumptions that must be used in adjusting benefits and
limitations. 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 in the plan. Under GATT, if 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 is generally effective as of the
first day of the first limitation year beginning in 1995.
GATT made similar changes to the interest rate and
mortality assumptions used to calculate the value of lump-sum
distributions for purposes of the rule permitting involuntary
dispositions of certain accrued benefits. In the case of a plan
adopted and in effect before December 8, 1995, those provisions
do not apply before the earlier of (1) the date a plan
amendment applying the new assumption is adopted or made
effective (whichever is later), or (2) the first day of the
first plan year beginning after December 31, 1999.
Reasons for change
The Committee is aware that the GATT provisions enacted in
the 103rd Congress had the result of reducing the benefit
payments to certain pension plan beneficiaries. The Committee
believes that it is appropriate to ameliorate this result by
providing the same transition period for the modifications to
limits on contributions and benefits to that provided under
similar GATT provisions, and by providing that the interest
rate to be used to reduce the dollar limit on benefits under
section 415 in cases where the participant retires before age
62 should be the same regardless of the form of benefit.
Explanation of provision
The bill conforms the effective date of the new interest
rate and mortality assumptions that must be used under section
415 to calculate the limits on benefits and contributions to
the effective date of the provision relating to the calculation
of lump-sum distributions. This rule applies only in the case
of plans that were adopted and in effect before the date of
enactment of GATT (December 8, 1994). To the extent plans have
already been amended to reflect the new assumptions, plan
sponsors are permitted within 1 year of the date of enactment
to amend the plan to reverse retroactively such
amendment.71
---------------------------------------------------------------------------
\71\ The Committee intends that plan sponsors will have flexibility
in adopting the actuarial assumptions required under GATT. For example,
plan sponsors are permitted to apply the actuarial assumptions that
must be used for 415 purposes retroactively as provided under GATT.
Alternatively, plan sponsors can apply such actuarial assumptions
prospectively by either (1) providing a benefit equal to (i) the
accrued benefit as of the effective date of the adoption of the new
actuarial assumptions determined after applying section 415 using the
old actuarial assumptions, plus (ii) the benefit accrued after such
effective date determined after applying section 415 using the new
actuarial assumptions; or (2) providing a benefit equal to the greater
of (i) the accrued benefit as the effective date of the adoption of the
new actuarial assumptions determined after applying section 415 using
the old actuarial assumptions, or (ii) the entire accrued benefit
determined after applying section 415 using the new actuarial
assumptions.
---------------------------------------------------------------------------
The bill also repeals the GATT provision which requires
that if the benefit is payable before age 62 in a form subject
to the requirements of section 417(e)(3) (e.g., lump sum), then
the interest rate to be used to reduce the dollar limit on
benefits under section 415 cannot be less than the greater of
the rate on 30-year Treasury securities or the rate specified
in the plan. Consequently, regardless of the form of benefit,
the interest rate to be used cannot be less than the greater of
5 percent or the rate specified in the plan.
Effective date
The provision is effective as if included in GATT.
10. Multiple salary reduction agreements permitted under section 403(b)
(sec. 1450(a) of the bill and sec. 403(b) of the Code)
Present law
Under Treasury regulations, a participant in a tax-
sheltered annuity plan (sec. 403(b)) is not permitted to enter
into more than one salary reduction agreement in any taxable
year. These regulations further provide that a salary reduction
agreement is effective only with respect to amounts ``earned''
after the agreement becomes effective, and that a salary
reduction agreement must be irrevocable with respect to amounts
earned while the agreement is in effect.
These restrictions do not apply to other elective deferral
arrangements such as a qualified cash or deferred arrangement
(sec. 401(k)). Under present law, employee elective
contributions to a qualified cash or deferred arrangement are
not treated as distributed or made available merely because
such arrangement permits the employee to elect between making
the contribution or receiving the amount in cash (sec.
402(e)(3)). Under Treasury regulations, participants in a
qualified cash or deferred arrangement may enter into more than
one salary reduction agreement in a taxable year, such an
agreement is effective with respect to compensation currently
available to the participant after the agreement becomes
effective even though previously ``earned,'' and the agreement
may be revoked by the participant.
Reasons for change
It is appropriate to conform the treatment of salary
reduction agreements under section 403(b) to the treatment of
qualified cash or deferred arrangements.
Explanation of provision
The bill clarifies that amounts are not treated as
distributed or made available merely because a participant
enters into a salary reduction agreement with respect to a tax-
sheltered annuity plan. In addition, for participants in a tax-
sheltered annuity plan, the frequency that a salary reduction
agreement may be entered into, the compensation to which such
agreement applies, and the ability to revoke such agreement
shall be determined under the rules applicable to qualified
cash or deferred arrangements.
Effective date
The provision is effective for taxable years beginning
after December 31, 1995.
11. Treatment of Indian tribal governments under section 403(b) (sec.
1450(b) of the bill and sec. 403(b) of the Code)
Present law
Under present law, certain tax-exempt employers and certain
State and local government educational organizations are
permitted to maintain tax-sheltered annuity plans (sec.
403(b)). Indian tribal governments are treated as States for
this purpose, so certain educational organizations associated
with a tribal government are eligible to maintain tax-sheltered
annuity plans.
Reasons for change
The Committee believes that there is some uncertainty under
present law about the ability of Indian tribal governments to
establish 403(b) plans for all tribal government employees.
Following enactment of the Indian Tribal Government Tax Status
Act of 1982, several insurance companies and financial advisors
marketed 403(b) plans to tribes representing that the plans
could be adopted on a tribal-wide basis to cover all employees.
As a result, many tribes adopted 403(b) plans for their
employees that are not in compliance with the law. Given this
uncertainty, the Committee believes it is appropriate to
requalify such plans. In addition, the Committee believes it is
appropriate to permit Indian tribal governments to maintain
tax-sheltered annuity plans in the future.
Explanation of provision
The bill provides that any section 403(b) annuity contract
purchased in a plan year beginning before January 1, 1997, by
an Indian tribal government will be treated as purchased by an
entity permitted to maintain a tax-sheltered annuity plan. The
bill also provides that such contracts may be rolled over into
a section 401(k) plan maintained by the Indian tribal
government.
In addition, beginning January 1, 1997, Indian tribal
governments will be permitted to maintain tax-sheltered annuity
plans.
Effective date
The provision generally is effective on the date of
enactment, except that the provision permitting Indian tribal
governments to maintain tax-sheltered annuity plans is
effective for taxable years beginning after December 31, 1996.
12. Application of elective deferral limit to section 403(b) contracts
(sec. 1450(c) of the bill and sec. 403(b) of the Code)
Present law
A tax-sheltered annuity plan must provide that elective
deferrals made under the plan on behalf of an employee may not
exceed the annual limit on elective deferrals ($9,500 for
1996). Plans that do not comply with this requirement may lose
their tax-favored status.
Reasons for change
The Committee does not believe that employees participating
in a tax-sheltered annuity plan should be negatively affected
if other employees violate the annual limit on elective
deferrals with respect to their individual tax-sheltered
annuity contracts (or custodial accounts).
Explanation of provision
Under the bill, each tax-sheltered annuity contract, not
the tax-sheltered annuity plan, must provide that elective
deferrals made under the contract may not exceed the annual
limit on elective deferrals. The Committee intends that the
contract terms be given effect in order for this requirement to
be satisfied. Thus, for example, if the annuity contract issuer
takes no steps to ensure that deferrals under the contract do
not exceed the applicable limit, then the contract will not be
treated as satisfying section 403(b). The provision is intended
to make clear that the exclusion of elective deferrals from
gross income by employees who have not exceeded the annual
limit on elective deferrals will not be affected to the extent
other employees exceed the annual limit. However, if the
occurrence of an uncorrected elective deferral made by an
employee is attributable to reasonable error, the contract will
not fail to satisfy section 403(b), and only the portion of the
elective deferral in excess of the annual limit would be
includible in gross income.
Effective date
The provision is effective for years beginning after
December 31, 1995, except that an annuity contract is not
required to meet any change in any requirement by reason of the
provision before the 90th day after the date of enactment. The
Committee intends no inference as to whether the exclusion of
elective deferrals from gross income by employees who have not
exceeded the annual limit on elective deferrals is affected to
the extent other employees exceed the annual limit prior to the
effective date of this provision.
13. Waiver of minimum waiting period for qualified plan distributions
(sec. 1451 of the bill and sec. 417(c) of the Code)
Present law
Under present law, in the case of a qualified joint and
survivor annuity (``QJSA''), a written explanation of the form
of benefit must generally be provided to participants no less
than 30 days and no more than 90 days before the annuity
starting date. Even if a participant has elected to waive the
qualified joint and survivor annuity and the spouse has
consented to the distribution, the distribution from the plan
cannot be made until 30 days after the written explanation was
provided to the participant.72
---------------------------------------------------------------------------
\72\ On September 15,1995, Treasury issued temporary regulations
(T.D. 8620) which provide that a plan may permit a participant to elect
(with any applicable spousal consent) a distribution with an annuity
starting date before 30 days have elapsed since the explanation was
provided, as long as the distribution commences more than seven days
after the explanation was provided. Consequently, even if the
participant (and spouse, if applicable) has elected to waive the
minimum waiting period for receiving a qualified plan distribution, the
distribution from the plan cannot be made until seven days have elapsed
since the explanation was provided to the participant.
---------------------------------------------------------------------------
Reasons for change
The Committee believes that the notice period applicable to
a QJSA should not prevent the payment of benefits if such
period is waived by the plan participant and, if applicable,
the participant's spouse.
Explanation of provision
The bill provides that the minimum period between the date
the explanation of the qualified joint and survivor annuity is
provided and the annuity starting date does not apply if it is
waived by the participant and, if applicable, the participant's
spouse. For example, if the participant has not elected to
waive the qualified joint and survivor annuity, only the
participant needs to waive the minimum waiting period.
Effective date
The provision is effective with respect to plan years
beginning after December 31, 1996.
14. Repeal of combined plan limit (sec. 1452 of the bill and sec.
415(e) of the Code)
Present law
Combined plan limit
Present law provides limits on contributions and benefits
under qualified retirement plans based on the type of plan
(i.e., based on whether the plan is a defined contribution plan
or a defined benefit pension plan). An overall limit applies if
an individual is a participant in both a defined benefit
pension plan and a defined contribution plan (called the
combined plan limit).
Excess distribution tax
Present law imposes a 15-percent excise tax on excess
distributions from qualified retirement plans, tax-sheltered
annuities, and IRAs. Excess distributions are generally the
aggregate amount of retirement distributions from such plans
during any calendar year in excess of $150,000 (or $750,000 in
the case of a lump-sum distribution). An additional 15-percent
estate tax is also imposed on an individual's excess retirement
accumulation.
Reasons for change
One of the most significant sources of complexity relating
to qualified pension plans is the calculation of the combined
plan limit under section 415(e). Many new employers do not
establish defined benefit pension plans, which provide
employees with the greatest retirement income security. One of
the reasons that defined benefit pension plans are not being
established is because of the complex rules governing these
plan and the significant administrative costs entailed in
maintaining them. Section 415(e) is just one of the deterrents
to the establishment and maintenance of qualified defined
benefit pension plans. Thus, the Committee does not believe
that the administrative costs associated with section 415(e)
and the complexity of the calculations required are justified.
Further, the Committee believes that section 415(e) may have
the effect of discouraging employers from providing adequate
retirement benefits to their employees.
The excise tax on excess distributions has a similar
purpose to the combined plan limit, although it applies to all
of an individual's retirement distributions, not just those
from a single employer. The Committee believes that both the
combined plan limit and the excise tax on excess distributions
should not apply at the same time.
Explanation of provision
Combined plan limit
The bill repeals the combined plan limit.
Excess distribution tax
Until the repeal of the combined plan limit is effective,
the bill suspends the excise tax on excess distributions. The
additional estate tax on excess accumulations continues to
apply.
Effective date
The provision repealing the combined plan limit is
effective with respect to limitation years beginning after
December 31, 1999. The provision relating to the excise tax on
excess distributions is effective with respect to distributions
received in 1997, 1998, and 1999.
15. Tax on prohibited transactions (sec. 1453 of the bill and sec. 4975
of the Code)
Present law
Present law prohibits 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. The initial
level tax is equal to 5 percent of the amount involved with
respect to the transaction. 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 Committee believes it is appropriate to increase the
initial level prohibited transaction tax to discourage
disqualified persons from engaging in such transactions.
Explanation of provision
The bill increases the initial-level prohibited transaction
tax from 5 percent to 10 percent.
Effective date
The provision is effective with respect to prohibited
transactions occurring after the date of enactment.
16. Treatment of leased employees (sec. 1454 of the bill and sec.
414(n) of the Code)
Present Law
An individual (a leased employee) who performs services for
another person (the recipient) may be required to be treated as
the recipient's employee for various employee benefit
provisions, if the services are performed pursuant to an
agreement between the recipient and any other person (the
leasing organization) who is otherwise treated as the
individual's employer (sec. 414(n)). The individual is to be
treated as the recipient's employee only if the individual has
performed services for the recipient on a substantially full-
time basis for a year, and the services are of a type
historically performed by employees in the recipient's business
field.
An individual who otherwise would be treated as a
recipient's leased employee will not be treated as such an
employee if the individual participates in a safe harbor plan
maintained by the leasing organization meeting certain
requirements. Each leased employee is to be treated as an
employee of the recipient, regardless of the existence of a
safe harbor plan, if more than 20 percent of an employer's
nonhighly compensated workforce are leased.
Reasons for change
The leased employee rules are complex and have unexpected
and sometimes indefensible results, especially as interpreted
under regulations proposed by the Secretary. For example, under
the ``historically performed'' standard, the employees and
partners of a law firm may be the leased employees of a client
of the firm if they work a sufficient number of hours for the
client and if it is not unusual for employers in that business
field to have in-house counsel. While arguably meeting the
present-law leased employee definition, it is believed that
situations such as this are outside the intended scope of the
rules.
Explanation of provision
Under the bill, the present-law ``historically performed''
test is replaced with a new test under which an individual is
not considered a leased employee unless the individual's
services are performed under primary direction or control by
the service recipient. As under present law, the determination
of whether someone is a leased employee is made after
determining whether the individual is a common-law employee of
the recipient. Thus, an individual who is not a common-law
employee of the service recipient could nevertheless be a
leased employee of the service recipient. Similarly, the fact
that a person is or is not found to perform services under
primary direction or control of the recipient for purposes of
the employee leasing rules is not determinative of whether the
person is or is not a common-law employee of the recipient.
Whether services are performed by an individual under
primary direction or control by the service recipient depends
on the facts and circumstances. In general, primary direction
and control means that the service recipient exercises the
majority of direction and control over the individual. Factors
that are relevant in determining whether primary direction or
control exists include whether the individual is required to
comply with instructions of the service recipient about when,
where, and how he or she is to perform the services, whether
the services must be performed by a particular person, whether
the individual is subject to the supervision of the service
recipient, and whether the individual must perform services in
the order or sequence set by the service recipient. Factors
that generally are not relevant in determining whether such
direction or control exists include whether the service
recipient has the right to hire or fire the individual and
whether the individual works for others.
For example, an individual who works under the direct
supervision of the service recipient would be considered to be
subject to primary direction or control of the service
recipient even if another company hired and trained the
individual, had the ultimate (but unexercised) legal right to
control the individual, paid his wages, withheld his employment
and income taxes, and had the exclusive right to fire him.
Thus, for example, temporary secretaries, receptionists, word
processing personnel and similar office personnel who are
subject to the day-to-day control of the employer in
essentially the same manner as a common law employee are
treated as leased employees if the period of service threshold
is reached.
On the other hand, an individual who is a common-law
employee of Company A who performs services for Company B on
the business premises of Company B under the supervision of
Company A would generally not be considered to be under primary
direction or control of Company B. The supervision by Company A
must be more than nominal, however, and not merely a mechanism
to avoid the literal language of the direction or control test.
An example of the situation in the preceding paragraph
might be a work crew that comes into a factory to install,
repair, maintain, or modify equipment or machinery at the
factory. The work crew includes a supervisor who is an employee
of the equipment (or equipment repair) company and who has the
authority to direct and control the crew, and who actually does
exercise such direction and control. In this situation, the
supervisor and his or her crew are required to comply with the
safety and environmental precautions of the manufacturer, and
the supervisor is in frequent communication with the employees
of the manufacturer. As another example, certain professionals
(e.g., attorneys, accountants, actuaries, doctors, computer
programmers, systems analysts, and engineers) who regularly
make use of their own judgement and discretion on matters of
importance in the performance of their services and are guided
by professional, legal, or industry standards, are not leased
employees even though the common law employer does not closely
supervise the professional on a continuing basis, and the
service recipient requires the services to be performed on site
and according to certain stages, techniques, and timetables. In
addition to the example above, outside professionals who
maintain their own businesses (e.g., attorneys, accountants,
actuaries, doctors, computer programmers, systems analysts, and
engineers) generally would not be considered to be subject to
such primary direction or control.
Under the direction or control test, clerical and similar
support staff (e.g., secretaries and nurses in a doctor's
office) generally would be considered to be subject to primary
direction or control of the service recipient and would be
leased employees provided the other requirements of section
414(n) are met.
In many cases, the ``historically performed'' test is
overly broad, and results in the unintended treatment of
individuals as leased employees. One of the principal purposes
for changing the leased employee rules is to relieve the
unnecessary hardship and uncertainty created for employers in
these circumstances. However, it is not intended that the
direction or control test enable employers to engage in abusive
practices. Thus, it is intended that the Secretary interpret
and apply the leased employee rules in a manner so as to
prevent abuses. This ability to prevent abuses under the
leasing rules is in addition to the present-law authority of
the Secretary under section 414(o). For example, one
potentially abusive situation exists where the benefit
arrangements of the service recipient overwhelmingly favor its
highly compensated employees, the employer has no or very few
nonhighly compensated common-law employees, yet the employer
makes substantial use of the services of nonhighly compensated
individuals who are not its common-law employees.
Effective date
The provision is effective for years beginning after
December 31, 1996, except that the bill would not apply to
relationships that have been previously determined by an IRS
ruling not to involve leased employees. In applying the leased
employee rules to years beginning before the effective date, it
is intended that the Secretary use a reasonable interpretation
of the statute to apply the leasing rules to prevent abuse.
17. Uniform penalty provisions to apply to certain pension reporting
requirements (sec. 1455 of the bill and secs. 6652(i) and
6724(d) of the Code)
Present law
Any person who fails to file an information report with the
IRS on or before the prescribed filing date is subject to
penalties for each failure. A different, flat-amount penalty
applies for each failure to provide information reports to the
IRS or statements to payees relating to pension payments.
Reasons for change
Conforming the information-reporting penalties that apply
with respect to pension payments to the general information-
reporting penalty structure would simplify the overall penalty
structure through uniformity and provide more appropriate
information-reporting penalties with respect to pension
payments.
Explanation of provision
The bill incorporates into the general penalty structure
the penalties for failure to provide information reports
relating to pension payments to the IRS and to recipients.
Effective date
The provision is effective with respect to returns and
statements the due date for which is after December 31, 1996.
18. Retirement benefits of ministers not subject to tax on net earnings
from self-employment (sec. 1456 of the bill and sec. 1402(a) of
the Code)
Present law
Under present law, certain benefits provided to ministers
after they retire are subject to self-employment tax.
Reasons for change
The Committee believes that, like retirement benefits paid
from qualified plans sponsored by private employers, retirement
benefits paid from church plans to ministers should not be
subject to self-employment tax. The Committee believes this
treatment should also apply to the rental value or allowance of
any parsonage (including utilities) provided after retirement.
Explanation of provision
The bill provides that retirement benefits received from a
church plan after a minister retires, and the rental value or
allowance of a parsonage (including utilities) furnished to a
minister after retirement, are not subject to self-employment
taxes.
Effective date
The provision is effective for years beginning before, on,
or after December 31, 1994.
19. Treasury to provide model forms for spousal consent and qualified
domestic relations orders (sec. 1457 of the bill and secs.
414(p) and 417(a)(2))
Present law
Present law contains a number of rules designed to provide
income to the surviving spouse of a deceased employee. Under
these spousal protection rules, defined benefit pension plans
and money purchase pension plans are required to provide that
vested retirement benefits with a present value in excess of
$3,500 are payable in the form of a qualified joint and
survivor annuity (``QJSA'') or, in the case of a participant
who dies before the annuity starting date, a qualified
preretirement survivor annuity (``QPSA'').
Benefits from a plan subject to the survivor benefit rules
may be paid in a form other than a QJSA or QPSA if the
participant waives the QJSA or QPSA (or both) and the
applicable notice, election, and spousal consent requirements
are satisfied.
Present law contains detailed rules regarding the waiver of
the QJSA or QPSA forms of benefit and the spousal consent
requirements. Generally an election to waive the QJSA or QPSA
forms of benefit must be in writing, and, if the participant is
married on the annuity starting date, must be accompanied by a
written spousal consent acknowledging the effect of such
consent and witnessed by a plan representative or notary
public. Both the participant's waiver and the spousal consent
must state the specific nonspouse beneficiary who will receive
the benefit, and, in the case of a QJSA waiver, must specify
the particular optional form of benefit that will be paid. The
waiver will not be valid unless the participant has previously
received a written explanation of (1) the terms and conditions
of the QJSA or QPSA forms of benefit, (2) the participant's
right to make, and the effect of, an election to waive these
forms of benefits, (3) the rights of the participant's spouse,
and (4) the right to make, and the effect of, a revocation of
an election to waive these forms of benefits.
Also, under present law, benefits under a qualified
retirement plan are subject to prohibitions against assignment
or alienation of benefits. An exception to this rule generally
applies in the case of plan benefits paid to a former spouse
pursuant to a qualified domestic relations order (``QDRO'').
Reasons for change
The Committee recognizes that the rules relating to spousal
consents and QDROs serve important purposes in protecting
spousal rights to retirement plan benefits. However, the
Committee also recognizes that these rules are extremely
complicated. Consequently, the Committee believes it is
appropriate to direct the Secretary to develop model forms for
spousal consent and QDROs so that spouses can more easily
comply with these important rules.
Explanation of provision
Model spousal consent form
The Secretary is required to develop a model spousal
consent form, no later than January 1, 1997, waiving the QJSA
and QPSA forms of benefit. Such form must be written in a
manner calculated to be understood by the average person, and
must disclose in plain form whether the waiver is irrevocable
and that it may be revoked by a QDRO.
Model QDRO
The Secretary is required to develop a model QDRO, no later
than January 1, 1997, which satisfies the requirements of a
QDRO under present law, and the provisions of which focus
attention on the need to consider the treatment of any lump sum
payment, QJSA, or QPSA.
Effective date
The provision is effective on the date of enactment.
20. Treatment of length of service awards for certain volunteers under
section 457 (sec. 1458 of the bill and sec. 457 of the Code)
Present law
Under section 457 of the Code, compensation deferred under
an eligible deferred compensation plan of a tax-exempt or
governmental employer that meets certain requirements is not
includible in gross income until paid or made available. One of
the requirements for a section 457 plan is that the maximum
annual amount that can be deferred is the lesser of $7,500 or
33\1/3\ percent of the individual's taxable compensation. This
maximum limit is coordinated with the annual limit on elective
deferrals under qualified cash or deferred arrangements (sec.
401(k) plans) and under tax-sheltered annuities (sec. 403(b)
plans), which is $9,500 for 1996. Under this rule, elective
deferrals to section 401(k) and 403(b) plans are treated as
amounts deferred under a section 457 plan (and vice versa).
Thus, for example, if an individual who is a participant in
both a section 403(b) plan and a section 457 plan elects to
contribute $2,000 to the 403(b) plan, then the maximum amount
that can be deferred in that year under the section 457 plan is
$5,500.
Another requirement under section 457 is that (until the
compensation is made available to the participant), all amounts
of compensation deferred under the plan, all property and
rights purchased with such amounts, and all income attributable
to such amounts, property, or rights must remain solely the
property and rights of the employer, subject only to the claims
of the employer's general creditors.
Amounts deferred under plans of tax-exempt and governmental
employers that do not meet the requirements of section 457
(other than amounts deferred under tax-qualified retirement
plans, section 403(b) annuities and certain other plans) are
includible in gross income in the first year in which there is
no substantial risk of forfeiture of such amounts.
Reasons for change
The Committee believes it is both appropriate and important
to allow for the provision of length of service awards to
volunteer firefighters, and other emergency medical (including
ambulance services) personnel.
Explanation of provision
Under the bill, the requirements of section 457 do not
apply to any plan paying solely length of service awards to
bona fide volunteers (or their beneficiaries) on account of
fire fighting and prevention, emergency medical, and ambulance
services performed by such volunteers. An individual is
considered a ``bona fide volunteer'' if the only compensation
received by such individual for performing such services is
reimbursement (or a reasonable allowance) for expenses incurred
in the performance of such services, or reasonable benefits
(including length of service awards) and nominal fees for such
services customarily paid by tax-exempt or governmental
employers in connection with the performance of such services
by volunteers. Under the bill, a length of service award plan
will not qualify for this special treatment under section 457
if the aggregate amount of length of service awards accruing
with respect to any year of service for any bona fide volunteer
exceeds $3,000.
In addition, any amounts exempt from the requirements of
section 457 under the bill are not considered wages for
purposes of the Federal Insurance Contribution Act (``FICA'')
taxes.
Effective date
The provision applies to accruals of length of service
awards after December 31, 1996.
21. Date for adoption of plan amendments (sec. 1459 of the bill)
Present 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.
Reasons for change
Plan sponsors should have adequate time to amend plan
documents.
Explanation of provision
The bill generally provides that any amendments to a plan
or annuity contract required by the pension simplification
amendments would not be required to be made before the first
plan year beginning on or after January 1, 1997. The date for
amendments is extended to the first plan year beginning on or
after January 1, 1999, in the case of a governmental plan.
Effective date
The provision is effective on the date of enactment.
Other Provisions
A. Miscellaneous Revenue Provisions
1. Exempt Alaska from diesel dyeing requirement while Alaska is exempt
from similar Clean Air Act dyeing requirement (sec. 1801 of the
bill and sec. 4081 of the Code)
Present law
An excise tax totaling 24.3 cents per gallon is imposed on
diesel fuel. In the case of fuel used in highway
transportation, 20 cents per gallon is dedicated to the Highway
Trust Fund. The remaining portion of this tax is imposed on
transportation generally and is retained in the General Fund.
The diesel fuel tax is imposed on removal of the fuel from
a pipeline or barge terminal facility (i.e., at the ``terminal
rack''). Present law provides that tax is imposed on all diesel
fuel removed from terminal facilities unless the fuel is
destined for a nontaxable use and is indelibly dyed pursuant to
Treasury Department regulations.
In general, the diesel fuel tax does not apply to non-
transportation uses of the fuel. Off-highway business uses are
included within this non-transportation use exemption. This
exemption includes use on a farm for farming purposes and as
fuel powering off-highway equipment (e.g., oil drilling
equipment). Use as heating oil also is exempt. (Most fuel
commonly referred to as heating oil is diesel fuel.) The tax
also does not apply to fuel used by State and local
governments, to exported fuels, and to fuel used in commercial
shipping. Fuel used by intercity buses and trains is partially
exempt from the diesel fuel tax.
A similar dyeing regime exists for diesel fuel under the
Clean Air Act. That Act prohibits the use on highways of diesel
fuel with a sulphur content exceeding prescribed levels. This
``high sulphur'' diesel fuel is required to be dyed by the EPA.
The State of Alaska generally was exempted from the Clean Air
Act, but not the excise tax, dyeing regime for three years
(until October 1, 1996) (urban areas) or permanently (remote
areas).
Reasons for change
Most diesel fuel sold in Alaska is sold for nontaxable,
off-highway uses. Due to this fact and the Clean Air Act
provision exempting the State from that Act's dyeing
requirement, the Committee believes that adequate tax
compliance in Alaska can be achieved without dyeing diesel fuel
destined for nontaxable uses.
Explanation of provision
Diesel fuel sold in the State of Alaska will be exempt from
the diesel dyeing requirement during the period when that State
is exempt from the Clean Air Act dyeing requirements. Thus,
subject to a certification procedure to be developed by the
Treasury Department, undyed diesel fuel which is destined for a
nontaxable use may be removed from terminals without payment of
tax through September 30, 1996 (urban areas, unless extended by
the Environmental Protection Agency) or permanently (remote
areas).
Effective date
The provision is effective beginning with the first
calendar quarter after the date of enactment.
2. Application of common paymaster rules to certain agency accounts at
State universities (sec. 1802 of the bill and sec. 3121 of the
Code)
Present law
In general, the OASDI portion of the Federal Insurance
Contributions Act (``FICA'') taxes are payable with respect to
employee remuneration which does not exceed the contribution
base specified in the law. If an employee works for more than
one employer during the year, these taxes are payable for each
employer up to the contribution base.
Section 3121(s) of the Internal Revenue Code provides an
exception known as the ``common paymaster'' rule. If two or
more related corporations concurrently employ the same
individual and compensate that individual through a common
paymaster which is one of the corporations, then the common
paymaster is considered to be the only employer regardless of
the fact that the individual performed services for other
related corporations. Thus, the remuneration is subject to
taxation only up to the contribution base for the total
remuneration.
Section 125 of the Social Security Amendments of 1983
provides that a State university that employs health care
professionals as faculty members at a medical school and a tax-
exempt faculty practice plan that employs faculty members of
the medical school are deemed to be related corporations for
purposes of the common paymaster rule, provided that 30 percent
or more of the employees of the plan are concurrently employed
by the medical school. Remuneration that is disbursed by the
faculty practice plan to an individual employed by both the
plan and the university which, when added to remuneration
actually disbursed by the university, exceeds the contribution
base, will be deemed to have been actually disbursed by the
university as a common paymaster and not to have been disbursed
by the faculty practice plan. Current Internal Revenue Service
interpretation of the statute does not extend the ``common
paymaster'' exception to apply to circumstances where such
compensation is made through a university agency account, and
not directly by a medical school faculty practice plan.
Reasons for change
The Committee believes that the application of the common
paymaster rule is appropriate under the foregoing circumstances
where such compensation is made through a university agency
account.
Explanation of provision
The bill establishes a common paymaster rule in cases where
a: (1) State or state university provides remuneration pursuant
to a single contract of employment to certain health care
professionals as members of its medical school faculty and, (2)
an agency account at such institution also provides
remuneration to such health care professionals. The agency
account must receive funds for the remuneration from a faculty
practice plan described in section 501(c)(3) of the Code. The
payments may only be distributed by the agency account to
faculty members who render patient care at the medical school.
The faculty members receiving payments must comprise at least
30 percent of the membership of the faculty practice plan.
Effective date
The provision is effective for remuneration paid after
December 31, 1996. It is intended that, with respect to years
before the effective date, the Secretary apply present law in a
manner consistent with the proposal.
3. Modifications to excise tax on ozone-depleting chemical
a. Exempt imported recycled halons from the excise tax on
ozone-depleting chemicals (sec. 1803 of the bill
and sec. 4682 of the Code)
Present 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 $5.80 per pound in 1996 and
will 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.
Reasons for change
The Committee recognizes that, under the Clean Air Act as
amended and under the terms of the Montreal Protocol, domestic
production of halons generally ceased after 1993. However,
these chemicals are valuable as fire suppressants, particularly
in those environments where human life may be endangered. The
international restriction on production of halons has caused
some individuals who had used halons in certain fire
suppression systems to withdraw the halons from those systems
and make them available for more highly valued uses. The
Committee believes that the substantial tax on imported halons
impedes the flow of these recovered and recycled halons to
their most highly valued uses. The Committee further observes
that, because production of new halons is banned domestically,
permitting imported recycled halons to enter the domestic
market with a rate of tax less than that of new production does
not place at a disadvantage domestic producers or dealers in
halons. Therefore, the Committee believes it is appropriate to
provide comparable tax treatment to imported recycled halons to
that accorded domestic recycled halons.
Explanation of provision
The bill extends the exemption from tax for domestically
recovered and recycled ozone-depleting chemicals to imported
recycled halons. The exemption for imported recycled halons
applies only to such chemicals imported from countries that are
signatories to the Montreal Protocol on Substances that Deplete
the Ozone Layer.
The Committee recognizes that it is generally impossible to
distinguish recycled halons from newly manufactured halons. The
Committee intends that the Secretary of the Treasury, after
consultation with the Administrator of the Environmental
Protection Agency, establish a certification procedure drawing
upon the international regulatory framework for trade in such
chemicals provided under the Montreal Protocol and its
subsequent amendments, as ratified by the United States Senate.
Effective date
The provision is effective for chemicals imported after
December 31, 1996.
b. Exempt chemicals used in metered-dose inhalers from the
excise tax on ozone-depleting chemicals (sec. 1803
of the bill and sec. 4682 of the Code)
Present 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 $5.80 per pound in 1996 and
will increase by 45 cents per pound per year thereafter.
A reduced rate of tax of $1.67 per pound applies to
chemicals used as propellants in metered-dose inhalers (sec.
4682(g)(4)).
Reasons for change
The Committee recognizes that under the Clean Air Act as
amended and under the terms of the Montreal Protocol, the use
of ozone-depleting chemicals as a propellant in metered-dose
inhalers has been designated as an essential use, permitting
use of ozone- depleting chemicals as propellants in metered-
dose inhalers despite the general prohibition on such
chemicals. In light of this, the Committee believes it is
appropriate to provide a corresponding exemption from tax for
these important medical uses.
Explanation of provision
The bill exempts chemicals used as propellants in metered-
dose inhalers from the excise tax on ozone-depleting chemicals.
Effective date
The provision is effective for chemicals sold or used seven
days after the date of enactment.
4. Tax-exempt bonds for the sale of Alaska Power Administration
facility (sec. 1804 of the bill and secs. 142 and 147 of the
Code)
Present law
Interest on State and local government bonds generally is
excluded from income unless the bonds are issued to provide
financing for private parties. Present law includes several
exceptions, however, that allow tax-exempt bonds to be used to
provide financing for certain specifically identified private
purposes (``private activity bonds''), including financing for
certain facilities for the furnishing of electricity and gas.
State and local government bonds issued to acquire existing
output property (other than water facilities) are treated as
private activity bonds even if a State or local government owns
or operates the property. Similarly, bonds issued to acquire
existing property, the output from which will be sold to a
private party under a take or pay contract are private activity
bonds.
Most private activity bonds are subject to annual State
volume limits of the greater of $50 per resident of the State
or $150 million. Additionally, persons acquiring property
financed with most private activity bonds must satisfy a
rehabilitation requirement as a condition of the financing.
Reasons for change
Limited tax-exempt financing is an integral component of
proposed legislation for the sale of certain facilities by the
Alaska Power Administration. That sale legislation has recently
been enacted by the Congress. The Committee determined that a
limited exception to the tax-exempt bond rules is appropriate
to facilitate completion of this unique transaction.
Explanation of provision
The provision provides an exception from the general
rehabilitation requirement for private activity bonds used to
acquire existing property for certain bonds to finance the
acquisition of the Snettisham hydroelectric project from the
Alaska Power Administration pursuant to legislation that has
been enacted authorizing that transaction. Bonds for this
acquisition will be subject to the State of Alaska's private
activity bond volume limit.
Effective date
The provision is effective for bonds issued after the date
of enactment.
5. Allow bank common trust funds to transfer assets to regulated
investment companies without taxation (sec. 1805 of the bill
and sec. 584 of the Code)
Present law
Common trust funds
A common trust fund is a fund maintained by a bank
exclusively for the collective investment and reinvestment of
monies contributed by the bank in its capacity as a trustee,
executor, administrator, guardian, or custodian of certain
accounts and in conformity with rules and regulations of the
Board of Governors of the Federal Reserve System or the
Comptroller of the Currency pertaining to the collective
investment of trust funds by national banks (sec. 584(a)).
The common trust fund is not subject to tax and is not
treated as a corporation (sec. 584(b)). Each participant in a
common trust fund includes his proportional share of common
trust fund income, whether or not the income is distributed or
distributable (sec. 584(c)).
No gain or loss is realized by the fund upon admission or
withdrawal of a participant. Participants generally treat their
admission to the fund as the purchase of an interest.
Withdrawals from the fund generally are treated as the sale of
an interest by the participant (sec. 584(e)).
Regulated investment companies (RICs)
A RIC also is treated as a conduit for Federal income tax
purposes. Conduit treatment is accorded by allowing the RIC a
deduction for dividend distributions to its shareholders.
Present law is unclear as to the tax consequences when a common
trust fund transfers its assets to one or more RICs.
Reasons for change
The Committee understands that administrative costs of
managing pools of assets can be reduced for many banks if the
bank utilizes the expertise of professional investment managers
employed at mutual funds rather than attempting to duplicate
the same investment management services within the bank. The
Committee further recognizes that generally both common trust
funds and mutual funds seek broad diversification of the assets
contributed by the investors in the common trust fund or the
mutual fund. Because both the common trust fund and the mutual
fund are conduit entities for Federal income tax purposes, the
Committee believes that it would be inappropriate to impose a
tax when the common trust fund transfers substantially all of
its assets to one or more RICs, because only the form of the
investment pool has been changed.
Explanation of provision
In general, the bill permits a common trust fund to
transfer substantially all of its assets to one or more RICs
without gain or loss being recognized by the fund or its
participants. The fund must transfer its assets to the RICs
solely in exchange for shares of the RICs, and the fund must
then distribute the RIC shares to the fund's participants in
exchange for the participant's interests in the fund.
The basis of any asset received by a RIC will be the basis
of the asset in the hands of the fund prior to transfer
(increased by the amount of gain recognized by reason of the
rule regarding the assumption of liabilities). In addition, the
basis of any RIC shares (``converted shares'') that are
received by a fund participant will be an allocable portion of
the participant's basis in the interests exchanged. If stock in
more than one RIC is received in exchange for assets of a
common trust fund, the basis of the shares in each RIC shall be
determined by allocating the basis of common fund assets used
in the exchange among the shares of each RIC received in the
exchange on the basis of the respective fair market values of
the RICs. For example, assume a common trust fund with basis of
$100 and market value of $1,000 transfers its assets to two
RICs, receiving $600 worth of shares in the first RIC and $400
worth of shares in the second RIC. The basis of first RIC
shares will be $600 multiplied by $100 divided by $1,000, or
$60. The basis of the second RIC shares will be $40.
The tax-free transfer is not available to a common trust
fund with assets that are not diversified under the
requirements of section 368(a)(2)(F)(ii), except that the
diversification test is modified so that Government securities
are not to be included as securities of an issuer and are to be
included in determining total assets for purposes of the 25-
and 50-percent tests.
No inference is intended as to the tax consequences under
law in effect prior to the effective date of the provision when
a common trust fund transfers its assets to one or more RICs.
Effective date
The provision is effective for transfers after December 31,
1995.
6. Treatment of qualified State tuition programs (sec. 1806 of the bill
and new sec. 529 of the Code)
Present law
In Michigan v. United States, 40 F.3d 817 (6th Cir. 1994),
the Sixth Circuit held that the Michigan Education Trust, an
entity created by the State of Michigan to operate a prepaid
tuition payment program, is an integral part of the State, and,
thus, the investment income realized by the Trust is not
currently subject to Federal income tax. The Trust was
established to receive advance payments of college tuition,
invest the money, and ultimately make disbursements under a
program that allows beneficiaries to attend any of the State's
public colleges or universities without further tuition costs
for a year or more (depending on the terms of the contract).
Section 115 of the Code provides that gross income does not
include income derived from any public utility or the exercise
of any essential governmental function and accruing to a State
or any political subdivision thereof, or the District of
Columbia.
Section 2501 imposes a Federal gift tax on certain
transfers of property by gift. Section 2503(e) specifically
excludes from gifts subject to tax under section 2501 any
``qualified transfer,'' which includes any amount paid on
behalf of an individual as tuition to an educational
institution (as described in sec. 170(b)(1)(A)(ii)) for the
education or training of such individual.
On June 11, 1996, the Treasury Department issued final
regulations under the original issue discount (``OID'')
provisions of the Code (secs. 163(e) and 1271 through 1275),
including regulations relating to debt instruments that provide
for contingent payments (see TD 8674). These regulations
specifically provide that they do not apply to contracts issued
pursuant to State-sponsored prepaid tuition programs, whether
or not the contracts are debt instruments. In addition, the IRS
announced in Rev. Proc. 96-34 that it will not issue advance
rulings or determination letters regarding State-sponsored
prepaid tuition plans because issues that arise under such
plans are being studied.
Reasons for change
The Committee believes that it is appropriate to clarify
the tax treatment of State-sponsored prepaid tuition and
educational savings programs in order to encourage persons to
save to meet post-secondary educational expenses.
Explanation of provision
The bill provides tax-exempt status to ``qualified State
tuition programs,'' meaning 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 sole purpose of meeting qualified
higher education expenses of the designated beneficiary of the
account. ``Qualified higher education expenses'' are defined as
tuition, fees, books, and equipment required for the enrollment
or attendance at a college or university (or certain vocational
schools). Although generally exempt from Federal income tax, a
qualified State tuition program is subject to the unrelated
business income tax (UBIT). 73
---------------------------------------------------------------------------
73 The bill specifically provides that an interest in a qualified
State tuition program will not be treated as debt for purposes of the
UBIT debt-financed property rules (sec. 514). Consequently, a qualified
State tuition program's investment income will not constitute debt-
financed property income subject to the UBIT merely because the program
accepts contributions and is obligated to pay out (or refund) such
contributions and certain earnings thereon to designated beneficiaries
or to contributors. However, investment income of a qualified State
tuition program could be subject to the UBIT as debt-financed property
income to the extent the program acquires indebtedness when investing
the contributions made on behalf of designated beneficiaries.
---------------------------------------------------------------------------
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 74), 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. 75 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
76, 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. A qualified State tuition program may not
allow any interest in the program or any portion thereof to be
used as security for a loan.
---------------------------------------------------------------------------
74 The bill allows for a change in designated beneficiaries,
so long as the new beneficiary is a member of the same family as the
old beneficiary.
75 For this purpose, the term ``member of the same family''
is defined under present-law section 2032A(e)(2).
76 Thus, a State need not impose a monetary penalty when a
refund is made from a qualified State tuition program in order to cover
medical expenses incurred by (or on behalf of) a designated beneficiary
who suffers a disabling illness (and who could be any member of the
same family of the originally designated beneficiary).
---------------------------------------------------------------------------
In addition, the bill 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 contribution to, 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
amount or the value of the educational benefits exceeds
contributions made on behalf of the beneficiary, and (2)
amounts distributed to a contributor (e.g., when a parent or
other relative receives a refund) will be included in the
contributor's gross income to the extent such amounts exceed
contributions made by that person. 77
---------------------------------------------------------------------------
77 Specifically, the bill 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.
---------------------------------------------------------------------------
The bill further provides that, for purposes of present-law
section 2503(e), contributions made by an individual to a
qualified State tuition program are treated as a qualified
transfer and, thus, not subject to Federal gift tax.
Effective date
The provision is effective for taxable years ending after
the date of enactment. The bill also includes a transition rule
providing 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 bill will apply to contributions (and earnings allocable
thereto) made before the later of such dates without regard to
whether the requirements of a qualified State tuition program
are met with respect to such contributions and earnings (e.g.,
even if the interest in the tuition or educational savings
program covers not only qualified higher education expenses but
also room and board expenses).
Revenue Offsets
1. Modifications of the Puerto Rico and possession tax credit (sec.
1601 of the bill and sec. 936 and new sec. 30A of the Code)
Present law
Certain domestic corporations with business operations in
the U.S. possessions (including, for this purpose, Puerto Rico
and the U.S. Virgin Islands) may elect the Puerto Rico and
possession tax credit which generally eliminates the U.S. tax
on certain income related to their operations in the
possessions. In contrast to the foreign tax credit, the Puerto
Rico and possession tax credit is a ``tax sparing'' credit.
That is, the credit is granted whether or not the electing
corporation pays income tax to the possession. Income eligible
for the credit under this provision falls into two broad
categories: (1) possession business income, which is derived
from the active conduct of a trade or business within a U.S.
possession or from the sale or exchange of substantially all of
the assets that were used in such a trade or business; and (2)
qualified possession source investment income (``QPSII''),
which is attributable to the investment in the possession or in
certain Caribbean Basin countries of funds derived from the
active conduct of a possession business.
In order to qualify for the Puerto Rico and possession tax
credit for a taxable year, a domestic corporation must satisfy
two conditions. First, the corporation must derive at least 80
percent of its gross income for the three-year period
immediately preceding the close of the taxable year from
sources within a possession. Second, the corporation must
derive at least 75 percent of its gross income for that same
period from the active conduct of a possession business.
A domestic corporation that has elected the Puerto Rico and
possession tax credit and that satisfies these two conditions
for a taxable year generally is entitled to a credit based on
the U.S. tax attributable to the sum of the taxpayer's
possession business income and its QPSII. However, the amount
of the credit attributable to possession business income is
subject to the limitations enacted by the Omnibus Budget
Reconciliation Act of 1993. Under the economic activity limit,
the amount of the credit with respect to such income cannot
exceed an amount equal to the sum of (i) 60 percent of the
taxpayer's qualifying wage and fringe benefit expenses, (ii)
specified percentages of the taxpayer's depreciation allowances
with respect to qualifying tangible property, and (iii) in
certain cases, the taxpayer's qualifying possession income
taxes. The credit calculated under the economic activity limit
is referred to herein as the ``wage credit.'' In the
alternative, the taxpayer may elect to apply a limit equal to
the applicable percentage of the credit that would otherwise be
allowable with respect to possession business income; the
applicable percentage is phased down to 50 percent for 1996, 45
percent for 1997, and 40 percent for 1998 and thereafter. The
credit calculated under the applicable percentage limit is
referred to herein as the ``income credit.'' The amount of the
Puerto Rico and possession tax credit attributable to QPSII is
not subject to these limitations.
Reasons for change
The tax benefits provided by the Puerto Rico and possession
tax credit are enjoyed by only the relatively small number of
U.S. corporations that operate in the possessions. The
Committee is concerned that the high cost of these tax benefits
is borne by all U.S. taxpayers. In light of current budget
constraints, the Committee believes that the tax exemption
provided to corporations pursuant to the Puerto Rico and
possession tax credit should be modified.
The Committee believes that appropriate transition rules
should be provided for corporations with existing operations in
the possessions. In this regard, the Committee believes that
ten years is an appropriate transition period with respect to
the credit computed without regard to the economic activity
limit ( i.e, the income credit). On the other hand, the credit
computed under the economic activity limit ( i.e., the wage
credit) operates as a credit in the traditional sense, measured
by the level of employment and other economic activity
generated by the taxpayer in the possession. Accordingly, the
Committee believes that it is appropriate to continue the wage
credit for corporations with existing possession operations
beyond such ten-year period, subject to a tighter limit on the
amount of such credit relative to the compensation paid by the
corporation in the possession. Moreover, the Committee believes
that it is appropriate to move the wage credit with respect to
operations in Puerto Rico to a new section of the Code
contained in the subpart that includes other business-type
credits.
Explanation of provision
In general
The provision generally repeals the Puerto Rico and
possession tax credit with respect to possession business
income for taxable years beginning after December 31, 1995.
However, the provision provides special rules under which a
corporation that is an existing credit claimant continues to be
eligible to claim credits under the wage credit method. In
addition, the provision provides grandfather rules under which
a corporation that is an existing credit claimant is eligible
to claim credits under the income credit method for a 10-year
transition period. Further, a special rule applies to credits
attributable to operations in Guam, American Samoa, and the
Commonwealth of the Northern Mariana Islands.
The Puerto Rico and possession tax credit attributable to
QPSII generally is eliminated for taxable years beginning after
December 31, 1995. However, the credit attributable to QPSII
continues to be allowed for QPSII earned before July 1, 1996.
For taxable years beginning after December 31, 1995,
credits with respect to possession business income under both
the income credit and wage credit methods apply only to
corporations that qualify as existing credit claimants (as
defined below). The determination of whether a corporation is
an existing credit claimant is made separately for each
possession. A corporation that is an existing credit claimant
with respect to such possession is subject to the limitations
described below in determining the credit with respect to
operations in such possession for taxable years beginning after
December 31, 1995. The credit, subject to such limitations, is
computed separately for each possession with respect to which
the corporation is an existing credit claimant.
Wage credit
For corporations that are existing credit claimants with
respect to a possession and that use the wage credit, the wage
credit is determined in the same manner as under present law
for taxable years beginning after December 31, 1995 and before
January 1, 2002. For taxable years beginning after December 31,
2001 and before January 1, 2006, the corporation's possession
business income that is eligible for the wage credit is subject
to a cap computed as described below. For taxable years
beginning in 2006 and thereafter, in computing the economic
activity limit on the wage credit, the percentage of the
taxpayer's qualifying wage and fringe benefit expenses that is
taken into account is reduced from 60 percent to 40 percent;
the percentages with respect to the other components of the
economic activity limit are not changed. Moreover, for taxable
years beginning in 2006 and thereafter, the corporation's
business income that is eligible for the wage credit continues
to be subject to the cap described below.
The provision adds to the Code a new section which provides
a credit determined under the wage credit method for business
income from Puerto Rico. Such credit is computed under the
rules described above with respect to the possession tax credit
determined under the wage credit method. Such section applies
for taxable years beginning after December 31, 1995.
Income credit
For corporations that are existing credit claimants with
respect to a possession and that elected to use the income
credit, the income credit continues to be determined as under
present law for taxable years beginning after December 31, 1995
and before January 1, 1998. For taxable years beginning after
December 31, 1997 and before January 1, 2006, the corporation's
possession business income that is eligible for the income
credit is subject to a cap computed as described below. For
taxable years beginning in 2006 and thereafter, the income
credit is eliminated.
A corporation that had elected to use the income credit
rather than the wage credit is permitted to revoke that
election under present law. Under the provision, such a
revocation is required to be made not later than with respect
to the first taxable year beginning after December 31, 1996;
such revocation, if made, applies to such taxable year and to
all subsequent taxable years. Accordingly, a corporation that
had an election in effect to use the income credit could revoke
such election effective for its taxable year beginning in 1997
and thereafter; such corporation would continue to use the
income credit for its taxable year beginning in 1996 and would
use the wage credit for its taxable year beginning in 1997 and
thereafter.
Computation of income cap
The cap on a corporation's possession business income that
is eligible for either the income credit or the wage credit is
computed based on the corporation's possession business income
for the base period years (``average adjusted base period
possession business income''). Average adjusted base period
possession business income is the average of the adjusted
possession business income for each of the corporation's base
period years. For the purpose of this computation, the
corporation's possession business income for a base period year
is adjusted by an inflation factor that reflects inflation from
such year to 1995. In addition, as a proxy for real growth in
income throughout the base period, the inflation factor is
increased by 5 percentage points compounded for each year from
such year to the corporation's first taxable year beginning on
or after October 14, 1995.
The corporation's base period years generally are three of
the corporation's five most recent years ending before October
14, 1995, determined by disregarding the taxable years in which
the adjusted possession business incomes were highest and
lowest. For purposes of this computation, only years in which
the corporation had significant possession business income are
taken into account. A corporation is considered to have
significant possession business income for a taxable year if
such income exceeds 2 percent of the corporation's possession
business income for the each of the six taxable years ending
with the first taxable year ending on or after October 14,
1995. If the corporation has significant possession business
income for only four of the five most recent taxable years
ending before October 14, 1995, the base period years are
determined by disregarding the year in which the corporation's
possession business income was lowest. If the corporation has
significant possession business income for three years or fewer
of such five years, then the base period years are all such
years. If there is no year of such five taxable years in which
the corporation has significant possession business income,
then the corporation is permitted to use as its base period its
first taxable year ending on or after October 14, 1995; for
this purpose, the amount of possession business income taken
into account is the annualized amount of such income for the
portion of the year ended September 30, 1995.
As one alternative, the corporation is permitted to elect
to use its taxable year ending in 1992 as its base period (with
the adjusted possession business income for such year
constituting its cap). As another alternative, the corporation
is permitted to elect to use as its cap the annualized amount
of its possession business income for the first ten months of
calendar year 1995, calculated by excluding any extraordinary
items (as determined under generally accepted accounting
principles) for such period. For this purpose, the Committee
intends that transactions with a related party that are not in
the ordinary course of business will be considered to be
extraordinary items.
If a corporation's possession business income in a year for
which the cap is applicable exceeds the cap, then the
corporation's possession business income for purposes of
computing its income credit or its wage credit for the year is
an amount equal to the cap. The corporation's income credit
continues to be subject to the applicable percentage limit,
with such limit applied based on the corporation's possession
business income as reduced to reflect the application of the
cap. The corporation's wage credit is subject to the economic
activity limit, with such limit applied based on the
corporation's possession business income as reduced to reflect
the application of the cap.
Qualification as existing credit claimant
A corporation is an existing credit claimant with respect
to a possession if (1) the corporation was engaged in the
active conduct of a trade or business within the possession on
October 13, 1995, and (2) the corporation has elected the
benefits of the Puerto Rico and possession tax credit pursuant
to an election which is in effect for its taxable year that
includes October 13, 1995. A corporation that adds a
substantial new line of business after October 13, 1995, ceases
to be an existing credit claimant as of the beginning of the
taxable year during which such new line of business is added.
For purposes of these rules, a corporation is treated as
engaged in the active conduct of a trade or business within a
possession on October 13, 1995, if such corporation was engaged
in the active conduct of such trade or business before January
1, 1996, and such corporation had in effect on October 13,
1995, a binding contract for the acquisition of assets to be
used in, or the sale of property to be produced in, such trade
or business. For example, if a corporation had in effect on
October 13, 1995, binding contracts for the lease of a facility
and the purchase of machinery to be used in a manufacturing
business in a possession and if the corporation began actively
conducting that manufacturing business in the possession before
January 1, 1996, that corporation will be an existing credit
claimant. A change in the ownership of a corporation does not
affect its status as an existing credit claimant.
In determining whether a corporation has added a
substantial new line of business, the Committee intends that
principles similar to those reflected in Treas. Reg. section
1.7704-2(d) (relating to the transition rules for existing
publicly traded partnerships) apply. For example, a corporation
that modifies its current production methods, expands existing
facilities, or adds new facilities to support the production of
its current product lines and products within the same four-
digit Industry Number Standard Industrial Classification Code
(Industry SIC Code) will not be considered to have added a
substantial new line of business. In this regard, the Committee
intends that the fact that a business which is added is
assigned a different four-digit Industry SIC Code than is
assigned to an existing business of the corporation will not
automatically cause the corporation to be considered to have
added a new line of business. For example, a pharmaceutical
corporation that begins manufacturing a new drug will not be
considered to have added a new line of business. Moreover, a
pharmaceutical corporation that begins to manufacture a
complete product from the bulk active chemical through the
finished dosage form, a process that may be assigned two
separate four-digit Industry SIC Codes, will not be considered
to have added a new line of business even though it was
previously engaged in activities that involved only a portion
of the entire manufacturing process from bulk chemicals to
finished dosages. The Committee further intends that, in the
case of a merger of affiliated possession corporations that are
existing credit claimants, the corporation that survives the
merger will not be considered to have added a substantial new
line of business by reason of its operation of the existing
business of the affiliate that was merged into it.
Special rules for certain possessions
A special rule applies to the Puerto Rico and possession
tax credit with respect to operations in Guam, American Samoa,
and the Commonwealth of the Northern Mariana Islands. For any
taxable year beginning after December 31, 1995, and before
January 1, 2006, a corporation that is an existing credit
claimant with respect to one of these possessions for such year
continues to determine its Puerto Rico and possession tax
credit with respect to operations in such possession as under
present law.
For taxable years beginning in 2006 and thereafter, both
the Puerto Rico and possession tax credit under the income
credit method and the credit attributable to QPSII with respect
to operations in Guam, American Samoa, and the Commonwealth of
the Northern Mariana Islands are eliminated. For taxable years
beginning in 2006 and thereafter, a corporation that is an
existing credit claimant with respect to one of these
possessions continues to be entitled to the wage credit with
respect to the operations in such possession. However, for such
years, in computing the economic activity limit on the wage
credit, the percentage of the taxpayer's qualifying wage and
fringe benefit expenses that is taken into account is reduced
from 60 percent to 40 percent. Moreover, for such years, the
corporation's possession business income attributable to
operations in such possession that is eligible for the wage
credit is subject to the cap computed as described above.
Study of wage credit method
The Committee directs the Treasury Department to study the
effect on the economy of Puerto Rico of the wage credit (under
present law and as amended by the bill), including an analysis
of the impact of such credit on unemployment rates and economic
growth. The Treasury Department is directed to submit to the
House Committee on Ways and Means and the Senate Committee on
Finance reports on its findings with respect to the impact of
the wage credit within two years of the date of enactment and
every four years thereafter.
Effective Date
The provision is effective for taxable years beginning
after December 31, 1995.
2. Repeal 50-percent interest income exclusion for financial
institution loans to ESOPs (sec. 1602 of the bill and sec. 133
of the Code)
Present law
A bank, insurance company, regulated investment company, or
a corporation actively engaged in the business of lending money
may generally exclude from gross income 50 percent of interest
received on an ESOP loan (sec. 133). The 50-percent interest
exclusion only applies if: (1) immediately after the
acquisition of securities with the loan proceeds, the ESOP owns
more than 50 percent of the outstanding stock or more than 50
percent of the total value of all outstanding stock of the
corporation; (2) the ESOP loan term will not exceed 15 years;
and (3) the ESOP provides for full pass-through voting to
participants on all allocated shares acquired or transferred in
connection with the loan.
Reasons for change
The Committee believes that the 50-percent exclusion for
interest with respect to ESOP loans provides an unnecessary tax
benefit to financial institutions for loans they would make
without regard to the interest exclusion. The Committee finds
no evidence that employers that maintain ESOPs have less access
to borrowing than other borrowers or that there is a need to
provide an incentive to lenders to make money available to
ESOPs.
Explanation of provision
The provision repeals the 50-percent interest exclusion
with respect to ESOP loans.
Effective date
The provision is effective with respect to loans made after
the date of enactment, other than loans made pursuant to a
written binding contract in effect before June 10, 1996, and at
all times thereafter before such loan is made. The repeal of
the 50-percent interest exclusion does not apply to the
refinancing of an ESOP loan originally made on or before the
date of enactment or pursuant to a binding contract in effect
before June 10, 1996, provided: (1) such refinancing loan
otherwise meets the requirements of section 133 in effect on
the day before the date of enactment; (2) the outstanding
principal amount of the loan is not increased; and (3) the term
of the refinancing loan does not extend beyond the term of the
original ESOP loan.
3. Taxation of punitive damages received on account of personal injury
or sickness (sec. 1603 of the bill and sec. 104(a)(2) of the
Code)
Present law
Under present law, gross income does not include any
damages received (whether by suit or agreement and whether as
lump sums or as periodic payments) on account of personal
injury or sickness (sec. 104(a)(2)).
The exclusion from gross income of damages received on
account of personal injury or sickness specifically does not
apply to punitive damages received in connection with a case
not involving physical injury or sickness. Courts presently
differ as to whether the exclusion applies to punitive damages
received in connection with a case involving a physical injury
or physical sickness.78 Certain States provide that, in
the case of claims under a wrongful death statute, only
punitive damages may be awarded.
---------------------------------------------------------------------------
\78\ The Supreme Court recently agreed to decide whether punitive
damages awarded in a physical injury lawsuit are excludable from gross
income. O'gilvie v. U.S., 66 F.3d 1550 (10th Cir. 1995), cert. granted,
64 U.S.L.W. 3639 (U.S. March 25, 1996)(No. 95-966). Also, the Tax Court
recently held that if punitive damages are not of a compensatory
nature, they are not excludable from income, regardless of whether the
underlying claim involved a physical injury or physical sickness.
Bagley v. Commissioner, 105 T.C. No. 27 (1995).
---------------------------------------------------------------------------
Reasons for change
Punitive damages are intended to punish the wrongdoer and
are not intended to compensate the claimant (e.g., for lost
wages or pain and suffering). Thus, they are a windfall to the
taxpayer and appropriately should be included in taxable
income.
Explanation of provision
The bill provides that the exclusion from gross income does
not apply to any punitive damages received on account of
personal injury or sickness whether or not related to a
physical injury or physical sickness. Under the bill, present
law continues to apply to punitive damages received in a
wrongful death action if the applicable State law (as in effect
on September 13, 1995 without regard to subsequent
modification) provides, or has been construed to provide by a
court decision issued on or before such date, that only
punitive damages may be awarded in a wrongful death action. The
Committee intends no inference as to the application of the
exclusion to punitive damages prior to the effective date of
the bill in connection with a case involving a physical injury
or physical sickness.
Effective date
The provision generally is effective with respect to
amounts received after June 30, 1996. The provision does not
apply to amounts received under a written binding agreement,
court decree, or mediation award in effect on (or issued on or
before) September 13, 1995.
4. Extension and phaseout of excise tax on luxury automobiles (sec.
1604 of the bill and sec. 4001 of the Code)
Present law
Present law imposes an excise tax on the sale of
automobiles whose price exceeds a designated threshold,
currently $34,000. The excise tax is imposed at a rate of 10-
percent on the excess of the sales price above the designated
threshold. The $34,000 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.
The tax applies to sales before January 1, 2000.
Reasons for change
The Committee believes that the expiration date of January
1, 2000, at which time the rate of tax on certain automobiles
would fall from ten percent to zero, will create an
unacceptable disruption of the automobile market. The Committee
believes a more gradual phaseout of the tax will be less
disruptive to the market and believes it is appropriate to
commence the phaseout this year.
Explanation of provision
The provision extends and phases out the luxury tax on
automobiles. The tax rate is reduced by one percentage point
per year beginning in 1996. The tax rate for sales (on or after
July 1) in 1996 is 9 percent. The tax rate for sales in 1997 is
8 percent. The tax rate for sales in 1998 is 7 percent. The tax
rate for sales in 1999 is 6 percent. The tax rate for sales in
2000 is 5 percent. The tax rate for sales in 2001 is 4 percent.
The tax rate for sales in 2002 is 3 percent. The tax will
expire after December 31, 2002.
Effective date
The provision is effective for sales on or after July 1,
1996.
5. Allow certain persons engaged in the local furnishing of electricity
or gas to elect not to be eligible for future tax-exempt bond
financing (sec. 1605 of the amendment and sec. 142 of the Code)
Present law
Interest on State and local government bonds generally is
excluded from income except where the bonds are issued to
provide financing for private parties. Present law includes
several exceptions, however, that allow tax-exempt bonds to be
used to provide financing for certain specifically identified
private parties. One such exception allows tax-exempt bonds to
be issued to finance facilities for the furnishing of
electricity or gas by private parties if the area served by the
facilities does not exceed (1) two contiguous counties or (2) a
city and a contiguous county (commonly referred to as the
``local furnishing'' of electricity or gas).
Most private activity tax-exempt bonds are subject to
general State private activity bond volume limits of $50 per
resident of the State ($150 million, if greater) per year. Tax-
exempt bonds for facilities used in the local furnishing of
electricity or gas are subject to this limit. Like most other
private beneficiaries of tax-exempt bonds, borrowers using tax-
exempt bonds to finance these facilities are denied interest
deductions on the debt underlying the bonds if the facilities
cease to be used in qualified local furnishing activities.
Additionally, as with all tax-exempt bonds, if the use of
facilities financed with the bonds (or the beneficiary of the
bonds) changes to a use (or beneficiary) not qualified for tax-
exempt financing after the debt is incurred, interest on the
bonds becomes taxable unless certain safe harbor standards are
satisfied.
Reasons for change
Tax-exempt financing is a Federal tax subsidy which should
be subject to careful scrutiny. The Committee is aware that
past use of this subsidy during periods when the utility
industry was more sheltered from competition may preclude
prudent business expansion in certain cases under the current
environment, particularly for persons engaged in the local
furnishing of electricity or gas. The Committee determined
that, in light of these industry changes, a narrow provision
allowing for acceleration of the removal of this subsidy and
limiting the subsidy to current recipients (and certain
successors in interest) is appropriate in view of the current
deregulation in these industries.
Explanation of provision
The provision allows persons that have received tax-exempt
financing of facilities that currently qualify as used in the
local furnishing of electricity or gas to elect to terminate
their qualification for this tax-exempt financing and to expand
their service areas without incurring the present-law loss of
interest deductions and loss of tax-exemption penalties if--
(1) no additional bonds are issued for facilities of the
person making the election (or were issued for any predecessor)
after the date of the provision's enactment;
(2) the expansion of the person's service area is not
financed with any tax-exempt bond proceeds; and
(3) all outstanding tax-exempt bonds of the person making
the election (and any predecessor) are redeemed no later than
six months after the earliest date on which redemption is not
prohibited under the terms of the bonds, as issued, (or six
months after the election, if later).
Except as described below, the provision further limits the
exception allowing tax-exempt bonds to be issued for facilities
used in the local furnishing of electricity or gas to bonds for
facilities (1) of persons that qualified as engaged in that
activity on the date of the provision's enactment and (2) that
serve areas served by those persons on that date. The area
which is considered to be served on the date of the provision's
enactment consists of the geographic area in which service
actually is being provided on that date. Service initially
provided after the date of enactment to a new customer within
that area (e.g., as a result of new construction or of a change
in heating fuel type) is not treated as a service area
expansion.
For purposes of this requirement, a change in the identity
of a person serving an area is disregarded if the change is the
result of a corporate reorganization where the area served
remains unchanged and there is common ownership of both the
predecessor and successor entities. To facilitate compliance
with electric and gas industry restructuring now in progress,
the provision further permits continued qualification of
successor entities under a ``step-in-the-shoes'' rule without
regard to common ownership if the service provided remains
unchanged and the area served after the facilities are
transferred does not exceed the area served before the
transfer. For example, if facilities of a person engaged in
local furnishing are sold to another person, the purchaser
(when it engages in otherwise qualified local furnishing
activities) is eligible for continued tax-exempt financing to
the same extent that the seller would have been had the sale
not occurred if the service provided and the area served do not
change.
Similarly, a purchaser ``steps into the shoes'' of its
seller with regard to eligibility for making the election to
terminate its status as engaged in local furnishing without
imposition of certain penalties on outstanding tax-exempt
bonds. For example, if a person engaged in local furnishing
activities on the date of the provision's enactment receives
financing from tax-exempt bonds issued after the date of the
provision's enactment (and is thereby ineligible to make the
election), any purchaser from that person likewise is
ineligible.
Effective date
The provision is effective on the date of enactment.
6. Repeal of financial institution transition rule to interest
allocation rules (sec. 1606 of the bill and sec. 1215(c) of the
Tax Reform Act of 1986)
Present law
For foreign tax credit purposes, taxpayers generally are
required to allocate and apportion interest expense between
U.S. and foreign source income based on the proportion of the
taxpayer's total assets in each location. Such allocation and
apportionment is required to be made for affiliated groups (as
defined in sec. 864(e)(5)) as a whole rather than on a
subsidiary-by-subsidiary basis. However, certain types of
financial institutions that are members of an affiliated group
are treated as members of a separate affiliated group for
purposes of the allocation and apportionment of their interest
expense. Section 1215(c)(5) of the Tax Reform Act of 1986 (P.L.
99-514, 100 Stat. 2548) includes a targeted rule which treats a
certain corporation as a financial institution for this
purpose.
Reasons for change
The Committee believes that it is inappropriate to provide
narrowly targeted rules for purposes of allocating and
apportioning interest expense under the foreign tax credit
rules.
Explanation of provision
The bill repeals the targeted rule of section 1215(c)(5) of
the Tax Reform Act of 1986.
Effective date
The provision applies to taxable years beginning after
December 31, 1995.
7. Reinstate Airport and Airway Trust Fund excise taxes (sec. 1607 of
the bill and secs. 4041, 4081, 4091, 4261, and 4271 of the
Code)
Present law
Before January 1, 1996, five separate excise taxes were
imposed to fund the Federal Airport and Airway Trust Fund (the
``Trust Fund'') program. These aviation excise taxes were--
(1) a 10-percent tax on domestic passenger tickets;
(2) a 6.25-percent tax on domestic freight waybills;
(3) a $6-per-person tax on international departures;
(4) a 17.5-cents-per-gallon tax on jet fuel used in
noncommercial aviation; and
(5) a 15-cents-per-gallon tax on gasoline used in
noncommercial aviation.79
---------------------------------------------------------------------------
\79\ 14 cents per gallon of this tax continues to be imposed, with
the revenues being deposited in the Highway Trust Fund.
---------------------------------------------------------------------------
Current trust fund authorizations extend through September
30, 1996.
During the period that these excise taxes were imposed, an
exemption was provided for emergency medical helicopters and
helicopters engaged in the exploration and development of hard
minerals, oil and gas when the helicopters did not take off
from or land at Federally assisted airports or otherwise use
Federal aviation facilities or services.
Reasons for change
The aviation excise taxes, which expired after December 31,
1995, fund important Federal air transportation services. Their
expiration is depleting monies available to finance these
services, which Congress is in the process of reauthorizing for
the period beginning October 1, 1996. The Committee determined
that a short-term extension of those taxes will provide needed
revenue while allowing a more complete review of the bases on
which the excise taxes are calculated, once the findings of a
cost allocation study currently being completed by the Federal
Aviation Administration are available.
Explanation of provision
The expired Airport and Airway Trust Fund excise taxes, and
transfer of these revenues to the Trust Fund, are reinstated
during the period beginning seven days after enactment and
ending after December 31, 1996.
The exemption for certain emergency medical helicopters is
expanded to include fixed-wing aircraft equipped for and
exclusively dedicated to acute care emergency medical
transportation. Further, this exemption will no longer be
limited to flights that do not take off from or land at
Federally assisted airports or otherwise use the Federal air
navigation system, but rather will apply to all qualifying
flights by emergency medical aircraft.
Clarification is provided that the exemption for
helicopters when engaged in exploration for and development of
hard minerals, oil, and gas extends to discrete segments of
flights that otherwise originate and/or terminate at Federally
assisted airports where no Federal air navigation facilities or
services are utilized during the segments. That is, a flight
segment between intermediate take-offs and landings, neither of
which occurs at Federally assisted facilities, is exempt from
the aviation excise taxes if no Federal facilities or services
are used during that flight segment.
Effective date
The reinstatement of the aviation excise taxes is effective
beginning seven days after the date of the provision's
enactment; however, the passenger ticket and freight waybill
taxes do not apply to any amount paid before that date for
transportation occurring during the period when the taxes
otherwise are reinstated.
8. Modify basis adjustment rules under section 1033 (sec. 1608 of the
bill and sec. 1033 of the Code)
Present 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. The replacement property may be
acquired directly or by acquiring control of a corporation
(generally, 80 percent of the stock of the corporation) that
owns replacement property. The taxpayer's basis in the
replacement property generally is the same as the taxpayer's
basis in the converted property, decreased by the amount of any
money or loss recognized on the conversion, and increased by
the amount of any gain recognized on the conversion. In cases
in which a taxpayer purchases stock as replacement property,
the taxpayer generally reduces the basis of the stock, but does
not reduce the basis of the underlying assets. Thus, the
reduction in the basis of the stock generally does not result
in reduced depreciation deductions where the corporation holds
depreciable property, and may result in the taxpayer having
more aggregate depreciable basis after the acquisition of
replacement property than before the involuntary conversion.
Reasons for change
The Committee believes that if a taxpayer elects to defer
the recognition of gain with respect to property that is
involuntarily converted, the taxpayer should have the same
adjusted basis in the acquired property that is similar or
related in service or use to the converted property, regardless
of whether such property is acquired directly or indirectly
through the acquisition of stock of a corporation.
Explanation of provision
The provision provides that where the taxpayer satisfies
the replacement property requirement of section 1033 by
acquiring stock in a corporation, the corporation generally
will reduce its adjusted bases in its assets by the amount by
which the taxpayer reduces its basis in the stock. The
corporation's adjusted bases in its assets will not be reduced,
in the aggregate, below the taxpayer's basis in its stock
(determined after the appropriate basis adjustment for the
stock). In addition, the basis of any individual asset will not
be reduced below zero. The basis reduction first is applied to:
(1) property that is similar or related in service or use to
the converted property, then (2) to other depreciable property,
then (3) to other property.
The application of these rules can be demonstrated by the
following examples:
Example 1.--Assume that a taxpayer owned a commercial
building with an adjusted basis of $100,000 that was
involuntarily converted, causing the taxpayer to receive $1
million in insurance proceeds. Further assume that the taxpayer
acquires, as replacement property, all of the stock of a
corporation, the sole asset of the corporation is a building
with a value and an adjusted basis of $1 million. Under the
provision, for section 1033 to apply, the taxpayer would reduce
its basis in the stock to $100,000 (as under present law) and
the corporation would reduce its adjusted basis in the building
to $100,000.
Example 2.--Assume the same facts as in Example 1, except
that on the date of acquisition, the corporation has an
adjusted basis of $100,000 (rather than $1 million) in the
building. Under the bill, the taxpayer reduces its basis in the
stock to $100,000 (as under present law) and the corporation is
not required to reduce its adjusted basis in the building.
Effective date
The provision applies to involuntary conversions occurring
after the date of enactment of this Act.
9. Extension of withholding to certain gambling winnings (sec. 1609 of
the bill and sec. 3402(q) of the Code)
Present law
In general, proceeds from a wagering transaction are
subject to withholding at a rate of 28 percent if the proceeds
exceed $5,000 and are at least 300 times as large as the amount
wagered. No withholding tax is imposed on winnings from bingo
or keno.
Reasons for change
The Committee believes that imposing withholding on
winnings from bingo and keno will improve tax compliance.
Explanation of provision
The bill imposes withholding on proceeds from bingo or keno
wagering transactions at a rate of 28 percent if such proceeds
exceed $5,000, regardless of the odds of the wager.
Effective date
The provision is effective 30 days after the date of
enactment.
10. Treatment of certain insurance contracts on retired lives (sec.
1610 of the bill and sec. 817(d) of the Code)
Present law
Life insurance companies are allowed a deduction for any
net increase in reserves and are required to include in income
any net decrease in reserves. The reserve of a life insurance
company for any contract is the greater of the net surrender
value of the contract or the reserve determined under Federally
prescribed rules. In no event, however, may the amount of the
reserve for tax purposes for any contract at any time exceed
the amount of the reserve for annual statement purposes.
Special rules are provided in the case of a variable
contract. Under these rules, the reserve for a variable
contract is adjusted by (1) subtracting any amount that has
been added to the reserve by reason of appreciation in the
value of assets underlying such contract, and (2) adding any
amount that has been subtracted from the reserve by reason of
depreciation in the value of assets underlying such contract.
In addition, the basis of each asset underlying a variable
contract is adjusted for appreciation or depreciation to the
extent the reserve is adjusted.
A variable contract generally is defined as any annuity or
life insurance contract (1) that provides for the allocation of
all or part of the amounts received under the contract to an
account that is segregated from the general asset accounts of
the company, and (2) under which, in the case of an annuity
contract, the amounts paid in, or the amounts paid out, reflect
the investment return and the market value of the segregated
asset account, or, in the case of a life insurance contract,
the amount of the death benefit (or the period of coverage) is
adjusted on the basis of the investment return and the market
value of the segregated asset account. A pension plan contract
that is not a life, accident, or health, property, casualty, or
liability insurance contract is treated as an annuity contract
for purposes of this definition.
Reasons for change
The Committee believes that certain contracts which provide
insurance on retired lives should be treated as variable
contracts in order to simplify the treatment of such contracts
and to provide a more accurate measure of the income of life
insurance companies with respect to such contracts.
Explanation of provision
The bill provides that a variable contract is to include a
contract that provides for the funding of group term life or
group accident and health insurance on retired lives if: (1)
the contract provides for the allocation of all or part of the
amounts received under the contract to an account that is
segregated from the general asset account of the company; and
(2) the amounts paid in, or the amounts paid out, under the
contract reflect the investment return and the market value of
the segregated asset account underlying the contract.
Thus, the reserve for such a contract is to be adjusted by
(1) subtracting any amount that has been added to the reserve
by reason of appreciation in the value of assets underlying
such contract, and (2) adding any amount that has been
subtracted from the reserve by reason of depreciation in the
value of assets underlying such contract. In addition, the
basis of each asset underlying the contract is to be adjusted
for appreciation or depreciation to the extent that the reserve
is adjusted.
Effective date
The provision applies to taxable years beginning after
December 31, 1995.
11. Treatment of contributions in aid of construction for water
utilities (sec. 1611(a) of the bill and sec. 118 of the Code)
Present and prior law
The gross income of a corporation does not include
contributions to its capital. A contribution to the capital of
a corporation does not include any contribution in aid of
construction or any other contribution as a customer or
potential customer.
Prior to the enactment of the Tax Reform Act of 1986
(``1986 Act''), a regulated public utility that provided
electric energy, gas, water, or sewage disposal services was
allowed to treat any amount of money or property received from
any person as a tax-free contribution to its capital so long as
such amount: (1) was a contribution in aid of construction and
(2) was not included in the taxpayer's rate base for rate-
making purposes. A contribution in aid of construction did not
include a connection fee. The basis of any property acquired
with a contribution in aid of construction was zero.
If the contribution was in property other than electric
energy, gas, steam, water, or sewerage disposal facilities,
such contribution was not includible in the utility's gross
income so long as: (1) an amount at least equal to the amount
of the contribution was expended for the acquisition or
construction of tangible property that was used predominantly
in the trade or business of furnishing utility services; (2)
the expenditure occurred before the end of the second taxable
year after the year that the contribution was received; and (3)
certain records were kept with respect to the contribution and
the expenditure. In addition, the statute of limitations for
the assessment of deficiencies was extended in the case of
these contributions.
These rules were repealed by the 1986 Act. Thus, after the
1986 Act, the receipt by a utility of a contribution in aid of
construction is includible in the gross income of the utility,
and the basis of property received or constructed pursuant to
the contribution is not reduced.
Reasons for change
The Committee believes that the changes made by the 1986
Act with respect to the treatment of contributions in the aid
of construction to water utilities may inhibit the development
of certain communities and the modernization of water and
sewerage facilities.
Explanation of provision
The provision restores the contributions in aid of
construction provisions that were repealed by the 1986 Act for
regulated public utilities that provide water or sewerage
disposal services.
Effective date
The provision is effective for amounts received after June
12, 1996.
12. Require water utility property to be depreciated over 25 years
(sec. 1611(b) of the bill and sec. 168 of the Code)
Present law
Property used by a water utility in the gathering,
treatment, and commercial distribution of water and municipal
sewers are depreciated over a 20-year period for regular tax
purposes. The depreciation method generally applicable to
property with a recovery period of 20 years is the 150-percent
declining balance method (switching to the straight-line method
in the year that maximizes the depreciation deduction). The
straight-line method applies to property with a recovery period
over 20 years.
Reasons for change
The Committee believes that it is appropriate to extend the
depreciable life of water utility property given the exception
provided by the Committee for contributions in aid of
construction of water utility companies and the long useful
lives generally exhibited by such property.
Explanation of provision
The provision provides that water utility property will be
depreciated using a 25-year recovery period and the straight-
line method for regular tax purposes. For this purpose, ``water
utility property'' means (1) property that is an integral part
of the gathering, treatment, or commercial distribution of
water, and that, without regard to the provision, would have a
recovery period of 20 years and (2) any municipal sewer. Such
property generally is described in Asset Classes 49.3 and 51 of
Revenue Procedure 87-56, 1987-2 C.B. 674. The provision does
not change the class lives of water utility property for
purposes of the alternative depreciation system of section
168(g).
Effective date
The provision is effective for property placed in service
after June 12, 1996, other than property placed in service
pursuant to a binding contract in effect before June 10, 1996,
and at all times thereafter before the property is placed in
service.
13. Treatment of financial asset securitization investment trusts
(``FASITs'') (sec. 1621 of the bill and new secs. 860H, 860J,
860K, and 860L of the Code)
Present law
An individual can own income-producing assets directly, or
indirectly through an entity (i.e., a corporation, partnership,
or trust). Where an individual owns assets through an entity
(e.g., a corporation), the nature of the interest in the entity
(e.g., stock of a corporation) is different than the nature of
the assets held by the entity (e.g., assets of the
corporation).
Securitization is the process of converting one type of
asset into another and generally involves the use of an entity
separate from the underlying assets. In the case of
securitization of debt instruments, the instruments created in
the securitization typically have different maturities and
characteristics than the debt instruments that are securitized.
Entities used in securitization include entities that are
subject to tax (e.g., a corporation), conduit entities that
generally are not subject to tax (e.g., a partnership, grantor
trust, or real estate mortgage investment conduit (``REMIC'')),
or partial-conduit entities that generally are subject to tax
only to the extent income is not distributed to owners (e.g., a
trust, real estate investment trust (``REIT''), or regulated
investment company (``RIC'')).
There is no statutory entity that facilitates the
securitization of revolving, non-mortgage debt obligations.
Reasons for change
The Committee believes that there are substantial benefits
to the economy from increased securitization of assets in the
form of debt because securitization of such assets will spread
the risk of credit on the debt to others. The Committee
believes that the spreading of credit risk will lessen the
concentration of such risk in banks and other financial
intermediaries which, in turn, will lessen the pressure on
Federal deposit insurance. Further, the Committee believes that
the spreading of credit risk through securitization will result
in lower interest rates for consumers.
The Committee understands that it is difficult to
securitize revolving debt (such as credit card receivables)
under present law without the imposition of a corporate tax if
the sponsor of the securitization does not want to report the
securitized assets and the interests therein on his financial
reports. Accordingly, the Committee bill would create a new
type of entity, known as a ``financial asset securitization
investment trust'' or ``FASIT,'' through which securitizations
of all types of debt, including revolving credit debt, can be
accomplished without the imposition of a corporate tax even
though the securitized debt and the interests in the
securitized debt are not reported on the financial statements
of the securitization's sponsor.
Basically, the Committee bill achieves its purpose by
allowing the FASIT to issue instruments, called ``regular
interests,'' which will be treated as debt (and, therefore,
payments of the return on such interests would be deductible as
interest) even though such instruments might not otherwise be
treated as debt for Federal income tax purposes. Nonetheless,
in order that there be a corporate tax on returns that approach
returns on equity, the bill requires that instruments whose
yield is more than five percentage points higher than the yield
on U.S. Treasury obligations (called ``high-yield interests'')
be held, directly or indirectly, by domestic, non-exempt
corporations and such yield cannot be offset by any net
operating loss of its owner. In addition, in order to insure
that FASITs are not used for purposes other than
securitization, the bill imposes a 100-percent excise tax on
any income not related to securitizations (called a
``prohibited transaction'').
Explanation of provision
In general
The bill creates a new type of statutory entity called a
``financial asset securitization investment trust'' (``FASIT'')
that facilitates the securitization of debt obligations such as
credit card receivables, home equity loans, and auto loans. A
FASIT generally will not be taxable; the FASIT's taxable income
or net loss will flow through to the owner of the FASIT.
The ownership interest of a FASIT generally will be
required to be entirely held by a single domestic C
corporation. The Committee expects that the Treasury Department
will issue guidance on how this rule would apply to cases in
which the entity that owns the FASIT joins in the filing of a
consolidated return with other members of the group that wish
to hold an ownership interest in the FASIT. In addition, a
FASIT generally may hold only qualified debt obligations, and
certain other specified assets, and will be subject to certain
restrictions on its activities. An entity that qualifies as a
FASIT can issue instruments that meet certain specified
requirements and treat those instruments as debt for Federal
income tax purposes. Instruments issued by a FASIT bearing
yields to maturity over five percentage points above the yield
to maturity on specified United States government obligations
(i.e., ``high-yield interests'') must be held, directly or
indirectly, only by domestic C corporations that are not exempt
from income tax.
Qualification as a FASIT
In general
To qualify as a FASIT, an entity must: (1) make an election
to be treated as a FASIT for the year of the election and all
subsequent years; (2) have assets substantially all of which
(including assets that the FASIT is treated as owning because
they support regular interests) are specified types called
``permitted assets;'' (3) have non-ownership interests be
certain specified types of debt instruments called ``regular
interests''; (4) have a single ownership interest which is held
by an ``eligible holder''; and (5) not qualify as a RIC. Any
entity, including a corporation, partnership, or trust may be
treated as a FASIT. In addition, a segregated pool of assets
may qualify as a FASIT.
Election to be a FASIT
Once an election to be a FASIT is made, the election
applies from the date specified in the election and all
subsequent years until the entity ceases to be a FASIT. The
manner of making the election to be a FASIT is to determined by
the Secretary of the Treasury. If an election to be a FASIT is
made after the initial year of an entity, all of the assets in
the entity at the time of the FASIT election are deemed
contributed to the FASIT at that time and, accordingly, any
gain (but not loss) on such assets will be recognized at that
time.80
---------------------------------------------------------------------------
\80\ The bill provides transitional relief under which gain in pre-
effective date entities that make a FASIT election may be deferred.
---------------------------------------------------------------------------
Ceasing to be a FASIT
Once an entity ceases to be a FASIT, it is not a FASIT for
that year or any subsequent year. Nonetheless, an entity can
continue to be a FASIT where the Treasury Department determines
that the entity inadvertently ceases to be a FASIT, steps are
taken reasonably soon after it is discovered that the entity
ceased being a FASIT so that it again qualifies as a FASIT, and
the FASIT and its owner take those steps that the Treasury
Department deems necessary. An entity will cease qualifying as
a FASIT if the entity's owner ceases being an eligible
corporation. Loss of FASIT status is to be treated as if all of
the regular interests of the FASIT were retired and then
reissued without the application of the rule which deems
regular interests of a FASIT to be debt. The Committee
understands that this treatment could result in the creation of
cancellation of indebtedness income where the new instruments
deemed to be issued are treated as stock under general tax
principles.
Permitted assets
In general.--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; and (6) a regular interest in another FASIT. 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.
Permitted debt instruments.--A debt instrument will be a
permitted asset only if the instrument is indebtedness for
Federal income tax purposes including trade receivables,
regular interests in a real estate mortgage investment conduit
(REMIC), or regular interests issued by another FASIT and it
bears (1) fixed interest or (2) variable interest of a type
that relates to qualified variable rate debt (as defined in
Treasury regulations prescribed under sec. 860G(a)(1)(B)).
Except for cash equivalents, permitted debt obligations cannot
be obligations issued, directly or indirectly, by the owner of
the FASIT or a related person.
Foreclosure property.--Permitted assets include property
acquired on default (or imminent default) of debt instruments,
swap contracts, forward contracts, or similar contracts held by
the FASIT that would be foreclosure property to a REIT (under
sec. 856(e)) if the property that was acquired by foreclosure
by the FASIT was real property or would be foreclosure property
to a REIT but for certain leases entered into or construction
performed (as described in sec. 856(e)(4)) while held by the
FASIT.
Hedges.--Permitted assets include interest rate or foreign
currency notional principal contracts, letters of credit,
insurance, guarantees against payment defaults, notional
principal contracts that are ``in the money,'' or other similar
instruments as permitted under Treasury regulations, which are
reasonably required to guarantee or hedge against the FASIT's
risks associated with being the obligor of regular interests.
An instrument is a hedge if it results in risk reduction as
described in Treasury Income Tax Regulations 1.1221-2.
``Regular interests'' of a FASIT
Under the bill, ``regular interests'' of a FASIT, including
``high-yield interests,'' are treated as debt for Federal
income tax purposes regardless of whether instruments with
similar terms issued by non-FASITs might be characterized as
equity under general tax principles. To be treated as a
``regular interest,'' an instrument must have fixed terms and
must: (1) unconditionally entitle the holder to receive a
specified principal amount; (2) pay interest that is based on
(a) one or more rates that are fixed, (b) rates that measure
contemporaneous variations in the cost of newly borrowed
funds,81 or (c) to the extent permitted by Treasury
regulations, variable rates allowed to regular interests of a
REMIC if the FASIT would otherwise qualify as a REMIC; (3) have
a term to maturity of no more than 30 years, except as
permitted by Treasury regulations; (4) be issued to the public
with a premium of not more than 25 percent of its stated
principal amount; and (5) have a yield to maturity determined
on the date of issue of no more than five percentage points
above the applicable Federal rate (AFR) for the calendar month
in which the instrument is issued.
---------------------------------------------------------------------------
\81\ Variable interest rates that would meet this standard include
variable interest rates described in Treasury Income Tax Regulations
1.860G-1(a)(3).
---------------------------------------------------------------------------
A FASIT also may issue high-yield debt instruments, which
includes any debt instrument issued by a FASIT that meets the
second and third conditions described above, so long as such
interests are not held by a disqualified holder. A
``disqualified holder'' generally is any holder other than (1)
a domestic C corporation that does not qualify as a RIC, REIT,
REMIC, or cooperative 82 or (2) a dealer who acquires
FASIT debt for resale to customers in the ordinary course of
business. An excise tax is imposed at the highest corporate
rate on a dealer if there is a change in dealer status or if
the holding of the instrument is for investment purposes. A 31-
day grace period is granted before ownership of an interest
held by a dealer generally could be treated as held by the
FASIT owner for investment purposes.
---------------------------------------------------------------------------
\82\ The bill treats cooperatives as disqualified holders since
cooperatives, like RICs and REITs, are treated as pass-through entities
and, also like the owners of RICs and REITs, the coopertive's members
and patrons need not be C corporations.
---------------------------------------------------------------------------
Permitted ownership holder
A permitted holder of the ownership interest in a FASIT
generally is a non-exempt domestic C corporation, other than a
corporation that qualifies as a RIC, REIT, REMIC, or
cooperative.
Transfers to non-permitted holders of high-yield interests
A transfer of a high-yield interest to a disqualified
holder is to be ignored for Federal income tax purposes. Thus,
such a transferor will continue to be liable for any taxes due
with respect to the transferred interest.
Taxation of a FASIT
In general
A FASIT generally is not subject to tax. Instead, all of
the FASIT's assets and liabilities are treated as assets and
liabilities of the FASIT's owner and any income, gain,
deduction or loss of the FASIT is allocable directly to its
owner. Accordingly, income tax rules applicable to a FASIT
(e.g., related party rules, sec. 871(h), sec. 165(g)(2)) are to
be applied in the same manner as they apply to the FASIT's
owner. Any securities held by the FASIT that are treated as
held by its owner are treated as held for investment. The
taxable income of a FASIT is calculated using an accrual method
of accounting. The constant yield method and principles that
apply for purposes of determining OID accrual on debt
obligations whose principal is subject to acceleration apply to
all debt obligations held by a FASIT to calculate the FASIT's
interest and discount income and premium deductions or
adjustments. For this purpose, a FASIT's income does not
include any income subject to the 100-percent penalty excise
tax on prohibited transactions.
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 83), (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. Notwithstanding this rule, the owner of a FASIT may
currently deduct its losses incurred in prohibited transactions
in computing its taxable income for the year of the loss.
---------------------------------------------------------------------------
\83\ 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 REMIC in section 860F(a)(4).
---------------------------------------------------------------------------
Taxation of interests in the FASIT
Taxation of holders of regular interests
In general.--A holder of a regular interest, including a
high-yield interest, is taxed in the same manner as a holder of
any other debt instrument, except that the regular interest
holder is required to account for income relating to the
interest on an accrual method of accounting, regardless of the
method of accounting otherwise used by the holder.84
---------------------------------------------------------------------------
\84\ Regular interest in a FASIT 95 percent or more of whose assets
are real estate mortgages are treated as real estate assets where
relevant (e.g., secs. 856, 593, 7701(a)(19)).
---------------------------------------------------------------------------
High-yield interests.--Holders of high-yield interests are
not allowed to use net operating losses to offset any income
derived from the high-yield debt. Any net operating loss
carryover shall be computed by disregarding any income arising
by reason of the disallowed loss.
In addition, a transfer of a high-yield interest to a
disqualified holder is not recognized for Federal income tax
purposes such that the transferor will continue to be taxed on
the income from the high-yield interest unless the transferee
provides the transferor with an affidavit that the transferee
is not a disqualified person or the Treasury Secretary
determines that the high-yield interest is no longer held by a
disqualified person and a corporate tax has been paid on the
income from the high-yield interest while it was held by a
disqualified person.85 High-yield interests may be held
without a corporate tax being imposed on the income from the
high-yield interest where the interest is held by a dealer in
securities who acquired such high-yield interest for sale in
the ordinary course of his business as a securities dealer. In
such a case, a corporate tax is imposed on such a dealer if his
reason for holding the high-yield interest changes to
investment. There is a presumption that the dealer has not
changed his intent for holding high-yield instruments to
investment for the first 31 days he holds such interests unless
such holding is part of a plan to avoid the restriction on
holding of high-yield interests by disqualified persons.
---------------------------------------------------------------------------
\85\ Under this rule, no high-yield interests will be treated as
issued where the FASIT directly issues such interests to a disqualified
holder.
---------------------------------------------------------------------------
Where a pass-through entity (other than a FASIT) issues
either debt or equity instruments that are secured by regular
interests in a FASIT and such instruments bear a yield to
maturity greater than the yield on the regular interests or the
applicable Federal rate plus five percentage points (determined
on date that the pass-through entity acquires the regular
interests in the FASIT) and the pass-through entity issued such
debt or equity with a principal purpose of avoiding the rule
that high-yield interests be held by corporations, then an
excise tax is imposed on the pass-through entity at a rate
equal to the highest corporate rate on the income of any holder
of such instrument attributable to the regular interests.
Taxation of holder of ownership interest
All of the FASIT's assets and liabilities are treated as
assets and liabilities of the holder of a FASIT ownership
interest and that owner takes into account all of the FASIT's
income, gain, deduction, or loss in computing its taxable
income or net loss for the taxable year. The character of the
income to the holder of an ownership interest is the same as
its character to the FASIT, except tax-exempt interest is taken
into income of the holder as ordinary income.86
---------------------------------------------------------------------------
\86\ Ownership interests in a FASIT 95 percent or more of whose
assets are real estate mortgages are treated as real estate assets
where relevant (e.g., secs. 856, 593, 7701(a)(19)).
---------------------------------------------------------------------------
Losses on assets contributed to the FASIT are not allowed
upon their contribution, but may be allowed to the FASIT owner
upon their disposition by the FASIT. A special rule provides
that the holder of a FASIT ownership interest cannot offset
income or gain from the FASIT ownership interest with any other
losses. Any net operating loss carryover of the FASIT owner
shall be computed by disregarding any income arising by reason
of a disallowed loss.
For purposes of the alternative minimum tax, the owner's
taxable income is determined without regard to the minimum
FASIT income. The alternative minimum taxable income of the
FASIT owner cannot be less than the FASIT income for that year,
and the alternative minimum tax net operating loss deduction is
computed without regard to the minimum FASIT income.
Transfers to FASITs
Gain generally is recognized immediately by the owner of
the FASIT upon the transfer of assets to a FASIT. Assets that
are acquired by the FASIT from someone other than its owner are
treated as if they were acquired by the owner and then
contributed to the FASIT. In addition, any assets of the FASIT
owner or a related person that are used to support 87
FASIT regular interests are treated as contributed to the FASIT
and, thus, any gain on any such assets also will be recognized
at the earliest date that such assets support any FASIT's
regular interests.88 To the extent provided by Treasury
regulations, gain recognition on the contributed assets may be
deferred until such assets support regular interests issued by
the FASIT or any indebtedness of the owner or related person.
These regulations may adjust other statutory FASIT provisions
to the extent such provisions are inconsistent with such
regulations. For example, such regulations may disqualify
certain assets as permitted assets. The basis of any FASIT
asset is increased by the amount of the taxable gain recognized
on the contribution of the assets to the FASIT.
---------------------------------------------------------------------------
\87\ For this purpose, supporting assets includes any assets that
are reasonably expected to directly or indirectly pay regular interests
or to otherwise secure or collateralize regular interests. In the case
where there is a commitment to make additional contributions to a
FASIT, any such assets will not be treated as supporting the FASIT
until they are transferred to the FASIT or set aside for such use.
\88\ In the case of a securities dealer which may be an eligible
holder, the Committee understands that the mark-to-market rule of
section 475 will not apply to an ownership interest in a FASIT or
assets held in the FASIT.
---------------------------------------------------------------------------
Valuation rules
In general, except in the case of debt instruments, the
value of FASIT assets is their fair market value. In the case
of debt instruments that are traded on an established
securities market, then the market price will be used for
purposes of determining the amount of gain realized upon
contribution of such assets to a FASIT. Nonetheless, the bill
contains special rules for valuing other debt instruments for
purposes of computing gain on the transfer to a FASIT. Under
these rules, the value of such debt instruments is the sum of
the present values of the reasonably expected cash flows from
such obligations discounted over the weighted average life of
such assets. The discount rate is 120 percent of the applicable
Federal rate, compounded semiannually, or such other rate that
the Treasury Secretary shall prescribe by regulations. For
purposes of determining the value of a pool of revolving loan
accounts having substantially the same terms, each extension of
credit (other than the accrual of interest) is treated as a
separate debt instrument and the maturity of the instruments is
determined using the reasonably anticipated periodic payment
rate at which principal payments will be made as a proportion
of their aggregate outstanding principal balances assuming that
payments are applied to the earliest credit extensions. The
Committee understands that reasonably expected cash flows from
loans will reflect nonpayment (i.e., losses), early payments
(i.e., prepayments), and reasonable costs of servicing the
loans. This value shall be used in determining the amount of
gain realized upon the contribution of assets to a FASIT even
though that value may be different than the value of such
assets would be applying a willing buyer/willing seller
standard.
Related person
For purposes of the FASIT rules, a person is related to
another person if that person bears a relationship to the other
person specified in sections 267(b) or 707(b)(1), using a 20-
percent ownership test instead of the 50-percent test, or such
persons are engaged in trades or businesses under common
control as determined under sections 52(a) or (b).
Related amendments
For purposes of the wash sale rule (sec. 1091), an
ownership interest of a FASIT is treated as a ``security.'' In
addition, an ownership interest in a FASIT and a residual
interest in a pool of debt obligations that are substantially
similar to the debt obligations in the FASIT shall be treated
as ``substantially identical stock or securities''. Finally,
the wash sale period begins six months before, and ends six
months after, the sale of the ownership interest of the FASIT.
Effective Date
The provision takes effect on the date of enactment. The
bill provides a special transition rule for existing entities
(e.g., a trust whose interests are taxed like a partnership)
that elect to be a FASIT.
14. Revision of expatriation tax rules (secs. 1631-1633 of the bill and
secs. 102, 877, 2107, 2501, and 7701 and new secs. 877A and
6039F of the Code)
Present Law
Taxation of United States citizens, residents, and nonresidents
Individual income taxation
Income taxation of U.S. citizens and residents
In general.--A United States citizen generally is subject
to the U.S. individual income tax on his or her worldwide
taxable income. All income earned by a U.S. citizen, from
sources inside and outside the United States, is taxable,
whether or not the individual lives within the United States. A
non-U.S. citizen who resides in the United States generally is
taxed in the same manner as a U.S. citizen if the individual
meets the definition of a ``resident alien,'' described below.
The taxable income of a U.S. citizen or resident is equal
to the taxpayer's total income less certain exclusions,
exemptions, and deductions. The appropriate tax rates are then
applied to a taxpayer's taxable income to determine his or her
individual income tax liability. A taxpayer may reduce his or
her income tax liability by any applicable tax credits. When an
individual disposes of property, any gain or loss on the
disposition is determined by reference to the taxpayer's cost
basis in the property, regardless of whether the property was
acquired during the period in which the taxpayer was a citizen
or resident of the United States.
If a U.S. citizen or resident earns income from sources
outside the United States, and that income is subject to
foreign income taxes, the individual generally is permitted a
foreign tax credit against his or her U.S. income tax liability
to the extent of foreign income taxes paid on that income.
89 In addition, a United States citizen who lives and
works in a foreign country generally is permitted to exclude up
to $70,000 of annual compensation from being subject to U.S.
income taxes, and is permitted an exclusion or deduction for
certain housing expenses. 90
---------------------------------------------------------------------------
\89\ See sections 901-907.
\90\ Section 911.
---------------------------------------------------------------------------
Resident aliens.--In general, a non-U.S. citizen is
considered a resident of the United States if the individual
(1) has entered the United States as a lawful permanent U.S.
resident (the ``green card test''); 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 3-year
period weighted toward the present year (the ``substantial
presence test''). 91
---------------------------------------------------------------------------
\91\ The definitions of resident and nonresident aliens are set
forth in section 7701(b). The substantial presence test will compare
183 days to the sum of (1) the days present during the current calendar
year, (2) one-third of the days present during the preceding calendar
year, and (3) one-sixth of the days present during the second preceding
calendar year. Presence for 122 days (or more) per year over the 3-year
period would constitute substantial presence under the test.
---------------------------------------------------------------------------
If an individual is present in the United States for fewer
than 183 days during the calendar year, and if the individual
establishes that he or she has a closer connection with a
foreign country than with the United States and has a tax home
in that country for the year, the individual generally is not
subject to U.S. tax as a resident on account of the substantial
presence test. If an individual is present for as many as 183
days during a calendar year, this closer connections/tax home
exception is not available. An alien who has an application
pending to change his or her status to permanent resident or
who has taken other steps to apply for status as a lawful
permanent U.S. resident is not eligible for the closer
connections/tax home exception.
For purposes of applying the substantial presence test, any
days that an individual is present as an ``exempt individual''
are not counted. Exempt individuals include certain foreign
government-related individuals, teachers, trainees, students,
and professional athletes temporarily in the United States to
compete in charitable sports events. In addition, the
substantial presence test does not count days of presence of an
individual who is physically unable to leave the United States
because of a medical condition that arose while he or she was
present in the United States, if the individual can establish
to the satisfaction of the Secretary of the Treasury that he or
she qualifies for this special medical exception.
In some circumstances, an individual who meets the
definition of a U.S. resident (as described above) could also
be defined as a resident of another country under the internal
laws of that country. In order to avoid the double taxation of
such individuals, most income tax treaties include a set of
``tie-breaker'' rules to determine the individual's country of
residence for income tax purposes. In general, a dual resident
is deemed to be a resident of the country in which such person
has a permanent home. If the individual has a permanent home
available in both countries, the individual's residence is
deemed to be the country with which his or her personal and
economic relations are closer (i.e., the ``center of vital
interests.'') If the country in which such individual has his
or her center of vital interests cannot be determined, or if
such individual does not have a permanent home available in
either country, he or she is deemed to be a resident of the
country in which he or she has an habitual abode. If the
individual has an habitual abode in both countries or in
neither country, he or she is deemed to be a resident of the
country of which he or she is a citizen. If each country
considers the person to be its citizen or if he or she is a
citizen of neither country, the competent authorities of the
countries are to settle the question of residence by mutual
agreement.
Income taxation of nonresident aliens
Non-U.S. citizens who do not meet the definition of
``resident aliens'' are considered to be nonresident aliens for
tax purposes. Nonresident aliens are subject to U.S. tax only
to the extent their income is from U.S. sources or is
effectively connected with the conduct of a trade or business
within the United States. Bilateral income tax treaties may
modify the U.S. taxation of a nonresident alien.
A nonresident alien is taxed at regular graduated rates on
net profits derived from a U.S. business.92 Nonresident
aliens also are taxed at a flat rate of 30 percent on certain
types of passive income derived from U.S. sources, although a
lower rate may be provided by treaty (e.g., dividends are
frequently taxed at a reduced rate of 15 percent). Such passive
income includes interest, dividends, rents, salaries, wages,
premiums, annuities, compensations, remunerations, emoluments,
and other fixed or determinable annual or periodical gains,
profits and income. There is no U.S. tax imposed, however, on
interest earned by nonresident aliens with respect to deposits
with U.S. banks and certain types of portfolio debt
investments.93 Gains on the sale of stocks or securities
issued by U.S. persons generally are not taxable to a
nonresident alien because they are considered to be foreign
source income.94
---------------------------------------------------------------------------
\92\ Section 871.
\93\ See Sections 871(h) and 871(i)(3).
\94\ Section 865(a).
---------------------------------------------------------------------------
Nonresident aliens are subject to U.S. income taxation on
any gain recognized on the disposition of an interest in U.S.
real property.95 Such gains generally are subject to tax
at the same rates that apply to similar income received by U.S.
persons. If a U.S. real property interest is acquired from a
foreign person, the purchaser generally is required to withhold
10 percent of the amount realized (gross sales price).
Alternatively, either party may request that the Internal
Revenue Service (``IRS'') determine the transferor's maximum
tax liability and issue a certificate prescribing a reduced
amount of withholding (not to exceed the transferor's maximum
tax liability).96
---------------------------------------------------------------------------
\95\ Sections 897, 1445, 6039C, and 6652(f), known as the Foreign
Investment in Real Property Tax Act (``FIRPTA''). Under the FIRPTA
provisions, tax is imposed on gains from the disposition of an interest
(other than an interest solely as a creditor) in real property
(including an interest in a mine, well, or other natural deposit)
located in the United States or the U.S. Virgin Islands. Also included
int he definition of a U.S. real property interest is any interest
(other than an interest solely as a creditor) in any domestic
corporation unless the taxpayer establishes that the corporation was
not a U.S. real property holding corporation (``USRPHC'') at any time
during the five-year period ending on the date of the disposition of
the interest (sec. 897(c)(1)(A)(ii). A USRPHC is any corporation, the
fair market value of whose U.S. real property interests equals or
exceeds 50 percent of the sum of the fair market values of (1) its U.S.
real property interests, (2) its interests in foreign real property,
plus (3) any other of its assets which are used or held for use in a
trade or business (sec. 897(c)(2)).
\96\ Section 1445.
---------------------------------------------------------------------------
Estate and gift taxation
The United States imposes a gift tax on any transfer of
property by gift made by a U.S. citizen or resident, 97
whether made directly or indirectly and whether made in trust
or otherwise. Nonresident aliens are subject to the gift tax
with respect to transfers of tangible real or personal property
where the property is located in the United States at the time
of the gift. No gift tax is imposed, however, on gifts made by
nonresident aliens of intangible property having a situs within
the United States (e.g., stocks and bonds). 98
---------------------------------------------------------------------------
\97\ Section 2501.
\98\ Section 2501(a)(2).
---------------------------------------------------------------------------
The United States also imposes an estate tax on the
worldwide ``gross estate'' of any person who was a citizen or
resident of the United States at the time of death, and on
certain property belonging to a nonresident of the United
States that is located in the United States at the time of
death. 99
---------------------------------------------------------------------------
\99\ Sections 2001, 2031, 2101, and 2103.
---------------------------------------------------------------------------
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 U.S. citizen or resident
during his or her lifetime and at death. Under this rate
schedule, the unified estate and gift tax rates begin at 18
percent on the first $10,000 in cumulative taxable transfers
and reach 55 percent on cumulative taxable transfers over $3
million. 100 A unified credit of $192,800 is available
with respect to taxable transfers by gift and at death. The
unified credit effectively exempts a total of $600,000 in
cumulative taxable transfers from the estate and gift tax.
---------------------------------------------------------------------------
\100\ Section 2001(c).
---------------------------------------------------------------------------
Residency for purposes of estate and gift taxation is
determined under different rules than those applicable for
income tax purposes. In general, an individual is considered to
be a resident of the United States for estate and gift tax
purposes if the individual is ``domiciled'' in the United
States. An individual is domiciled in the United States if the
individual (a) is living in the United States and has the
intention to remain in the United States indefinitely; or (b)
has lived in the United States with such an intention and has
not formed the intention to remain indefinitely in another
country. In the case of a U.S. citizen who resided in a U.S.
possession at the time of death, if the individual acquired
U.S. citizenship solely on account of his or her birth or
residence in a U.S. possession, that individual is not treated
as a U.S. citizen or resident for estate tax purposes.101
---------------------------------------------------------------------------
\101\ Section 2209.
---------------------------------------------------------------------------
In addition to the estate and gift taxes, a separate
transfer tax is imposed on certain ``generation-skipping''
transfers.
Special tax rules with respect to the movement of persons into or out
of the United States
Individuals who relinquish U.S. citizenship with a
principal purpose of avoiding U.S. tax
An individual who relinquishes his or her U.S. citizenship
with a principal purpose of avoiding U.S. taxes is subject to
an alternative method of income taxation for 10 years after
expatriation under section 877.102 Under this provision,
if the Treasury Department establishes that it is reasonable to
believe that the expatriate's loss of U.S. citizenship would,
but for the application of this provision, result in a
substantial reduction in U.S. tax based on the expatriate's
probable income for the taxable year, then the expatriate has
the burden of proving that the loss of citizenship did not have
as one of its principal purposes the avoidance of U.S. income,
estate or gift taxes. Section 877 does not apply to resident
aliens who terminate their U.S. residency.
---------------------------------------------------------------------------
\102\ Treasury regulations provide that an individual's citizenship
status is governed by the provisions of the Immigration and Nationality
Act, specifically referrig to the ``rules governing loss of citizenship
[set forth in] sections 349 to 357, inclusive, of such Act (8 U.S.C.
1481-1489).'' Treas. Reg. section 1.1-1(c). Under the Immigration and
Nationality Act, an individual is generally considered to lose U.S.
citizenship on the date that an expatriating act is committed. The
present-law rules governing the loss of citizenship, and a description
of the types of expatriating acts that lead to a loss of citizenship,
are discussed more fully below.
---------------------------------------------------------------------------
The alternative method modifies the rules generally
applicable to the taxation of nonresident aliens in two ways.
First, the expatriate is subject to tax on his or her U.S.
source income at the rates applicable to U.S. citizens rather
than the rates applicable to other nonresident aliens. (Unlike
U.S. citizens, however, individuals subject to section 877 are
not taxed on any foreign source income.) Second, the scope of
items treated as U.S. source income for section 877 purposes is
broader than those items generally considered to be U.S. source
income under the Code. For example, gains on the sale of
personal property located in the United States, and gains on
the sale or exchange of stocks and securities issued by U.S.
persons, generally are not considered to be U.S. source income
under the Code. However, if an individual is subject to the
alternative taxing method of section 877, such gains are
treated as U.S. source income with respect to that individual.
The alternative method applies only if it results in a higher
U.S. tax liability than would otherwise be determined if the
individual were taxed as a nonresident alien.
Because section 877 alters the sourcing rules generally
used to determine the country having primary taxing
jurisdiction over certain items of income, there is an
increased potential for such items to be subject to double
taxation. For example, a former U.S. citizen subject to the
section 877 rules may have capital gains derived from stock in
a U.S. corporation. Under section 877, such gains are treated
as U.S. source income, and are, therefore, subject to U.S. tax.
Under the internal laws of the individual's new country of
residence, however, that country may provide that all capital
gains realized by a resident of that country are subject to
taxation in that country, and thus the individual's gain from
the sale of U.S. stock also would be taxable in his or her
country of residence. If the individual's new country of
residence has an income tax treaty with the United States, the
treaty may provide for the amelioration of this potential
double tax.
Similar rules apply in the context of estate and gift
taxation if the transferor relinquished U.S. citizenship with a
principal purpose of avoiding U.S. taxes within the 10-year
period ending on the date of the transfer. A special rule is
applied to the estate tax treatment of any decedent who
relinquished his or her U.S. citizenship within 10 years of
death, if the decedent's loss of U.S. citizenship had as one of
its principal purposes a tax avoidance motive.103 Once the
Secretary of the Treasury establishes a reasonable belief that
the expatriate's loss of U.S. citizenship would result in a
substantial reduction in estate, inheritance, legacy and
succession taxes, the burden of proving that one of the
principal purposes of the loss of U.S. citizenship was not
avoidance of U.S. income or estate tax is on the executor of
the decedent's estate.
---------------------------------------------------------------------------
\103}\Section 2107.
---------------------------------------------------------------------------
In general, the estates of individuals who have
relinquished U.S. citizenship are taxed in accordance with the
rules generally applicable to the estates of nonresident aliens
(i.e., the gross estate includes all U.S.-situs property held
by the decedent at death, is subject to U.S. estate tax at the
rates generally applicable to the estates of U.S. citizens, and
is allowed a unified credit of $13,000, as well as credits for
State death taxes, gift taxes, and prior transfers). However, a
special rule provides that the individual's gross estate also
includes his or her pro-rata share of any U.S.-situs property
held through a foreign corporation in which the decedent had a
10-percent or greater voting interest, provided that the
decedent and related parties together owned more than 50
percent of the voting power of the corporation. Similarly,
gifts of intangible property having a situs within the United
States (e.g., stocks and bonds) made by a nonresident alien who
relinquished his or her U.S. citizenship within the 10-year
period ending on the date of transfer are subject to U.S. gift
tax, if the loss of U.S. citizenship had as one of its
principal purposes a tax avoidance motive.104
---------------------------------------------------------------------------
\104\ Section 2501(a)(3).
---------------------------------------------------------------------------
Aliens having a break in residency status
A special rule applies in the case of an individual who has
been treated as a resident of the United States for at least
three consecutive years, if the individual becomes a
nonresident but regains residency status within a three-year
period.105 In such cases, the individual is subject to
U.S. tax for all intermediate years under the section 877 rules
described above (i.e., the individual is taxed in the same
manner as a U.S. citizen who renounced U.S. citizenship with a
principal purpose of avoiding U.S. taxes). The special rule for
a break in residency status applies regardless of the
subjective intent of the individual.
---------------------------------------------------------------------------
\105\ Section 7701(b)(10).
---------------------------------------------------------------------------
Requirements for United States citizenship, immigration, and visas
United States citizenship
An individual may acquire U.S. citizenship in one of three
ways: (1) being born within the geographical boundaries of the
United States; (2) being born outside the United States to at
least one U.S. citizen parent (as long as that parent had
previously been resident in the United States for a requisite
period of time); or (3) through the naturalization process. All
U.S. citizens are required to pay U.S. income taxes on their
worldwide income. The State Department estimates that there are
approximately 3 million U.S. citizens living abroad, although
thousands of these individuals may not even know that they are
U.S. citizens.
A U.S. citizen may voluntarily give up his or her U.S.
citizenship at any time by performing one of the following acts
(``expatriating acts'') with the intention of relinquishing
U.S. nationality: (1) becoming naturalized in another country;
(2) formally declaring allegiance to another country; (3)
serving in a foreign army; (4) serving in certain types of
foreign government employment; (5) making a formal renunciation
of nationality before a U.S. diplomatic or consular officer in
a foreign country; (6) making a formal renunciation of
nationality in the United States during a time of war; or (7)
committing an act of treason.106 An individual who wishes
formally to renounce citizenship (item (5), above) must execute
an Oath of Renunciation before a consular officer, and the
individual's loss of citizenship is effective on the date the
oath is executed. In all other cases, the loss of citizenship
is effective on the date that the expatriating act is
committed, even though the loss may not be documented until a
later date. The State Department generally documents loss in
such cases when the individual acknowledges to a consular
officer that the act was taken with the requisite intent. In
all cases, the consular officer abroad submits a certificate of
loss of nationality (``CLN'') to the State Department in
Washington, D.C. for approval.107 Upon approval, a copy of
the CLN is issued to the affected individual.
---------------------------------------------------------------------------
\106\ 8 U.S.C. section 1481.
\107\ 8 U.S.C. section 1501.
---------------------------------------------------------------------------
Before a CLN is issued, the State Department reviews the
individual's files to confirm that: (1) the individual was a
U.S. citizen; (2) an expatriating act was committed; (3) the
act was undertaken voluntarily; and (4) the individual had the
intent of relinquishing citizenship when the expatriating act
was committed. If the expatriating act involved an action of a
foreign government (for example, if the individual was
naturalized in a foreign country or joined a foreign army), the
State Department will not issue a CLN until it has obtained an
official statement from the foreign government confirming the
expatriating act. If a CLN is not issued because the State
Department does not believe that an expatriating act has
occurred (for example, if the requisite intent appears to be
lacking), the issue is likely to be resolved through
litigation. Whenever the loss of U.S. nationality is put in
issue, the burden of proof is on the person or party claiming
that a loss of citizenship has occurred to establish, by a
preponderance of the evidence, that the loss occurred.108
Similarly, if a CLN has been issued, but the State Department
later discovers that such issuance was improper (for example,
because fraudulent documentation was submitted, or the
requisite intent appears to be lacking), the State Department
could initiate proceedings to revoke the CLN. If the recipient
is unable to establish beyond a preponderance of the evidence
that citizenship was lost on the date claimed, the CLN would be
revoked. To the extent that the IRS believes a CLN was
improperly issued, the IRS could present such evidence to the
State Department and request that revocation proceedings be
commenced. If it is determined that the individual has indeed
committed an expatriating act, the date for loss of citizenship
will be the date of the expatriating act.
---------------------------------------------------------------------------
\108\ 8 U.S.C. section 1481(b).
---------------------------------------------------------------------------
A child under the age of 18 cannot lose U.S. citizenship by
naturalizing in a foreign state or by taking an oath of
allegiance to a foreign state. A child under 18 can, however,
lose U.S. citizenship by serving in a foreign military or by
formally renouncing citizenship, but such individuals may
regain their citizenship by asserting a claim of citizenship
before reaching the age of eighteen years and six months.
A naturalized U.S. citizen can have his or her citizenship
involuntarily revoked if a U.S. court determines that the
certificate of naturalization was illegally procured, or was
procured by concealment of a material fact or by willful
misrepresentation. In such cases, the individual's certificate
of naturalization is canceled, effective as of the original
date of the certificate; in other words, it is as if the
individual were never a U.S. citizen at all.
United States immigration and visas
In general, a non-U.S. citizen who enters the United States
is required to obtain a visa.109 An immigrant visa (also
known as a ``green card'') is issued to an individual who
intends to relocate to the United States permanently. Various
types of nonimmigrant visas are issued to individuals who come
to the United States on a temporary basis and intend to return
home after a certain period of time. The type of nonimmigrant
visa issued to such individuals is dependent upon the purpose
of the visit and its duration. An individual holding a
nonimmigrant visa is prohibited from engaging in activities
that are inconsistent with the purpose of the visa (for
example, an individual holding a tourist visa is not permitted
to obtain employment in the United States).
---------------------------------------------------------------------------
\109\ Under the Visa Waiver Pilot Program, nationals of most
European countries are not required to obtain a visa to enter the
United States if they are coming as tourists and staying a maximum of
90 days. Also, citizens of Canada, Mexico, and certain islands in close
proximity to the United States do not need visas to enter the United
States, although other types of travel documents may be required.
---------------------------------------------------------------------------
Foreign business people and investors often obtain ``E''
visas to come into the United States. Generally, an ``E'' visa
is initially granted for a one-year period, but it can be
routinely extended for additional two-year periods. There is no
overall limit on the amount of time an individual may retain an
``E'' visa. There are two types of ``E'' visas: an ``E-1''
visa, for ``treaty traders'' and an ``E-2'' visa, for ``treaty
investors.''
Relinquishment of green cards
There are several ways in which a green card can be
relinquished. First, an individual who wishes to terminate his
or her permanent residency may simply return his or her green
card to the INS. Second, an individual may be involuntarily
deported from the United States (through a judicial or
administrative proceeding), and the green card must be
relinquished at that time. Third, a green card holder who
leaves the United States and attempts to re-enter more than a
year later may have his or her green card taken away by the INS
border examiner, although the individual may appeal to an
immigration judge to have the green card reinstated. A green-
card holder may permanently leave the United States without
relinquishing his or her green card, although such individuals
would continue to be taxed as U.S. residents.110
---------------------------------------------------------------------------
\110\ Section 7701(b)(6)(B) provides that an individual who has
obtained the status of residing permanently in the United States as an
immigrant (i.e., an individual who has obtained a green card) will
continue to be taxed as a lawful permanent resident of the United
States until such status is revoked, or is administratively or
judicially determined to have been abandoned.
---------------------------------------------------------------------------
Reasons for change
The Committee has been informed that a small number of very
wealthy individuals each year relinquish their U.S. citizenship
for the purpose of avoiding U.S. income, estate, and gift
taxes. By so doing, such individuals reduce their annual U.S.
income tax liability and eliminate their eventual U.S. estate
tax liability.
The Committee recognizes that citizens of the United States
have a basic right not only physically to leave the United
States to live elsewhere, but also to relinquish their U.S.
citizenship. The Committee does not believe that the Internal
Revenue Code should be used to stop U.S. citizens from
expatriating; however, the Committee also does not believe that
the Code should provide a tax incentive for expatriating.
The Committee is concerned that present law, which bases
the application of the alternative method of taxation under
section 877 on proof of a tax-avoidance purpose, is difficult
to administer. In addition, the Committee is concerned that the
alternative method can be avoided by postponing the realization
of U.S. source income for 10 years. The Committee believes that
section 877 is largely ineffective in taxing U.S. citizens who
expatriate with a principal purpose to avoid tax.
The Committee believes that the alternative tax system of
section 877 should be replaced by a tax regime applicable to
wealthy expatriates that does not rely on establishing a tax-
avoidance motive. Because U.S. citizens who retain their
citizenship are subject to income tax on accrued appreciation
when they dispose of their assets, as well as estate tax on the
full value of assets that are held until death, the Committee
believes it fair and equitable to tax expatriates on the
appreciation in their assets when they relinquish their U.S.
citizenship. The Committee believes that an exception from the
expatriation tax should be provided for individuals whose
income and net worth are relatively modest.
Explanation of provision
In general
The provision replaces the present-law expatriation income
tax rules with rules that generally subject certain U.S.
citizens who relinquish their U.S. citizenship and certain
long-term U.S. residents who relinquish their U.S. residency to
tax on the net unrealized gain in their property as if such
property were sold for fair market value on the expatriation
date. The provision also imposes information reporting
obligations on U.S. citizens who relinquish their citizenship
and long-term residents whose U.S. residency is terminated.
Individuals covered
The provision applies the expatriation tax to certain U.S.
citizens and long-term residents who terminate their U.S.
citizenship or residency. For this purpose, a long-term
resident is any individual who was a lawful permanent resident
of the United States for at least 8 out of the 15 taxable years
ending with the year in which the termination of residency
occurs. In applying this 8-year test, an individual is not
considered to be a lawful permanent resident of the United
States for any year in which the individual is taxed as a
resident of another country under a treaty tie-breaker rule. An
individual's U.S. residency is considered to be terminated when
either the individual ceases to be a lawful permanent resident
pursuant to section 7701(b)(6) (i.e., the individual loses his
or her green-card status) or the individual is treated as a
resident of another country under a tie-breaker provision of a
tax treaty (and the individual does not elect to waive the
benefits of such treaty).
The expatriation tax applies only to individuals whose
average income tax liability or net worth exceeds specified
levels. U.S. citizens who lose their citizenship and long-term
residents who terminate U.S. residency are subject to the
expatriation tax if they meet either of the following tests:
(1) the individual's average annual U.S. Federal income tax
liability for the 5 taxable years ending before the date of
such loss or termination is greater than $100,000, or (2) the
individual's net worth as of the date of such loss or
termination is $500,000 or more. The dollar amount thresholds
contained in these tests are indexed for inflation in the case
of a loss of citizenship or termination of residency occurring
in any calendar year after 1996.
Exceptions from the expatriation tax are provided for
individuals in two situations. The first exception applies to
an individual who was born with citizenship both in the United
States and in another country, provided that (1) as of the date
of relinquishment of U.S. citizenship the individual continues
to be a citizen of, and is taxed as a resident of, such other
country, and (2) the individual was a resident of the United
States for no more than 8 out of the 15 taxable years ending
with the year in which the relinquishment of U.S. citizenship
occurred. The second exception applies to a U.S. citizen who
relinquishes citizenship before reaching age 18\1/2\, provided
that the individual was a resident of the United States for no
more than 5 taxable years before such relinquishment.
Deemed sale of property upon expatriation
Under the provision, individuals who are subject to the
expatriation tax generally are treated as having sold all of
their property at fair market value immediately prior to the
relinquishment of citizenship or termination of residency. Gain
or loss from the deemed sale of property is recognized at that
time, generally without regard to provisions of the Code that
would otherwise provide nonrecognition treatment. The net gain,
if any, on the deemed sale of all such property is subject to
U.S. tax at such time to the extent it exceeds $600,000 ($1.2
million in the case of married individuals filing a joint
return, both of whom expatriate).
The deemed sale rule of the provision generally applies to
all property interests held by the individual on the date of
relinquishment of citizenship or termination of residency,
provided that the gain on such property interest would be
includible in the individual's gross income if such property
interest were sold for its fair market value on such date.
Special rules apply in the case of trust interests (see
``Interests in trusts'', below). U.S. real property interests,
which remain subject to U.S. taxing jurisdiction in the hands
of nonresident aliens, generally are excepted from the
provision. An exception also applies to interests in qualified
retirement plans and, subject to a limit of $500,000, interests
in certain foreign pension plans as prescribed by regulations.
The Secretary of the Treasury is authorized to issue
regulations exempting other property interests as appropriate.
For example, an exclusion could be provided for an interest in
a nonqualified compensation plan of a U.S. employer, where
payments from such plan to the individual following
expatriation would continue to be subject to U.S. withholding
tax.
Under the provision, an individual who is subject to the
expatriation tax is required to pay a tentative tax equal to
the amount of tax that would be due for a hypothetical short
tax year ending on the date the individual relinquished
citizenship or terminated residency. Thus, the tentative tax is
based on all the income, gain, deductions, loss and credits of
the individual for the year through such date, including
amounts realized from the deemed sale of property. The
tentative tax is due on the 90th day after the date of
relinquishment of citizenship or termination of residency.
Deferral of payment of tax
Under the provision, an individual is permitted to elect to
defer payment of the expatriation tax with respect to the
deemed sale of any property. Under this election, the
expatriation tax with respect to a particular property, plus
interest thereon, is due when the property is subsequently
disposed of. For this purpose, except as provided in
regulations, the disposition of property in a nonrecognition
transaction constitutes a disposition. In addition, if an
individual holds property until his or her death, the
individual is treated as having disposed of the property
immediately before death. In order to elect deferral of the
expatriation tax, the individual is required to provide
adequate security to ensure that the deferred expatriation tax
and interest ultimately will be paid. A bond in the amount of
the deferred tax and interest constitutes adequate security.
Other security mechanisms also are permitted provided that the
individual establishes to the satisfaction of the Secretary of
the Treasury that the security is adequate. In the event that
the security provided with respect to a particular property
subsequently becomes inadequate and the individual fails to
correct such situation, the deferred expatriation tax and
interest with respect to such property becomes due. As a
further condition to making this election, the individual is
required to consent to the waiver of any treaty rights that
would preclude the collection of the expatriation tax.
Interests in trusts
In general
Under the provision, special rules apply to trust interests
held by the individual at the time of relinquishment of
citizenship or termination of residency. The treatment of trust
interests depends upon whether the trust is a qualified trust.
For this purpose, a ``qualified trust'' is a trust that is
organized under and governed by U.S. law and that is required
by its instruments to have at least one U.S. trustee.
Constructive ownership rules apply to a trust beneficiary
that is a corporation, partnership, trust or estate. In such
cases, the shareholders, partners or beneficiaries of the
entity are deemed to be the direct beneficiaries of the trust
for purposes of applying these provisions. In addition, an
individual who holds (or who is treated as holding) a trust
interest at the time of relinquishment of citizenship or
termination of residency is required to disclose on his or her
tax return the methodology used to determine his or her
interest in the trust, and whether such individual knows (or
has reason to know) that any other beneficiary of the trust
uses a different method.
Nonqualified trusts
If an individual holds an interest in a trust that is not a
qualified trust, a special rule applies for purposes of
determining the amount of the expatriation tax due with respect
to such trust interest. The individual's interest in the trust
is treated as a separate trust consisting of the trust assets
allocable to such interest. Such separate trust is treated as
having sold its assets as of the date of relinquishment of
citizenship or termination of residency and having distributed
all proceeds to the individual, and the individual is treated
as having recontributed such proceeds to the trust. The
individual is subject to the expatriation tax with respect to
any net income or gain arising from the deemed distribution
from the trust. The election to defer payment is available for
the expatriation tax attributable to a nonqualified trust
interest.
A beneficiary's interest in a nonqualified trust is
determined on the basis of all facts and circumstances. These
include the terms of the trust instrument itself, any letter of
wishes or similar document, historical patterns of trust
distributions, and the role of any trust protector or similar
advisor.
Qualified trusts
If the individual has an interest in a qualified trust, a
different set of rules applies. Under these rules, the amount
of unrealized gain allocable to the individual's trust interest
is calculated at the time of expatriation. In determining this
amount, all contingencies and discretionary interests are
resolved in the individual's favor (i.e., the individual is
allocated the maximum amount that he or she potentially could
receive under the terms of the trust instrument). The
expatriation tax imposed on such gains generally is collected
when the individual receives distributions from the trust, or,
if earlier, upon the individual's death. Interest is charged
for the period between the date of expatriation and the date on
which the tax is paid.
If an individual has an interest in a qualified trust, the
individual is subject to expatriation tax upon the receipt of
any distribution from the trust. Such distributions may also be
subject to U.S. income tax. For any distribution from a
qualified trust made to an individual after he or she has
expatriated, expatriation tax is imposed in an amount equal to
the amount of the distribution multiplied by the highest tax
rate generally applicable to trusts and estates, but in no
event will the tax imposed exceed the deferred tax amount with
respect to such trust interest. The ``deferred tax amount'' is
equal to (1) the tax calculated with respect to the unrealized
gain allocable to the trust interest at the time of
expatriation, (2) increased by interest thereon, and (3)
reduced by the tax imposed under this provision with respect to
prior trust distributions to the individual.
If an individual's interest in a trust is vested as of the
expatriation date (e.g., if the individual's interest in the
trust is non-contingent and non-discretionary), the gain
allocable to the individual's trust interest is determined
based on the trust assets allocable to his or her trust
interest. If the individual's interest in the trust is not
vested as of the expatriation date (e.g., if the individual's
trust interest is a contingent or discretionary interest), the
gain allocable to his or her trust interest is determined based
on all of the trust assets that could be allocable to his or
her trust interest, determined by resolving all contingencies
and discretionary powers in the individual's favor. In the case
where more than one trust beneficiary is subject to the
expatriation tax with respect to trust interests that are not
vested, the rules are intended to apply so that the same
unrealized gain with respect to assets in the trust is not
taxed to both individuals.
If the individual disposes of his or her trust interest,
the trust ceases to be a qualified trust, or the individual
dies, expatriation tax is imposed as of such date. The amount
of such tax is equal to the lesser of (1) the tax calculated
under the rules for nonqualified trust interests applied as of
such date or (2) the deferred tax amount with respect to the
trust interest as of such date.
If the individual agrees to waive any treaty rights that
would preclude collection of the tax, the tax is imposed under
this provision with respect to distributions from a qualified
trust to the individual deducted and withheld from
distributions. If the individual does not agree to such a
waiver of treaty rights, the tax with respect to distributions
to the individual is imposed on the trust, the trustee is
personally liable therefor, and any other beneficiary of the
trust will have a right of contribution against such individual
with respect to such tax. Similarly, in the case of the tax
imposed in connection with an individual's disposition of a
trust interest, the individual's death while holding a trust
interest or the individual's holding of an interest in a trust
that ceases to be qualified, the tax is imposed on the trust,
the trustee is personally liable therefor, and any other
beneficiary of the trust will have a right of contribution
against such individual with respect to such tax.
Election to be treated as a U.S. citizen
Under the provision, an individual is permitted to make an
irrevocable election to continue to be taxed as a U.S. citizen
with respect to all property that otherwise is covered by the
expatriation tax. This election is an ``all-or-nothing''
election; an individual is not permitted to elect this
treatment for some property but not other property. The
election, if made, applies to all property that would be
subject to the expatriation tax and to any property the basis
of which is determined by reference to such property. Under
this election, the individual continues to pay U.S. income
taxes at the rates applicable to U.S. citizens following
expatriation on any income generated by the property and on any
gain realized on the disposition of the property, as well as
any excise tax imposed with respect to the property (see, e.g.,
sec. 1491). In addition, the property continues to be subject
to U.S. gift, estate, and generation-skipping transfer taxes.
However, the amount of any transfer tax so imposed is limited
to the amount of income tax that would have been due if the
property had been sold for its fair market value immediately
before the transfer or death. The $600,000 exclusion provided
with respect to the expatriation tax under the provision is
available to reduce the tax imposed by reason of this election.
In order to make this election, the taxpayer is required to
waive any treaty rights that would preclude the collection of
the tax. The individual also is required to provide security to
ensure payment of the tax under this election in such form,
manner, and amount as the Secretary of the Treasury requires.
Date of relinquishment of citizenship
Under the provision, an individual is treated as having
relinquished U.S. citizenship on the date that the individual
first makes known to a U.S. government or consular officer his
or her intention to relinquish U.S. citizenship. Thus, a U.S.
citizen who relinquishes citizenship by formally renouncing his
or her U.S. nationality before a diplomatic or consular officer
of the United States is treated as having relinquished
citizenship on that date, provided that the renunciation is
later confirmed by the issuance of a CLN. A U.S. citizen who
furnishes to the State Department a signed statement of
voluntary relinquishment of U.S. nationality confirming the
performance of an expatriating act with the requisite interest
to relinquish his or her citizenship is treated as having
relinquished his or her citizenship on the date the statement
is so furnished (regardless of when the expatriating act was
performed), provided that the voluntary relinquishment is later
confirmed by the issuance of a CLN. If neither of these
circumstances exist, the individual is treated as having
relinquished citizenship on the date a CLN is issued or a
certificate of naturalization is canceled. The date of
relinquishment of citizenship determined under the provision
applies for all tax purposes.
Effect on present-law expatriation provisions
Under the provision, the present-law income tax provisions
with respect to U.S. citizens who expatriate with a principal
purpose of avoiding tax (sec. 877) and certain aliens who have
a break in residency status (sec. 7701(b)(10)) do not apply to
U.S. citizens who are treated as relinquishing their
citizenship on or after February 6, 1995 or to long-term U.S.
residents who terminate their residency on or after such date.
The special estate and gift tax provisions with respect to
individuals who expatriate with a principal purpose of avoiding
tax (secs. 2107 and 2501(a)(3)), however, continue to apply; a
credit against the tax imposed solely by reason of such special
provisions is allowed for the expatriation tax imposed with
respect to the same property.
Treatment of gifts and inheritances from an expatriate
Under the provision, the exclusion from income provided in
section 102 does not apply to the value of any property
received by gift or inheritance from an individual who was
subject to the expatriation tax (i.e., an individual who
relinquished citizenship or terminated residency and to whom
the expatriation tax was applicable). Accordingly, a U.S.
taxpayer who receives a gift or inheritance from such an
individual is required to include the value of such gift or
inheritance in gross income and is subject to U.S. income tax
on such amount.
Required information reporting and sharing
Under the provision, an individual who relinquishes
citizenship or terminates residency is required to provide a
statement which includes the individual's social security
number, forwarding foreign address, new country of residence
and citizenship and, in the case of individuals with a net
worth of at least $500,000, a balance sheet. In the case of a
former citizen, such statement is due not later than the date
the individual's citizenship is treated as relinquished and is
provided to the State Department (or other government entity
involved in the administration of such relinquishment). The
entity to which the statement is provided by former citizens is
required to provide to the Secretary of the Treasury copies of
all statements received and the names of individuals who refuse
to provide such statements. In the case of a former long-term
resident, the statement is provided to the Secretary of the
Treasury with the individual's tax return for the year in which
the individual's U.S. residency is terminated. An individual's
failure to provide the statement required under this provision
results in the imposition of a penalty for each year the
failure continues equal to the greater of (1) 5 percent of the
individual's expatriation tax liability for such year or (2)
$1,000.
The provision requires the State Department to provide the
Secretary of the Treasury with a copy of each CLN approved by
the State Department. Similarly, the provision requires the
agency administering the immigration laws to provide the
Secretary of the Treasury with the name of each individual
whose status as a lawful permanent resident has been revoked or
has been determined to have been abandoned.
Further, the provision requires the Secretary of the
Treasury to publish in the Federal Register the names of all
former U.S. citizens with respect to whom it receives the
required statements or whose names it receives under the
foregoing information-sharing provisions.
Treasury report
The provision directs the Treasury Department to undertake
a study on the tax compliance of U.S. citizens and green-card
holders residing outside the United States and to make
recommendations regarding the improvement of such compliance.
The findings of such study and such recommendations are
required to be reported to the House Committee on Ways and
Means and the Senate Committee on Finance within 90 days of the
date of enactment.
Effective date
The provision is effective for U.S. citizens whose date of
relinquishment of citizenship (as determined under the
provision, see ``Date of relinquishment of citizenship'' above)
occurs on or after February 6, 1995. Similarly, the provision
is effective for long-term residents who terminate their U.S.
residency on or after February 6, 1995.
U.S. citizens who committed an expatriating act with the
requisite intent to relinquish their U.S. citizenship prior to
February 6, 1995, but whose date of relinquishment of
citizenship (as determined under the provision) does not occur
until after such date, are subject to the expatriation tax
under the provision as of date of relinquishment of
citizenship. However, the individual is not subject
retroactively to worldwide tax as a U.S. citizen for the period
after he or she committed the expatriating act (and therefore
ceased being a U.S. citizen for tax purposes under present
law). Such an individual continues to be subject to the
expatriation tax imposed by present-law section 877 until the
individual's date of relinquishment of citizenship (at which
time the individual is subject to the expatriation tax of the
provision). The rules described in this paragraph do not apply
to an individual who committed an expatriating act prior to
February 6, 1995, but did not do so with the requisite intent
to relinquish his or her U.S. citizenship.
The tentative tax is not required to be paid, and the
reporting requirements are not required to be met, until 90
days after the date of enactment. The reporting provisions
apply to all individuals whose date of relinquishment of U.S.
citizenship or termination of U.S. residency occurs on or after
February 6, 1995.
Tax Technical Corrections Provisions
The technical corrections subtitle contains clerical,
conforming and clarifying amendments to the provisions enacted
by the Revenue Reconciliation Act of 1990, the Revenue
Reconciliation Act of 1993, and other recently enacted
legislation. All amendments made by this title are meant to
carry out the intent of Congress in enacting the original
legislation. Therefore, no separate ``Reasons for Change'' is
set forth for each individual amendment. Except as otherwise
described, the amendments made by the technical corrections
title take effect as if included in the original legislation to
which each amendment relates.
a. technical corrections to the revenue reconciliation act of 1990
1. Excise tax provisions
a. Application of the 2.5-cents-per-gallon tax on fuel used
in rail transportation to States and local
governments (sec. 1702(b)(2) of the bill, sec.
11211(b)(4) of the 1990 Act, and sec. 4093 of the
Code)
Present law
The 1990 Act increased the highway and motorboat fuels
taxes by 5 cents per gallon, effective on December 1, 1990. The
1990 Act continued the exemption from these taxes for fuels
used by States and local governments.
The 1990 Act further imposed a 2.5-cents-per-gallon tax on
fuel used in rail transportation, also effective on December 1,
1990. Because of a drafting error, the 2.5-cents-per-gallon tax
on fuel used in rail transportation incorrectly applies to fuel
used by States and local governments.
Explanation of provision
The bill clarifies that the 2.5-cents-per-gallon tax on
fuel used in rail transportation does not apply to such uses by
States and local governments.
b. Small winery production credit and bonding requirements
(secs. 1702(b)(5), (6), and (7) of the bill, sec.
11201 of the 1990 Act, and sec. 5041 of the Code)
Present law
A 90-cents-per-gallon credit is allowed to wine producers
who produce no more than 250,000 gallons of wine in a year. The
credit may be claimed against the producers' excise or income
taxes.
Wine producers must post a bond in amounts determined by
reference to expected excise tax liability as a condition of
legally operating.
Explanation of provision
The bill clarifies that wine produced by eligible small
wineries may be transferred without payment of tax to bonded
warehouses that become liable for payment of the wine excise
tax without losing credit eligibility. In such cases, the
bonded warehouse will be eligible for the credit to the same
extent as the producer otherwise would have been.
The bill further clarifies that the Treasury Department has
broad regulatory authority to prevent the benefit of the credit
from accruing (directly or indirectly) to wineries producing in
excess of 250,000 gallons in a calendar year.
It is intended that the Treasury regulatory authority will
extend to all circumstances in which wine production is
increased with a purpose of securing indirect credit
eligibility for wine produced by such large producers.
The bill also clarifies that the Treasury Department may
take the amount of credit expected to be claimed against a
producer's wine excise tax liability into account in
determining the amount of required bond.
2. Other revenue-increase provisions of the 1990 Act
a. Deposits of Railroad Retirement Tax Act taxes (sec.
1702(c)(3) of the bill, sec. 11334 of the 1990 Act,
and sec. 6302(g) of the Code)
Present law
Employers must deposit income taxes withheld from
employees' wages and FICA taxes that are equal to or greater
than $100,000 by the close of the next banking day. Under the
Railroad Retirement Solvency Act of 1983, the deposit rules for
withheld income taxes and FICA taxes automatically apply to
Railroad Retirement Tax Act taxes (sec. 226 of P.L. 98-76).
Explanation of provision
The bill conforms the Internal Revenue Code to the Railroad
Retirement Solvency Act of 1983 by stating in the Code that
these deposit rules for withheld income taxes and FICA taxes
apply to Railroad Retirement Tax Act taxes.
b. Treatment of salvage and subrogation of property and
casualty insurance companies (sec. 1702(c)(4) of
the bill and sec. 11305 of the 1990 Act)
Present law
For taxable years beginning after December 31, 1989,
property and casualty insurance companies are required to
reduce the deduction allowed for losses incurred (both paid and
unpaid) by estimated recoveries of salvage and subrogation
attributable to such losses. In the case of any property and
casualty insurance company that took into account estimated
salvage and subrogation recoverable in determining losses
incurred for its last taxable year beginning before January 1,
1990, 87 percent of the discounted amount of the estimated
salvage and subrogation recoverable as of the close of the last
taxable year beginning before January 1, 1990, is allowed as a
deduction ratably over the first 4 taxable years beginning
after December 31, 1989. This special deduction was enacted in
order to provide such property and casualty insurance companies
with substantially the same Federal income tax treatment as
that provided to those property and casualty insurance
companies that prior to the Revenue Reconciliation Act of 1990
did not take into account estimated salvage and subrogation
recoverable in determining losses incurred.
Explanation of provision
The bill provides that the earnings and profits of any
property and casualty insurance company that took into account
estimated salvage and subrogation recoverable in determining
losses incurred for its last taxable year beginning before
January 1, 1990, is to be determined without regard to the
special deduction that is allowed over the first 4 taxable
years beginning after December 31, 1989. The special deduction
is to be taken into account, however, in determining earnings
and profits for purposes of applying sections 56, 902, and
subpart F of part III of subchapter N of chapter 1 of the
Internal Revenue Code of 1986. This provision is considered
necessary in order to provide those property and casualty
insurance companies that took into account estimated salvage
and subrogation recoverable in determining losses incurred with
substantially the same Federal income tax treatment as that
provided to those property and casualty insurance companies
that prior to the 1990 Act did not take into account estimated
salvage and subrogation recoverable in determining losses
incurred.
c. Information with respect to certain foreign-owned or
foreign corporations: Suspension of the statute of
limitations during certain judicial proceedings
(sec. 1702(c)(5) of the bill, secs. 11314 and 11315
of the 1990 Act, and secs. 6038A and 6038C of the
Code)
Present law
Any domestic corporation that is 25-percent owned by one
foreign person is subject to certain information reporting and
recordkeeping requirements with respect to transactions carried
out directly or indirectly with certain foreign persons treated
as related to the domestic corporation (``reportable
transactions'') (sec. 6038A(a)). In addition, the Code provides
procedures whereby an IRS examination request or summons with
respect to reportable transactions can be served on foreign
related persons through the domestic corporation (sec.
6038A(e)). Similar provisions apply to any foreign corporation
engaged in a trade or business within the United States, with
respect to information, records, examination requests, and
summonses pertaining to the computation of its liability for
tax in the United States (sec. 6038C). Certain noncompliance
rules may be applied by the Internal Revenue Service in the
case of the failure by a domestic corporation to comply with a
summons pertaining to a reportable transaction (a ``6038A
summons'') (sec. 6038A(e)), or the failure by a foreign
corporation engaged in a U.S. trade or business to comply with
a summons issued for purposes of determining the foreign
corporation's liability for tax in the United States (a ``6038C
summons'') (sec. 6038C(d)).
Any corporation that is subject to the provisions of
section 6038A or 6038C has the right to petition a Federal
district court to quash a 6038A or 6038C summons, or to review
a determination by the IRS that the corporation did not
substantially comply in a timely manner with the 6038A or 6038C
summons (sec. 6038A(e)(4)(A) and (B); sec. 6038C(d)(4)). During
the period that either such judicial proceeding is pending
(including appeals), and for up to 90 days thereafter, the
statute of limitations is suspended with respect to any
transaction (or item, in the case of a foreign corporation) to
which the summons relates (secs. 6038A(e)(4)(D), 6038C(d)(4)).
The legislative history of the 1989 Act amendments to
section 6038A states that the suspension of the statute of
limitations applies to ``the taxable year(s) at issue.''
111 The legislative history of the 1990 Act, which added
section 6038C to the Code, uses the same language.112
---------------------------------------------------------------------------
\111\ H. Rept. No. 247, 101st Cong., 1st Sess. 1301 (1989);
``Explanation of Provisions Approved by the Committee on October 3,
1989,'' Senate Finance Committee Print, 101st Cong., 1st Sess. 118
(October 12, 1989).
\112\ ``Legislative History of Ways and Means Democratic
Alternative,'' House Ways and Means Committee Print (WMCP: 101-37),
101st Cong., 2nd Sess. 58 (October 15, 1990); Report language submitted
by the Senate Finance Committee to the Senate Budget Committee on S.
3299, 136 Cong. Rec. S 15629, S 15700 (1990).
---------------------------------------------------------------------------
Explanation of provision
The bill modifies the provisions in sections 6038A and
6038C that suspend the statute of limitations to clarify that
the suspension applies to any taxable year the determination of
the amount of tax imposed for which is affected by the
transaction or item to which the summons relates.
It is intended that, under the provision, a transaction or
item would affect the determination of the amount of tax
imposed for the taxable year directly at issue, as well as for
any taxable year indirectly affected through, for example, net
operating loss carrybacks or carryforwards. It is not intended
that, under the provision, a transaction or item would affect
the determination of the amount of tax imposed for any taxable
year other than the taxable year directly at issue solely by
reason of any similarity of issues involved. Similarly, it is
not intended that, under the provision, a transaction or item
would affect the determination of the amount of tax imposed on
any taxpayer unrelated to the taxpayer to whom the summons is
directed.
d. Rate of interest for large corporate underpayments
(secs. 1702(c)(6) and (7) of the bill, sec. 11341
of the 1990 Act, and sec. 6621(c) of the Code)
Present law
The rate of interest otherwise applicable to underpayments
of tax is increased by two percent in the case of large
corporate underpayments (generally defined to exceed $100,000),
applicable to periods after the 30th day following the earlier
of a notice of proposed deficiency, the furnishing of a
statutory notice of deficiency, or an assessment notice issued
in connection with a nondeficiency procedure.
Explanation of provision
The bill provides that an IRS notice that is later
withdrawn because it was issued in error does not trigger the
higher rate of interest. The bill also corrects an incorrect
reference to ``this subtitle''.
3. Research credit provision: Effective date for repeal of special
proration rule (sec. 1702(d)(1) of the bill and sec. 11402 of
the 1990 Act)
Present law
The Omnibus Budget Reconciliation Act of 1989 (``1989
Act'') effectively extended the research credit for nine months
by prorating certain qualified research expenses incurred
before January 1, 1991. The special rule to prorate qualified
research expenses applied in the case of any taxable year which
began before October 1, 1990, and ended after September 30,
1990. Under this special proration rule, the amount of
qualified research expenses incurred by a taxpayer prior to
January 1, 1991, was multiplied by the ratio that the number of
days in that taxable year before October 1, 1990, bears to the
total number of days in such taxable year before January 1,
1991. The amendments made by the 1989 Act to the research
credit (including the new method for calculating a taxpayer's
base amount) generally were effective for taxable years
beginning after December 31, 1989. However, this effective date
did not apply to the special proration rule (which applied to
any taxable year which began prior to October 1, 1990--
including some years which began before December 31, 1989--if
such taxable year ended after September 30, 1990).
Section 11402 of the Revenue Reconciliation Act of 1990
(``1990 Act'') extended the research credit through December
31, 1991, and repealed the special proration rule provided for
by the 1989 Act. Section 11402 of the 1990 Act was effective
for taxable years beginning after December 31, 1989. Thus, in
the case of taxable years beginning before December 31, 1989,
and ending after September 30, 1990 (e.g., a taxable year of
November 1, 1989 through October 31, 1990), the special
proration rule provided by the 1989 Act would continue to
apply.
Explanation of provision
The bill repeals for all taxable years ending after
December 31, 1989, the special proration rule provided for by
the 1989 Act.
4. Energy tax provision: Alternative minimum tax adjustment based on
energy preferences (secs. 1702(e)(1) and (4) of the bill, sec.
11531(a) of the 1990 Act, and former sec. 56(h) of the Code)
Present law
In computing alternative minimum taxable income (and the
adjusted current earnings (ACE) adjustment of the alternative
minimum tax), certain adjustments are made to the taxpayer's
regular tax treatment for intangible drilling costs (IDCs) and
depletion. For certain taxable years, a special energy
deduction is also allowed. The special energy deduction is
initially determined by determining the taxpayer's (1)
intangible drilling cost preference and (2) the marginal
production depletion preference. The intangible drilling cost
preference is the amount by which the taxpayer's alternative
minimum taxable income would be reduced if it were computed
without regard to the adjustments for IDCs. The marginal
production depletion preference is the amount by which the
taxpayer's alternative minimum taxable income would be reduced
if it were computed without regard to depletion adjustments
attributable to marginal production. The intangible drilling
cost preference is then apportioned between (1) the portion of
the preference related to qualified exploratory costs and (2)
the remaining portion of the preference. The portion of the
preference related to qualified exploratory costs is multiplied
by 75 percent and the remaining portion is multiplied by 15
percent. The marginal production depletion preference is
multiplied by 50 percent. The three products described above
are added together to arrive at the taxpayer's special energy
deduction (subject to certain limitations).
The special energy deduction is not allowed to the extent
that it exceeds 40 percent of alternative minimum taxable
income determined without regard to either this special energy
deduction or the alternative tax net operating loss deduction.
Any special energy deduction amount limited by the 40-percent
threshold may not be carried to another taxable year. In
addition, the combination of the special energy deduction, the
alternative minimum tax net operating loss and the alternative
minimum tax foreign tax credit cannot generally offset, in the
aggregate, more than 90 percent of a taxpayer's alternative
minimum tax determined without such attributes.
The special energy deduction was repealed for taxable years
beginning after December 31, 1992.
Explanation of provision
Interaction of special energy deduction with net operating loss and
investment tax credit
The bill clarifies that the amount of alternative tax net
operating loss that is utilized in any taxable year is to be
appropriately adjusted to take into account the amount of
special energy deduction claimed for that year. This operates
to preserve a portion of the alternative tax net operating loss
carryover by reducing the amount of net operating loss utilized
to the extent of the special energy deduction claimed, which if
unused, could not be carried forward.
In addition, the bill contains a similar provision which
clarifies that the limitation on the utilization of the
investment tax credit for purposes of the alternative minimum
tax is to be determined without regard to the special energy
deduction.
Interaction of special energy deduction with adjustment based on
adjusted current earnings
The bill provides that the ACE adjustment for taxable years
beginning in 1991 and 1992 is to be computed without regard to
the special energy deduction. Thus, the bill specifies that the
ACE adjustment is equal to 75 percent of the excess of a
corporation's adjusted current earnings over its alternative
minimum taxable income computed without regard to either the
ACE adjustment, the alternative tax net operating loss
deduction, or the special energy deduction.
5. Estate tax freezes (sec. 1702(f) of the bill, sec. 11602 of the 1990
Act, and secs. 2701-2704 of the Code)
Present law
Generally
The value of property transferred by gift or includible in
the decedent's gross estate is its fair market value. Fair
market value generally is the price at which the property would
change hands between a willing buyer and willing seller,
neither being under any compulsion to buy or sell and both
having reasonable knowledge of relevant facts (Treas. Reg. sec.
20.2031). Chapter 14 contains rules that supersede the willing
buyer, willing seller standard (Code secs. 2701-2704).
Preferred interests in corporations and partnerships
Valuation of retained interests
Scope.--Section 2701 provides special rules for valuing
certain rights retained in conjunction with the transfer to a
family member of an interest in a corporation or partnership.
These rules apply to any applicable retained interest held by
the transferor or an applicable family member immediately after
the transfer of an interest in such entity. An ``applicable
family member'' is, with respect to any transferor, the
transferor's spouse, ancestors of the transferor and the
spouse, and spouses of such ancestors.
An applicable retained interest is an interest with respect
to which there is one of two types of rights (``affected
rights''). The first type of affected right is a liquidation,
put, call, or conversion right, generally defined as any
liquidation, put, call, or conversion right, or similar right,
the exercise or nonexercise of which affects the value of the
transferred interest. The second type of affected right is a
distribution right 113 in an entity in which the
transferor and applicable family members hold control
immediately before the transfer. In determining control, an
individual is treated as holding any interest held by the
individual's brothers, sisters and lineal descendants. A
distribution right does not include any right with respect to a
junior equity interest.
---------------------------------------------------------------------------
\113\ Distribution right generally is a right to a distribution
from a corporation with respect to its stock, or from a partnership
with respect to a partner's interest in the partnership.
---------------------------------------------------------------------------
Valuation.--Section 2701 contains two rules for valuing
applicable retained interests. Under the first rule, an
affected right other than a right to qualified payments is
valued at zero. Under the second rule, any retained interest
that confers (1) a liquidation, put, call or conversion right
and (2) a distribution right that consists of the right to
receive a qualified payment is valued on the assumption that
each right is exercised in a manner resulting in the lowest
value for all such rights (the ``lowest value rule''). There is
no statutory rule governing the treatment of an applicable
retained interest that confers a right to receive a qualified
payment, but with respect to which there is no liquidation,
put, call or conversion right.
A qualified payment is a dividend payable on a periodic
basis and at a fixed rate under cumulative preferred stock (or
a comparable payment under a partnership agreement). A
transferor or applicable family member may elect not to treat
such a dividend (or comparable payment) as a qualified payment.
A transferor or applicable family member also may elect to
treat any other distribution right as a qualified payment to be
paid in the amounts and at the times specified in the election.
Inclusion in transfer tax base.--Failure to make a
qualified payment valued under the lowest value rule within
four years of its due date generally results in an inclusion in
the transfer tax base equal to the difference between the
compounded value of the scheduled payments over the compounded
value of the payments actually made. The Treasury Department
has regulatory authority to make subsequent transfer tax
adjustments in the transfer of an applicable retained interest
to reflect the increase in a prior taxable gift by reason of
section 2701.
Generally, this inclusion occurs if the holder transfers by
sale or gift the applicable retained interest during life or at
death. In addition, the taxpayer may, by election, treat the
payment of the qualified payment as giving rise to an inclusion
with respect to prior periods.
The inclusion continues to apply if the applicable retained
interest is transferred to an applicable family member. There
is no inclusion on a transfer of an applicable retained
interest to a spouse for consideration or in a transaction
qualifying for the marital deduction, but subsequent transfers
by the spouse are subject to the inclusion. Other transfers to
applicable family members result in an immediate inclusion as
well as subjecting the transferee to subsequent inclusions.
Minimum value of residual interest
Section 2701 also establishes a minimum value for a junior
equity interest in a corporation or partnership. For
partnerships, a junior equity interest is an interest under
which the rights to income and capital are junior to the rights
of all other classes of equity interests.
Trusts and term interests in property
The value of a transfer in trust is the value of the entire
property less the value of rights in the property retained by
the grantor. Section 2702 provides that in determining the
extent to which a transfer of an interest in trust to a member
of the transferor's family is a gift, the value of an interest
retained by the transferor or an applicable family member is
zero unless such interest takes certain prescribed forms.
For a transfer with respect to a specified portion of
property, section 2702 applies only to such portion. The
section does not apply to the extent that the transfer is
incomplete.
Options and buy-sell agreements
A restriction upon the sale or transfer of property may
reduce its fair market value. Treasury regulations provide that
a restriction is to be disregarded unless the agreement
represents a bona fide business arrangement and not a device to
pass the decedent's shares to the natural objects of his bounty
for less than full and adequate consideration (Treas. Reg. sec.
20.2031-2(h)).
Section 2703 provides, that for transfer tax purposes, the
value of property is determined without regard to any option,
agreement or other right to acquire or use the property at less
than fair market value or any restriction on the right to sell
or use such property. Certain options are excepted from this
rule. To fall within the exception, the option, agreement,
right or restriction must (1) be a bona fide business
arrangement, (2) not be a device to transfer such property to
members of the decedent's family for less than full and
adequate consideration in money or money's worth, and (3) have
terms comparable to similar arrangements entered into by
persons in an arm's length transaction.
Explanation of provision
Preferred interests in corporations and partnerships
Valuation
The bill provides that an applicable retained interest
conferring a distribution right to qualified payments with
respect to which there is no liquidation, put, call, or
conversion right is valued without regard to section 2701. The
bill also provides that the retention of such right gives rise
to potential inclusion in the transfer tax base. In making
these changes, it is understood that Treasury regulations could
provide, in appropriate circumstances, that a right to receive
amounts on liquidation of the corporation or partnership
constitutes a liquidation right within the meaning of section
2701 if the transferor, alone or with others, holds the right
to cause liquidation.
The bill modifies the definition of junior equity interest
by granting regulatory authority to treat a partnership
interest with rights that are junior with respect to either
income or capital as a junior equity interest. The bill also
modifies the definition of distribution right by replacing the
junior equity interest exception with an exception for a right
under an interest that is junior to the rights of the
transferred interest. As a result, section 2701 does not affect
the valuation of a transferred interest that is senior to the
retained interest, even if the retained interest is not a
junior equity interest.
The bill modifies the rules for electing into or out of
qualified payment treatment. A dividend payable on a periodic
basis and at a fixed rate under a cumulative preferred stock
held by the transferor is treated as a qualified payment unless
the transferor elects otherwise. If held by an applicable
family member, such stock is not treated as a qualified payment
unless the holder so elects.114 In addition, a transferor
or applicable family member holding any other distribution
right may treat such right as a qualified payment to be paid in
the amounts and at the times specified in the election.
---------------------------------------------------------------------------
\114\ With respect to gifts made prior to the date of enactment,
the provision provides that this election may be made by the due date
(including extensions) of the transferor's gift tax return due for the
first calendar year after the date of enactment.
---------------------------------------------------------------------------
Prior technical corrections bills also included a provision
to provide a special definition of ``applicable family member''
for purposes of determining control under section 2701. The
bill does not include this provision.
Inclusion in transfer tax base
The bill grants the Treasury Department regulatory
authority to make subsequent transfer tax adjustments to
reflect the inclusion of unpaid amounts with respect to a
qualified payment. This authority, for example, would permit
the Treasury Department to eliminate the double taxation that
might occur if, with respect to a transfer, both the inclusion
and the value of qualified payment arrearages were included in
the transfer tax base. It also would permit elimination of the
double taxation that might result from a transfer to a spouse,
who, under the statute, is both an applicable family member and
a member of the transferor's family.
The bill treats a transfer to a spouse falling under the
annual exclusion the same as a transfer qualifying for the
marital deduction. Thus, no inclusion would occur upon the
transfer of an applicable retained interest to a spouse, but
subsequent transfers by the spouse would be subject to
inclusion. The bill also clarifies that the inclusion continues
to apply if an applicable family member transfers a right to
qualified payments to the transferor.
The provision clarifies the consequences of electing to
treat a distribution as giving rise to an inclusion. Under the
bill, the election gives rise to an inclusion only with respect
to the payment for which the election is made. The inclusion
with respect to other payments is unaffected.
Trust and term interests in property
The bill conforms section 2702 to existing regulatory
terminology by substituting the term ``incomplete gift'' for
``incomplete transfer.'' In addition, the bill limits the
exception for incomplete gifts to instances in which the entire
gift is incomplete. The Treasury Department is granted
regulatory authority, however, to create additional exceptions
not inconsistent with the purposes of the section. This
authority, for example, could be used to except a charitable
remainder trust that meets the requirements of section 664 and
that does not otherwise create an opportunity for transferring
property to a family member free of transfer tax.
6. Miscellaneous provisions
a. Conforming amendments to the repeal of the General
Utilities doctrine (secs. 1702(g)(1) and (2) of the
bill, sec. 11702(e)(2) of the 1990 Act, and secs.
897(f) and 1248 of the Code)
Present law
As a result of changes made by recent tax legislation, gain
is generally recognized on the distribution of appreciated
property by a corporation to its shareholders. The Technical
Corrections subtitle of the 1990 Act and technical correction
provisions in prior acts made various conforming amendments
arising out of these changes. For example, the 1990 Act made a
conforming change to section 355(c) to state the treatment of
distributions in section 355 transactions in the affirmative
rather than by reference to the provisions of section 311. In
addition, the Technical and Miscellaneous Revenue Act of 1988
(``1988 Act'') made a conforming change to section 1248(f) to
update the references to the nonrecognition provisions
contained in that subsection. One of the changes was to change
the reference to ``section 311(a)'' from ``section 311''.
Explanation of provision
The bill makes three conforming changes to the Code with
respect to the repeal of the General Utilities doctrine.
First, section 1248(f) is amended to add a reference to
section 355(c)(1), which provides generally for the
nonrecognition of gain or loss on the distribution of stock or
securities in certain subsidiary corporations. This retains the
substance of the law as it existed before the conforming change
to section 355(c) made by the 1990 Act. This provision is not
intended to affect the authority of the Secretary of the
Treasury to issue regulations under section 1248(f) providing
exceptions to the rule recognizing gain in certain
distributions (cf. Notice 87-64, 1987-2 C.B. 375).
Second, section 1248 is amended to clarify that,
notwithstanding the conforming changes made by the 1988 Act,
with respect to any transaction in which a U.S. person is
treated as realizing gain from the sale or exchange of stock of
a controlled foreign corporation, the U.S. person shall be
treated as having sold or exchanged the stock for purposes of
applying section 1248. Thus, if a U.S. person distributes
appreciated stock of a controlled foreign corporation to its
shareholders in a transaction in which gain is recognized under
section 311(b), section 1248 shall be applied as if the stock
had been sold or exchanged at its fair market value. Under
section 1248(a), part or all of the gain may be treated as a
dividend. Under the bill, the rule treating the distribution
for purposes of section 1248 as a sale or exchange also applies
where the U.S. person is deemed to distribute the stock under
the provisions of section 1248(i). Under section 1248(i), gain
will be recognized only to the extent of the amount treated as
a dividend under section 1248.
Third, section 897(f), relating to the basis in a United
States real property interest distributed to a foreign person,
is repealed as deadwood. The basis of the distributed property
is its fair market value in accordance with section 301(d).
b. Prohibited transaction rules (sec. 1702(g)(3) of the
bill, sec. 11701(m) of the 1990 Act, and sec. 4975
of the Code)
Present law
The Code and title I of the Employee Retirement Income
Security Act of 1974 (ERISA) prohibit certain transactions
between an employee benefit plan and certain persons related to
such plan. An exemption to the prohibited transaction rules of
title I of ERISA is provided in the case of sales of employer
securities the plan is required to dispose of under the Pension
Protection Act of 1987 (ERISA sec. 408(b)(12)). The 1990 Act
amended the Code to provide that certain transactions that are
exempt from the prohibited transaction rules of ERISA are
automatically exempt from the prohibited transaction rules of
the Code. The 1990 Act change was intended to be limited to
transactions exempt under section 408(b)(12) of ERISA.
Explanation of provision
The bill conforms the statutory language to legislative
intent by providing that transactions that are exempt from the
prohibited transaction rules of ERISA by reason of ERISA
section 408(b)(12) are also exempt from the prohibited
transaction rules of the Code.
c. Effective date of LIFO adjustment for purposes of
computing adjusted current earnings (sec.
1702(g)(4) of the bill, sec. 11701 of the 1990 Act,
sec. 7611(b) of the 1989 Act, and sec. 56(g) of the
Code)
For purposes of computing the adjusted current earnings
(ACE) component of the corporate alternative minimum tax,
taxpayers are required to make the LIFO inventory adjustments
provided in section 312(n)(4) of the Code. Section 312(n)(4)
generally is applicable for purposes of computing earnings and
profits in taxable years beginning after September 30, 1984.
The ACE adjustment generally is applicable to taxable years
beginning after December 31, 1989.
Explanation of provision
The bill clarifies that the LIFO inventory adjustment
required for ACE purposes shall be computed by applying the
rules of section 312(n)(4) only with respect to taxable years
beginning after December 31, 1989. The effective date
applicable to the determination of earnings and profits
(September 30, 1984) is inapplicable for purposes of the ACE
LIFO inventory adjustment. Thus, the ACE LIFO adjustment shall
be computed with reference to increases (and decreases, to the
extent provided in Treasury regulations) in the ACE LIFO
reserve in taxable years beginning after December 31, 1989.
d. Low-income housing credit (sec. 1702(g)(5) of the bill,
sec. 11701(a)(11) of the 1990 Act, and sec. 42 of
the Code)
Present law
The amendments to the low-income housing tax credit
contained in the Omnibus Budget Reconciliation Act of 1989
(``1989 Act'') generally were effective for buildings placed in
service after December 31, 1989, to the extent the buildings
were financed by tax-exempt bonds (``bond-financed
buildings''). This rule applied regardless of when the bonds
were issued.
A technical correction enacted in the Revenue
Reconciliation Act of 1990 (``1990 Act'') limited this
effective date to buildings financed with bonds issued after
December 31, 1989. Thus, the technical correction applied pre-
1989 Act law to bond-financed buildings placed in service after
December 31, 1989, if the bonds were issued before January 1,
1990.
Explanation of provision
The bill repeals the 1990 technical correction. The bill
provides, however, that pre-1989 Act law will apply to a bond-
financed building if the owner of the building establishes to
the satisfaction of the Secretary of the Treasury reasonable
reliance upon the 1990 technical correction. In the case of
buildings placed in service before the date of the bill's
enactment, reasonable reliance may be established by a showing
of compliance with the law as in effect for those buildings
before enactment of the amendments made by the bill.
7. Expired or obsolete provisions (``deadwood provisions'') (secs.
1702(h)(1)-(18) of the bill and secs. 11801-1816 of the 1990
Act)
Present law
The 1990 Act repealed and amended numerous sections of the
Code by deleting obsolete provisions (``deadwood''). These
amendments were not intended to make substantive changes to the
tax law.
Explanation of provision
The bill makes several amendments to restore the substance
of prior law which was inadvertently changed by the deadwood
provisions of the 1990 Act. These amendments include (1) a
provision that clarifies that solar or wind property owned by a
public utility may qualify as 5-year MACRS property (sec.
168(e)(3)(B)(vi)); (2) a provision restoring the prior-law rule
providing that if any member of an affiliated group of
corporations elects the credit under section 901 for foreign
taxes paid or accrued, then all members of the group paying or
accruing such taxes must elect the credit in order for any
dividend paid by a member of the group to qualify for the 100-
percent dividends received deduction (sec. 243(b)); and (3) a
provision that denies section 179 expensing for property
described in section 50(b) and air conditioning and heating
units.
The bill also makes several nonsubstantive clerical
amendments to conform the Code to the amendments made by the
deadwood provisions. None of these amendments is intended to
change the substance of pre-1990 law.
B. technical corrections to the revenue reconciliation act of 1993
1. Treatment of full-time students under the low-income housing credit
(sec. 1703(b)(1) of the bill, sec. 13142 of the 1993 Act and
sec. 42 of the Code).
Present law
The Revenue Reconciliation Act of 1993 (``1993 Act'')
codified prior law rules relating to the treatment of married
students filing joint returns. Further, it provided that a
housing unit occupied entirely by full-time students may
qualify for the credit if the full-time students are a single
parent and his or her minor children and none of the tenants is
a dependent of a third party.
Explanation of provision
The bill provides that the full-time student provision is
effective on the date of enactment of the 1993 Act.
2. Indexation of threshold applicable to excise tax on luxury
automobiles (sec. 1703(c) of the bill, sec. 13161 of the 1993
Act, and sec. 4001(e)(1) of the Code)
Present law
The 1993 Act indexed the threshold above which the excise
tax on luxury automobiles is to apply.
Explanation of provision
The bill corrects the application of the indexing
adjustment so that the adjustment calculated for a given
calendar year applies for that calendar year rather than in the
subsequent calendar year. This conforms the indexation to that
described in the conference report to the 1993 Act.115 The
intent of Congress, as reflected in the conference report, was
that current year indexation be effective on the date of
enactment of the 1993 Act. Under the bill, the provision would,
however, be effective on the date of enactment, to alleviate
the difficulties that both taxpayers and the Treasury would
experience in administering a retroactive refund effective to
August 10, 1993.
---------------------------------------------------------------------------
\115\ See, H. Rept. 103-213, August 4, 1993, p. 558.
---------------------------------------------------------------------------
3. Indexation of the limitation based on modified adjusted gross income
for income from United States Savings bonds used to pay higher
education tuition and fees (sec. 1703(d) of the bill, sec.
13201 of the 1993 Act, and sec. 135(b)(2)(B) of the Code)
Present law
A taxpayer may exclude from gross income the proceeds from
the redemption of qualified United States savings bonds if the
proceeds are used to pay qualified higher education expenses
and the taxpayer's modified adjusted gross income is equal to
or less than $60,000 ($40,000 in the case of a single return).
The exclusion is phased out for incomes above these thresholds.
The $60,000 ($40,000) threshold is indexed for inflation
occurring after 1992.
Explanation of provision
The bill corrects the indexing of the $60,000 ($40,000)
threshold to provide that the thresholds be indexed for
inflation after 1989, as was provided prior to the 1993 Act.
4. Reporting and notification requirements for lobbying and political
expenditures of tax-exempt organizations (sec. 1703(g) of the
bill, sec. 13222 of the 1993 Act and sec. 6033(e) of the Code)
Present law
Tax-exempt organizations which incur political expenditures
are subject to tax under Code section 527(f). The tax is
calculated by applying the highest corporate rate to the lesser
of (a) the net investment income of the organization, or (b)
the amount of political expenditures incurred by the
organization during the taxable year. Expenditures covered by
Code section 527(f) are those expended for ``influencing or
attempting to influence the selection, nomination, election, or
appointment of any individual to any Federal, State, or local
public office or office in a political organization, or the
election of Presidential or Vice-Presidential electors, whether
of not such individual or electors are selected, nominated,
elected, or appointed.''
Code section 162(e), as amended by the 1993 Act, provides a
separate set of rules regarding the tax treatment of lobbying
and political expenditures. Political expenditures include
amounts paid or incurred in connection with ``participation in,
or intervention in, any political campaign on behalf of (or in
opposition to) any candidate for public office.'' Taxpayers may
not deduct the portion of dues or similar amounts paid to a
tax-exempt organization which the organization notifies the
taxpayer are allocable to lobbying or political expenditures.
Code section 6033(e) sets forth reporting and notification
requirements applicable to tax-exempt organizations (other than
charities) that incur lobbying or political expenditures within
the meaning of Code section 162(e). First, the organization
must report on its annual tax return both the total amount of
its lobbying and political expenditures, and the total amount
of dues (or similar payments) allocable to such expenditures.
Second, the organization must either provide notice to its
members of the portion of dues allocable to lobbying and
political expenditures (so that such amounts are not deductible
by members), or may elect to pay a proxy tax (at the highest
corporate rate) on its lobbying and political expenditures, up
to the amount of dues receipts.
Explanation of provision
The bill amends Code section 6033(e) to clarify that any
political expenditures on which tax is paid pursuant to Code
section 527(f) are not subject to the reporting and
notification requirements of Code section 6033(e). In addition,
the bill clarifies that the reporting and notification
requirements of Code section 6033(e) apply to organizations
exempt from tax under Code section 501(a), other than charities
described in section 501(c)(3).
5. Estimated tax rules for certain tax-exempt organizations (sec.
1703(h) of the bill, sec. 13225 of the 1993 Act and sec.
6655(g)(3) of the Code)
Present law
A tax-exempt organization is generally subject to an
addition to tax for any underpayment of estimated tax on its
unrelated business taxable income or its net investment income
(as the case may be). Under the 1993 Act, for years beginning
after December 31, 1993, a corporation or tax-exempt
organization does not have an underpayment of estimated tax if
it makes four timely estimated tax payments that total at least
100 percent of the tax liability shown on its return for the
current taxable year. A corporation or tax-exempt organization
may estimate its current year tax liability prior to year-end
by annualizing its income. The 1993 Act also changed the method
by which a corporation annualizes its current year tax
liability.
Explanation of provision
The bill clarifies that the 1993 Act did not change the
method by which a tax-exempt organization annualizes its
current year tax liability.
6. Current taxation of certain earnings of controlled foreign
corporations--application of foreign tax credit limitation
(sec. 1703(i)(1) of the bill, sec. 13231(b) of the 1993 Act,
and sec. 904(d) of the Code)
Present law
Present law requires U.S. shareholders of a controlled
foreign corporation to include in income the corporation's
subpart F income, certain earnings invested in U.S. property,
and, as modified by the 1993 Act, certain earnings invested in
excess passive assets. A U.S. shareholder's tax liability
attributable to the inclusion may be offset by foreign tax
credits for certain foreign taxes paid or deemed paid by the
shareholder.
The foreign tax credit limitation applies separately to
several categories of income. The separate limitations apply to
a dividend from a controlled foreign corporation to a U.S.
shareholder of that controlled foreign corporation by reference
to the character of the earnings and profits of the
distributing corporation.
An inclusion of a controlled foreign corporation's earnings
invested in U.S. property is treated like a dividend for
purposes of the foreign tax credit limitation. Although the
1993 Act provided that inclusions of earnings invested in
excess passive assets generally are determined in the same
manner as inclusions of earnings invested in U.S. property, the
1993 Act did not specify how the separate limitations of the
foreign tax credit should apply to inclusions of earnings
invested in excess passive assets.
Some have argued that the separate limitations of the
foreign tax credit do not apply to an inclusion of a controlled
foreign corporation's earnings invested in excess passive
assets; rather, that such an inclusion is allocated entirely to
the general foreign tax credit limitation, without regard to
the character of the underlying earnings and profits of the
controlled foreign corporation.
Explanation of provision
The bill clarifies that a U.S. shareholder's inclusion of a
controlled foreign corporation's earnings invested in excess
passive assets is treated like a dividend for purposes of the
foreign tax credit limitation. Thus, the inclusion is
characterized by reference to the underlying earnings and
profits of the controlled foreign corporation. This treatment
is consistent with present law's application of the separate
limitations of the foreign tax credit to other amounts included
in income with respect to a controlled foreign corporation.
7. Current taxation of certain earnings of controlled foreign
corporations--measurement of accumulated earnings (sec.
1703(i)(2) of the bill, sec. 13231(b) of the 1993 Act, and sec.
956A(b) of the Code)
Present law
Present law, as modified by the 1993 Act, limits the
availability of deferral of U.S. tax on certain earnings of
controlled foreign corporations by requiring U.S. shareholders
of a controlled foreign corporation to include in income the
corporation's accumulated 116 or current earnings invested
in excess passive assets. Some have argued that the Code's
definition of earnings subject to this treatment permits an
accumulated deficit in earnings to eliminate positive current
earnings, resulting in no income inclusion in a case where an
actual distribution would be treated as a dividend out of
current earnings. In addition, some have argued that the Code's
definition of earnings subject to this treatment takes current-
year earnings into account more than once.
---------------------------------------------------------------------------
\116\ Accumulated earnings and profits are taken into account only
to the extent that they were accumulated in taxable years beginning
after September 30, 1993.
---------------------------------------------------------------------------
Explanation of provision
The bill clarifies that the accumulated earnings and
profits of a controlled foreign corporation taken into account
for purposes of determining the foreign corporation's earnings
invested in excess passive assets do not include any deficit in
accumulated earnings and profits,117 and do not include
current earnings (which are taken into account separately).
---------------------------------------------------------------------------
\117\ Incurred in taxable years beginning after September 30, 1993.
---------------------------------------------------------------------------
8. Current taxation of certain earnings of controlled foreign
corporations--aggregation and look-through rules (sec.
1703(i)(3) of the bill, sec. 13231(b) of the 1993 Act, and sec.
956A(f) of the Code)
Present law
Present law, as modified by the 1993 Act, provides certain
aggregation and look-through rules in connection with requiring
U.S. shareholders of a controlled foreign corporation to
include in income certain of the corporation's earnings
invested in excess passive assets. Under the aggregation rule,
certain groups of controlled foreign corporations that are
linked by stock ownership of more than 50 percent (CFC groups)
are treated as a single corporation for purposes of determining
their earnings invested in excess passive assets. Look-through
treatment applies to certain corporations whose stock is owned
at least 25 percent by a controlled foreign corporation. Some
have argued that these rules permit the assets of one foreign
corporation to be taken into account more than once through a
combination of CFC group treatment and look-through treatment.
In addition, some have argued that these rules permit the
assets of one foreign corporation to be taken into account more
than once through membership of the foreign corporation in more
than one CFC group.
Explanation of provision
The bill clarifies that, within the regulatory authority
provided to the Secretary of the Treasury under the 1993 Act,
regulations are specifically authorized to coordinate the CFC
group treatment and look-through treatment applicable for
purposes of determining a foreign corporation's earnings
invested in excess passive assets. Pending the promulgation of
guidance by the Secretary, it is intended that taxpayers be
permitted to coordinate such treatment using any reasonable
method for taking assets into account only once, so long as the
method is consistently applied to all controlled foreign
corporations (whether or not members of any CFC group) in all
taxable years.
9. Treatment of certain leased assets for PFIC purposes (sec.
1703(i)(5) of the bill, sec. 13231(d)(4) of the 1993 Act, and
sec. 1297(d) of the Code)
Present law
Under present law, as modified by the 1993 Act, certain
property leased by a foreign corporation may be treated as an
asset actually owned by the foreign corporation in measuring
the assets of the foreign corporation for purposes of the
passive foreign investment company (``PFIC'') asset test of
section 1296(a)(2). The 1993 Act provided a special measurement
rule, under which the adjusted basis of the leased asset for
this purpose is determined by reference to the unamortized
portion of the present value of the payments under the lease
for the use of the property. Some have argued, however, that
the special measurement rule does not apply to PFICs that are
permitted to measure their assets by fair market value, rather
than by adjusted basis. Under this argument, the entire fair
market value of the leased asset might be treated as owned by
the foreign corporation.
Explanation of provision
The bill clarifies that, in the case of any item of
property leased by a foreign corporation and treated as an
asset actually owned by the foreign corporation in measuring
the assets of the foreign corporation for purposes of the PFIC
asset test, the amount taken into account with respect to the
leased property is the amount determined under the 1993 Act's
special measurement rule, which is based on the unamortized
portion of the present value of the payments under the lease
for the use of the property. That is, the provision clarifies
that the special measurement rule of the 1993 Act applies to
all PFICs, regardless of whether they are generally permitted
to measure their assets by fair market value rather than
adjusted basis.
10. Expiration date of special ethanol blender refund (sec. 1703(k) of
the bill and sec. 6427 of the Code)
Present law
A 54-cents-per-gallon blender income tax credit is provided
for ethanol used as a motor fuel. This credit applies to
ethanol which is blended with gasoline (``gasohol'').
Gasoline is subject to an 18.3-cents-per-gallon excise tax.
As an alternative to claiming the income tax credit, gasohol
blenders may claim the benefit of the ethanol income tax credit
against their gasoline excise tax liability. The benefit may be
claimed against excise tax liability in either of two ways: (1)
by purchasing gasoline destined for blending with ethanol at a
reduced excise tax rate, or (2) before October 1, 1995, by
claiming expedited refunds of the excise tax paid on gasoline
purchased at the full excise tax rate, after that gasoline is
blended with ethanol. In general, the gasoline (including
gasohol) excise tax provisions associated with the Highway
Trust Fund expire after September 30, 1999.
Explanation of provision
The bill corrects a 1990 drafting error by conforming the
expiration date for the excise tax expedited refund provision
for gasohol blenders to that for gasoline tax provisions
generally. Thus, these refunds will be permitted through
September 30, 1999.
11. Amortization of goodwill and certain other intangibles (sec.
1703(l) of the bill, sec. 13261(g) of the 1993 Act and sec. 197
of the Code)
Present law
The 1993 Act allows amortization deductions to certain
intangible assets acquired after the 1993 Act's effective date
that were not amortizable under prior law. The 1993 Act
contains ``antichurning'' rules that deny amortization to
intangible assets that were not amortizable under prior law if
such assets are acquired by the taxpayer after the effective
date from certain related parties.
The 1993 Act also contains an election under which a
taxpayer and certain related parties may elect to treat all
acquisitions after July 25, 1991 as subject to the provisions
of the 1993 Act.
Explanation of provision
The bill clarifies that when a taxpayer and its related
parties have made an election to apply the 1993 Act to all
acquisitions after July 25, 1991, the antichurning rules will
not apply when property acquired from an unrelated party after
July 25, 1991 (and not subject to the antichurning rules in the
hands of the acquirer) is transferred to a taxpayer related to
the acquirer after the date of enactment of the 1993 Act.
12. Empowerment zones and eligibility of small farms for tax incentives
(sec. 1703(m) of the bill, sec. 13301 of the 1993 Act and sec.
1397B(d)(5)(B) of the Code)
Present law
Pursuant to the 1993 Act, on December 21, 1994, six
empowerment zones and 65 enterprise communities were designated
in eligible urban areas, and three empowerment zones and 30
enterprise communities were designated in rural areas. Special
tax incentives (i.e., a wage credit, additional section 179
expensing, and expanded tax-exempt financing) are available for
certain business activities conducted in urban and rural
empowerment zones. Expanded tax-exempt financing benefits are
available for certain facilities located in urban and rural
enterprise communities.
The empowerment zone 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)) if, as of the
close of the current taxable year, the sum of the aggregate
unadjusted bases (or, if greater, the fair market value) of
assets of the farm exceed $500,000 (sec. 1396(d)(2)(E)). In
contrast, the additional section 179 expensing (available in
empowerment zones) and expanded tax-exempt financing benefits
(available in both empowerment zones and enterprise
communities) are not allowed for any trade or business the
principal activity of which is farming if, as of the close of
the preceding taxable year, the sum of the aggregate bases (or,
if greater, the fair market value) of the assets of the farm
exceed $500,000 (sec. 1397B(d)(5)).
Explanation of provision
The bill provides that the $500,000 asset test for
determining whether a farm is eligible for additional section
179 expensing (in an empowerment zone) and expanded tax-exempt
financing benefits (in an empowerment zone or enterprise
community) is applied based on the assets of the farm at the
end of the current taxable year. Thus, the $500,000 asset test
for determining farm eligibility is based on the same taxable
period (i.e., the current taxable year) for purposes of all tax
incentives available in empowerment zones and enterprise
communities.
C. Other Tax Technical Corrections
1. Hedge bonds (sec. 1704(b) of the bill, sec. 11701 of the 1989 Act,
and sec. 149(g) of the Code)
Present law
The 1989 Act provided generally that interest on hedge
bonds is not tax-exempt unless prescribed minimum percentages
of the proceeds are reasonably expected to be spent at set
intervals during the five-year period after issuance of the
bonds (sec. 149(g)). A hedge bond is defined generally as a
bond (1) at least 85 percent of the proceeds of which is not
reasonably expected to be spent within three years following
issuance and (2) more than 50 percent of the proceeds of which
is invested at substantially guaranteed yields for four years
or more.
This restriction does not apply, however, if at least 95
percent of the bond proceeds is invested in other tax-exempt
bonds (not subject to the alternative minimum tax). The 95-
percent investment requirement is not violated if investment
earnings exceeding five percent of the proceeds are temporarily
invested for up to 30 days pending reinvestment in taxable
(including alternative minimum taxable) investments.
This provision is effective as if included in the Omnibus
Budget Reconciliation Act of 1989.
Explanation of provision
The bill clarifies that the 30-day exception for temporary
investments of investment earnings applies to amounts (i.e.,
principal and earnings thereon) temporarily invested during the
30-day period immediately preceding redemption of the bonds as
well as such periods preceding reinvestment of the proceeds.
2. Withholding on distributions from U.S. real property holding
companies (sec. 1704(c) of the bill, sec. 129 of the Deficit
Reduction Act of 1984, and sec. 1445 of the Code)
Present law
In general
Under the Foreign Investment in Real Property Tax Act of
1980 (``FIRPTA''), a foreign investor that disposes of a U.S.
real property interest generally is required to pay tax on any
gain on the disposition. For this purpose a U.S. real property
interest generally includes stock in a domestic corporation
that is a U.S. real property holding corporation (``USRPHC''),
or was a USRPHC at any time during the previous five years.
A sale or exchange of stock in a USRPHC is an example of a
disposition of a U.S. real property interest. In addition,
provisions of subchapter C of the Code treat amounts received
in certain corporate distributions as amounts received in sales
or exchanges, giving rise to tax liability under the FIRPTA
rules when a foreign person receives such a distribution from a
present or former USRPHC. Thus, amounts received by a foreign
shareholder in a USRPHC in a distribution in complete
liquidation of the USRPHC are treated as in full payment in
exchange for the USRPHC stock, and are therefore subject to tax
under FIRPTA (sec. 331; Treas. Reg. sec. 1.897-5T(b)(2)(iii)).
Similarly, amounts received by a foreign shareholder in a
USRPHC upon redemption of the USRPHC stock are treated as a
distribution in part or full payment in exchange for the stock,
and are therefore subject to tax under FIRPTA (sec. 302(a);
Treas. Reg. sec. 1.897-5T(b)(2)(ii)). Third, amounts received
by a foreign shareholder in a USRPHC, in a section 301
distribution from the USRPHC that exceeds the available
earnings and profits of the USRPHC, are treated as gain from
the sale or exchange of the shareholder's USRPHC stock to the
extent that they exceed the shareholder's adjusted basis in the
stock; such amounts are therefore also subject to tax under
FIRPTA (sec. 301(c)(3); Treas. Reg. sec. 1.897-5T(b)(2)(i)).
FIRPTA withholding
The Deficit Reduction Act of 1984 established a withholding
system to enforce the FIRPTA tax. Unless an exception applies,
a transferee of a U.S. real property interest from a foreign
person generally is required to withhold the lesser of 10
percent of the amount realized (purchase price), or the maximum
tax liability on disposition (as determined by the IRS) (sec.
1445). Such withholding may be reduced or eliminated pursuant
to a withholding certificate issued by the Internal Revenue
Service (Treas. Reg. sec. 1.1445-3).
Although the FIRPTA withholding requirement by its terms
generally applies to all dispositions of U.S. real property
interests, and subchapter C treats amounts received in certain
distributions as amounts received in sales or exchanges, the
FIRPTA withholding provisions also provide express rules for
withholding on certain distributions treated as sales or
exchanges. Generally, distributions in a transaction to which
section 302 (redemptions) or part II of subchapter C
(liquidations) applies are subject to 10-percent
withholding.118 Although a section 301 distribution in
excess of earnings and profits is also treated as a disposition
for purposes of computing the FIRPTA liability of a foreign
recipient of the distribution, there is no corresponding
withholding provision expressly addressed to the payor of such
a distribution.
---------------------------------------------------------------------------
\118\ Under other rules, dividend distributions (i.e., distribtions
to which sec. 301(c)(1) applies) to foreign persons by U.S.
corporations, including USRPHCs, are subject to 30-percent withholding
under the Code. Under treaties, the withholding on a dividend may be
reduced to as little as 5 or 15 percent.
---------------------------------------------------------------------------
Explanation of provision
The bill clarifies that FIRPTA withholding requirements
apply to any section 301 distribution to a foreign person by a
domestic corporation that is or was a USRPHC, which
distribution is not made out of the corporation's earnings and
profits and is therefore treated as an amount received in a
sale or exchange of a U.S. real property interest. (The bill
does not alter the withholding treatment of section 301
distributions by such a corporation that are out of earnings
and profits.) Under the bill, the FIRPTA withholding
requirements that apply to a section 301 distribution not out
of earnings and profits are similar to the requirements
applicable to redemption or liquidation distributions to a
foreign person by such a corporation. It is anticipated that
withholding certificates will be available to taxpayers that
expect to receive section 301 distributions not out of earnings
and profits.
The provision is effective for distributions made after the
date of enactment of the bill. No inference is intended to be
drawn from the provision as to the FIRPTA withholding
requirements applicable to such a distribution under present
law.
3. Treatment of credits attributable to working interests in oil and
gas properties (sec. 1704(d) of the bill, sec. 501 of the Tax
Reform Act of 1986, and sec. 469 of the Code)
Present law
Under present law, a working interest in an oil and gas
property which does not limit the liability of the taxpayer is
not a ``passive activity'' for purposes of the passive loss
rules (sec. 469). However, if any loss from an activity is
treated as not being a passive loss by reason of being from a
working interest, any net income from the activity in
subsequent years is not treated as income from a passive
activity, notwithstanding that the activity may otherwise have
become passive with respect to the taxpayer.
Explanation of provision
The bill clarifies that any credit attributable to a
working interest in an oil and gas property, in a taxable year
in which the activity is no longer treated as not being a
passive activity, will not be treated as attributable to a
passive activity to the extent of any tax allocable to the net
income from the activity for the taxable year. Any credits from
the activity in excess of this amount of tax will continue to
be treated as arising from a passive activity and will be
treated under the rules generally applicable to the passive
activity credit. The provision applies to taxable years
beginning after December 31, 1986.
4. Clarification of passive loss disposition rule (sec. 1704(e) of the
bill, sec. 501 of the Tax Reform Act of 1986, sec.
1005(a)(2)(A) of the Technical and Miscellaneous Revenue Act of
1988, and sec. 469(g)(1)(A) of the Code)
Present law
The Tax Reform Act of 1986 (``1986 Act'') provided that if
a passive activity is disposed of in a transaction in which all
gain or loss is recognized, any overall loss from the activity
in the year of disposition is recognized and allowed against
income (whether active or passive income).119 The language
of the 1986 Act provided that any loss was allowable, first,
against income or gain from the passive activity, second,
against income or gain from all passive activities, and
finally, against any other income or gain. This rule was
rewritten by the technical corrections portion of the Technical
and Miscellaneous Revenue Act of 1988 (``1988 Act''). The
statutory language (as amended by the 1988 Act) providing for
the computation of the overall loss for the taxable year of
disposition is not entirely clear where the activity is
disposed of at a gain.
---------------------------------------------------------------------------
\119\ See S. Rept. 99-313, p. 725.
---------------------------------------------------------------------------
Explanation of provision
The bill clarifies the rule relating to the computation of
the overall loss allowed upon the disposition of a passive
activity. The bill provides that, in a transaction in which all
gain or loss is recognized on the disposition of a passive
activity, any loss from the activity for the taxable year
(taking into account all income, gain, and loss, including gain
or loss recognized on the disposition) in excess of any net
income or gain from other passive activities for the taxable
year is treated as a loss which is not from a passive activity.
The provision applies to taxable years beginning after December
31, 1986.
5. Estate tax unified credit allowed nonresident aliens under treaty
(sec. 1704(f)(1) of the bill, sec. 5032(b)(2) of the Technical
and Miscellaneous Revenue Act of 1988, and sec. 2102(c)(3)(A)
of the Code)
Present law
Amount subject to tax
For U.S. citizens and residents, the amount subject to
Federal estate and gift tax is determined by reference to all
property, wherever situated. For nonresident aliens, the Code
provides that the amount subject to Federal estate and gift tax
is determined only by reference to property situated in the
United States.
The United States has entered into bilateral treaties
designed to avoid double transfer taxation. Early treaties
typically did this by providing rules for determining situs and
requiring that the State of domicile allow a credit for taxes
paid to the situs country.120 In contrast, treaties signed
in the 1980s, and the U.S. and OECD model treaties, exempt most
property, wherever situated, from taxation outside the State of
domicile.121
---------------------------------------------------------------------------
\120\ See Staff of the Joint Committee on Taxation, 98th Cong., 2d
Sess., Explanation of Proposed Estate and Gift Tax Treaty Between the
United States and Sweden 8 (1984).
\121\ See, e.g., U.S. Treasury Model Estate and Gift Tax Treaty
(1980), Article 7, paragraph 1: ``Transfers and deemed transfers by an
individual domiciled in a Contracting State of property other an
property referred to in Article 5 (Real Property) and 6 (Business
Property of a Permanent Establishment and Asset Pertaining to a Fixed
Base Used for the Performance of Independent Personal Services) shall
be taxable only in that State.''
---------------------------------------------------------------------------
Specific exemption and unified credit
Prior to the Tax Reform Act of 1976 (``1976 Act''), the
Code allowed a ``specific exemption'' against the estate tax.
The estate of a U.S. citizen or resident was allowed an
exemption of $60,000, while the estate of a nonresident alien
was allowed a lesser amount. A number of U.S. estate tax
treaties ratified in the 1950s allowed a nonresident alien a
``specific exemption'' equal to the exemption allowed a U.S.
citizen or resident multiplied by the percentage of the gross
estate subject to U.S. estate tax (the ``pro rata
exemption'').122
---------------------------------------------------------------------------
\122\ See Rev. Rul. 81-303, 1981-2 C.B. 255.
---------------------------------------------------------------------------
The 1976 Act replaced the specific exemption with a unified
credit of $47,000 for the estate of U.S. citizen or resident
and $3,600 for the estate of a nonresident alien. After 1976,
two courts interpreted the pro rata exemption allowed in the
1950s treaties as applying to the unified credit, i.e., as
allowing a unified credit no less than the unified credit
allowed a U.S. citizen or resident multiplied by the percentage
of the gross estate situated in the United States (and
therefore subject to U.S. estate tax under those
treaties).123
---------------------------------------------------------------------------
\123\ See Mudry v. United States, 11 Cl. Ct. 207 (1986) (Swiss
treaty); Burghardt v. Commissioner, 80 T.C. 705 (1983), affd., 734F.2d
3 (3d Cir. 1984) (Italian treaty).
---------------------------------------------------------------------------
The Technical and Miscellaneous Revenue Act of 1988 (``1988
Act'') increased the unified credit allowed an estate of a
nonresident alien to $13,000. In so doing, the 1988 Act
provided that, ``to the extent required by any treaty,'' the
estate of a nonresident alien is allowed a unified credit equal
to the unified credit allowed a U.S. citizen or resident
multiplied by the percentage of the gross estate situated in
the United States (Code sec. 2102(c)(3)(A)). Thus, the 1988 Act
did not override the ``specific exemption'' language of the
1950s treaties, as interpreted by the two courts, and could be
interpreted as encouraging the negotiation of pro rata unified
credits in future treaties.
Explanation of provision
The bill clarifies that in determining the pro rata unified
credit required by treaty, property exempted by the treaty from
U.S. estate tax is not treated as situated in the United
States. Under this rule, a treaty granting a pro rata unified
credit would allow a nonresident alien the unified credit
allowed a U.S. citizen or resident multiplied by the percentage
of the gross estate subject to U.S. estate tax, as modified by
treaty.
The provision is not intended to affect existing treaties
that contain pro rata exemptions pursuant to which the assets
reserved for situs taxation by the non-domiciliary country are
specifically described. In the case of a treaty that contains a
pro rata exemption but does not provide rules for determining
the situs for property (e.g., the treaty with Canada), the bill
clarifies that property exempted by the treaty from U.S. estate
tax is not treated as situated in the United States. The Senate
Foreign Relations Committee Report with respect to the revised
protocol amending the tax convention with Canada anticipated
the enactment of this provision (Sen. Exec. Rep. No. 104-9,
104th Cong., 1st Sess. at 15). For future treaties, it is
intended that any pro rata unified credit negotiated not exceed
the proportion of the gross worldwide estate subject to U.S.
estate and gift tax, as modified by treaty.
The provision is effective upon the date of its enactment.
6. Limitation on deduction for certain interest paid by corporation to
related persons (sec. 1704(f)(2)(A) of the bill, sec. 7210(a)
of the 1989 Act, and sec. 163(j) of the Code)
Present law
Subject to certain limitations, a taxpayer may deduct
interest paid or accrued on indebtedness within a taxable year
(sec. 163(a)). The 1989 Act added a so-called ``earnings
stripping'' limitation on interest deductibility with respect
to certain interest paid by corporations to related persons
(sec. 163(j)). If the provision applies to a corporation for a
taxable year, it disallows deductions for certain amounts of
``disqualified interest'' paid or accrued by the corporation
during that year. If in a taxable year a deduction is
disallowed, under the provision, for an amount of interest paid
or accrued in that year, the disallowed amount is treated under
the earnings stripping provision as disqualified interest paid
or accrued in the succeeding taxable year.124
---------------------------------------------------------------------------
\124\ Disqualified interest is interest paid by a corporation to
related persons that are not subject to U.S. tax on the interest
received. (If, in accordance with a U.S. income tax treaty, interest
income of a related person is subject to a reduced rate of U.S. tax, a
portion of the interest paid to the related person is deemed to be
interest on which no tax is imposed.)
---------------------------------------------------------------------------
In order for the earnings stripping provision to apply to a
corporation for a taxable year, two thresholds must be
exceeded. To exceed the first threshold, the corporation must
have ``excess interest expense'' as that term is defined in the
Code for this purpose. To exceed the second threshold, the
corporation must have a ratio of debt to equity as of the close
of the taxable year in question (or on any other day prescribed
by the Secretary in regulations) that exceeds 1.5 to 1. Excess
interest expense is the excess (if any) of the corporation's
net interest expense over the sum of 50 percent of the adjusted
taxable income of the corporation plus any excess limitation
carryforward from a prior year. Excess limitation is the excess
(if any) of 50 percent of adjusted taxable income over net
interest expense.
Explanation of provision
The bill provides that the debt-equity threshold does not
apply for purposes of applying the earnings stripping provision
to a carryover of excess interest expense from a prior taxable
year. Thus, the bill clarifies that excess interest carried
forward from a year in which the debt-equity ratio threshold is
exceeded may be deducted in a subsequent year in which that
threshold is not exceeded, but only to the extent that such
interest would not otherwise be treated as excess interest
expense in the carryforward year.
For example, assume that in year 1 $20 of a corporation's
interest expense is nondeductible due to the operation of the
earnings stripping provision. The corporation carries forward
the $20 of interest deduction that it could not use in year 1.
Assume that in year 2 the corporation has a debt-equity ratio
of 1 to 1 and $50 of current net and gross interest expense,
all of which is disqualified interest, and that it earns $400
of adjusted taxable income. The provision is intended to
clarify that the $20 of interest carried forward from year 1 is
deductible in year 2. This is because $70, the sum of the
current net interest expense for year 2 ($50) plus the interest
expense carried over from year 1 ($20), does not exceed one-
half of adjusted taxable income in year 2.
As another example, assume that in year 2 the corporation
has a debt-equity ratio of 1 to 1 and $50 of current net and
gross interest expense, all of which is disqualified interest,
and that it earns $80 of adjusted taxable income. The provision
is intended to clarify that the $20 of interest carried forward
from year 1 is not deductible in year 2. This is because the
current net interest expense for year 2 ($50) exceeds by $10
one-half of adjusted taxable income in year 2 ($80 divided by
2, or $40). Therefore, treating the year 1 carryover as an
interest expense in year 2 causes the corporation to have
excess interest expense equal to $30. But for the debt-equity
safe harbor, the corporation would have a $30 interest expense
disallowance in year 2 if the carried over amount were treated
as having been paid in year 2. Under the bill, no actual year 2
interest can be disallowed. However, under these facts, none of
the interest carried over from year 1 can be deducted in year
2. Instead, the interest carried over from year 1 is carried
forward for potential deduction (subject to the same rules that
applied to the carryforward in year 2) in a year subsequent to
year 2.
As a third example, assume that in year 2 the corporation
has a debt-equity ratio of 1 to 1 and $50 of current net and
gross interest expense, all of which is disqualified interest,
and that it earns $110 of adjusted taxable income. The
provision is intended to clarify that $5 of interest carried
forward from year 1 is deductible in year 2, and the other $15
of interest carried forward from year 1 is not deductible in
year 2. This is because the current net interest expense for
year 2 ($50) is $5 less than one-half of adjusted taxable
income in year 2 (one-half of $110, or $55). Therefore, even if
the debt-equity safe harbor had not been met in year 2, the
corporation would have had $5 of excess limitation in year 2
had there been no carryover amount from year 1. On the other
hand, treating the year 1 carryover as an interest expense in
year 2 causes the corporation to have excess interest expense
equal to $15. This $15 may be carried forward to a subsequent
year.
The provision is effective as if included in the amendments
made by section 7210(a) of the Revenue Reconciliation Act of
1989.
7. Interaction between passive activity loss rules and earnings
stripping rules (sec. 1704(f)(2)(B) and (C) of the bill, sec.
7210(a) of the 1989 Act, and sec. 163(j) of the Code)
Present law
The passive loss rules limit deductions and credits from
passive trade or business activities (sec. 469). Deductions
attributable to passive activities, to the extent they exceed
income from passive activities, generally may not be deducted
against other income, such as wages, portfolio income, or
business income that is not derived from a passive activity.
Deductions and credits that are suspended are carried forward
and treated as deductions and credits from passive activities
in the next year. Suspended losses from a passive activity are
allowed in full when a taxpayer disposes of his entire interest
in the passive activity to an unrelated person. The passive
loss rules apply to any taxpayer that is an individual, estate,
trust, closely held C corporation, or personal service
corporation. In determining passive activity deductions,
Treasury regulations provide that ``an item of deduction arises
in the taxable year in which the item would be allowable as a
deduction under the taxpayer's method of accounting if taxable
income for all taxable years were determined without regard to
sections 469, 613A(d) and 1211'' (Treas. Reg. sec. 1.469-
2(d)(8)). Thus, these regulations effectively require other
limitations to be applied before applying the passive loss
rules.
The at-risk rules limit deductible losses from an activity
to the amount that the taxpayer has at risk, in the case of an
individual or a closely-held corporation (sec. 465). The amount
at risk is generally the sum of (1) cash contributions, (2) the
adjusted basis of contributed property, and (3) amounts
borrowed for use in the activity with respect to which the
taxpayer has personal liability or has pledged as security
property not used in the activity. The amount at risk is
increased by income from the activity and decreased by losses
and withdrawals.
A taxpayer generally may deduct interest paid or accrued on
indebtedness within a taxable year (sec. 163(a)). The Revenue
Reconciliation Act of 1989 (the ``1989 Act'') added an
``earnings stripping'' limitation on interest deductibility
with respect to certain interest paid by corporations to
related persons (sec. 163(j)). If the provision applies to a
corporation for a taxable year, it disallows deductions for
certain amounts of ``disqualified interest'' paid or accrued by
the corporation during that year. Disqualified interest is
interest paid by a corporation to related persons that are not
subject to U.S. tax on the interest received. The disallowed
amount is treated under the earnings stripping provision as
disqualified interest paid or accrued in the succeeding taxable
year. Proposed Treasury regulations would provide that
``sections 465 and 469 shall be applied before applying section
163(j)'' (Prop. Treas. Reg. sec. 1.163(j)-7(b)(3)).
Explanation of provision
The provision modifies section 163(j) of the Code to
clarify that the earnings stripping rules apply before the
passive loss rules and the at-risk rules.
The provision is effective as if included in the 1989 Act.
8. Branch-level interest tax (sec. 1704(f)(3) of the bill, sec. 1241 of
the 1986 Act, and sec. 884 of the Code)
Present law
Interest paid (or treated as if paid) by a U.S. trade or
business (i.e., a U.S. branch) of a foreign corporation is
treated as if paid by a U.S. corporation and, hence, is U.S.
source and subject to U.S. withholding tax of 30 percent,
unless the tax is reduced or eliminated by a specific Code or
treaty provision. The Treasury has regulatory authority to
limit U.S. sourcing, and hence U.S. withholding, to the amount
of interest reasonably expected to be deducted in arriving at
the U.S. branch's effectively connected taxable income.
To the extent a U.S. branch of a foreign corporation has
allocated to it under Treasury Regulation section 1.882-5 an
interest deduction in excess of the interest actually paid by
the branch (this generally occurs where the indebtedness of the
U.S. branch is disproportionately small compared to the total
indebtedness of the foreign corporation), the excess is treated
as if it were interest paid on a notional loan to a U.S.
subsidiary (the U.S. branch, in actuality) from its foreign
corporate parent (the home office). This excess is subject to
the 30-percent tax, absent a specific Code exemption or treaty
reduction (sec. 884(f)(1)(B)).
These branch-level interest taxes, along with the branch
profits tax, were intended to reflect the view that a foreign
corporation doing business in the United States generally
should be subject to the same substantive tax rules that apply
to a foreign corporation operating in the United States through
a U.S. subsidiary.125 Where a U.S. corporation pays
interest to its foreign corporate parent, that interest, like
the interest deducted by a U.S. branch of a foreign
corporation, is also generally subject to a 30-percent U.S.
withholding tax unless the tax is reduced by treaty. In the
case of a U.S. subsidiary of a foreign parent corporation, the
withholding tax applies without regard to whether the interest
payment is currently deductible by the U.S. subsidiary. For
example, deductions for interest may be delayed or denied under
section 163, 263, 263A, 266, 267, or 469, but it is still
subject (or not subject) to withholding when paid without
regard to the operation of those provisions.
---------------------------------------------------------------------------
\125\ Staff of the Joint Committee on Taxation, 100th Cong., 1st
Sess., General Explanation of the Tax Reform Act of 1986 at 1036
(1987).
---------------------------------------------------------------------------
Explanation of provision
The bill provides that the branch level interest tax on
interest not actually paid by the branch applies to any
interest which is allocable to income which is effectively
connected with the conduct of a trade or business in the United
States. Similarly, in the case of interest paid by the U.S.
branch, the bill provides regulatory authority to limit U.S.
sourcing, and hence U.S. withholding, to the amount of interest
reasonably expected to be allocable to income which is
effectively connected with the conduct of a trade or business
in the United States. Thus, where an interest expense of a
foreign corporation is allocable to U.S. effectively connected
income, but that interest expense would not have been fully
deductible for tax purposes under another Code provision had it
been paid by a U.S. corporation, the bill clarifies that such
interest is nonetheless treated for branch level interest tax
purposes like a payment by a U.S. corporation to a foreign
corporate parent. Similarly, with regard to the Treasury's
regulatory authority to treat an interest payment by a foreign
corporation's U.S. branch as though not paid by a U.S. person
for source and withholding purposes, the bill clarifies that
the authority extends to interest payments in excess of those
reasonably expected to be allocable to U.S. effectively
connected income of the foreign corporation.
These provisions are effective as if they were made by the
Tax Reform Act of 1986.
9. Determination of source in case of sales of inventory property (sec.
1704(f)(4) of the bill, sec. 211 of the 1986 Act, and sec.
865(b) of the Code)
Present law
Prior to the 1986 Act, the source of income derived from
the sale of personal property generally was determined by the
place of sale (commonly referred to as the ``title passage''
rule) (see, e.g., Treas. Reg. sec. 1.861-7, T.D. 6258, 1957-2
C.B. 368). While the 1986 Act generally replaced the place-of-
sale rule for sales of personal property with a residence-of-
the-seller rule (sec. 865(a)), the Act did not change the
place-of-sale rule for most sales of inventory property (sec.
865(b)).
Before and after the 1986 Act, statutory rules for sourcing
income from inventory sales have included those covering income
from (1) purchasing inventory property outside the United
States (other than within a U.S. possession) and selling it in
the United States (sec. 861(a)(6)); (2) purchasing inventory
property in the United States and selling it outside the United
States (sec. 862(a)(6)); (3) selling outside the United States
inventory property which has been produced by the taxpayer in
the United States (or selling in the United States inventory
property which has been produced by the taxpayer outside the
United States) (sec. 863(b)(2)); and (4) purchasing inventory
property in a U.S. possession and selling it in the United
States (sec. 863(b)(3)). Prior to the 1986 Act, these
provisions were not limited in application to income from sales
of inventory property, but rather covered sales of personal
property generally.
In addition to statutory rules for sourcing items of income
from transactions involving inventory property specified in the
Code, such as those listed above, the Code both before and
after the 1986 Act has contained other sourcing rules that do
not make specific reference to property sales, and includes
general regulatory authority to allocate and apportion between
U.S. and foreign sources items of gross income, expenses,
losses, and deductions other than those specified in sections
861(a) and 862(a) (sec. 863(a)). In carving income from the
sale of inventory property out of the general residence-of-the-
seller rule of section 865, section 865(b) makes reference to
the above statutory rules making specific reference to
inventory property, but not to the general grant of regulatory
authority in section 863(a).
Explanation of provision
The bill modifies the general provision relating to the
sourcing of income from the sale of personal property (sec.
865) so that the cross-reference to sourcing rules applicable
to inventory property includes a reference to all of section
863, rather than simply to section 863(b). The bill thus
clarifies that, to the extent that the Secretary of the
Treasury had general regulatory authority to provide rules for
the sourcing of income from the sales of personal property
prior to the 1986 Act, the Secretary of the Treasury retains
that authority under present law with respect to inventory
property.
The bill is not intended to increase the Treasury
Secretary's regulatory authority under section 863(a) beyond
the authority that he had under the law in effect prior to the
enactment of the 1986 Act. It is intended that no inference be
drawn from this provision either as to the correctness of, or
as to the post-1986 Act implications of, any judicial decision
interpreting the scope of that pre-1986 Act authority.
The provision is effective as if it were included in the
Tax Reform Act of 1986.
10. Repeal of obsolete provisions (sec. 1704(f)(5) of the bill, sec.
10202 of the Revenue Act of 1987, and secs. 6038(a)(1)(F) and
6038A(b)(4) of the Code)
Present law
A U.S. person who controls a foreign corporation must
report certain information related to that foreign corporation
as may be required by the Treasury Secretary (sec. 6038).
Information reporting is also required with respect to certain
foreign-owned domestic corporations (sec. 6038A). Included
under each of these information reporting provisions is a
requirement to report such information as the Treasury
Secretary may require for purposes of carrying out the
provisions of section 453C. Section 453C, relating to certain
indebtedness treated as payment on installment obligations (the
so-called ``proportional disallowance rule''), was repealed in
the Revenue Act of 1987.
Explanation of provision
The bill repeals as obsolete the information reporting
requirements of sections 6038 and 6038A relating to section
453C. The provision is effective upon the date of its
enactment.
11. Clarification of a certain stadium bond transition rule in Tax
Reform Act of 1986 (sec. 1704(g) of the bill and sec.
1317(3)(A) of the Tax Reform Act of 1986)
Present law
The Tax Reform Act of 1986 included a transition rule
authorizing tax-exempt bonds not exceeding $200 million to be
issued by or on behalf of the City of Cleveland, Ohio, to
finance a stadium. The bonds were required to be issued before
January 1, 1991 (and were so issued). As enacted, the rule
required Cleveland to retain a residual interest in the stadium
following planned private business use.
Explanation of provision
The bill permits the residual interest in the stadium
currently held by the City of Cleveland to be assigned to
Cuyahoga County, Ohio (the county in which both Cleveland and
the stadium are located) because of a change in Ohio State law
prior to issuance of the bonds. The bill does not extend the
time for issuing the bonds or otherwise affect the amount of
bonds or the location or design of the stadium.
This provision is effective as if included in the Tax
Reform Act of 1986.
12. Health care continuation rules (sec. 1704(h) of the bill, sec.
7862(c)(5) of the 1989 Act, sec. 4980B(f)(2)(B)(i) of the Code,
sec. 602(2)(A) of ERISA, and sec. 2202(2)(A) of the Public
Health Service Act)
Present law
The Revenue Reconciliation Act of 1989 (``1989 Act'')
amended the health care continuation rules to provide that if a
covered employee is entitled to Medicare and within 18 months
of such entitlement separates from service or has a reduction
in hours, the duration of continuation coverage for the spouse
and dependents is 36 months from the date the covered employee
became entitled to Medicare. One possible interpretation of the
statutory language, however, would permit continuation coverage
for up to 54 months. This extension of the coverage period was
not intended.
Explanation of provision
The bill amends the Code (sec. 4980B), title I of the
Employee Retirement Income Security Act (sec. 602), and the
Public Health Service Act (sec. 2202(2)(A)) to limit the
continuation coverage in such cases to no more than 36 months.
The provision is effective for plan years beginning after
December 31, 1989.
13. Taxation of excess inclusions of a residual interest in a REMIC for
taxpayers subject to alternative minimum tax with net operating
losses (sec. 1704(i) of the bill and sec. 860E(a)(6) of the
Code)
Present law
Residual interests in a REMIC
A real estate mortgage investment conduit (``REMIC'') is an
entity that holds real estate mortgages. All interests in a
REMIC must be ``regular interests'' or ``residual interests.''
A regular interest is an interest the terms of which are fixed
on the start-up day, which unconditionally entitles the holder
to receive a specified principal amount, and which provides
that interest amounts are payable based on a fixed rate (or a
variable rate to the extent provided in the Treasury
regulations). A residual interest is any interest that is so
designated and that is not a regular interest in a REMIC.
Generally, the holder of a residual interest in a REMIC
takes into account his daily portion of the taxable income or
net loss of such REMIC for each day during which he held such
interest. The taxable income of any holder of a residual
interest in a REMIC for any taxable year cannot be less than
the excess inclusion for the year (sec. 860E). Thus, in
general, income from excess inclusions cannot be offset by a
net operating loss (or net operating loss carryover) in
computing the taxpayer's regular tax.
Alternative minimum tax
Taxpayers are subject to an alternative minimum tax which
is payable, in addition to all other tax liabilities, to the
extent it exceeds the taxpayer's regular tax. The tax is
imposed at rates of 26 and 28 percent (20 percent in the case
of a corporation) on alternative minimum taxable income in
excess of an exemption amount. Alternative minimum taxable
income generally is the taxpayer's taxable income, as increased
or decreased by certain adjustments and preferences. A taxpayer
may offset no more than ninety percent of its alternative
minimum taxable income with its alternative tax net operating
loss carryover.
Because the determination of a taxpayer's alternative
minimum taxable income begins with taxable income, a holder of
a residual interest in a REMIC may have positive alternative
minimum taxable income even where the taxpayer has a net
operating loss for the year.
Explanation of provision
The bill provides that three rules for determining the
alternative minimum taxable income of a taxpayer that is not a
thrift institution that holds residual interests in a REMIC.
First, the alternative minimum taxable income of such a
taxpayer is computed without regard to the REMIC rule that
taxable income cannot be less than the amount of excess
inclusions. This provision prevents a taxpayer from having to
include in alternative minimum taxable income preference items
for which it received no tax benefit.
Second, the alternative minimum taxable income of such a
taxpayer for a taxable year cannot be less than the excess
inclusions of the residual interests for that year. In effect,
this provision prevents nonrefundable credits from reducing the
taxpayer's income tax below an amount equal to what the
tentative minimum tax would be if computed only on excess
inclusions.
Third, the amount of any alternative minimum tax net
operating loss deduction of such a taxpayer is computed without
regard to any excess inclusions. This provision insures that
the net operating losses will not reduce any income
attributable to any excess inclusions. Thus, all such taxpayers
subject to the alternative minimum tax will pay a tax on excess
inclusions at the alternative minimum tax rate, regardless of
whether the taxpayer has a net operating loss.
The provision is effective for all taxable years beginning
after December 31, 1986, unless the taxpayer elects to apply
the rules of the bill only to taxable years beginning after the
date of enactment.
14. Application of harbor maintenance tax to Alaska and Hawaii ship
passengers (sec. 1704(j) of the bill and sec. 4462(b) of the
Code)
Present law
A harbor maintenance excise tax (``harbor tax'') of 0.125
percent of value applies generally to commercial cargo
(including passenger fares) loaded or unloaded at U.S. ports
(sec. 4461). The harbor tax does not apply to commercial cargo
(other than crude oil with respect to Alaska) loaded or
unloaded in Alaska, Hawaii, and U.S. possessions where such
cargo is transported to or from the U.S. mainland (for domestic
use) or where such cargo is loaded and unloaded in the same
State (Alaska or Hawaii) or possession (sec. 4462(b)).
Explanation of provision
The bill clarifies that the harbor tax does not apply to
passenger fares where the passengers are transported on U.S.
flag vessels operating solely within the State waters of Alaska
or Hawaii and adjacent international waters (i.e., leaving and
returning to a port in the same State without stopping
elsewhere).
The provision applies as if included in the Harbor
Maintenance Revenue Act of 1986 (April 1, 1987).
15. Modify effective date provision relating to the Energy Policy Act
of 1992 (sec. 1704(k) of the bill and secs. 53 and 30 of the
Code)
Present law
The nonconventional fuels production credit (sec. 29)
cannot reduce the taxpayer's tax liability to less than the
amount of the tentative minimum tax. The credit for prior year
minimum tax liability (sec. 53) is increased by the amount of
the nonconventional fuels credit not allowed for the taxable
year solely by reason of the limitation based on the taxpayer's
tentative minimum tax.
Explanation of provision
The bill corrects a cross reference to section 29(b)(6)(B)
contained in section 53(d)(1)(B)(iv), and clarifies that the
correction applies to taxable years beginning after December
31, 1990. In addition, section 1702(e)(5) of the bill clarifies
that a correction made in the Energy Policy Act of 1992 to a
similar cross reference in section 53(d)(1)(B)(iii) applies to
taxable years beginning after December 31, 1990.
The bill also clarifies the relationship between the basis
adjustment rules for the electric vehicle credit (sec.
30(d)(1)) and the alternative minimum tax.
16. Treat qualified football coaches plan as multiemployer pension plan
for purposes of the Internal Revenue Code (sec. 1704(l) of the
bill and sec. 1022 of ERISA)
Present law
Section 3(37) of the Employee Retirement Income Security
Act of 1974 (``ERISA''), as amended by Public Law 100-202
(Continuing Appropriations for Fiscal Year 1988), provides
that, for purposes of Title I of ERISA, a qualified football
coaches plan generally is treated as a multiemployer plan and
may include a qualified cash or deferred arrangement. Under
section 3(37) of ERISA, a qualified football coaches plan is
defined as any defined contribution plan established and
maintained by an organization described in section 501(c) of
the Internal Revenue Code (the ``Code''), the membership of
which consists entirely of individuals who primarily coach
football as full-time employees of 4-year colleges or
universities, if the organization was in existence on September
18, 1986. This definition is generally intended to apply to the
American Football Coaches Association.
However, section 9343(a) of the Omnibus Budget
Reconciliation Act of 1987 (P.L. 100-203) provides that Titles
I and IV of ERISA are not applicable in interpreting Title II
of ERISA (the Code provisions relating to qualified plans),
except to the extent specifically provided in the Code or as
determined by the Secretary of the Treasury.
Explanation of provision
The bill amends Title II of ERISA to provide that, for
purposes of determining the qualified plan status of a
qualified football coaches plan, section 3(37) of ERISA is
treated as part of Title II of ERISA and a qualified football
coaches plan is treated as a multiemployer collectively
bargained plan.
The provision is effective for years beginning after
December 22, 1987 (the date of enactment of P.L. 100-202).
17. Determination of unrecovered investment in annuity contract (sec.
1704(m) of the bill and sec. 72 (b) and (c) of the Code)
Present law
An exclusion is provided for amounts received as an annuity
under an annuity, endowment, or life insurance contract, as
determined under a statutory exclusion ratio (sec. 72(b)). The
exclusion ratio is determined as the ratio of (1) the
taxpayer's investment in the contract (as of the annuity
starting date) to (2) the expected return under the contract
(as of such date). In the case of a contract with a refund
feature, the amount of a taxpayer's investment in the contract
is reduced by the value of the refund feature (sec.72(c)).
This exclusion was modified by the Tax Reform Act of 1986
to limit the excludable amount to the taxpayer's unrecovered
investment in the contract, and to provide a deduction for the
unrecovered investment in the contract if payments as an
annuity under the contract cease by reason of the death of an
annuitant. In the case of a contract with a refund feature, the
1986 Act modifications reduce the exclusion ratio so that it is
possible that less than the entire investment in the contract
can be recovered tax-free.
Explanation of provision
The bill modifies the definition of the unrecovered
investment in the contract, in the case of a contract with a
refund feature, so that the entire investment in the contract
can be recovered tax-free.
The provision is effective as if enacted in the Tax Reform
Act of 1986.
18. Election by parent to claim unearned income of certain children on
parent's return (sec. 1704(n) of the bill and secs. 1 and 59(j)
of the Code)
Present law
The net unearned income of a child under 14 years of age is
taxed to the child at the parent's statutory rate. Net unearned
income means unearned income less the sum of $650 (for 1995)
and the greater of: (1) $650 (for 1995) or, (2) if the child
itemizes deductions, the amount of allowable deductions
directly connected with the production of the unearned income.
The dollar amounts are adjusted for inflation.
In certain circumstances, a parent may elect to include a
child's unearned income on the parent's income tax return if
the child's income is less than $5,000. A parent making this
election must include the gross income of the child in excess
of $1,000 in income for the taxable year. In addition, the
parent must report an additional tax liability equal to the
lesser of (1) $75 or (2) 15 percent of the excess of the
child's income over $500. The dollar amounts for the election
are not adjusted for inflation.
A person claimed as a dependent cannot claim a standard
deduction exceeding the greater of $650 (for 1995) or such
person's earned income. For alternative minimum tax purposes,
the exemption of a child under 14 years of age generally cannot
exceed the sum of such child's earned income plus $1,000. The
$650 amount is adjusted for inflation but the $1,000 amount is
not.
Explanation of provision
The bill adjusts for inflation the dollar amounts involved
in the election to claim unearned income on the parent's
return. It likewise indexes the $1,000 amount used in computing
the child's alternative minimum tax.
The provision is effective for taxable years beginning
after December 31, 1995.
19. Treatment of certain veterans' reemployment rights (sec. 1704(o) of
the bill and new sec. 414(u) of the Code)
Present law
Under the Uniformed Services Employment and Reemployment
Rights Act of 1994 (``USERRA''), Pub. L. No. 103-353, 38 U.S.C.
Sec. Sec. 4301, ff., which revised and restated the Federal law
protecting veterans' reemployment rights, an employee who
leaves a civilian job for qualified military service generally
is entitled to be reemployed by the civilian employer if the
individual returns to employment within a specified time
period. In addition to reemployment rights, a returning veteran
also is entitled to the restoration of certain pension, profit
sharing and similar benefits that would have accrued, but for
the employee's absence due to the qualified military service.
USERRA generally provides that for a reemployed veteran
service in the uniformed services is considered service with
the employer for retirement plan benefit accrual purposes, and
the employer that reemploys the returning veteran is liable for
funding any resulting obligation. USERRA also provides that the
reemployed veteran is entitled to any accrued benefits that are
contingent on the making of, or derived from, employee
contributions or elective deferrals only to the extent the
reemployed veteran makes payment to the plan with respect to
such contributions or deferrals. No such payment may exceed the
amount the reemployed veteran would have been permitted or
required to contribute had the person remained continuously
employed by the employer throughout the period of uniformed
service. Under USERRA, any such payment to the plan must be
made during the period beginning with the date of reemployment
and whose duration is three times the reemployed veteran's
period of uniform service, not to exceed five years.
Under the Internal Revenue Code, overall limits are
provided on contributions and benefits under certain retirement
plans. For example, the maximum amount of elective deferrals
that can be made by an individual into a qualified cash or
deferred arrangement in any taxable year is limited to $9,500
for 1996 (sec. 402(g)). Annual additions with respect to each
participant under a qualified defined contribution plan
generally are limited to the lesser of $30,000 (for 1996) or 25
percent of compensation (sec 415(c)). Annual deferrals with
respect to each participant under an eligible deferred
compensation plan (sec. 457) generally are limited to the
lesser of $7,500 or 33\1/3\ percent of includible compensation.
There is no provision under present law that permits
contributions or deferrals to exceed these and other annual
limits in the case of contributions with respect to a
reemployed veteran.
Other requirements for which there is no special provision
for contributions with respect to a reemployed veteran include
the limit on deductible contributions and the qualified plan
nondiscrimination, coverage, minimum participation, and top
heavy rules.
Explanation of provision
The bill provides special rules in the case of certain
contributions (``make-up contributions'') with respect to a
reemployed veteran that are required or authorized under
USERRA. The bill applies to contributions made by an employer
or employee to an individual account plan or to contributions
made by an employee to a defined benefit plan that provides for
employee contributions.
Under the bill, if any make-up contribution is made by an
employer or employee with respect to a reemployed veteran, then
such contributions are not subject to the generally applicable
plan contribution limits (i.e., secs. 402(g), 402(h), 403(b),
408, 415, or 457) or the limit on deductible contributions
(i.e., secs. 404(a) or 404(h)) as applied with respect to the
year in which the contribution is made. In addition, the make-
up contribution are not taken into account in applying the plan
contribution or deductible contribution limits to any other
contribution made during the year. However, the amount of any
make-up contribution could not exceed the aggregate amount of
contributions that would have been permitted under the plan
contribution and deductible contribution limits for the year to
which the contribution relates had the individual continued to
be employed by the employer during the period of uniformed
service.
Under the bill, a plan to which a make-up contribution is
made on account of a reemployed veteran is not treated as
failing to meet the qualified plan nondiscrimination, coverage,
minimum participation, and top heavy rules (i.e., secs.
401(a)(4), 401(a)(26), 401(k)(3), 401(k)(11), 401(k)(12),
401(m), 403(b)(12), 408(k)(3), 408(k)(6), 408(p), 410(b), or
416) by reason of the making of such contribution.
Consequently, for purposes of applying the requirements and
tests associated with these rules, make-up contributions are
not taken into account either for the year in which they are
made or for the year to which they relate.
Under the bill, a special rule applies in the case of make-
up contributions of salary reduction, employer matching, and
after-tax employee amounts. A plan that provides for elective
deferrals or employee contributions is treated as meeting the
requirements of USERRA if the employer permits reemployed
veterans to make additional elective deferrals or employee
contributions under the plan during the period which begins on
the date of reemployment and has the same length as the lesser
of (1) the period of the individual's absence due to uniformed
service multiplied by three or (2) five years.
The employer is required to match any additional elective
deferrals or employee contributions at the same rate that would
have been required had the deferrals or contributions actually
been made during the period of uniformed service. Additional
elective deferrals, employer matching contributions, and
employee contributions is treated as make-up contributions for
purposes of the rule exempting such contributions from
qualified plan nondiscrimination, coverage, minimum
participation, and top heavy rules as described above.
The bill clarifies that USERRA does not require (1) any
earnings to be credited to an employee with respect to any
contribution before such contribution is actually made or (2)
any make-up allocation of any forfeiture that occurred during
the period of uniformed service.
The bill also provides that the plan loan, plan
qualification, and prohibited transaction rules will not be
violated merely because a plan suspends the repayment of a plan
loan during a period of uniformed service.
The bill also defines compensation to be used for purposes
of determining make-up contributions and would conform the
rules contained in the Code with certain rights of reemployed
veterans contained in USERRA pertaining to employee benefit
plans.
The provision is effective as of December 12, 1994, the
effective date of the benefits-related provisions of USERRA.
20. Reporting of real estate transactions (sec. 1704(p) of the bill and
sec. 6045(e)(3) of the Code)
Present law
It is unlawful for any real estate reporting person to
charge separately any customer for complying with the
information reporting requirements with respect to real estate
transactions.
Explanation of provision
The bill clarifies that real estate reporting persons may
take into account the cost of complying with the reporting
requirements of Code section 6045 in establishing charges for
their services, so long as a separately listed charge for such
costs is not made.
The provision is effective on November 11, 1988 (as if
originally enacted as part of the amendment to the Code
relating to separate charges).
21. Clarification of denial of deductions for stock redemption expenses
(sec. 1704(q) of the bill and sec. 162(k)(2) of the Code)
Present law
Section 162(k), added by the Tax Reform Act of 1986, denies
a deduction for any amount paid or incurred by a corporation in
connection with the redemption of its stock. An exception is
provided for any deduction allowable under section 163
(relating to interest). The Internal Revenue Service has taken
the position that costs properly allocable to a borrowing the
interest on which is deductible under the exception may not be
amortized over the period of the loan, due to section 162(k).
Different courts have reached differing conclusions when
taxpayers have litigated the question.126
---------------------------------------------------------------------------
\126\ See, e.g., Fort Howard Corp. v. Commissioner 103 T.C. 345
(1994) upholding the IRS position; compare U.S. v. Kroy (Europe)
Limited, 27 F.3d 367 (9th Cir. 1994) (to the contrary).
---------------------------------------------------------------------------
Explanation of provision
The bill clarifies that amounts properly allocable to
indebtedness on which interest is deductible and properly
amortized over the term of that indebtedness are not subject to
the provision of section 162(k) denying a deduction for any
amount paid or incurred by a corporation in connection with the
redemption of its stock.
In addition, the bill clarifies that the rules of section
162(k) apply to any acquisition of its stock by a corporation
or by a party that has a relationship to the corporation
described in section 465(b)(3)(C) (which applies a more than 10
percent relationship test in certain cases).
Thus, for example, it is clarified that the denial of a
deduction applies to any reacquisition (i.e., any transaction
that is in effect an acquisition of previously outstanding
stock) regardless of whether the transaction is treated as a
redemption for purposes of subchapter C of the Code, regardless
of whether it is treated for tax purposes as a sale of the
stock or as a dividend, and regardless of whether the
transaction is a reorganization or other transaction.
Apart from the clarification relating to amounts properly
allocable to indebtedness, it is not intended that application
of the 1986 Act deduction denial to any amount or transaction
be limited under the bill.
The provision clarifying that amounts properly allocable to
indebtedness and amortized over the term of that indebtedness
are not subject to the denial under section 162(k), is
effective as if included in the Tax Reform Act of 1986.
The other clarifications apply to amounts paid or incurred
after September 13, 1995. No inference is intended that any
amounts described in these other clarifications are deductible
under present law.
22. Definition of passive income in determining passive foreign
investment company status (sec. 1704(s) of the bill, sec. 1235
of the 1986 Act and sec. 1296(b)(2) of the Code)
Present law
Under the export trade corporation (ETC) provisions, a
controlled foreign corporation (CFC) that qualifies as an ETC
is not subject to current U.S. tax on certain export trade
income. In 1971, the ETC provisions were replaced by rules
applicable to domestic international sales corporations
(DISCs). Only those ETCs in existence at that time are allowed
to continue operating as ETCs. In 1984, the DISC provisions
were largely replaced by the rules applicable to foreign sales
corporations (FSCs). Certain foreign trade income of a FSC is
exempt from U.S. income tax. In addition, a domestic
corporation is allowed a 100-percent dividends-received
deduction for dividends distributed from the FSC out of
earnings attributable to certain foreign trade income.
The Tax Reform Act of 1986 established an anti-deferral
regime for passive foreign investment companies (PFICs). A
foreign corporation is a PFIC 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 amount of its assets
consists of assets that produce, or are held for the production
of passive income. Passive income for this purpose generally
means income that satisfies the definition of foreign personal
holding company income under subpart F. Foreign personal
holding company income generally includes interest, dividends,
and annuities; certain rents and royalties; related party
factoring income; net commodities gains; net foreign currency
gains; and net gains from sales or exchanges of certain other
property. In determining whether a foreign corporation is a
PFIC, passive income does not include certain active-business
banking, insurance, or (in the case of the U.S. shareholders of
a CFC) securities income, or certain amounts received from a
related party (to the extent that the amounts are allocable to
income of the related party which is not passive income).
Explanation of provision
The bill clarifies that foreign trade income of a FSC and
export trade income of an ETC do not constitute passive income
for purposes of the PFIC definition.
The provision is effective as if it were included in the
Tax Reform Act of 1986.
23. Exclusion from income for combat zone compensation (sec. 1704(t)(4)
of the bill and sec. 112 of the Code)
Present law
The Code provides that gross income does not include
compensation received by a taxpayer for active service in the
Armed Forces of the United States for any month during any part
of which the taxpayer served in a combat zone (or was
hospitalized as a result of injuries, wounds or disease
incurred while serving in a combat zone) (limited to $500 per
month for commissioned officers). The heading refers to
``combat pay,'' although that term is no longer used to refer
to special pay provisions for members of the Armed Forces, nor
is the exclusion limited to those special pay provisions
(hazardous duty pay (37 U.S.C. sec. 301) and hostile fire or
imminent danger pay (37 U.S.C. sec. 310)).
Explanation of provision
The bill modifies the heading of Code section 112 to refer
to ``combat zone compensation'' instead of ``combat pay.'' The
bill also makes conforming changes to cross-references
elsewhere in the Code. This provision is effective on the date
of enactment.
III. BUDGET EFFECTS OF THE BILL
A. Committee Estimates
In accordance with paragraph 11(a) of rule XXVI of the
Standing Rules of the Senate, the following statement is made
concerning the estimated budget effects of the committee
amendment to Title I of the bill.
The revenue provisions of Title I are estimated to have the
following effects on the budget for fiscal years 1996-2005:
B. Budget Authority and Tax Expenditures
Budget authority
In accordance with section 308(a)(1) of the Budget Act, the
Committee states that the committee amendment to Title I
involves no new or increased budget authority.
Tax expenditures
In accordance with section 308(a)(2) of the Budget Act, the
Committee states that the revenue-reducing income tax
provisions of the committee amendment to Title I generally
involve increased tax expenditures and that the revenue-
increasing income tax provisions generally involve decreased
tax expenditures (other than the revision of expatriation tax
rules). Excise tax and estate and gift tax provisions are not
classified as tax expenditures under the Budget Act. (See the
revenue table in Part III.A., above, for specific income tax
provisions.)
C. Consultation With Congressional Budget Office
In accordance with section 403 of the Budget Act, the
Committee advises that the Congressional Budget Office has
submitted the following statement on the budget effects of the
committee amendment to Title I of the bill:
U.S. Congress,
Congressional Budget Office,
Washington, DC, June 18, 1996.
Hon. William V. Roth, Jr.,
Chairman, Committee on Finance,
U.S. Senate, Washington, DC.
Dear Mr. Chairman: The Congressional Budget Office and the
Joint Committee on Taxation (JCT) have reviewed H.R. 3448, the
``Small Business Job Protection Act of 1996,'' as ordered
reported by the Senate Committee on Finance on June 12, 1996.
The JCT estimates that this bill would increase governmental
receipts by $258 million in fiscal year 1996 and by $72 million
over fiscal years 1996 through 2005. CBO concurs with this
estimate.
H.R. 3448 would increase the expensing limitation for small
businesses, extend certain expiring provisions, simplify
pension and foreign asset provisions, modify the tax treatment
of Subchapter S corporations and make technical corrections. In
addition, the bill would reinstate the Airport and Airway Trust
Fund excise taxes through December 31, 1996, modify the
possessions tax credit, repeal the 50 percent interest income
exclusion for financial institution loans to ESOPs, and make
other changes that would increase taxes on corporations and
other businesses. The revenue effects of H.R. 3448 are
summarized in the table below. Please refer to the enclosed
table for a more detailed estimate of the bill.
Revenue Effects of H.R. 3448
[By fiscal years, in billions of dollars]
----------------------------------------------------------------------------------------------------------------
1996 1997 1998 1999 2000 2001-2005
----------------------------------------------------------------------------------------------------------------
Projected revenues: Under current
law \1\.......................... 1,417.583 1,475.572 1,547.285 1,619,979 1,699,866 9,999.271
Proposed changes.................. 0.258 0.405 -0.375 -0.179 -0.072 0.029
Projected revenues: Under H.R.
3074............................. 1,417.841 1,475.977 1,546.910 1,619.800 1,699.794 9,999.300
----------------------------------------------------------------------------------------------------------------
\1\ Includes the revenue effects of P.L. 104-7 (H.R. 831), P.L. 104-104 (S. 652), P.L. 104-117 (H.R. 2778), P.L.
104-121 (H.R. 3136), P.L. 104-132 (S. 735), and P.L. 104-134 (H.R. 3019).
In accordance with the requirements of Public Law 104-4,
the Unfunded Mandates Reform Act of 1995, JCT has determined
that the bill contains one intergovernmental mandate. The
provision to reinstate the Airport and Airway Trust Fund excise
taxes through December 31, 1996, imposes a Federal
intergovernmental mandate because State, local, and tribal
governments will be required to pay the requisite taxes for
commercial air travel by their employees. JCT estimates that
the direct costs of complying with this Federal
intergovernmental mandate will not exceed $50 million in any of
the first five fiscal years.
In addition, JCT has determined that the bill contains
several Federal private sector mandates. The JCT estimates the
direct mandate costs of tax increases in H.R. 3448 would total
$655 million in 1996, and about $6.914 billion over the 1996-
2000 period, as shown below:
FEDERAL PRIVATE SECTOR MANDATES
[By fiscal years, in millions of dollars]
----------------------------------------------------------------------------------------------------------------
1996 1997 1998 1999 2000
----------------------------------------------------------------------------------------------------------------
Direct cost of tax increases....................................... 655 2,568 1,129 1,273 1,289
----------------------------------------------------------------------------------------------------------------
Please refer to the enclosed letter for a more detailed
account of these provisions.
In addition to theses Federal private sector mandates, the
bill also provides for reductions in taxes. At this point, it
is unclear to CBO whether these tax reductions should be viewed
as offsets to the direct costs of the mandates in the bill. JCT
estimates that the savings to the private sector associated
with the tax reductions in H.R. 3448 would total $397 million
in 1996, and about $6.051 billion over the 1996-2000 period, as
shown below:
FEDERAL PRIVATE SECTOR SAVINGS
[By fiscal years, in millions of dollars]
----------------------------------------------------------------------------------------------------------------
1996 1997 1998 1999 2000
----------------------------------------------------------------------------------------------------------------
Reductions in taxes........................................... -397 -1,865 -1,281 -1,170 -1,228
----------------------------------------------------------------------------------------------------------------
Section 252 of the Balanced Budget and Emergency Deficit
Control Act of 1985 sets up pay-as-you-go procedures for
legislation affecting receipts or direct spending through 1998.
Because the bill would affect receipts, pay-as-you-go
procedures would apply to the bill. These effects are
summarized in the table below.
PAY-AS-YOU-GO CONSIDERATIONS
[By fiscal years in millions of dollars]
------------------------------------------------------------------------
1996 1997 1998
------------------------------------------------------------------------
Changes in receipts.......................... 258 405 -375
Changes in outlays........................... N.A. N.A. N.A.
------------------------------------------------------------------------
Not Applicable.
If you wish further details, please free to contact me or
your staff may wish to contact Stephanie Weiner.
Sincerely,
June E. O'Neill,
Director.
U.S. Congress,
Joint Committee on Taxation,
Washington, DC, June 18, 1996.
Mrs. June O'Neill,
Director, Congressional Budget Office
U.S. Congress, Washington, DC.
Dear Mrs. O'Neill: We have reviewed H.R. 3448, the ``Small
Business Job Protection Act,'' as amended and ordered to be
reported by the Senate Committee on Finance on June 12, 1996.
In accordance with the requirements of Public Law 104-4, the
Unfunded Mandates Reform Act of 1995 (the ``Unfunded Mandates
Act''). We have determined that the following revenue
provisions of the bill contain Federal private sector mandates:
(1) the provision relating to adjustments to basis of inherited
S corporation stock; (2) the provision to repeal 5-year
averaging for lump-sum distributions from qualified pension
plans; (3) the provision to repeal the $5,000 exclusion for
employee death benefits; (4) the provision that would provide a
simplified method for taxing annuity distributions under
qualified pension plans; (5) the provision to modify the
section 936 credit; (6) the provision to repeal the 50-percent
interest income exclusion for financial institution loans to
ESOPs; (7) the provision to provide that punitive damages are
not excludable from income; (8) the provision to phase out and
extend the luxury automobile excise tax; (9) the provision to
modify the two county tax-exempt bond rule for local furnishers
of electricity or gas and to prohibit new local furnishers;
(10) the provision to eliminate the interest allocation
exception for certain nonfinancial corporations; (11) the
provision to reinstate the Airport and Airway Trust Fund excise
taxes through December 31, 1996; (12) the provision to change
the depreciation rules for water utilities; (13) the provision
to revise the expatriation tax rules; (14) the provision to
modify the basis adjustment rules under section 1033; (15) the
provision to repeal the exemption from withholding for gambling
winnings from bingo and keno; and (16) and the provision
relating to the treatment of retired lives reserves. The
attached revenue table (items I.B.13., II.A.I., 2., and 3., and
IV.1-3., 5-8., and 10., and VI.B. I-3.) generally reflects
amounts that are no greater than the aggregate estimated
amounts that the private sector will be required to spend in
order to comply with these Federal private sector mandates. In
the case of the provision modifying the depreciation rules for
water utilities, the staff of the Joint Committee on Taxation
estimates that the amounts that the private sector will be
required to spend to comply with the Federal private sector
mandate will not exceed $6 million in fiscal year 1997, $20
million in fiscal year 1998, $34 million in fiscal year 1999,
$47 million in fiscal year 2000, and $59 million in fiscal year
2001.
The provision to reinstate the Airport and Airway Trust
Fund excise taxes through December 31, 1996, imposes a Federal
intergovernmental mandate because State, local, and tribal
governments will be required to pay the requisite taxes for
commercial air travel by State, local, and tribal government
employees. The staff of the Joint Committee on Taxation
estimates that the direct costs of complying with this Federal
intergovernmental mandate will not exceed $50,000,000 in either
the first fiscal year or in any of the 4 fiscal years following
the first fiscal year.
If you would like to discuss this matter in further detail,
please feel free to contact me. Thank you for your cooperation
in this matter.
Sincerely,
Kenneth J. Kies,
Chief of Staff.
IV. VOTES OF THE COMMITTEE
In accordance with paragraph 7(b) of rule XXVI of the
Standing Rules of the Senate, the following statement is made
concerning the votes taken on the committee amendment to Title
I of the bill.
Motion to approve committee amendment
The Committee approved the Chairman's amendment, as
amended, by unanimous voice vote, a quorum being present. The
committee amendment is a substitute for Title I of H.R. 3448
(revenue provisions).
Amendment to the Chairman's proposed amendment
The Committee approved an en bloc amendment by Senator
Moynihan to the Chairman's proposed committee amendment by
unanimous voice vote, a quorum being present.
V. REGULATORY IMPACT AND OTHER MATTERS
a. regulatory impact
In accordance with paragraph 11(b) of rule XXVI of the
Standing Rules of the Senate, the Committee makes the following
statement concerning the regulatory impact that might be
incurred in carrying out the committee amendment to Title I of
the bill.
Impact on individuals and businesses
Subtitle A of Title I provides tax relief benefiting small
businesses. Subtitle B contains temporary extensions of certain
expired or expiring tax provisions. Subtitle C provides
modifications benefiting S corporations. Subtitle D provides
pension simplification provisions. Subtitle E contains certain
revenue offsets to pay for the revenue-reducing provisions of
the committee amendment. Subtitle F contains technical
corrections to recent tax legislation. Subtitle G includes
miscellaneous revenue measures.
The revenue-increasing provisions will result in increased
tax payments by the affected taxpayers, and will require such
taxpayers to make the necessary calculations to comply with the
provisions.
Impact on personal privacy and paperwork
The committee amendment to Title I of the bill will have
little impact on personal privacy. Certain of the tax
provisions will involve revised calculations by taxpayers in
order to correctly compute their tax liability.
b. information relating to unfunded mandates
This information is provided in accordance with section 423
of the Unfunded Mandates Act of 1995 (P.L. 104-4).
The Committee has determined that the following provisions
of the bill contain Federal mandates on the private sector: (1)
the provision relating to adjustments to basis of inherited S
corporation stock; (2) the provision to repeal 5-year averaging
for lump-sum distributions from qualified pension plans; (3)
the provision to repeal the $5,000 exclusion for employee death
benefits; (4) the provision that would provide a simplified
method for taxing annuity distributions under qualified pension
plans; (5) the provision to modify the section 936 credit; (6)
the provision to repeal the 50-percent interest income
exclusion for financial institution loans to ESOPs; (7) the
provision to provide that punitive damages are not excludable
from income; (8) the provision to phase out and extend the
luxury automobile excise tax; (9) the provision to modify the
two county tax-exempt bond rule for local furnishers or
electricity or gas to prohibit new local furnishers; (10) the
provision to eliminate the interest allocation exception for
certain nonfinancial corporations; (11) the provision to
reinstate the Airport and Airway Trust Fund excise taxes
through December 31, 1996; (12) the provision to change the
depreciation rules for water utilities; (13) the provision to
revise the expatriation tax rules, (14) the provision to modify
the basis adjustment rules under section 1033; (15) the
provision to repeal the exemption from withholding for gambling
winnings from bingo and keno; and (16) and the provision
relating to the treatment of retired lives reserves.
The costs required to comply with each Federal private
sector mandate generally is no greater than the revenue
estimate for the provision. Benefits from the provisions
include improved administration of the Federal income tax laws,
simplification for individual taxpayers, and a more accurate
measurement of gross income for Federal income tax purposes.
The Committee believes the benefits of the bill are greater
than the costs required to comply with the Federal private
sector mandates contained in the bill.
The provision to repeal five-year averaging for lump-sum
distributions from qualified pension plans results in a better
measurement of gross income for Federal income tax purposes and
encourages taxpayers to take qualified pension plan
distributions in a form other than a lump-sum distribution. The
provision to repeal the $5,000 exclusion for employee death
benefits results in a better measurement of gross income for
Federal income tax purposes. The provision to provide a
simplified method for taxing annuity distributions under
qualified pension plans generally adopts an alternative method
for taxing such distributions contained in Treasury regulations
as the sole method for taxing such distributions and, thereby,
simplifies the determination for individual taxpayers.
The provision relating to the adjustment to basis of
inherited S corporation stock provides that a person acquiring
stock in an S corporation from a decedent will treat as income
in respect of a decedent (``IRD'') his or her pro rata share of
any item of income of the corporation that would have been IRD
if that item had been acquired directly from the decedent,
thereby improving the measurement of income for tax purposes.
The provision to modify the section 936 credit with
transition rules for companies that have existing operations in
the possessions will result in the better measurement of gross
income for Federal income tax purposes by generally eliminating
a tax benefit enjoyed by only a small number of U.S.
corporations operating in possessions.
The provision to repeal the 50-percent interest income
exclusion for financial institution loans to ESOPs will result
in a better measurement of the income of such financial
institutions.
The provision to repeal the exclusion for punitive damages
will result in a better measurement of income for Federal tax
purposes.
The provision to phase out and extend the luxury automobile
excise tax will result in a more gradual phase out of the
excise tax, which will result in less disruption of the
automobile market.
The provision to modify the two county tax-exempt bond rule
for local furnishers of electricity or gas and to prohibit new
local furnishers eliminates a Federal tax subsidy for certain
persons engaged in the local furnishing of electricity or gas
and should result in a more accurate measure of income for
Federal tax purposes.
The provision to eliminate the interest allocation
exception for certain nonfinancial corporations eliminates a
narrowly targeted rule for allocating and apportioning interest
expense under the foreign tax credit rules and should result in
a more accurate measure of income for Federal tax purposes.
The provision to reinstate the Airport and Airway Trust
Fund excise taxes through December 31, 1996, funds important
air transportation services.
The provision to change the depreciation rules for water
utilities should result in a more accurate measure of income
for Federal tax purposes given the long useful lives generally
exhibited by water utility property.
The provision to revise the expatriation rules helps to
ensure that the Federal tax laws do not provide individuals
with an incentive to expatriate.
The provision to modify the basis adjustment rules under
section 1033 should result in a more accurate measure of income
for Federal tax purposes.
The provision to repeal the exemption from withholding for
gambling winnings from bingo and keno will improve tax
compliance and administration.
The provision relating to the treatment of retired reserves
will simplify the treatment of such contracts and result in a
better measurement of income for Federal tax purposes.
The revenue-raising provisions of the bill are used to
offset the cost of certain small business initiatives
(including increased expensing, extension of the FICA tip
credit to certain delivery persons, and pension and S
corporation simplification provisions) and the extension of
certain expiring provisions. These provisions are generally
designed to relieve the burdens of Federal income taxation on
individuals and small business and the revenue-raising
provisions of the bill are critical to achieving these goals.
The provision to reinstate the Airport and Airway Trust
Fund taxes through December 31, 1996, imposes a Federal
intergovernmental mandate because State, local, and tribal
governments will be required to pay the requisite taxes for
commercial air travel by State, local, and tribal government
employees. The staff of the Joint Committee on Taxation
estimates that the direct costs of complying with this Federal
intergovernmental mandate will be less than $50,000,000 in
either the first fiscal year or in any one of the 4 fiscal
years following the first fiscal year. The Committee intends
that the Federal intergovernmental mandate be unfunded because
the Airport and Airway Trust Fund excise taxes are intended to
fund the maintenance of U.S. airports and airways and the
Committee believes that it is appropriate for State, local, and
tribal governments to bear their allocable share of the
responsibility for such funding.
The revenue provisions of the bill generally affect
activities that are only engaged in by the private sector. The
provision reinstating the Airport and Airway Trust Fund excise
taxes are imposed both on the private sector and on State,
local, and tribal governments and, thus, do not affect the
competitive balance between such governments and the private
sector.
VI. CHANGES IN EXISTING LAW MADE BY THE BILL, AS REPORTED
In the opinion of the Committee, it is necessary in order
to expedite the business of the Senate, to dispense with the
requirements of paragraph 12 of the Rule XXVI of the Standing
rules of the Senate (relating to the showing of changes in
existing law made by the bill as reported by the Committee).