[Congressional Bills 104th Congress]
[From the U.S. Government Publishing Office]
[H.R. 2692 Introduced in House (IH)]







104th CONGRESS
  1st Session
                                H. R. 2692

 To amend the Internal Revenue Code of 1986 to provide for deductible 
  contributions to medical finance accounts and to reform the earned 
                             income credit.


_______________________________________________________________________


                    IN THE HOUSE OF REPRESENTATIVES

                           November 30, 1995

  Mr. Royce introduced the following bill; which was referred to the 
                      Committee on Ways and Means

_______________________________________________________________________

                                 A BILL


 
 To amend the Internal Revenue Code of 1986 to provide for deductible 
  contributions to medical finance accounts and to reform the earned 
                             income credit.

    Be it enacted by the Senate and House of Representatives of the 
United States of America in Congress assembled,

                   TITLE I--MEDICAL FINANCE ACCOUNTS

SEC. 101. MEDICAL FINANCE ACCOUNTS.

    (a) In General.--Part VII of subchapter B of chapter 1 of the 
Internal Revenue Code of 1986 (relating to additional itemized 
deductions for individuals) is amended by redesignating section 220 as 
section 221 and by inserting after section 219 the following new 
section:

``SEC. 220. MEDICAL FINANCE ACCOUNTS.

    ``(a) Deduction Allowed.--In the case of an individual, there shall 
be allowed as a deduction for the taxable year an amount equal to the 
aggregate amount paid in cash by such individual during such taxable 
year to a medical finance account of such individual.
    ``(b) Limitations.--
            ``(1) In general.--Except as otherwise provided in this 
        subsection, the amount allowable as a deduction under 
        subsection (a) to an individual for any taxable year shall not 
        exceed the greater of--
                    ``(A) $3,000 or, in the case of an individual who 
                is married, has a dependent (as defined in section 
                152), or is a dependent (as so defined) for the taxable 
                year, the amount determined under paragraph (3),
                    ``(B) in the case of an individual who is covered 
                by a catastrophic health plan, the deductible under 
                such plan, or
                    ``(C) the excess of--
                            ``(i) the limitation under this paragraph 
                        (determined without regard to this 
                        subparagraph) for the taxable year and each of 
                        the preceding 4 taxable years, over
                            ``(ii) the sum of the amounts allowed as a 
                        deduction under this section for each of such 4 
                        taxable years.
        For purposes of subparagraph (C), any of such preceding 4 
        taxable years during which the individual did not have a 
        medical finance account shall not be taken into account, and 
        any taxable year beginning before January 1, 1996, shall not be 
        taken into account.
            ``(2) Coordination with exclusion for employer 
        contributions.--The limitation which would (but for this 
        paragraph) apply under this subsection to any individual for 
        any taxable year shall be reduced (but not below zero) by the 
        amount which would (but for section 106(b)) be includible in 
        such individual's gross income for such taxable year.
            ``(3) Special rules for married individuals and families.--
        For purposes of paragraph (1)(A)--
                    ``(A) In general.--Subject to subparagraphs (B) and 
                (C), the amount determined under this paragraph, with 
                respect to an individual who is married or has a 
                dependent (as defined in section 152) for the taxable 
                year, is $5,000.
                    ``(B) Treatment of family as one individual.--For 
                purposes of subparagraph (A), an individual, the spouse 
                (if any) of such individual, and all dependents of such 
                individual or such spouse shall be treated as 1 
                individual.
                    ``(C) Division of amounts between family members.--
                Individuals who are married to each other may allocate 
                the amount applicable under subparagraph (A) between 
                them in any proportion on which they agree. If there is 
                no such agreement, such amount shall be allocated 
                equally between such individuals. Any individual may 
                allocate to any dependent (as defined in section 152) 
                of such individual any portion of the amount otherwise 
                allocable to such individual under this paragraph.
            ``(4) Special rule if one deductible applies to family.--
        For purposes of paragraph (1)(B), rules similar to the rules of 
        subparagraphs (B) and (C) of paragraph (3) shall apply with 
        respect to any catastrophic health plan which applies one 
        deductible to--
                    ``(A) an individual, and
                    ``(B)(i) the spouse (if any) of such individual, or
                    ``(ii) any dependent of such individual or such 
                spouse.
    ``(c) Medical Finance Account.--For purposes of this section--
            ``(1) Medical finance account.--The term `medical finance 
        account' means a trust created or organized in the United 
        States exclusively for the purpose of paying the qualified 
        medical expenses of the account holder, but only if the written 
        governing instrument creating the trust meets the following 
        requirements:
                    ``(A) Except in the case of a rollover contribution 
                described in subsection (f)(3), contributions will be 
                accepted--
                            ``(i) only in cash, and
                            ``(ii) only to the extent not in excess of 
                        the limitation under subsection (b) (determined 
                        without regard to paragraph (2) thereof).
                    ``(B) The trustee is a bank (as defined in section 
                408(n)), an insurance company (as defined in section 
                816), or another person who demonstrates to the 
                satisfaction of the Secretary that the manner in which 
                such person will administer the trust will be 
                consistent with the requirements of this section.
                    ``(C) No part of the trust assets will be invested 
                in life insurance contracts.
                    ``(D) The assets of the trust will not be 
                commingled with other property except in a common trust 
                fund or common investment fund.
                    ``(E) The interest of an individual in the balance 
                in his account is nonforfeitable.
            ``(2) Qualified medical expenses.--The term `qualified 
        medical expenses' means, with respect to an account holder, 
        amounts paid by such holder for medical care (as defined in 
        section 213(d)), or long-term care, for--
                    ``(A) such individual, the spouse of such 
                individual, and any dependent (as defined in section 
                152) of such individual, or
                    ``(B) any member of the family of such individual 
                or spouse who has attained age 65,
        but only to the extent such amounts are not compensated for by 
        insurance or otherwise, and
            ``(3) Account holder.--The term `account holder' means the 
        individual on whose behalf the medical finance account was 
        established.
            ``(4) Certain rules to apply.--Rules similar to the 
        following rules shall apply for purposes of this section:
                    ``(A) Section 219(d)(2) (relating to no deduction 
                for rollovers).
                    ``(B) Section 219(f)(3) (relating to time when 
                contributions deemed made).
                    ``(C) Except as provided in section 106(b), section 
                219(f)(5) (relating to employer payments).
                    ``(D) Section 408(h) (relating to custodial 
                accounts).
    ``(d) Tax Treatment of Accounts.--
            ``(1) In general.--A medical finance account is exempt from 
        taxation under this subtitle, unless such account has ceased to 
        be a medical finance account by reason of the rules referred to 
        in paragraph (2). Notwithstanding the preceding sentence, any 
        such account is subject to the taxes imposed by section 511 
        (relating to imposition of tax on unrelated business income of 
        charitable, etc., organizations).
            ``(2) Account assets treated as distributed in the case of 
        prohibited transactions or account pledged as security for 
        loan.--Rules similar to the rules of paragraphs (2) and (4) of 
        section 408(e) shall apply to medical finance accounts, and any 
        amount treated as distributed under such rules shall be treated 
        as not used to pay qualified medical expenses.
    ``(e) Tax Treatment of Distributions.--
            ``(1) Inclusion of amounts not used for qualified medical 
        expenses.--Any amount paid or distributed out of a medical 
        finance account shall be included in the gross income of the 
        account holder unless such amount is used exclusively to pay 
        the qualified medical expenses of such holder.
            ``(2) Penalty for amounts not used for qualified medical 
        expenses.--
                    ``(A) In general.--The tax imposed by this chapter 
                for any taxable year in which any amount is included in 
                gross income by reason of paragraph (1) shall be 
                increased by 10 percent of such amount.
                    ``(B) Exceptions.--Subparagraph (A) shall not apply 
                with respect to any amount paid or distributed on or 
after the date the account holder--
                            ``(i) becomes disabled within the meaning 
                        of section 72(m)(7), or
                            ``(ii) dies.
            ``(3) Excess contributions returned before due date of 
        return.--Paragraph (1) shall not apply to the distribution of 
        any contribution paid during a taxable year to a medical 
        finance account to the extent that such contribution exceeds 
        the limitation under subsection (b) (determined without regard 
        to paragraph (3) thereof) if--
                    ``(A) such distribution is received by the account 
                holder on or before the last day prescribed by law 
                (including extensions of time) for filing such 
                individual's return for such taxable year, and
                    ``(B) such distribution is accompanied by the 
                amount of net income attributable to such excess 
                contribution.
        Any net income described in subparagraph (B) shall be included 
        in the gross income of the account holder for the taxable year 
        in which it is received.
            ``(4) Rollovers and transfers at death.--Paragraph (1) 
        shall not apply to any amount paid or distributed out of a 
        medical finance account if the entire amount received 
        (including money and any other property) is paid into another 
        medical finance account for the benefit of--
                    ``(A) such holder,
                    ``(B) the spouse of such holder,
                    ``(C) any dependent of such holder who has attained 
                age 21 as of the date of the payment or distribution, 
                or
                    ``(D) in the case of a payment or distribution made 
                by reason of the death of such holder, the beneficiary 
                designated by such holder,
        not later than the 60th day after the date of such payment or 
        distribution.
            ``(5) Coordination with medical expense deduction.--For 
        purposes of section 213, any payment or distribution out of a 
        medical finance account for qualified medical expenses shall 
        not be treated as an expense paid for medical care.
            ``(6) Transfer of account incident to divorce.--The 
        transfer of an individual's interest in a medical finance 
        account to his spouse or former spouse under a divorce or 
        separation instrument described in subparagraph (A) of section 
        71(b)(2) is not to be considered a taxable transfer made by 
        such individual notwithstanding any other provision of this 
        subtitle, and such interest at the time of the transfer is to 
        be treated as a medical finance account of such spouse, and not 
        of such individual. Thereafter such account for purposes of 
        this subtitle is to be treated as maintained for the benefit of 
        such spouse.
    ``(f) Reports.--The trustee of a medical finance account shall make 
such reports regarding such account to the Secretary and to the account 
holder with respect to contributions, distributions, and such other 
matters as the Secretary may require under regulations. The reports 
required by this subsection shall be filed at such time and in such 
manner and furnished to such individuals at such time and in such 
manner as may be required by those regulations.''
    (b) Deduction Allowed Whether or Not Individual Itemizes Other 
Deductions.--Subsection (a) of section 62 of such Code is amended by 
inserting after paragraph (15) the following new paragraph:
            ``(16) Medical finance accounts.--The deduction allowed by 
        section 220.''
    (c) Exclusions for Employer Contributions To Medical Finance 
Accounts.--
            (1) Exclusion from income tax.--The text of section 106 of 
        such Code (relating to contributions by employer to accident 
        and health plans) is amended to read as follows:
    ``(a) General Rule.--Gross income of an employee does not include 
employer-provided coverage under an accident or health plan.
    ``(b) Contributions to Medical Finance Accounts.--
            ``(1) In general.--In the case of an employee, gross income 
        does not include amounts contributed by such employee's 
        employer to any medical finance account (as defined in section 
        220(c)) of such employee.
            ``(2) No constructive receipt.--No amount shall be included 
        in the gross income of any employee solely because the employee 
        may choose between the contributions referred to in paragraph 
        (1) and employer contributions to another health plan of the 
        employer.
            ``(3) Coordination with deduction limitation.--The amount 
        excluded from the gross income of an employee under this 
        subsection for any taxable year shall not exceed the limitation 
        under section 220(b)(1) (determined without regard to this 
        subsection) which is applicable to such employee for such 
        taxable year.''
            (2) Exclusion from employment taxes.--
                    (A) Social security taxes.--
                            (i) Subsection (a) of section 3121 of such 
                        Code is amended by striking ``or'' at the end 
                        of paragraph (20), by striking the period at 
                        the end of paragraph (21) and inserting ``; 
                        or'', and by inserting after paragraph (21) the 
                        following new paragraph:
            ``(22) any payment made to or for the benefit of an 
        employee if at the time of such payment it is reasonable to 
        believe that the employee will be able to exclude such payment 
        from income under section 106(b).''
                            (ii) Subsection (a) of section 209 of the 
                        Social Security Act is amended by striking 
                        ``or'' at the end of paragraph (17), by 
                        striking the period at the end of paragraph 
                        (18) and inserting ``; or'', and by inserting 
                        after paragraph (18) the following new 
                        paragraph:
            ``(19) any payment made to or for the benefit of an 
        employee if at the time of such payment it is reasonable to 
believe that the employee will be able to exclude such payment from 
income under section 106(b) of the Internal Revenue Code of 1986.''
                    (B) Railroad retirement tax.--Subsection (e) of 
                section 3231 of such Code is amended by adding at the 
                end the following new paragraph:
            ``(10) Medical finance account contributions.--The term 
        `compensation' shall not include any payment made to or for the 
        benefit of an employee if at the time of such payment it is 
        reasonable to believe that the employee will be able to exclude 
        such payment from income under section 106(b).''
                    (C) Unemployment tax.--Subsection (b) of section 
                3306 of such Code is amended by striking ``or'' at the 
                end of paragraph (15), by striking the period at the 
                end of paragraph (16) and inserting ``; or'', and by 
                inserting after paragraph (16) the following new 
                paragraph:
            ``(17) any payment made to or for the benefit of an 
        employee if at the time of such payment it is reasonable to 
        believe that the employee will be able to exclude such payment 
        from income under section 106(b).''
                    (D) Withholding tax.--Subsection (a) of section 
                3401 of such Code is amended by striking ``or'' at the 
                end of paragraph (19), by striking the period at the 
                end of paragraph (20) and inserting ``; or'', and by 
                inserting after paragraph (20) the following new 
                paragraph:
            ``(21) any payment made to or for the benefit of an 
        employee if at the time of such payment it is reasonable to 
        believe that the employee will be able to exclude such payment 
        from income under section 106(b).''
    (d) Exclusion of Medical Finance Accounts From Estate Tax.--Part IV 
of subchapter A of chapter 11 of such Code is amended by adding at the 
end the following new section:

``SEC. 2057. MEDICAL FINANCE ACCOUNTS.

    ``For purposes of the tax imposed by section 2001, the value of the 
taxable estate shall be determined by deducting from the value of the 
gross estate an amount equal to the value of any medical finance 
account (as defined in section 220(c)) included in the gross estate.''
    (e) Tax on Excess Contributions.--Section 4973 of such Code 
(relating to tax on excess contributions to individual retirement 
accounts, certain section 403(b) contracts, and certain individual 
retirement annuities) is amended--
            (1) by inserting ``medical finance accounts,'' after 
        ``accounts,'' in the heading of such section,
            (2) by redesignating paragraph (2) of subsection (a) as 
        paragraph (3) and by inserting after paragraph (1) the 
        following:
            ``(2) a medical finance account (within the meaning of 
        section 220(c)),'',
            (3) by striking ``or'' at the end of paragraph (1) of 
        subsection (a), and
            (4) by adding at the end thereof the following new 
        subsection:
    ``(d) Excess Contributions to Medical Finance Accounts.--For 
purposes of this section, in the case of a medical finance account 
(within the meaning of section 220(c)), the term `excess contributions' 
means the amount by which the amount contributed for the taxable year 
to the account exceeds the limitation under section 220(b) for such 
taxable year. For purposes of this subsection, any contribution which 
is distributed out of the medical finance account in a distribution to 
which section 220(e)(3) applies shall be treated as an amount not 
contributed.''
    (f) Tax on Prohibited Transactions.--Section 4975 of such Code 
(relating to tax on prohibited transactions) is amended--
            (1) by adding at the end of subsection (c) the following 
        new paragraph:
            ``(4) Special rule for medical finance accounts.--An 
        individual for whose benefit a medical finance account (within 
        the meaning of section 220(c)) is established shall be exempt 
        from the tax imposed by this section with respect to any 
        transaction concerning such account (which would otherwise be 
        taxable under this section) if, with respect to such 
        transaction, the account ceases to be a medical finance account 
        by reason of the application of section 220(d)(2) to such 
        account.'', and
            (2) by inserting ``or a medical finance account described 
        in section 220(c)'' in subsection (e)(1) after ``described in 
        section 408(a)''.
    (g) Failure To Provide Reports on Medical Finance Accounts.--
Section 6693 of such Code (relating to failure to provide reports on 
individual retirement accounts or annuities) is amended--
            (1) by inserting ``or on medical finance accounts'' after 
        ``annuities'' in the heading of such section, and
            (2) by adding at the end of subsection (a) the following: 
        ``The person required by section 220(f) to file a report 
        regarding a medical finance account at the time and in the 
        manner required by such section shall pay a penalty of $50 for 
        each failure to so file unless it is shown that such failure is 
        due to reasonable cause.''
    (h) Clerical Amendments.--
            (1) The table of sections for part VII of subchapter B of 
        chapter 1 of such Code is amended by striking the last item and 
        inserting the following:

                              ``Sec. 220. Medical finance accounts.
                              ``Sec. 221. Cross reference.''
            (2) The table of sections for subchapter B of chapter 68 of 
        such Code is amended by inserting ``or on medical finance 
        accounts'' after ``annuities'' in the item relating to section 
        6693.
            (3) The table of sections for part IV of subchapter A of 
        chapter 11 of such Code is amended by adding at the end the 
        following new item:

                              ``Sec. 2057. Medical finance accounts.''
    (i) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 1995.

              TITLE II--REFORM OF THE EARNED INCOME CREDIT

SEC. 201. AMENDMENT OF 1986 CODE.

    Except as otherwise expressly provided, whenever in this title an 
amendment or repeal is expressed in terms of an amendment to, or repeal 
of, a section or other provision, the reference shall be considered to 
be made to a section or other provision of the Internal Revenue Code of 
1986.

SEC. 202. EARNED INCOME CREDIT DENIED TO INDIVIDUALS NOT AUTHORIZED TO 
              BE EMPLOYED IN THE UNITED STATES.

    (a) In General.--Section 32(c)(1) (relating to individuals eligible 
to claim the earned income credit) is amended by adding at the end the 
following new subparagraph:
                    ``(F) Identification number requirement.--The term 
                `eligible individual' does not include any individual 
                who does not include on the return of tax for the 
                taxable year--
                            ``(i) such individual's taxpayer 
                        identification number, and
                            ``(ii) if the individual is married (within 
                        the meaning of section 7703), the taxpayer 
                        identification number of such individual's 
                        spouse.''.
    (b) Special Identification Number.--Section 32 is amended by adding 
at the end the following new subsection:
    ``(l) Identification Numbers.--Solely for purposes of subsections 
(c)(1)(F) and (c)(3)(D), a taxpayer identification number means a 
social security number issued to an individual by the Social Security 
Administration (other than a social security number issued pursuant to 
clause (II) (or that portion of clause (III) that relates to clause 
(II)) of section 205(c)(2)(B)(i) of the Social Security Act).''.
    (c) Extension of Procedures Applicable to Mathematical or Clerical 
Errors.--Section 6213(g)(2) (relating to the definition of mathematical 
or clerical errors) is amended by striking ``and'' at the end of 
subparagraph (D), by striking the period at the end of subparagraph (E) 
and inserting a comma, and by inserting after subparagraph (E) the 
following new subparagraphs:
                    ``(F) an omission of a correct taxpayer 
                identification number required under section 32 
                (relating to the earned income credit) to be included 
                on a return, and
                    ``(G) an entry on a return claiming the credit 
                under section 32 with respect to net earnings from 
                self-employment described in section 32(c)(2)(A) to the 
                extent the tax imposed by section 1401 (relating to 
                self-employment tax) on such net earnings has not been 
                paid.''.
    (d) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 1995.

SEC. 203. REPEAL OF EARNED INCOME CREDIT FOR INDIVIDUALS WITHOUT 
              CHILDREN.

    (a) In General.--Subparagraph (A) of section 32(c)(1) (defining 
eligible individual) is amended to read as follows:
                    ``(A) In general.--The term `eligible individual' 
                means any individual who has a qualifying child for the 
                taxable year.''.
    (b) Conforming Amendments.--Each of the tables contained in 
paragraphs (1) and (2) of section 32(b) are amended by striking the 
items relating to no qualifying children.
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 1995.

SEC. 204. MODIFICATION OF EARNED INCOME CREDIT AMOUNT AND PHASEOUT.

    (a) Modification of Phaseout.--Subparagraph (B) of section 32(a)(2) 
is amended to read as follows:
                    ``(B) the sum of--
                            ``(i) the initial phaseout percentage of so 
                        much of the adjusted gross income (or, if 
                        greater, the earned income) of the taxpayer for 
                        the taxable year as exceeds the initial 
                        phaseout amount but does not exceed the final 
                        phaseout amount, plus
                            ``(ii) the final phaseout percentage of so 
                        much of the adjusted gross income (or, if 
                        greater, the earned income) of the taxpayer for 
                        the taxable year as exceeds the final phaseout 
                        amount.''
    (b) Percentages and Amounts.--
            (1) In general.--Subsection (b) of section 32, as amended 
        by section 203(b), is amended to read as follows:
    ``(b) Percentages and Amounts.--
            ``(1) Percentages.--The credit percentage, the initial 
        phaseout percentage, and the final phaseout percentage shall be 
        determined as follows:



                                                                                                                
   ``In the case of an eligible                                 The initial phaseout       The final phaseout   
         individual with:          The credit percentage is:       percentage is:            percentage is:     
                                                                                                                
1 qualifying child...............              34                       15.98                      20           
2 or more qualifying children....              36                       21.06                      25           
                                                                                                                

  
            ``(2) Amounts.--The earned income amount, the initial 
        phaseout amount, and the final phaseout amount shall be 
        determined as follows:



                                                                                                                
   ``In the case of an eligible     The earned income amount    The initial phaseout       The final phaseout   
         individual with:                     is:                    amount is:                amount is:       
                                                                                                                
1 qualifying child...............            $6,340                    $11,630                   $14,850        
2 or more qualifying children....            $8,910                    $11,630                 $17,750''.       
                                                                                                                

  
            (2) Increase in credit for lower-income families having 2 
        or more qualifying children.--Subsection (d) of section 32 is 
        amended to read as follows:
    ``(d) Increase in Credit for Lower-Income Families Having 2 or More 
Qualifying Children.--
            ``(1) In general.--If an eligible individual has 2 or more 
        qualifying children, for purposes of applying paragraphs (1) 
        and (2)(A) of subsection (a)--
                    ``(A) the amount of the taxpayer's earned income 
                shall be treated as being equal to \10/9\ of such 
                income (determined without regard to this paragraph), 
                and
                    ``(B) the earned income amount shall be treated as 
                being equal to \10/9\ of such amount (determined 
                without regard to this paragraph).
            ``(2) Phaseout of benefit.--If the applicable income of the 
        taxpayer for the taxable year exceeds $14,000 ($17,000 in the 
        case of a joint return), the amount of each increase under 
        paragraph (1) shall be reduced (but not below zero) by an 
        amount which bears the same ratio to such increase (determined 
        without regard to this subparagraph) as such excess bears to 
        $4,000.
            ``(3) Applicable income.--For purposes of this subsection, 
        the term `applicable income' means adjusted gross income or, if 
        greater, earned income.''
            (3) Conforming amendments.--
                    (A) Subsection (j) of section 32 is amended--
                            (i) by striking ``subsection (b)(2)(A)'' 
                        and inserting ``subsection (b)(2) or (d)'',
                            (ii) by striking ``1994'' and inserting 
                        ``1996'', and
                            (iii) by striking ``1993'' and inserting 
                        ``1995''.
                    (B) Subsection (e) of section 32 is amended to read 
                as follows:
    ``(e) Other Special Rules.--
            ``(1) Married individuals.--In the case of an individual 
        who is married (within the meaning of section 7703), this 
        section shall apply only if a joint return is filed for the 
        taxable year.
            ``(2) Taxable year must be full taxable year.--Except in 
        the case of a taxable year closed by reason of the death of an 
        individual, no credit shall be allowable under this section in 
        the case of a taxable year covering a period of less than 12 
        months.''
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 1995.

SEC. 205. RULES RELATING TO DENIAL OF EARNED INCOME CREDIT ON BASIS OF 
              DISQUALIFIED INCOME.

    (a) Definition of Disqualified Income.--Paragraph (2) of section 
32(i) (defining disqualified income) is amended by striking ``and'' at 
the end of subparagraph (B), by striking the period at the end of 
subparagraph (C) and inserting ``, and'', and by adding at the end the 
following new subparagraph:
                    ``(D) the excess (if any) of--
                            ``(i) the aggregate income from all passive 
                        activities for the taxable year (determined 
                        without regard to any amount described in a 
                        preceding subparagraph), over
                            ``(ii) the aggregate losses from all 
                        passive activities for the taxable year (as so 
                        determined).
                For purposes of subparagraph (D), the term `passive 
                activity' has the meaning given such term by section 
                469.''.
    (b) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 1995.

SEC. 206. MODIFICATION OF ADJUSTED GROSS INCOME DEFINITION FOR EARNED 
              INCOME CREDIT.

    (a) In General.--Subsections (a)(2), (c)(1)(C), (d), and (f)(2)(B) 
of section 32, as amended by the preceding sections of this title, are 
each amended by striking ``adjusted gross income'' each place it 
appears and inserting ``modified adjusted gross income''.
    (b) Modified Adjusted Gross Income Defined.--Section 32(c) 
(relating to definitions and special rules) is amended by adding at the 
end the following new paragraph:
            ``(5) Modified adjusted gross income.--
                    ``(A) In general.--The term `modified adjusted 
                gross income' means adjusted gross income--
                            ``(i) increased by the sum of the amounts 
                        described in subparagraph (B), and
                            ``(ii) determined without regard to--
                                    ``(I) the amounts described in 
                                subparagraph (C), or
                                    ``(II) the deduction allowed under 
                                section 172.
                    ``(B) Nontaxable income taken into account.--
                Amounts described in this subparagraph are--
                            ``(i) social security benefits (as defined 
                        in section 86(d)) received by the taxpayer 
                        during the taxable year to the extent not 
                        included in gross income,
                            ``(ii) amounts which--
                                    ``(I) are received during the 
                                taxable year by (or on behalf of) a 
                                spouse pursuant to a divorce or 
                                separation instrument (as defined in 
                                section 71(b)(2)), and
                                    ``(II) under the terms of the 
                                instrument are fixed as payable for the 
                                support of the children of the payor 
                                spouse (as determined under section 
                                71(c)),
                        but only to the extent such amounts exceed 
                        $6,000,
                            ``(iii) interest received or accrued during 
                        the taxable year which is exempt from tax 
                        imposed by this chapter, and
                            ``(iv) amounts received as a pension or 
                        annuity, and any distributions or payments 
                        received from an individual retirement plan, by 
                        the taxpayer during the taxable year to the 
                        extent not included in gross income.
                Clause (iv) shall not include any amount which is not 
                includible in gross income by reason of section 402(c), 
                403(a)(4), 403(b)(8), 408(d) (3), (4), or (5), or 
                457(e)(10).
                    ``(C) Certain amounts disregarded.--An amount is 
                described in this subparagraph if it is--
                            ``(i) the amount of losses from sales or 
                        exchanges of capital assets in excess of gains 
                        from such sales or exchanges to the extent such 
                        amount does not exceed the amount under section 
                        1211(b)(1),
                            ``(ii) the net loss from the carrying on of 
                        trades or businesses, computed separately with 
                        respect to--
                                    ``(I) trades or businesses (other 
                                than farming) conducted as sole 
                                proprietorships,
                                    ``(II) trades or businesses of 
                                farming conducted as sole 
                                proprietorships, and
                                    ``(III) other trades or business,
                            ``(iii) the net loss from estates and 
                        trusts, and
                            ``(iv) the excess (if any) of amounts 
                        described in subsection (i)(2)(C)(ii) over the 
                        amounts described in subsection (i)(2)(C)(i) 
                        (relating to nonbusiness rents and royalties).
                For purposes of clause (ii), there shall not be taken 
                into account items which are attributable to a trade or 
                business which consists of the performance of services 
                by the taxpayer as an employee.''.
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 1995.

SEC. 207. PROVISIONS TO IMPROVE TAX COMPLIANCE.

    (a) Increase in Penalties for Return Preparers.--
            (1) Understatement penalty.--Section 6694 (relating to 
        understatement of income tax liability by income tax return 
        preparer) is amended--
                    (A) by striking ``$250'' in subsection (a) and 
                inserting ``$500'', and
                    (B) by striking ``$1,000'' in subsection (b) and 
                inserting ``$2,000''.
            (2) Other assessable penalties.--Section 6695 (relating to 
        other assessable penalties) is amended--
                    (A) by striking ``$50'' and ``$25,000'' in 
                subsections (a), (b), (c), (d), and (e) and inserting 
                ``$100'' and ``$50,000'', respectively, and
                    (B) by striking ``$500'' in subsection (f) and 
                inserting ``$1,000''.
    (b) Aiding and Abetting Penalty.--Section 6701(b) (relating to 
amount of penalty) is amended--
            (1) by striking ``$1,000'' in paragraph (1) and inserting 
        ``2,000'', and
            (2) by striking ``10,000'' in paragraph (2) and inserting 
        ``20,000''.
    (c) Effective Date.--The amendments made by this section shall 
apply to penalties with respect to taxable years beginning after 
December 31, 1995.
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