RESTORING EARNINGS TO LIFT INDIVIDUALS AND EMPOWER FAMILIES (RELIEF) ACT OF 2001

[Senate Prints 107-30]
[From the U.S. Government Publishing Office]

107th Congress 1st
Session COMMITTEE PRINT S. Prt.
107-30
_______________________________________________________________________

RESTORING EARNINGS TO LIFT INDIVIDUALS AND
EMPOWER FAMILIES (RELIEF) ACT OF 2001

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TECHNICAL EXPLANATION OF PROVISIONS APPROVED BY THE COMMITTEE ON MAY
15, 2001

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COMMITTEE ON FINANCE
UNITED STATES SENATE

Charles E. Grassley, Chairman

[GRAPHIC] [TIFF OMITTED] TONGRESS.#13

MAY 2001

Printed for the use of the Committee on Finance

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U.S. GOVERNMENT PRINTING OFFICE
72-423 WASHINGTON : 2001

COMMITTEE ON FINANCE

CHARLES E. GRASSLEY, Iowa, Chairman
ORRIN G. HATCH, Utah MAX BAUCUS, Montana
FRANK H. MURKOWSKI, Alaska JOHN D. ROCKEFELLER IV, West
DON NICKLES, Oklahoma Virginia
PHIL GRAMM, Texas TOM DASCHLE, South Dakota
TRENT LOTT, Mississippi JOHN BREAUX, Louisiana
JAMES M. JEFFORDS, Vermont KENT CONRAD, North Dakota
FRED THOMPSON, Tennessee BOB GRAHAM, Florida
OLYMPIA J. SNOWE, Maine JEFF BINGAMAN, New Mexico
JON KYL, Arizona JOHN F. KERRY, Massachusetts
ROBERT G. TORRICELLI, New Jersey
BLANCHE L. LINCOLN, Arkansas
Kolan Davis, Staff Director and Chief Counsel
John Angell, Democratic Staff Director

C O N T E N T S

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Page
I. Marginal Tax Rate Reduction......................................1
A. Individual Income Tax Rate Structure (Sec. 101 of
the bill and Sec. 1 of the Code)................... 1
B. Increase Starting Point for Phase-Out of Itemized
Deductions (Sec. 102 of the bill and Sec. 68 of the
Code).............................................. 5
C. Repeal of Phase-Out of Personal Exemptions (Sec. 103
of the bill and Sec. 151(d)(3) of the Code)........ 6
D. Compliance with Congressional Budget Act (Secs. 111
and 112 of the bill)............................... 7
II. Child Tax Credit.................................................9
A. Increase and Expand the Child Tax Credit (Sec. 201
of the bill and Sec. 24 of the Code)............... 9
B. Compliance with Congressional Budget Act (Secs. 211
and 212 of the bill)............................... 11
III. Marriage Penalty Relief Provisions..............................12
A. Standard Deduction Marriage Penalty Relief (Sec. 301
of the bill and Sec. 63 of the Code)............... 12
B. Expansion of the 15-Percent Rate Bracket For Married
Couples Filing Joint Returns (Sec. 302 of the bill
and Sec. 1 of the Code)............................ 14
C. Marriage Penalty Relief and Simplification Relating
to the Earned Income Credit (Sec. 303 of the bill
and Sec. 32 of the Code)........................... 16
D. Compliance with Congressional Budget Act (Secs. 311
and 312 of the bill)............................... 21
IV. Education Incentives............................................23
A. Modifications to Education IRAs (Sec. 401 of the
bill and Sec. 530 of the Code)..................... 23
B. Private Prepaid Tuition Programs; Exclusion From
Gross Income of Education Distributions From
Qualified Tuition Programs (Sec. 402 of the bill
and Sec. 529 of the Code).......................... 27
C. Exclusion for Employer-Provided Educational
Assistance (Sec. 411 of the bill and Sec. 127 of
the Code).......................................... 31
D. Modifications to Student Loan Interest Deduction
(Sec. 412 of the bill and Sec. 221 of the Code).... 32
E. Eliminate Tax on Awards Under the National Health
Service Corps Scholarship Program and the F. Edward
Hebert Armed Forces Health Professions Scholarship
and Financial Assistance Program (Sec. 413 of the
bill and Sec. 117 of the Code)..................... 33
F. Tax Benefits for Certain Types of Bonds for
Educational Facilities and Activities (Secs. 421-
422 of the bill and Secs. 142 and 146-148 of the
Code).............................................. 35
G. Deduction for qualified Higher Education Expenses
(Sec. 431 of the bill and new Sec. 222 of the Code) 39
H. Credit for Interest on qualified Higher Education
Loans (Sec. 432 of the bill and new Sec. 25B of the
Code).............................................. 41
I. Compliance with Congressional Budget Act (Secs. 441
and 442 of the bill)............................... 43
V. Estate, Gift, and Generation-Skipping Transfer Tax Provisions...45
A. Phaseout and Repeal of Estate and Generation-
Skipping Transfer Taxes; Increase in Gift Tax
Unified Credit Effective Exemption (Secs. 501-542
of the bill, secs. 121, 684, 1014, 1040, 1221,
2001-2210, 2501, 2502, 2503, 2505, 2511, 2601-2663,
4947, 6018, 6019, and 7701 of the Code, and new
Secs. 1022, 2058, 2210, 2664, and 6716 of the Code) 45
B. Expand Estate Tax Rule for Conservation Easements
(Sec. 551 of the bill and Sec. 2031 of the Code)... 59
C. Modify Generation-Skipping Transfer Tax Rules....... 60
1. Deemed allocation of the generation-skipping
transfer tax exemption to lifetime transfers to
trusts that are not direct skips (Sec. 561 of
the bill and Sec. 2632 of the Code)............ 60
2. Retroactive allocation of the generation-
skipping transfer tax exemption (Sec. 561 of
the bill and Sec. 2632 of the Code)............ 63
3. Severing of trusts holding property having an
inclusion ratio of greater than zero (Sec. 562
of the bill and Sec. 2642 of the Code)......... 64
4. Modification of certain valuation rules (Sec.
563 of the bill and Sec. 2642 of the Code)..... 65
5. Relief from late elections (Sec. 564 of the bill
and Sec. 2642 of the Code)..................... 66
6. Substantial compliance (Sec. 564 of the bill and
Sec. 2642 of the Code)......................... 67
D. Expand and Modify Availability of Installment
Payment of Estate Tax for Closely-Held Businesses
(Secs. 571 and 572 of the bill and Sec. 6166 of the
Code).............................................. 68
E. Compliance with Congressional Budget Act (Secs. 581
and 582 of the bill)............................... 69
VI. Pension and Individual Retirement Arrangement Provisions........71
A. Individual Retirement Arrangements (``IRAs'') (Secs.
601-603 of the bill and Secs. 219, 408, and 408A of
the Code).......................................... 71
B. Pension Provisions.................................. 75
2. Expanding coverage.............................. 75
(a) Increase in benefit and contribution limits
(Sec. 611 of the bill and Secs. 401(a)(17),
402(g), 408(p), 415 and 457 of the Code)... 75
(b) Plan loans for subchapter S shareholders,
partners, and sole proprietors (Sec. 612 of
the bill and Sec. 4975 of the Code)........ 78
(c) Modification of top-heavy rules (Sec. 613
of the bill and Sec. 416 of the Code)...... 79
(d) Elective deferrals not taken into account
for purposes of deduction limits (Sec. 614
of the bill and Sec. 404 of the Code)...... 83
(e) Repeal of coordination requirements for
deferred compensation plans of State and
local governments and tax-exempt
organizations (Sec. 615 of the bill and
Sec. 457 of the Code)...................... 84
(f) Deduction limits (Sec. 616 of the bill and
Sec. 404 of the Code)...................... 85
(g) Option to treat elective deferrals as
after-tax Roth contributions (Sec. 617 of
the bill and new Sec. 402A of the Code).... 87
(h) Nonrefundable credit to certain individuals
for elective deferrals and IRA
contributions (Sec. 618 of the bill and new
Sec. 25C of the Code)...................... 89
(i) Small business tax credit for qualified
retirement plan contributions (Sec. 619 of
the bill and new Sec. 45E of the Code)..... 91
(j) Small business tax credit for new
retirement plan expenses (Sec. 620 of the
bill and new Sec. 45F of the Code)......... 93
(k) Eliminate IRS user fees for certain
determination letter requests regarding
employer plans (Sec. 621 of the bill)...... 94
(l) Treatment of nonresident aliens engaged in
international transportation services (Sec.
622 of the bill and Sec. 861(a)(3) of the
Code)...................................... 95
2. Enhancing fairness for women.................... 96
(a) Additional salary reduction catch-up
contributions (Sec. 631 of the bill and
Sec. 414 of the Code)...................... 96
(b) Equitable treatment for contributions of
employees to defined contribution plans
(Sec. 632 of the bill and Secs. 403(b),
415, and 457 of the Code).................. 98
(c) Faster vesting of employer matching
contributions (Sec. 633 of the bill and
Sec. 411 of the Code)...................... 100
(d) Modifications to minimum distribution rules
(Sec. 634 of the bill and Sec. 401(a)(9) of
the Code).................................. 101
(e) Clarification of tax treatment of division
of section 457 plan benefits upon divorce
(Sec. 635 of the bill and Secs. 414(p) and
457 of the Code)........................... 104
(f) Provisions relating to hardship withdrawals
(Sec. 636 of the bill and Secs. 401(k) and
402 of the Code)........................... 105
(g) Pension coverage for domestic and similar
workers (Sec. 637 of the bill and Sec.
4972(c)(6) of the Code).................... 107
3. Increasing portability for participants......... 108
(a) Rollovers of retirement plan and IRA
distributions (Secs. 641-643 and 649 of the
bill and Secs. 401, 402, 403(b), 408, 457,
and 3405 of the Code)...................... 108
(b) Waiver of 60-day rule (Sec. 644 of the bill
and Secs. 402 and 408 of the Code)......... 112
(c) Treatment of forms of distribution (Sec.
645 of the bill and Sec. 411(d)(6) of the
Code)...................................... 112
(d) Rationalization of restrictions on
distributions (Sec. 646 of the bill and
Secs. 401(k), 403(b), and 457 of the Code). 114
(e) Purchase of service credit under
governmental pension plans (Sec. 647 of the
bill and Secs. 403(b) and 457 of the Code). 115
(f) Employers may disregard rollovers for
purposes of cash-out rules (Sec. 648 of the
bill and Sec. 411(a)(11) of the Code)...... 116
(g) Minimum distribution and inclusion
requirements for section 457 plans (Sec.
649 of the bill and Sec. 457 of the Code).. 117
4. Strengthening pension security and enforcement.. 118
(a) Phase-in repeal of 160 percent of current
liability funding limit; deduction for
contributions to fund termination liability
(Secs. 651 and 652 of the bill and Secs.
404(a)(1), 412(c)(7), and 4972(c) of the
Code)...................................... 118
(b) Excise tax relief for sound pension funding
(Sec. 653 of the bill and Sec. 4972 of the
Code)...................................... 119
(c) Modifications to section 415 limits for
multiemployer plans (Sec. 654 of the bill
and Sec. 415 of the Code).................. 121
(d) Investment of employee contributions in
401(k) plans (Sec. 655 of the bill and Sec.
1524(b) of the Taxpayer Relief Act of 1997) 122
(e) Prohibited allocations of stock in an S
corporation ESOP (Sec. 656 of the bill and
Secs. 409 and 4979A of the Code)........... 123
(f) Automatic rollovers of certain mandatory
distributions (Sec. 657 of the bill and
Secs. 401(a)(31) and 402(f)(1) of the Code
and Sec. 404(c) of ERISA).................. 126
(g) Clarification of treatment of contributions
to a multiemployer plan (Sec. 658 of the
bill)...................................... 128
(h) Notice of significant reduction in plan
benefit accruals (Sec. 659 of the bill and
new Sec. 4980F of the Code)................ 129
5. Reducing regulatory burdens..................... 133
(a) Modification of timing of plan valuations
(Sec. 661 of the bill and Sec. 412 of the
Code)...................................... 133
(b) ESOP dividends may be reinvested without
loss of dividend deduction (Sec. 662 of the
bill and Sec. 404 of the Code)............. 134
(c) Repeal transition rule relating to certain
highly compensated employees (Sec. 663 of
the bill and Sec. 1114(c)(4) of the Tax
Reform Act of 1986)........................ 135
(d) Employees of tax-exempt entities (Sec. 664
of the bill)............................... 135
(e) Treatment of employer-provided retirement
advice (Sec. 665 of the bill and Sec. 132
of the Code)............................... 136
(f) Reporting simplification (Sec. 666 of the
bill)...................................... 137
(g) Improvement to Employee Plans Compliance
Resolution System (Sec. 667 of the bill)... 139
(h) Repeal of the multiple use test (Sec. 668
of the bill and Sec. 401(m) of the Code)... 140
(i) Flexibility in nondiscrimination, coverage,
and line of business rules (Sec. 669 of the
bill and Secs. 401(a)(4), 410(b), and
414(r) of the Code)........................ 141
(j) Extension to all governmental plans of
moratorium on application of certain
nondiscrimination rules applicable to State
and local government plans (Sec. 670 of the
bill, sec. 1505 of the Taxpayer Relief Act
of 1997, and Secs. 401(a) and 401(k) of the
Code)...................................... 143
6. Other ERISA provisions.......................... 144
(a) Extension of PBGC missing participants
program (Sec. 681 of the bill and Secs.
206(f) and 4050 of ERISA).................. 144
(b) Reduce PBGC premiums for small and new
plans (Secs. 682 and 683 of the bill and
Sec. 4006 of ERISA)........................ 145
(c) Authorization for PBGC to pay interest on
premium overpayment refunds (Sec. 684 of
the bill and Sec. 4007(b) of ERISA)........ 146
(d) Rules for substantial owner benefits in
terminated plans (Sec. 685 of the bill and
Secs. 4021, 4022, 4043 and 4044 of ERISA).. 147
7. Miscellaneous provisions........................ 148
(a) Tax treatment of electing Alaska Native
Settlement Trusts (section 691 of the Bill
and new sections 646 and 6039H of the Code,
modifying Code sections including 1(e),
301, 641, 651, 661, and 6034A))............ 148
C. Compliance with Congressional Budget Act (Secs. 695-
696 of the bill)................................... 151
VII. Alternative Minimum Tax........................................153
A. Individual Alternative Minimum Tax Relief (Sec. 701
of the bill and Sec. 55 of the Code)............... 153
B. Compliance with Congressional Budget Act (Secs. 711
and 712 of the bill)............................... 154
VIII.Other Provisions...............................................156

A. Modification to Corporate Estimated Tax Requirements
(Sec. 801 of the bill)............................. 156
B. Authority to Postpone Certain Tax-Related Deadlines
by Reason of Presidentially declared disaster (Sec.
802 of the bill and Sec. 7508A of the Code)........ 156
C. Compliance with Congressional Budget Act (Secs. 811-
812 of the bill)................................... 157
Estimated Budget Effects of the ``Restoring Earnings to Life
Individuals and Empower Families (`Relief') Act of 2001,'' as
Ordered Reported by the Committee on Finance on May 15, 2001... 159

I. MARGINAL TAX RATE REDUCTION

A. Individual Income Tax Rate Structure

(Sec. 101 of the bill and Sec. 1 of the Code)

present law

Under the Federal individual income tax system, an
individual who is a citizen or a resident of the United States
generally is subject to tax on worldwide taxable income.
Taxable income is total gross income less certain exclusions,
exemptions, and deductions. An individual may claim either a
standard deduction or itemized deductions.
An individual's income tax liability is determined by
computing his or her regular income tax liability and, if
applicable, alternative minimum tax liability.
Regular income tax liability
Regular income tax liability is determined by applying the
regular income tax rate schedules (or tax tables) to the
individual's taxable income. This tax liability is then reduced
by any applicable tax credits. The regular income tax rate
schedules are divided into several ranges of income, known as
income brackets, and the marginal tax rate increases as the
individual's income increases. The income bracket amounts are
adjusted annually for inflation. Separate rate schedules apply
based on filing status: single individuals (other than heads of
households and surviving spouses), heads of households, married
individuals filing joint returns (including surviving spouses),
married individuals filing separate returns, and estates and
trusts. Lower rates may apply to capital gains.
For 2001, the regular income tax rate schedules for
individuals are shown in Table 1, below. The rate bracket
breakpoints for married individuals filing separate returns are
exactly one-half of the rate brackets for married individuals
filing joint returns. A separate, compressed rate schedule
applies to estates and trusts.

TABLE 1.--INDIVIDUAL REGULAR INCOME TAX RATES FOR 2001
----------------------------------------------------------------------------------------------------------------
But not
If taxable income is over over Then regular income tax equals
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Single individuals

$0.................................. $27,050 15 percent of taxable income.
$27,050............................. 65,550 $4,057.50, plus 28% of the amount over $27,050.
$65,550............................. 136,750 $14,837.50, plus 31% of the amount over $65,550.
$136,750............................ 297,350 $36,909.50, plus 36% of the amount over $136,750.
Over $297,350....................... .......... $94,725.50, plus 39.6% of the amount over $297,350.

Heads of households

$0.................................. 36,250 15 percent of taxable income.
$36,250............................. 93,650 $5,437.50, plus 28% of the amount over $36,250.
$93,650............................. 151,650 $21,509.50, plus 31% of the amount over $93,650.
$151,650............................ 297,350 $39,489.50, plus 36% of the amount over $151,650.
Over $297,350....................... .......... $91,941.50, plus 39.6% of the amount over $297,350.

Married individuals filing joint returns

$0.................................. 45,200 15 percent of taxable income.
$45,200............................. 109,250 $6,780.00, plus 28% of the amount over $45,200.
$109,250............................ 166,500 $24,714.50, plus 31% of the amount over $109,250.
$166,500............................ 297,350 $42,461.50, plus 36% of the amount over $166,500.
Over $297,350....................... .......... $89,567.50, plus 39.6% of the amount over $297,350
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reasons for change

The Committee believes that providing tax relief to the
American people is appropriate for a number of reasons. The
Congressional Budget Office (``CBO'') projects budget surpluses
of $5.6 trillion over the next 10 fiscal years (2001-2010).
Federal revenues have been rising as a share of the gross
domestic product (``GDP''). CBO projects that, during the
fiscal year 2001-2010 period, Federal revenues will be more
than 20 percent of the GDP annually. By contrast, during the
early 1990's, Federal revenues generally were only 17-18
percent of the GDP. Individual income taxes account for most of
the recent rise in revenues as a percentage of GDP. Federal
individual income tax revenues rose to over 10 percent of GDP
in fiscal year 2000 for the first time in history and are
projected by the CBO to exceed 10 percent of GDP for each of
the fiscal years 2001-2010. The CBO projects that the growth of
Federal revenues will, for fiscal year 2001, outstrip the
growth of GDP for the ninth consecutive year. Moreover, the CBO
statesthat ``[t]he most significant source of the growth of
income taxes relative to GDP was the increase in the effective tax
rate.'' \1\
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\1\ Congressional Budget Office, Congress of the United States, The
Budget and Economic Outlook: Fiscal Years 2002-2011, January 2001, at
56.
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Taking these things into account, the Committee believes
that at least a portion of the projected budget surpluses
should be returned to the taxpayers who are paying Federal
income taxes while still retaining adequate monies to pay down
the public debt, fund priorities such as education and defense,
and secure the future of Social Security and Medicare. The
Committee believes that this bill provides the appropriate
level of tax relief without threatening funding for other
national priorities.
The Committee bill provides immediate tax relief to
American taxpayers in the form of a new rate bracket for the
first $6,000 of taxable income for single individuals and the
first $12,000 of taxable income for married couples filing a
joint return. This new 10-percent rate bracket is effective
this year. The Committee believes that such immediate tax
relief may encourage short-term growth in the economy by
providing individuals with additional cash to spend. Also, the
new 10-percent rate bracket in the Committee bill delivers more
benefit as a percentage of income to low-income taxpayers than
high-income taxpayers.
The Committee bill will provide tax relief to more than 100
million income tax returns of individuals, including at least
16 million returns of individuals of owners of businesses (sole
proprietorships, partnerships, and S corporations). The
Committee believes that this tax cut will lead to increased
investment by these businesses, promoting long-term growth and
stability in the economy and rewarding the businessmen and
women who provide a foundation for our country's success.
The Committee also believes that it is appropriate to
repeal the 10-percent surtax imposed in 1993 to cut the
deficit. This 10-percent surtax on top of the 36-percent rate
resulted in a 39.6-percent marginal tax rate for those in the
highest income tax bracket. Because the Congressional Budget
Office is projecting budget surpluses over the next ten years,
the Committee believes that it is appropriate to repeal this
deficit-era surtax.
Finally, the Committee believes that the lower rates
provided by this bill is a fair means to provide tax relief for
all taxpayers.

Explanation of Provision

In general

The bill creates a new 10-percent regular income tax
bracket for a portion of taxable income that is currently taxed
at 15 percent, effective for taxable years beginning after
December 31, 2000. The bill also reduces other regular income
tax rates. By 2007, the present-law individual income tax rates
of 28 percent, 31 percent, 36 percent and 39.6 percent will be
lowered to 25 percent, 28 percent, 33 percent, and 36 percent,
respectively.

New low-rate bracket

The bill establishes a new 10-percent regular income tax
rate bracket for a portion of taxable income that is currently
taxed at 15 percent, as shown in Table 3, below. The taxable
income levels for the new 10-percent rate bracket will be
adjusted annually for inflation for taxable years beginning
after December 31, 2006. The new low-rate bracket for joint
returns and head of household returns will be rounded down to
the nearest $50. The bracket for single individuals and married
individuals filing separately will be one-half the bracket for
joint returns (after adjustment for inflation).
The 10-percent rate bracket applies to the first $6,000 of
taxable income for single individuals, $10,000 of taxable
income for heads of households, and $12,000 for married couples
filing joint returns.

Modification of 15-percent bracket

The 15-percent regular income tax bracket is modified to
begin at the end of the new low-rate regular income tax
bracket. The 15-percent regular income tax bracket ends at the
same level as under present law. The bill also makes other
changes to the 15-percent rate bracket.\2\
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\2\ See the discussion of marriage penalty relief, below (Sec. 302
of the bill).
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Reduction of other rates

The present-law regular income tax rates of 28 percent, 31
percent, 36 percent, and 39.6 percent are phased-down over six
years to 25 percent, 28 percent, 33 percent, and 36 percent,
effective for taxable years beginning after December 31, 2001.
The taxable income levels for the new rates are the same as the
taxable income levels that apply under the present-law rates.
Table 2, below, shows the schedule of regular income tax
rate reductions.

TABLE 2.--REGULAR INCOME TAX RATE REDUCTIONS
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28% rate 31% rate 36% rate 39.6% rate
Calendar year reduced to reduced to reduced to reduced to
----------------------------------------------------------------------------------------------------------------
2002-2004................................................... 27 30 35 38.6
2005-2006................................................... 26 29 34 37.6
2007 and later.............................................. 25 28 33 36%
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Projected regular income tax rate schedules under the bill

Table 3, below, shows the projected individual regular
income tax rate schedules when the rate reductions are fully
phased-in (i.e., for 2007). As under present law, the rate
brackets for married taxpayers filing separate returns will be
one half the rate brackets for married individuals filing joint
returns. In addition, appropriate adjustments will be made to
the separate, compressed rate schedule for estate and trusts.

TABLE 3.--INDIVIDUAL REGULAR INCOME TAX RATES FOR 2007 (PROJECTED)
----------------------------------------------------------------------------------------------------------------
But not
If taxable income is over Then regular income tax equals
----------------------------------------------------------------------------------------------------------------
Single individuals

$0.................................. $6,150 10 % of taxable income.
$6,150.............................. 31,700 $615, plus 15 % of the amount over $6,150.
$31,700............................. 76,800 $4,447.50, plus 25% of the amount over $31,700.
$76,800............................. 160,250 $15,722.50 plus 28% of the amount over $76,800.
$160,250............................ 348,350 $39,088.50 plus 33% of the amount over $160,250.
Over $348,350....................... .......... $101,161.50, plus 36% of the amount over $348,350.

Heads of households

$0.................................. 10,250 10 % of taxable income.
$10,250............................. 42,500 $1,025, plus 15% of the amount over $10,250.
$42,500............................. 109,700 $5,862.50, plus 25% of the amount over $42,500.
$109,700............................ 177,650 $22,662.50, plus 28% of the amount over $109,700.
$177,650............................ 348,350 $41,688.50, plus 33% of the amount over $177,650.
Over $348,350....................... .......... $98,019.50, plus 36% of the amount over $348,350.

Married individuals filing joint returns

$0.................................. 12,300 10 % of taxable income.
$12,300............................. \3\ 57,050 $1,230, plus 15% of the amount over $12,300.

$57,050............................. 128,000 $7,942.50, plus 25% of the amount over $57,050.
$128,000............................ 195,050 $25,680, plus 28% of the amount over $128,000.
$195,050............................ 348,350 $44,454, plus 33% of the amount over $195,050.
Over $348,350....................... .......... $95,043, plus 36% of the amount over $348,350.
----------------------------------------------------------------------------------------------------------------
\3\ The end point of the 15-percent rate bracket for married individuals filing joint returns also reflects the
phase-in of the increase in the size of the 15-percent bracket in section 302 of the bill, below.

Revised wage withholding for 2001

Under present law, the Secretary of the Treasury is
authorized to prescribe appropriate income tax withholding
tables or computational procedures for the withholding of
income taxes from wages paid by employers. The Secretary is
expected to make appropriate revisions to the wage withholding
tables to reflect the rate reduction for calendar year 2001 as
expeditiously as possible.

Effective Date

The new 10-percent rate bracket is effective for taxable
years beginning after December 31, 2000. The reduction in the
28 percent, 31 percent, 36 percent, and 39.6 percent rates is
phased-in beginning in taxable years beginning after December
31, 2001.

B. Increase Starting Point for Phase-Out of Itemized Deductions (Sec.
102 of the bill and Sec. 68 of the Code)

Present Law

Itemized deductions

Taxpayers may choose to claim either the basic standard
deduction (and additional standard deductions, if applicable)
or itemized deductions (subject to certain limitations) for
certain expenses incurred during the taxable year. Among these
deductible expenses are unreimbursed medical expenses,
investment interest, casualty and theft losses, wagering
losses, charitable contributions, qualified residence interest,
State and local income and property taxes, unreimbursed
employee business expenses, and certain other miscellaneous
expenses.

Overall limitation on itemized deductions (``Pease'' limitation)

Under present law, the total amount of otherwise allowable
itemized deductions (other than medical expenses, investment
interest, and casualty, theft, or wagering losses) is reduced
by three percent of the amount of the taxpayer's adjusted gross
income in excess of $132,950 in 2001 ($66,475 for married
couples filing separate returns). These amounts are adjusted
annually for inflation. In computing this reduction of total
itemized deductions, all present-law limitations applicable to
such deductions (such as the separate floors) are first applied
and, then, the otherwise allowable total amount of itemized
deductions is reduced in accordance with this provision. Under
this provision, the otherwise allowable itemized deductions may
not be reduced by more than 80 percent.

Reasons for Change

The Committee believes that the overall limitation on
itemized deductions is an unnecessarily complex way to impose
taxes and that the ``hidden'' way in which the limitation
raises marginal tax rates undermines respect for the tax laws.
The staff of the Joint Committee on Taxation recommended the
elimination of certain phase-outs, including the overall
limitation on itemized deductions, in a recent study containing
recommendations for simplification of the Code.\4\ The overall
limitation on itemized deductions requires a 10-line worksheet.
Moreover, the first line of that worksheet requires the adding
up of seven lines from Schedule A of the Form 1040, and the
second line requires the adding up of four lines of Schedule A
of the Form 1040. The Committee believes that reducing the
application of the overall limitation on itemized deductions
will significantly reduce complexity for affected taxpayers.
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\4\ Joint Committee on Taxation, Study of the Overall State of the
Federal Tax System and Recommendations for Simplification, Pursuant to
section 8022(3)(B) of the Internal Revenue Code of 1986 (JCS-3-01),
April 2001.
---------------------------------------------------------------------------

Explanation of Provision

The bill increases the starting point of the overall
limitation on itemized deductions for all taxpayers (other than
married couples filing separate returns) to the starting point
of the personal exemption phase-out for married couples filing
a joint return. This amount is projected under present law to
be $245,500 in 2009. The starting point of the overall
limitation on itemized deductions for married couples filing
separate returns would continue to be one-half of the amount
for other taxpayers.

Effective Date

The provision is effective for taxable years beginning
after December 31, 2008.

C. Repeal of Phase-Out of Personal Exemptions

(Sec. 103 of the bill and Sec. 151(d)(3) of the Code)

Present Law

In order to determine taxable income, an individual reduces
adjusted gross income by any personal exemptions, deductions,
and either the applicable standard deduction or itemized
deductions. Personal exemptions generally are allowed for the
taxpayer, his or her spouse, and any dependents. For 2001, the
amount deductible for each personal exemption is $2,900. This
amount is adjusted annually for inflation.
Under present law, the deduction for personal exemptions is
phased-out ratably for taxpayers with adjusted gross income
over certain thresholds. The applicable thresholds for 2001 are
$132,950 for single individuals, $199,450 for married
individuals filing a joint return, $166,200 for heads of
households, and $99,725 for married individuals filing separate
returns. These thresholds are adjusted annually for inflation.
The total amount of exemptions that may be claimed by a
taxpayer is reduced by two percent for each $2,500 (or portion
thereof) by which the taxpayer's adjusted gross income exceeds
the applicable threshold. The phase-out rate is two percent for
each $1,250 for married taxpayers filing separate returns.
Thus, the personal exemptions claimed are phased-out over a
$122,500 range ($61,250 for married taxpayers filing separate
returns), beginning at the applicable threshold. The size of
these phase-out ranges ($122,500/$61,250) is not adjusted for
inflation. For 2001, the point at which a taxpayer's personal
exemptions are completely phased-out is $255,450 for single
individuals, $321,950 for married individuals filing a joint
return, $288,700 for heads of households, and $160,975 for
married individuals filing separate returns.

Reasons for Change

The Committee believes that the personal exemption phase-
out is an unnecessarily complex way to impose income taxes and
that the ``hidden'' way in which the phase-out raises marginal
tax rates undermines respect for the tax laws. The staff of the
Joint Committee on Taxation recommended the elimination of
certain phase-outs, including the personal exemption phase-out,
in a recent study containing recommendations for simplification
of the Code.\5\ Furthermore, the Committee believes that the
phase-out imposes excessively high effective marginal tax rates
on families with children. The repeal of the personal exemption
phase-out would restore the full exemption amount to all
taxpayers and would simplify the tax laws.
---------------------------------------------------------------------------
\5\ Joint Committee on Taxation, Study of the Overall State of the
Federal Tax System and Recommendations for Simplification, Pursuant to
section 8022(3)(B) of the Internal Revenue Code of 1986 (JCS-3-01),
April 2001.
---------------------------------------------------------------------------

Explanation of Provision

The bill repeals the personal exemption phase-out.

Effective Date

The provision is effective for taxable years beginning
after December 31, 2008.

D. Compliance with Congressional Budget Act

(Secs. 111 and 112 of the bill)

Present Law

Reconciliation is a procedure under the Congressional
Budget Act of 1974 (the ``Budget Act'') by which Congress
implements spending and tax policies contained in a budget
resolution. The Budget Act contains numerous rules enforcing
the scope of items permitted to be considered under the budget
reconciliation process. One such rule, the so-called ``Byrd
rule,'' was incorporated into the Budget Act in 1990. The Byrd
rule, named after its principal sponsor, Senator Robert C.
Byrd, is contained in section 313 of the Budget Act. The Byrd
rule generally permits members to raise a point of order
against extraneous provisions (those which are unrelated to the
goals of the reconciliation process) from either a
reconciliation bill or a conference report on such bill.
Under the Byrd rule, a provision is considered to be
extraneous if it falls under one or more of the following six
definitions:
(1) It does not produce a change in outlays or
revenues;
(2) It produces an outlay increase or revenue
decrease when the instructed committee is not in
compliance with its instructions;
(3) It is outside of the jurisdiction of the
committee that submitted the title or provision for
inclusion in the reconciliation measure;
(4) It produces a change in outlays or revenues which
is merely incidental to the nonbudgetary components of
the provision;
(5) It would increase net outlays or decrease
revenues for a fiscal year beyond those covered by the
reconciliation measure; and
(6) It recommends changes in Social Security.

Reasons for Change

This title of the bill contains language sunsetting each
provision in the title in order to preclude each such provision
from violating the fifth definition of extraneity of the Byrd
rule. Inclusion of the language restoring each such provision
would undo the sunset language; therefore, the ``restoration''
language is itself subject to the Byrd rule.

Explanation of Provision

Sunset of provisions

To ensure compliance with the Budget Act, the bill provides
that all provisions of, and amendments made by, the bill
relating to income tax rates which are in effect on September
30, 2011, shall cease to apply as of the close of September 30,
2011.

Restoration of provisions

All provisions of, and amendments made by, the bill
relating to income tax rates which were terminated under the
sunset provision shall begin to apply again as of October 1,
2011, as provided in each such provision or amendment.

II. CHILD TAX CREDIT

A. Increase and Expand the Child Tax Credit

(Sec. 201 of the bill and Sec. 24 of the Code)

present law

Under present law, an individual may claim a $500 tax
credit for each qualifying child under the age of 17. In
general, a qualifying child is an individual for whom the
taxpayer can claim a dependency exemption and who is the
taxpayer's son or daughter (or descendent of either), stepson
or stepdaughter, or eligible foster child.
The child tax credit is phased-out for individuals with
income over certain thresholds. Specifically, the otherwise
allowable child tax credit is reduced by $50 for each $1,000
(or fraction thereof) of modified adjusted gross income over
$75,000 for single individuals or heads of households, $110,000
for married individuals filing joint returns, and $55,000 for
married individuals filing separate returns. Modified adjusted
gross income is the taxpayer's total gross income plus certain
amounts excluded from gross income (i.e., excluded income of
U.S. citizens or residents living abroad (Sec. 911); residents
of Guam, American Samoa, and the Northern Mariana Islands (Sec.
931); and residents of Puerto Rico (Sec. 933)). The length of
the phase-out range depends on the number of qualifying
children. For example, the phase-out range for a single
individual with one qualifying child is between $75,000 and
$85,000 of modified adjusted gross income. The phase-out range
for a single individual with two qualifying children is between
$75,000 and $95,000.
The child tax credit is not adjusted annually for
inflation.
In general, the child tax credit is nonrefundable. However,
for families with three or more qualifying children, the child
tax credit is refundable up to the amount by which the
taxpayer's Social Security taxes exceed the taxpayer's earned
income credit.
Alternative minimum tax liability
An individual's alternative minimum tax liability reduces
the amount of the refundable earned income credit and, for
taxable years beginning after December 31, 2001, the amount of
the refundable child credit for families with three or more
children. This is known as the alternative minimum tax offset
of refundable credits.
Through 2001, an individual generally may reduce his or her
tentative alternative minimum tax liability by nonrefundable
personal tax credits (such as the $500 child tax credit and the
adoption tax credit). For taxable years beginning after
December 31, 2001, nonrefundable personal tax credits may not
reduce an individual's income tax liability below his or her
tentative alternative minimum tax.

reasons for change

The Committee believes that a tax credit for families with
children recognizes the importance of helping families raise
children. This provision doubles the child tax credit in
orderto provide additional tax relief to families to help offset the
significant costs of raising a child. Further, the Committee believes
that in order to extend some of the benefit of the child credit to
families who currently do not benefit, the refundable child credit
should be made available to families regardless of the number of
children (rather than only families with three or more children).
Additionally, the Committee believes that the child credit should be
allowed to offset the alternative minimum tax. The Committee bill also
repeals the present-law provision reducing the refundable child credit
by the amount of the alternative minimum tax in order to ensure that no
taxpayer will face an increase in net income tax liability as a result
of the interaction of the alternative minimum tax with the regular
income tax reductions in the Committee bill.

Explanation of Provision

The bill increases the child tax credit to $1,000, phased-
in over eleven years, effective for taxable years beginning
after December 31, 2000.
Table 4, below, shows the increase of the child tax credit.

TABLE 4.--INCREASE OF THE CHILD TAX CREDIT
------------------------------------------------------------------------
Credit amount
Calendar year per child
------------------------------------------------------------------------
2001-2003............................................... $600
2004-2006............................................... 700
2007-2009............................................... 800
2010.................................................... 900
2011 and later.......................................... 1,000
------------------------------------------------------------------------

The bill allows the child credit to be claimed against both
the regular tax and the alternative minimum tax permanently and
repeals the alternative minimum tax offset of refundable
credits. Finally, the bill makes the child credit refundable to
the extent of 15 percent of the taxpayer's earned income in
excess of $10,000.\6\ Thus, in 2001, families with earned
income of at least $14,000 and one child will get a refundable
credit of $600. Families with three or more children are
allowed a refundable credit for the amount by which the
taxpayer's social security taxes exceed the taxpayer's earned
income credit (the present-law rule), if that amount is greater
than 15 percent of the taxpayer's earned income in excess of
$10,000.
---------------------------------------------------------------------------
\6\ For these purposes, earned income is defined as under section
32, as amended by this bill.
---------------------------------------------------------------------------

Effective Date

The provision is effective for taxable years beginning
after December 31, 2000.

B. Compliance with Congressional Budget Act

(Secs. 211 and 212 of the bill)

Present Law

reasons for change

Explanation of Provision

Sunset of provisions

To ensure compliance with the Budget Act, the bill provides
that all provisions of, and amendments made by, the bill
relating to the child tax credit which are in effect on
September 30, 2011, shall cease to apply as of the close of
September 30, 2011.

restoration of provisions

All provisions of, and amendments made by, the bill
relating to the child tax credit which were terminated under
the sunset provision shall begin to apply again as of October
1, 2011, as provided in each such provision or amendment.

III. MARRIAGE PENALTY RELIEF PROVISIONS

A. Standard Deduction Marriage Penalty Relief

(Sec. 301 of the bill and Sec. 63 of the Code)

present law

Marriage penalty
A married couple generally is treated as one tax unit that
must pay tax on the couple's total taxable income. Although
married couples may elect to file separate returns, the rate
schedules and other provisions are structured so that filing
separate returns usually results in a higher tax than filing a
joint return. Other rate schedules apply to single persons and
to single heads of households.
A ``marriage penalty'' exists when the combined tax
liability of a married couple filing a joint return is greater
than the sum of the tax liabilities of each individual computed
as if they were not married. A ``marriage bonus'' exists when
the combined tax liability of a married couple filing a joint
return is less than the sum of the tax liabilities of each
individual computed as if they were not married.
Basic standard deduction
Taxpayers who do not itemize deductions may choose the
basic standard deduction (and additional standard deductions,
if applicable),\7\ which is subtracted from adjusted gross
income (``AGI'') in arriving at taxable income. The size of the
basic standard deduction varies according to filing status and
is adjusted annually for inflation. For 2001, the basic
standard deduction amount for single filers is 60 percent of
the basic standard deduction amount for married couples filing
joint returns. Thus, two unmarried individuals have standard
deductions whose sum exceeds the standard deduction for a
married couple filing a joint return.
---------------------------------------------------------------------------
\7\ Additional standard deductions are allowed with respect to any
individual who is elderly (age 65 or over) or blind.
---------------------------------------------------------------------------

reasons for change

The Committee is concerned about the inequity that arises
when two working single individuals marry and experience a tax
increase solely by reason of their marriage. Any attempt to
address the marriage tax penalty involves the balancing of
several competing principles, including equal tax treatment of
married couples with equal incomes, the determination of
equitable relative tax burdens of single individuals and
married couples with equal incomes, and the goal of simplicity
in compliance and administration. The Committee believes that
an increase in the standard deduction for married couples
filing a joint return in conjunction with the other provisions
of the bill is a responsible reduction of the marriage tax
penalty.

explanation of provision

The bill increases the basic standard deduction for a
married couple filing a joint return to twice the basic
standard deduction for an unmarried individual filing a single
return. The basic standard deduction for a married taxpayer
filing separately will continue to equal one-half of the basic
standard deduction for a married couple filing jointly; thus,
the basic standard deduction for unmarried individuals filing a
single return and for married couples filing separately will be
the same. The increase is phased-in over five years beginning
in 2006 and would be fully phased-in for 2010 and thereafter.
Table 5, below, shows the standard deduction for married
couples filing a joint return as a percentage of the standard
deduction for single individuals during the phase-in period.

TABLE 5.--PHASE-IN OF INCREASE OF STANDARD DEDUCTION FOR MARRIED COUPLES
FILING JOINT RETURNS
------------------------------------------------------------------------
Standard
deduction for
joint returns as
Calendar year percentage of
standard
deduction for
single returns
------------------------------------------------------------------------
2006................................................. 174
2007................................................. 180
2008................................................. 187
2009................................................. 193
2010 and later....................................... 200%
------------------------------------------------------------------------

effective date

The provision is effective for taxables years beginning
after December 31, 2005.

B. Expansion of the 15-Percent Rate Bracket For Married Couples Filing
Joint Returns

(Sec. 302 of the bill and Sec. 1 of the Code)

Present Law

In general

Under the Federal individual income tax system, an
individual who is a citizen or resident of the United States
generally is subject to tax on worldwide taxable income.
Taxable income is total gross income less certain exclusions,
exemptions, and deductions. An individual may claim either a
standard deduction or itemized deductions.
An individual's income tax liability is determined by
computing his or her regular income tax liability and, if
applicable, alternative minimum tax liability.

Regular income tax liability

Regular income tax liability is determined by applying the
regular income tax rate schedules (or tax tables) to the
individual's taxable income and then is reduced by any
applicable tax credits. The regular income tax rate schedules
are divided into several ranges of income, known as income
brackets, and the marginal tax rate increases as the
individual's income increases. The income bracket amounts are
adjusted annually for inflation. Separate rate schedules apply
based on filing status: single individuals (other than heads of
households and surviving spouses), heads of households, married
individuals filing joint returns (including surviving spouses),
married individuals filing separate returns, and estates and
trusts. Lower rates may apply to capital gains.
In general, the bracket breakpoints for single individuals
are approximately 60 percent of the rate bracket breakpoints
for married couples filing joint returns.\8\ The rate bracket
breakpoints for married individuals filing separate returns are
exactly one-half of the rate brackets for married individuals
filing joint returns. A separate, compressed rate schedule
applies to estates and trusts.
---------------------------------------------------------------------------
\8\ The rate bracket breakpoint for the 39.6 percent marginal tax
rate is the same for single individuals and married couples filing
joint returns.
---------------------------------------------------------------------------

Reasons for Change

The Committee believes that the expansion of the 15-percent
rate bracket for married couples filing joint returns, in
conjunction with the other provisions of the bill, will
alleviate the effects of the present-law marriage tax penalty.
These provisions significantly reduce the most widely
applicable marriage penalties in present law.

Explanation of Provision

The bill increases the size of the 15-percent regular
income tax rate bracket for a married couple filing a joint
return to twice the size of the corresponding rate bracket for
an unmarried individual filing a single return. The increase is
phased-in over five years, beginning in 2006. Therefore, this
provision is fully effective (i.e., the size of the 15-percent
regular income tax rate bracket for a married couple filing a
joint return would be twice the size of the 15-percent regular
income tax rate bracket for an unmarried individual filing a
single return) for taxable years beginning after December 31,
2009. Table 6, below, shows the increase in the size of the 15-
percent bracket during the phase-in period.

TABLE 6.--INCREASE IN SIZE OF 15-PERCENT RATE BRACKET FOR MARRIED
COUPLES FILING A JOINT RETURN
------------------------------------------------------------------------
End point of 15-
percent rate
bracket for
married couple
filing joint
return as
Taxable year percentage of end
point of 15-
percent rate
bracket for
unmarried
individuals
------------------------------------------------------------------------
2006................................................. 174
2007................................................. 180
2008................................................. 187
2009................................................. 193
2010 and thereafter.................................. 200%
------------------------------------------------------------------------

Effective Date

The increase in the size of the 15-percent rate bracket is
effective for taxable years beginning after December 31, 2005.

C. Marriage Penalty Relief and Simplification Relating to the Earned
Income Credit

(Sec. 303 of the bill and Sec. 32 of the Code)

Present Law

In general

Eligible low-income workers are able to claim a refundable
earned income credit. The amount of the credit an eligible
taxpayer may claim depends upon the taxpayer's income and
whether the taxpayer has one, more than one, or no qualifying
children.
The earned income credit is not available to married
individuals who file separate returns. No earned income credit
is allowed if the taxpayer has disqualified income in excess of
$2,450 (for 2001) for the taxable year.\9\ In addition, no
earned income credit is allowed if an eligible individual is
the qualifying child of another taxpayer.\10\
---------------------------------------------------------------------------
\9\ Sec. 32(i). Disqualified income is the sum of: (1) interest and
dividends includible in gross income for the taxable year; (2) tax-
exempt income received or accrued in the taxable year; (3) net income
from rents and royalties for the taxable year not derived in the
ordinary course of business; (4) capital gain net income for the
taxpayer year; and (5) net passive income for the taxable year. Sec.
32(i)(2).
\10\ Sec. 32(c)(1)(B).
---------------------------------------------------------------------------

Definition of qualifying child and tie-breaker rules

To claim the earned income credit, a taxpayer must either
(1) have a qualifying child or (2) meet the requirements for
childless adults. A qualifying child must meet a relationship
test, an age test, and a residence test. First, the qualifying
child must be the taxpayer's child, stepchild, adopted child,
grandchild, or foster child. Second, the child must be under
the age 19 (or under age 24 if a full-time student) or
permanently and totally disabled regardless of age. Third, the
child must live with the taxpayer in the United States for more
than half the year (a full year for foster children).
An individual satisfies the relationship test under the
earned income credit if the individual is the taxpayer's: (1)
son or daughter or a descendant of either;\11\ (2) stepson or
stepdaughter; or (3) eligible foster child. An eligible foster
child is an individual (1) who is a brother, sister,
stepbrother, or stepsister of the taxpayer (or a descendant of
any such relative), or who is placed with the taxpayer by an
authorized placement agency, and (2) who the taxpayer cares for
as her or his own child. A married child of the taxpayer is not
treated as meeting the relationship test unless the taxpayer is
entitled to a dependency exemption with respect to the married
child (e.g., the support test is satisfied) or would be
entitled to the exemption if the taxpayer had not waived the
exemption to the noncustodial parent.\12\
---------------------------------------------------------------------------
\11\ A child who is legally adopted or placed with the taxpayer for
adoption by an authorized adoption agency is treated as the taxpayer's
own child. Sec. 32(c)(3)(B)(iv).
\12\ Sec. 32(c)(3)(B)(ii).
---------------------------------------------------------------------------
If a child otherwise qualifies with respect to more than
one person, the child is treated as a qualifying child only of
the person with the highest modified adjusted gross income.
``Modified adjusted gross income'' means adjusted gross
income determined without regard to certain losses and
increased by certain amounts not includible in gross
income.\13\ The losses disregarded are: (1) net capital losses
(up to $3,000); (2) net losses from estates and trusts; (3) net
losses from nonbusiness rents and royalties; (4) 75 percent of
the net losses from businesses, computed separately with
respect to sole proprietorships (other than farming), farming
sole proprietorships, and other businesses. The amounts added
to adjusted gross income to arrive at modified adjusted gross
income include: (1) tax-exempt interest; and (2) nontaxable
distributions from pensions, annuities, and individual
retirement plans (but not nontaxable rollover distributions or
trustee-to-trustee transfers).
---------------------------------------------------------------------------
\13\ Sec. 32(c)(5).
---------------------------------------------------------------------------

Definition of earned income

To claim the earned income credit, the taxpayer must have
earned income. Earned income consists of wages, salaries, other
employee compensation, and net earnings from self
employment.\14\ Employee compensation includes anything of
value received by the taxpayer from the employer in return for
services of the employee, including nontaxable earned income.
Nontaxable forms of compensation treated as earned income
include the following: (1) elective deferrals under a cash or
deferred arrangement or section 403(b) annuity (Sec. 402(g));
(2) employer contributions for nontaxable fringe benefits,
including contributions for accident and health insurance (Sec.
106), dependent care (Sec. 129), adoption assistance (Sec.
137), educational assistance (Sec. 127), and miscellaneous
fringe benefits (Sec. 132); (3) salary reduction contributions
under a cafeteria plan (Sec. 125); (4) meals and lodging
provided for the convenience of the employer (Sec. 119), and
(5) housing allowance or rental value of a parsonage for the
clergy (Sec. 107). Some of these items are not required to be
reported on the Wage and Tax Statement (Form W-2).
---------------------------------------------------------------------------
\14\ Sec. 32(c)(2)(A).
---------------------------------------------------------------------------

Calculation of the credit

The maximum earned income credit is phased in as an
individual's earned income increases. The credit phases out for
individuals with earned income (or if greater, modified
adjusted gross income) over certain levels. In the case of a
married individual who files a joint return, the earned income
credit both for the phase-in and phase-out is calculated based
on the couples' combined income.
The credit is determined by multiplying the credit rate by
the taxpayer's earned income up to a specified earned income
amount. The maximum amount of the credit is the product of the
credit rate and the earned income amount. The maximum credit
amount applies to taxpayers with (1) earnings at or above the
earned income amount and (2) modified adjusted gross income (or
earnings, if greater) at or below the phase-out threshold
level.
For taxpayers with modified adjusted gross income (or
earned income, if greater) in excess of the phase-out
threshold, the credit amount is reduced by the phase-out rate
multiplied by the amount of earned income (or modified adjusted
gross income, if greater) in excess of the phase-out threshold.
In other words, the credit amount is reduced, falling to $0 at
the ``breakeven'' income level, the point where a specified
percentage of ``excess'' income above the phase-out threshold
offsets exactly the maximum amount of the credit. The earned
income amount and the phase-out threshold are adjusted annually
for inflation. Table 7, below, shows the earned income credit
parameters for taxable year 2001.\15\
---------------------------------------------------------------------------
\15\ The table is based on Rev. Proc. 2001-13.

TABLE 7.--EARNED INCOME CREDIT PARAMETERS (2001)
----------------------------------------------------------------------------------------------------------------
Two or more
qualifying One qualifying No qualifying
children child children
----------------------------------------------------------------------------------------------------------------
Credit rate (percent)........................................... 40.00% 34.00% 7.65%
Earned income amount............................................ $10,020 $7,140 $4,760
Maximum credit.................................................. $4,008 $2,428 $364
Phase-out begins................................................ $13,090 $13,090 $5,950
Phase-out rate (percent)........................................ 21.06% 15.98% 7.65%
Phase-out ends.................................................. $32,121 $28,281 $10,710
----------------------------------------------------------------------------------------------------------------

An individual's alternative minimum tax liability reduces
the amount of the refundable earned income credit.\16\
---------------------------------------------------------------------------
\16\ Sec. 32(h).
---------------------------------------------------------------------------

Reasons for Change

The Committee believes that the present-law earned income
amount penalizes some individuals because they receive a
smaller earned income credit if they are married than if they
are not married. The Committee believes increasing the phase-
out amount for married taxpayers who file a joint return will
help to alleviate this penalty.
The bill repeals the present-law provision reducing the
earned income credit by the amount of the alternative minimum
tax. This provision ensures that no taxpayer will face an
increase in net income tax liability as a result of the
interaction of the alternative minimum tax with the regular
income tax reductions in the bill.
The Committee believes that providing tax relief to
Americans is a top priority. In addition, the Committee
believes that simplification of our tax laws is important to
alleviate the burdens on American taxpayers. As required by the
IRS Restructuring and Reform Act of 1998, the staff of the
Joint Committee on Taxation has recently released a
simplification study.\17\ The study contains approximately 150
recommendations for simplification reaching all areas of the
Federal tax laws. As a first step toward simplification, the
Committee believes it should consider simplification to the
extent possible in the context of fulfilling the priority of
providing needed tax relief. Thus, the Committee adopts three
of the proposals recommended by the Joint Committee staff
relating to the earned income credit: (1) the definition of
earned income, (2) replacement of the present-law tie-breaker
rules, and (3) uniformity in the definition of a qualifying
child.
---------------------------------------------------------------------------
\17\ Joint Committee on Taxation, Study of the Overall State of the
Federal Tax System and Recommendations for Simplification, Pursuant to
Section 8022(3)(B) of the Internal Revenue Code of 1986 (JCS-3-01),
April 2001.
---------------------------------------------------------------------------
The definition of earned income is a source of complexity
insofar as it includes nontaxable forms of employee
compensation. Present law requires both the IRS and taxpayers
to keep track of nontaxable amounts for determining earned
income credit eligibility even though such amounts are
generally not necessary for other tax purposes. Further, not
all forms of nontaxable earned income are reported on Form W-2.
As a result, a taxpayer may not know the correct amount of
nontaxable earned income received during the year. Further, the
IRS cannot easily determine such amounts. The Committee
believes that significant simplification would result from
redefining earned income to exclude amounts not includable in
gross income.
The present-law tie-breaker rules also result in
significant complexity. When a qualifying child lives with more
than one adult who appears to qualify to claim the child for
earned income credit purposes, under present law, the adult
with the highest modified adjusted gross income is to claim the
child. In its most recent study, the IRS found that the second
largest amount of errors, 17.1 percent of overclaims, was
attributable to the person with the lower modified adjusted
gross income claiming the child.\18\ The Committee believes it
is appropriate to replace the present-law tie-breaker rules
with a more simplified rule that applies only in the case of
competing claims.
---------------------------------------------------------------------------
\18\ Internal Revenue Service, Compliance Estimates for Earned
Income Tax Credit Claimed on 1997 Returns (September 2000), at 10.
---------------------------------------------------------------------------
The Committee applies the definition of qualifying child
recommended by the staff of the Joint Committee for purposes of
the earned income credit as a first step toward broader
simplification efforts. The Committee believes that the
distinctions among familial relationships drawn by present law
in defining a qualifying child add to the complexity of the
earned income credit. For example, a taxpayer's son or daughter
is a qualifying child if he or she lived with the taxpayer for
more than six months, while the taxpayer's niece or nephew is
required to live with the taxpayer for the entire year, even
though the taxpayer cared for the child as his or her own. In
addition, foster children must reside with the taxpayer for the
entire year as opposed to the general rule of six months. The
Committee believes that applying a uniform rule that
requiresany qualifying child to reside with the taxpayer for more than
six months will alleviate some of the complexity in this area.
The National Taxpayer Advocate has recommended the
elimination of the use of modified adjusted gross income as a
means to simplify the earned income credit.\19\ The Committee
believes that replacing modified adjusted gross income with
adjusted gross income reduces the number of calculations
required, thereby simplifying the credit.
---------------------------------------------------------------------------
\19\ Internal Revenue Service, National Taxpayer Advocate's FY2000
Annual Report to Congress, Publication 2104 (December 2000) at 74.
---------------------------------------------------------------------------
The IRS recently reported that more than a quarter of
earned income credit claims in 1997, $7.8 billion, were paid
erroneously.\20\ The IRS found that the most common error
involved taxpayers claiming children who did not meet the
eligibility criteria. The IRS attributes most of these errors
to taxpayers claiming the earned income credit for children who
do not meet the residency requirement.\21\ Recently, the IRS
began receiving data from the Department of Health and Human
Services' Federal Case Registry of Child Support Orders, a
Federal database containing state information on child support
payments. This data assists the IRS in identifying erroneous
earned income credit claims by noncustodial parents. The
Committee believes that giving the IRS authority to deny
questionable claims filed by noncustodial parents would reduce
the erroneous filing and payment of earned income credit
claims. The Committee, however, would like further information
regarding the accuracy of the Federal Case Registry of Child
Support Orders, its usefulness to the IRS in detecting
erroneous or fraudulent claims, and the appropriateness of
using math error procedures based on this data.
---------------------------------------------------------------------------
\20\ Internal Revenue Service, Compliance Estimates for Earned
Income Tax Credit Claimed on 1997 Returns (September 2000), at 3.
\21\ Id. at 10.
---------------------------------------------------------------------------

Explanation of Provision

For married taxpayers who file a joint return, the bill
increases the beginning and ending of the earned income credit
phase-out by $3,000. These beginning and ending points are to
be adjusted annually for inflation after 2002.
The bill simplifies the definition of earned income by
excluding nontaxable employee compensation from the definition
of earned income for earned income credit purposes. Thus, under
the bill, earned income includes wages, salaries, tips, and
other employee compensation, if includible in gross income for
the taxable year, plus net earnings from self employment.
The bill repeals the present-law provision that reduces the
earned income credit by the amount of an individual's
alternative minimum tax.
The bill simplifies the calculation of the earned income
credit by replacing modified adjusted gross income with
adjusted gross income.
The bill provides that the relationship test is met if the
individual is the taxpayer's son, daughter, stepson,
stepdaughter, or a descendant of any such individuals.\22\ A
brother, sister, stepbrother, stepsister, or a descendant of
such individuals, also qualifies if the taxpayer cares for such
individual as his or her own child. A foster child satisfies
the relationship test as well. A foster child is defined as an
individual who is placed with the taxpayer by an authorized
placement agency and who the taxpayer cares for as his or her
own child. In order to be a qualifying child, in all cases the
child must have the same principal place of abode as the
taxpayer for over one-half of the taxable year.
---------------------------------------------------------------------------
\22\ As under present law, an adopted child is treated as a child
of the taxpayer by blood.
---------------------------------------------------------------------------
The bill changes the present-law tie-breaking rule. Under
the bill, if an individual would be a qualifying child with
respect to more than one taxpayer, and more than one taxpayer
claims the earned income credit with respect to that child,
then the following tie-breaking rules apply. First, if one of
the individuals claiming the child is the child's parent (or
parents who file a joint return), then the child is considered
the qualifying child of the parent (or parents). Second, if
both parents claim the child and the parents do not file a
joint return together, then the child is considered a
qualifying child first of the parent with whom the child
resided for the longest period of time during the year, and
second of the parent with the highest adjusted gross income.
Finally, if none of the taxpayers claiming the child as a
qualifying child is the child's parent, the child is considered
a qualifying child with respect to the taxpayer with the
highest adjusted gross income.
The bill authorizes the IRS, beginning in 2004, to use math
error authority to deny the earned income credit if the Federal
Case Registry of Child Support Orders indicates that the
taxpayer is the noncustodial parent of the child with respect
to whom the credit is claimed.
It is the intent of the Committee that by September 2002,
the Department of the Treasury, in consultation with the
National Taxpayer Advocate, deliver to the Senate Committee on
Finance and the House Committee on Ways and Means a study of
the Federal Case Registry database. The study is to cover (1)
the accuracy and timeliness of the data in the Federal Case
Registry, (2) the efficacy of using math error authority in
this instance in reducing costs due to erroneous or fraudulent
claims, and (3) the implications of using math error authority
in this instance, given the findings on the accuracy and
timeliness of the data.

Effective Date

The bill generally is effective for taxable years beginning
after December 31, 2001. The bill to authorize the IRS to use
math error authority if the Federal Case Registry of Child
Support Orders indicates the taxpayer is the noncustodial
parent is effective beginning in 2004.

D. Compliance with Congressional Budget Act

(Secs. 311 and 312 of the bill)

Present Law

Reasons for Change

Explanation of Provision

Sunset of provisions

To ensure compliance with the Budget Act, the bill provides
that all provisions of, and amendments made by, the bill
relating to marriage penalty relief which are in effect on
September 30, 2011, shall cease to apply as of the close of
September 30, 2011.

Restoration of provisions

All provisions of, and amendments made by, the bill
relating to marriage penalty relief which were terminated under
the sunset provision shall begin to apply again as of October
1, 2011, as provided in each such provision or amendment.

IV. EDUCATION INCENTIVES

A. Modifications to Education IRAs

(Sec. 401 of the bill and Sec. 530 of the Code)

present law

In general
Section 530 of the Code provides tax-exempt status to
education individual retirement accounts (``education IRAs''),
meaning certain trusts or custodial accounts which are created
or organized in the United States exclusively for the purpose
of paying the qualified higher education expenses of a
designated beneficiary. Contributions to education IRAs may be
made only in cash.\23\ Annual contributions to education IRAs
may not exceed $500 per beneficiary (except in cases involving
certain tax-free rollovers, as described below) and may not be
made after the designated beneficiary reaches age 18.
---------------------------------------------------------------------------
\23\ Special estate and gift tax rules apply to contributions made
to and distributions made from education IRAs.
---------------------------------------------------------------------------
Phase-out of contribution limit
The $500 annual contribution limit for education IRAs is
generally phased-out ratably for contributors with modified
adjusted gross income (between $95,000 and $110,000. The phase-
out range for married taxpayers filing a joint return is
$150,000 to $160,000 of modified adjusted gross income.
Individuals with modified adjusted gross income above the
phase-out range are not allowed to make contributions to an
education IRA established on behalf of any individual.
Treatment of distributions
Earnings on contributions to an education IRA generally are
subject to tax when withdrawn. However, distributions from an
education IRA are excludable from the gross income of the
beneficiary to the extent that the total distribution does not
exceed the ``qualified higher education expenses'' incurred by
the beneficiary during the year the distribution is made.
If the qualified higher education expenses of the
beneficiary for the year are less than the total amount of the
distribution (i.e., contributions and earnings combined) from
an education IRA, then the qualified higher education expenses
are deemed to be paid from a pro-rata share of both the
principal and earnings components of the distribution. Thus, in
such a case, only a portion of the earnings are excludable
(i.e., the portion of the earnings based on the ratio that the
qualified higher education expenses bear to the total amount of
the distribution) and the remaining portion of the earnings is
includible in the beneficiary's gross income.
The earnings portion of a distribution from an education
IRA that is includible in income is also subject to an
additional 10-percent tax. The 10-percent additional tax does
not apply if a distribution is made on account of the death or
disability of the designated beneficiary, or on account of a
scholarship received by the designated beneficiary.
The additional 10-percent tax also does not apply to the
distribution of any contribution to an education IRA made
during the taxable year if such distribution is made on or
before the date that a return is required to be filed
(including extensions of time) by the beneficiary for the
taxable year during which the contribution was made (or, if the
beneficiary is not required to file such a return, April 15th
of the year following the taxable year during which the
contribution was made).
Present law allows tax-free transfers or rollovers of
account balances from one education IRA benefiting one
beneficiary to another education IRA benefiting another
beneficiary (as well as redesignations of the named
beneficiary), provided that the new beneficiary is a member of
the family of the old beneficiary and is under age 30.
Any balance remaining in an education IRA is deemed to be
distributed within 30 days after the date that the beneficiary
reaches age 30 (or, if earlier, within 30 days of the date that
the beneficiary dies).

Qualified higher education expenses

The term ``qualified higher education expenses'' includes
tuition, fees, books, supplies, and equipment required for the
enrollment or attendance of the designated beneficiary at an
eligible education institution, regardless of whether the
beneficiary is enrolled at an eligible educational institution
on a full-time, half-time, or less than half-time basis.
Qualified higher education expenses include expenses with
respect to undergraduate or graduate-level courses. In
addition, qualified higher education expenses include amounts
paid or incurred to purchase tuition credits (or to make
contributions to an account) under a qualified State tuition
program, as defined in section 529, for the benefit of the
beneficiary of the education IRA.
Moreover, qualified higher education expenses include,
within limits, room and board expenses for any academic period
during which the beneficiary is at least a half-time student.
Room and board expenses that may be treated as qualified higher
education expenses are limited to the minimum room and board
allowance applicable to the student in calculating costs of
attendance for Federal financial aid programs under section 472
of the Higher Education Act of 1965, as in effect on the date
of enactment of the Small Business Job Protection Act of 1996
(August 20, 1996). Thus, room and board expenses cannot exceed
the following amounts: (1) for a student living at home with
parents or guardians, $1,500 per academic year; (2) for a
student living in housing owned or operated by the eligible
education institution, the institution's ``normal'' room and
board charge; and (3) for all other students, $2,500 per
academic year.
Qualified higher education expenses generally include only
out-of-pocket expenses. Such qualified higher education
expenses do not include expenses covered by educational
assistance for the benefit of the beneficiary that is
excludable from gross income. Thus, total qualified higher
education expenses are reduced by scholarship or fellowship
grants excludable from gross income under present-law section
117, as well as any other tax-free educational benefits, such
as employer-provided educational assistance that is excludable
from the employee's gross income under section 127.
Present law also provides that if any qualified higher
education expenses are taken into account in determining the
amount of the exclusion for a distribution from an education
IRA, then no deduction (e.g., for trade or business expenses),
exclusion (e.g., for interest on education savings bonds) or
credit is allowed with respect to such expenses.
Eligible educational institutions are defined by reference
to section 481 of the Higher Education Act of 1965. Such
institutions generally are accredited post-secondary
educational institutions offering credit toward a bachelor's
degree, an associate's degree, a graduate-level or professional
degree, or another recognized post-secondary credential.
Certain proprietary institutions and post-secondary vocational
institutions also are eligible institutions. The institution
must be eligible to participate in Department of Education
student aid programs.

Time for making contributions

Contributions to an education IRA for a taxable year are
taken into account in the taxable year in which they are made.

Coordination with HOPE and Lifetime Learning credits

If an exclusion from gross income is allowed for
distributions from an education IRA with respect to an
individual, then neither the HOPE nor Lifetime Learning credit
may be claimed in the same taxable year with respect to the
same individual. However, an individual may elect to waive the
exclusion with respect to distributions from an education IRA.
If such a waiver is made, then the HOPE or Lifetime Learning
credit may be claimed with respect to the individual for the
taxable year.

Coordination with qualified tuition programs

An excise tax is imposed on contributions to an education
IRA for a year if contributions are made by anyone to a
qualified State tuition program on behalf of the same
beneficiary in the same year. The excise tax is equal to 6
percent of the contributions to the education IRA. The excise
tax is imposed each year after the contribution is made, unless
the contributions are withdrawn.

Reasons for Change

Education IRAs were intended to help families plan for
their children's education. However, the Committee believes
that the present-law limits on contributions to education IRAs
do not permit taxpayers to save adequately. Therefore, the
Committee bill increases the contribution limits to education
IRAs.
The Committee believes that education IRAs should be
expanded to provide greater flexibility to families in
providing for their children's education at all levels of
education. Thus,the Committee bill allows education IRAs to be
used for expenses related to elementary and secondary education.
The Committee believes that other modifications will also
improve the attractiveness and operation of education IRAs,
thus improving the effectiveness of education IRAs in assisting
families in paying for education. Such modifications include
more flexible rules for education IRAs for special needs
beneficiaries and relaxation of the rules restricting the use
of education IRAs and other tax benefits for education in the
same year.

Explanation of Provision

Annual contribution limit

The bill increases the annual limit on contributions to
education IRAs from $500 to $2,000. Thus, aggregate
contributions that may be made by all contributors to one (or
more) education IRAs established on behalf of any particular
beneficiary is limited to $2,000 for each year.

Qualified education expenses

The bill expands the definition of qualified education
expenses that may be paid tax-free from an education IRA to
include ``qualified elementary and secondary school expenses,''
meaning expenses for (1) tuition, fees, academic tutoring,
special need services, books, supplies, computer equipment
(including related software and services), and other equipment
incurred in connection with the enrollment or attendance of the
beneficiary at a public, private, or religious school providing
elementary or secondary education (kindergarten through grade
12) as determined under State law, and (2) room and board,
uniforms, transportation, and supplementary items or services
(including extended day programs) required or provided by such
a school in connection with such enrollment or attendance of
the beneficiary.

Phase-out of contribution limit

The bill increases the phase-out range for married
taxpayers filing a joint return so that it is twice the range
for single taxpayers. Thus, the phase-out range for married
taxpayers filing a joint return is $190,000 to $220,000 of
modified adjusted gross income.

Special needs beneficiaries

The bill provides that the rule prohibiting contributions
to an education IRA after the beneficiary attains 18 does not
apply in the case of a special needs beneficiary (as defined by
Treasury Department regulations). In addition, a deemed
distribution of any balance in an education IRA does not occur
when a special needs beneficiary reaches age 30.

Contributions by persons other than individuals

The bill clarifies that corporations and other entities
(including tax-exempt organizations) are permitted to make
contributions to education IRAs, regardless of the income of
the corporation or entity during the year of the contribution.

Contributions permitted until April 15

Under the bill, individual contributors to education IRAs
are deemed to have made a contribution on the last day of the
preceding taxable year if the contribution is made on account
of such taxable year and is made not later than the time
prescribed by law for filing the individual's Federal income
tax return for such taxable year (not including extensions).
Thus, individual contributors generally may make contributions
for a year until April 15 of the following year.

Qualified room and board expenses

The bill modifies the definition of room and board expenses
considered to be qualified higher education expenses. This
modification is described with the provisions relating to
qualified tuition programs, below.

Coordination with HOPE and Lifetime Learning credits

The bill allows a taxpayer to claim a HOPE credit or
Lifetime Learning credit for a taxable year and to exclude from
gross income amounts distributed (both the contributions and
the earnings portions) from an education IRA on behalf of the
same student as long as the distribution is not used for the
same educational expenses for which a credit was claimed.

Coordination with qualified tuition programs

The bill repeals the excise tax on contributions made by
any person to an education IRA on behalf of a beneficiary
during any taxable year in which any contributions are made by
anyone to a qualified State tuition program on behalf of the
same beneficiary.
If distributions from education IRAs and qualified tuition
programs exceed the beneficiary's qualified higher education
expenses for the year (after reduction by amounts used in
claiming the HOPE or Lifetime Learning credit), the beneficiary
is required to allocate the expenses between the distributions
to determine the amount includible in income.

Effective Date

The provisions modifying education IRAs are effective for
taxable years beginning after December 31, 2001.

B. Private Prepaid Tuition Programs; Exclusion From Gross Income of
Education Distributions From Qualified Tuition Programs

(Sec. 402 of the bill and Sec. 529 of the Code)

Present Law

Section 529 of the Code provides tax-exempt status to
``qualified State tuition programs,'' meaning certain programs
established and maintained by a State (or agency or
instrumentality thereof) under which persons may (1) purchase
tuition credits or certificates on behalf of a designated
beneficiary that entitle the beneficiary to a waiver or payment
of qualified higher education expenses of the beneficiary, or
(2) make contributions to an account that is established for
the purpose of meeting qualified higher education expenses of
the designated beneficiary of the account (a ``savings account
plan''). The term ``qualified higher education expenses''
generally has the same meaning as does the term for purposes of
education IRAs (as described above) and, thus, includes
expenses for tuition, fees, books, supplies, and equipment
required for the enrollment or attendance at an eligible
educational institution,\24\ as well as certain room and board
expenses for any period during which the student is at least a
half-time student.
---------------------------------------------------------------------------
\24\ An ``eligible education institution'' is defined the same for
purposes of education IRAs (described above) and qualified State
tuition programs.
---------------------------------------------------------------------------
No amount is included in the gross income of a contributor
to, or a beneficiary of, a qualified State tuition program with
respect to any distribution from, or earnings under, such
program, except that (1) amounts distributed or educational
benefits provided to a beneficiary are included in the
beneficiary's gross income (unless excludable under another
Code section) to the extent such amounts or the value of the
educational benefits exceed contributions made on behalf of the
beneficiary, and (2) amounts distributed to a contributor
(e.g., when a parent receives a refund) are included in the
contributor's gross income to the extent such amounts exceed
contributions made on behalf of the beneficiary.\25\
---------------------------------------------------------------------------
\25\ Distributions from qualified State tuition programs are
treated as representing a pro-rata share of the contributions and
earnings in the account.
---------------------------------------------------------------------------
A qualified State tuition program is required to provide
that purchases or contributions only be made in cash.\26\
Contributors and beneficiaries are not allowed to direct the
investment of contributions to the program (or earnings
thereon). The program is required to maintain a separate
accounting for each designated beneficiary. A specified
individual must be designated as the beneficiary at the
commencement of participation in a qualified State tuition
program (i.e., when contributions are first made to purchase an
interest in such a program), unless interests in such a program
are purchased by a State or local government or a tax-exempt
charity described in section 501(c)(3) as part of a scholarship
program operated by such government or charity under which
beneficiaries to be named in the future will receive such
interests as scholarships.
---------------------------------------------------------------------------
\26\ Special estate and gift tax rules apply to contributions made
to and distributions made from qualified State tuition programs.
---------------------------------------------------------------------------
A transfer of credits (or other amounts) from one account
benefiting one designated beneficiary to another account
benefiting a different beneficiary is considered a distribution
(as is a change in the designated beneficiary of an interest in
a qualified State tuition program), unless the beneficiaries
are members of the same family. For this purpose, the term
``member of the family'' means: (1) the spouse of the
beneficiary; (2) a son or daughter of the beneficiary or a
descendent of either; (3) a stepson or stepdaughter of the
beneficiary; (4) a brother, sister, stepbrother or stepsister
of the beneficiary; (5) the father or mother of the beneficiary
or an ancestor of either; (6) a stepfather or stepmother of the
beneficiary; (7) a son or daughter of a brother or sister of
the beneficiary; (8) a brother or sister of the father or
mother of the beneficiary; (9) a son-in-law, daughter-in-law,
father-in-law, mother-in-law, brother-in-law, or sister-in-law
of the beneficiary; or (10) the spouse of any person described
in (2)-(9).
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, (3) made on account of a scholarship received
by the beneficiary, or (4) a rollover distribution.
To the extent that a distribution from a qualified State
tuition program is used to pay for qualified tuition and
related expenses (as defined in sec. 25A(f)(1)), the
beneficiary (or another taxpayer claiming the beneficiary as a
dependent) may claim the HOPE credit or Lifetime Learning
credit with respect to such tuition and related expenses
(assuming that the other requirements for claiming the HOPE
credit or Lifetime Learning credit are satisfied and the
modified AGI phase-out for those credits does not apply).

Reasons for Change

The Committee believes that distributions from qualified
State tuition programs should not be subject to Federal income
tax to the extent that such distributions are used to pay for
qualified higher education expenses of undergraduate or
graduate students who are attending college, university, or
certain vocational schools. In addition, the Committee believes
that the present-law rules governing qualified tuition programs
should be expanded to permit private educational institutions
to maintain certain prepaid tuition programs. The Committee
believes that the amount of room and board expenses that can be
paid with tax-free distributions from prepaid tuition plans
should reflect current costs.

Explanation of Provision

Qualified tuition program

The bill expands the definition of ``qualified tuition
program'' to include certain prepaid tuition programs
established and maintained by one or more eligible educational
institutions (which may be private institutions) that satisfy
the requirements under section 529 (other than the present-law
State sponsorship rule). In the case of a qualified tuition
program maintained by one or more private eligible educational
institutions, persons are able to purchase tuition credits or
certificates on behalf of a designated beneficiary (as set
forth in sec. 529(b)(1)(A)(i)), but would not be able to make
contributions to a savings account plan (as described in
sec.529(b)(1)(A)(ii)). Except to the extent provided in regulations, a
tuition program maintained by a private institution is not treated as
qualified unless it has received a ruling or determination from the IRS
that the program satisfies applicable requirements.

Exclusion from gross income

Under the bill, an exclusion from gross income is provided
for distributions made in taxable years beginning after
December 31, 2001, from qualified State tuition programs to the
extent that the distribution is used to pay for qualified
higher education expenses. This exclusion from gross income is
extended to distributions from qualified tuition programs
established and maintained by an entity other than a State (or
agency or instrumentality thereof) for distributions made in
taxable years after December 31, 2003.

Qualified higher education expenses

The bill provides that, for purposes of the exclusion for
distributions from qualified tuition plans, the maximum room
and board allowance is the amount applicable to the student in
calculating costs of attendance for Federal financial aid
programs under section 472 of the Higher Education Act of 1965,
as in effect on the date of enactment, or, in the case of a
student living in housing owned or operated by an eligible
educational institution, the actual amount charged the student
by the educational institution for room and board.\27\
---------------------------------------------------------------------------
\27\ This definition also applies to distributions from education
IRAs.
---------------------------------------------------------------------------

Coordination with HOPE and Lifetime Learning credits

The bill allows a taxpayer to claim a HOPE credit or
Lifetime Learning credit for a taxable year and to exclude from
gross income amounts distributed (both the principal and the
earnings portions) from a qualified tuition program on behalf
of the same student as long as the distribution is not used for
the same expenses for which a credit was claimed.

Rollovers for benefit of same beneficiary

The bill provides that a transfer of credits (or other
amounts) from one qualified tuition program for the benefit of
a designated beneficiary to another qualified tuition program
for the benefit of the same beneficiary is not considered a
distribution. This rollover treatment applies to a maximum of
three such transfers with respect to the same designated
beneficiary.

Member of family

The bill provides that, for purposes of tax-free rollovers
and changes of designated beneficiaries, a ``member of the
family'' includes first cousins of the original beneficiary.

Effective Date

The provisions are effective for taxable years beginning
after December 31, 2001, except that the exclusion from gross
income for certain distributions from a qualified tuition
program established and maintained by an entity other than a
State (or agency or instrumentality thereof) is effective for
taxable years beginning after December 31, 2003.

C. Exclusion for Employer-Provided Educational Assistance

(Sec. 411 of the bill and Sec. 127 of the Code)

Present Law

Educational expenses paid by an employer for its employees
are generally deductible by the employer.
Employer-paid educational expenses are excludable from the
gross income and wages of an employee if provided under a
section 127 educational assistance plan or if the expenses
qualify as a working condition fringe benefit under section
132. Section 127 provides an exclusion of $5,250 annually for
employer-provided educational assistance. The exclusion does
not apply to graduate courses beginning after June 30, 1996.
The exclusion for employer-provided educational assistance for
undergraduate courses expires with respect to courses beginning
after December 31, 2001.
In order for the exclusion to apply, certain requirements
must be satisfied. The educational assistance must be provided
pursuant to a separate written plan of the employer. The
educational assistance program must not discriminate in favor
of highly compensated employees. In addition, not more than
five percent of the amounts paid or incurred by the employer
during the year for educational assistance under a qualified
educational assistance plan can be provided for the class of
individuals consisting of more than five percent owners of the
employer (and their spouses and dependents).
Educational expenses that do not qualify for the section
127 exclusion may be excludable from income as a working
condition fringe benefit.\28\ In general, education qualifies
as a working condition fringe benefit if the employee could
have deducted the education expenses under section 162 if the
employee paid for the education. In general, education expenses
are deductible by an individual under section 162 if the
education (1) maintains or improves a skill required in a trade
or business currently engaged in by the taxpayer, or (2) meets
the express requirements of the taxpayer's employer, applicable
law or regulations imposed as a condition of continued
employment. However, education expenses are generally not
deductible if they relate to certain minimum educational
requirements or to education or training that enables a
taxpayer to begin working in a new trade or business.\29\
---------------------------------------------------------------------------
\28\ These rules also apply in the event that section 127 expires.
\29\ In the case of an employee, education expenses (if not
reimbursed by the employer) may be claimed as an itemized deduction
only if such expenses, along with other miscellaneous expenses, exceed
two percent of the taxpayer's AGI. An individual's total deductions may
also be reduced by the overall limitation on itemized deductions under
section 68. These limitations do not apply in determining whether an
item is excludable from income as a working condition fringe benefit.
---------------------------------------------------------------------------

Reasons for Change

The Committee believes that the exclusion for employer-
provided educational assistance has enabled millions of workers
to advance their education and improve their job skills without
incurring additional taxes and a reduction in take-home pay. In
addition, the exclusion lessens the complexity of the tax laws.
Without the special exclusion, a worker receiving educational
assistance from his or her employer is subject to tax on the
assistance, unless the education is related to the worker's
current job. Because the determination of whether particular
educational assistance is job related is based on the facts and
circumstances, it may be difficult to determine with certainty
whether the educational assistance is excludable from income.
This uncertainty may lead to disputes between taxpayers and the
Internal Revenue Service.
The Committee believes that reinstating the exclusion for
graduate-level employer-provided educational assistance will
enable more individuals to seek higher education, and that
further extension of the exclusion is important.
The past experience of allowing the exclusion to expire and
later extending it retroactively has created burdens for
employers and employees. Employees may have difficulty planning
for their educational goals if they do not know whether their
tax bills will increase. For employers, the lack of permanence
of the provision has caused severe administrative problems.
Uncertainty about the exclusion's future may discourage some
employers from providing educational benefits.

Explanation of Provision

The provision extends the exclusion for employer-provided
educational assistance to graduate education and makes the
exclusion (as applied to both undergraduate and graduate
education) permanent.

Effective Date

The provision is effective with respect to courses
beginning after December 31, 2001.

D. Modifications to Student Loan Interest Deduction

(Sec. 412 of the bill and Sec. 221 of the Code)

Present Law

Certain individuals may claim an above-the-line deduction
for interest paid on qualified education loans, subject to a
maximum annual deduction limit. The deduction is allowed only
with respect to interest paid on a qualified education loan
during the first 60 months in which interest payments are
required. Required payments of interest generally do not
include voluntary payments, such as interest payments made
during a period of loan forbearance. Months during which
interest payments are not required because the qualified
education loan is in deferral or forbearance do not count
against the 60-month period. No deduction is allowed to an
individual if that individual is claimed as a dependent on
another taxpayer's return for the taxable year.
A qualified education loan generally is defined as any
indebtedness incurred solely to pay for certain costs of
attendance (including room and board) of a student (who may be
the taxpayer, the taxpayer's spouse, or any dependent of the
taxpayer as of the time the indebtedness was incurred) who is
enrolled in a degree program on at least a half-time basis at
(1) an accredited post-secondary educational institution
defined by reference to section 481 of the Higher Education Act
of 1965, or (2) an institution conducting an internship or
residency program leading to a degree or certificate from an
institution of higher education, a hospital, or a health care
facility conducting postgraduate training.
The maximum allowable annual deduction is $2,500. The
deduction is phased-out ratably for single taxpayers with
modified adjusted gross income between $40,000 and $55,000 and
for married taxpayers filing joint returns with modified
adjusted gross income between $60,000 and $75,000. The income
ranges will be adjusted for inflation after 2002.

Reasons for Change

The Committee believes that it is appropriate to expand the
deduction for individuals who pay interest on qualified
education loans by repealing the limitation that the deduction
is allowed only with respect to interest paid during the first
60 months in which interest payments are required. In addition,
the repeal of the 60-month limitation lessens complexity and
administrative burdens for taxpayers, lenders, loan servicing
agencies, and the Internal Revenue Service. The Committee also
believes it appropriate to increase the income phase-out ranges
applicable to the student loan interest deduction to make the
deduction available to more taxpayers and to reduce the
potential marriage penalty caused by the phase-out ranges.

Explanation of Provision

The bill increases the income phase-out ranges for
eligibility for the student loan interest deduction to $50,000
to $65,000 for single taxpayers and to $100,000 to $130,000 for
married taxpayers filing joint returns. These income phase-out
ranges are adjusted annually for inflation after 2002.
The bill repeals both the limit on the number of months
during which interest paid on a qualified education loan is
deductible and the restriction that voluntary payments of
interest are not deductible.

Effective Date

The provision is effective for interest paid on qualified
education loans after December 31, 2001.

E. Eliminate Tax on Awards Under the National Health Service Corps
Scholarship Program and the F. Edward Hebert Armed Forces Health
Professions Scholarship and Financial Assistance Program

(Sec. 413 of the bill and Sec. 117 of the Code)

Present Law

Section 117 excludes from gross income amounts received as
a qualified scholarship by an individual who is a candidate for
a degree and used for tuition and fees required for the
enrollment or attendance (or for fees, books, supplies, and
equipment required for courses of instruction) at a primary,
secondary, or post-secondary educational institution. The tax-
free treatment provided by section 117 does not extend to
scholarship amounts covering regular living expenses, such as
room and board. In addition to the exclusion for qualified
scholarships, section 117 provides an exclusion from gross
income for qualified tuition reductions for certain education
provided to employees (and their spouses and dependents) of
certain educational organizations.
The exclusion for qualified scholarships and qualified
tuition reductions does not apply to any amount received by a
student that represents payment for teaching, research, or
other services by the student required as a condition for
receiving the scholarship or tuition reduction.
The National Health Service Corps Scholarship Program (the
``NHSC Scholarship Program'') and the F. Edward Hebert Armed
Forces Health Professions Scholarship and Financial Assistance
Program (the ``Armed Forces Scholarship Program'') provide
education awards to participants on the condition that the
participants provide certain services. In the case of the NHSC
Program, the recipient of the scholarship is obligated to
provide medical services in a geographic area (or to an
underserved population group or designated facility) identified
by the Public Health Service as having a shortage of health
care professionals. In the case of the Armed Forces Scholarship
Program, the recipient of the scholarship is obligated to serve
a certain number of years in the military at an armed forces
medical facility. Because the recipients are required to
perform services in exchange for the education awards, the
awards used to pay higher education expenses are taxable income
to the recipient.

reasons for change

The Committee believes it appropriate to provide tax-free
treatment for scholarships received by medical, dental,
nursing, and physician assistant students under the NHSC
Scholarship Program and the Armed Forces Scholarship Program.

Explanation of Provision

The bill provides that amounts received by an individual
under the NHSC Scholarship Program or the Armed Forces
Scholarship Program are eligible for tax-free treatment as
qualified scholarships under section 117, without regard to any
service obligation by the recipient. As with other qualified
scholarships under section 117, the tax-free treatment does not
apply to amounts received by students for regular living
expenses, including room and board.

Effective Date

The provision is effective for education awards received
after December 31, 2001.

F. Tax Benefits for Certain Types of Bonds for Educational Facilities
and Activities

(Secs. 421-422 of the bill and Secs. 142 and 146-148 of the Code)

Present Law

Tax-exempt bonds

In general
Interest on debt \30\ incurred by States or local
governments is excluded from income if the proceeds of the
borrowing are used to carry out governmental functions of those
entities or the debt is repaid with governmental funds (Sec.
103).\31\ Like other activities carried out or paid for by
States and local governments, the construction, renovation, and
operation of public schools is an activity eligible for
financing with the proceeds of tax-exempt bonds.
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\30\ Hereinafter referred to as ``State or local government
bonds.''
\31\ Interest on this debt is included in calculating the
``adjusted current earnings'' preference of the corporate alternative
minimum tax.
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Interest on bonds that nominally are issued by States or
local governments, but the proceeds of which are used (directly
or indirectly) by a private person and payment of which is
derived from funds of such a private person is taxable unless
the purpose of the borrowing is approved specifically in the
Code or in a non-Code provision of a revenue Act. These bonds
are called ``private activity bonds.'' \32\ The term ``private
person'' includes the Federal Government and all other
individuals and entities other than States or local
governments.
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\32\ Interest on private activity bonds (other than qualified
501(c)(3) bonds) is a preference item in calculating the alternative
minimum tax.
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Private activities eligible for financing with tax-exempt
private activity bonds
Present law includes several exceptions permitting States
or local governments to act as conduits providing tax-exempt
financing for private activities. Both capital expenditures and
limited working capital expenditures of charitable
organizations described in section 501(c)(3) of the Code--
including elementary, secondary, and post-secondary schools--
may be financed with tax-exempt private activity bonds
(``qualified 501(c)(3) bonds'').
States or local governments may issue tax-exempt ``exempt-
facility bonds'' to finance property for certain private
businesses. Business facilities eligible for this financing
include transportation (airports, ports, local mass commuting,
and high speed intercity rail facilities); privately owned and/
or privately operated public works facilities (sewage, solid
waste disposal, local district heating or cooling, and
hazardous waste disposal facilities); privately-owned and/or
operated low-income rental housing; and certain private
facilities for the local furnishing of electricity or gas. A
further provision allows tax-exempt financing for
``environmental enhancements of hydro-electric generating
facilities.'' Tax-exempt financing also is authorized for
capital expenditures for small manufacturing facilities and
land and equipment for first-timefarmers (``qualified small-
issue bonds''), local redevelopment activities (``qualified
redevelopment bonds''), and eligible empowerment zone and enterprise
community businesses. Tax-exempt private activity bonds also may be
issued to finance limited non-business purposes: certain student loans
and mortgage loans for owner-occupied housing (``qualified mortgage
bonds'' and ``qualified veterans' mortgage bonds'').
Private activity tax-exempt bonds may not be issued to
finance schools for private, for-profit businesses.
In most cases, the aggregate volume of private activity
tax-exempt bonds is restricted by annual aggregate volume
limits imposed on bonds issued by issuers within each State.
These annual volume limits are equal to $62.50 per resident of
the State, or $187.5 million if greater. The volume limits are
scheduled to increase to the greater of $75 per resident of the
State or $225 million in calendar year 2002. After 2002, the
volume limits will be indexed annually for inflation.
Arbitrage restrictions on tax-exempt bonds
The Federal income tax does not apply to the income of
States and local governments that is derived from the exercise
of an essential governmental function. To prevent these tax-
exempt entities from issuing more Federally subsidized tax-
exempt bonds than is necessary for the activity being financed
or from issuing such bonds earlier than needed for the purpose
of the borrowing, the Code includes arbitrage restrictions
limiting the ability to profit from investment of tax-exempt
bond proceeds. In general, arbitrage profits may be earned only
during specified periods (e.g., defined ``temporary periods''
before funds are needed for the purpose of the borrowing) or on
specified types of investments (e.g., ``reasonably required
reserve or replacement funds''). Subject to limited exceptions,
profits that are earned during these periods or on such
investments must be rebated to the Federal Government.
Present law includes three exceptions to the arbitrage
rebate requirements applicable to education-related bonds.
First, issuers of all types of tax-exempt bonds are not
required to rebate arbitrage profits if all of the proceeds of
the bonds are spent for the purpose of the borrowing within six
months after issuance.\33\
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\33\ In the case of governmental bonds (including bonds to finance
public schools), the six-month expenditure exception is treated as
satisfied if at least 95 percent of the proceeds is spent within six
months and the remaining five percent is spent within 12 months after
the bonds are issued.
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Second, in the case of bonds to finance certain
construction activities, including school construction and
renovation, the six-month period is extended to 24 months.
Arbitrage profits earned on construction proceeds are not
required to be rebated if all such proceeds (other than certain
retainage amounts) are spent by the end of the 24-month period
and prescribed intermediate spending percentages are
satisfied.\34\ Issuers qualifying for this ``construction
bond'' exception may elect to be subject to a fixed penalty
payment regime in lieu of rebate if they fail to satisfy the
spending requirements.
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\34\ Retainage amounts are limited to no more than five percent of
the bond proceeds, and these amounts must be spent for the purpose of
the borrowing no later than 36 months after the bonds are issued.
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Third, governmental bonds issued by ``small'' governments
are not subject to the rebate requirement. Small governments
are defined as general purpose governmental units that issue no
more than $5 million of tax-exempt governmental bonds in a
calendar year. The $5 million limit is increased to $10 million
if at least $5 million of the bonds are used to finance public
schools.\35\
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\35\ The Small Business Job Protection Act of 1996 permitted
issuance of the additional $5 million in public school bonds by small
governments. Previously, small governments were defined as governments
that issued no more than $5 million of governmental bonds without
regard to the purpose of the financing.
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Qualified zone academy bonds

As an alternative to traditional tax-exempt bonds, States
and local governments are given the authority to issue
``qualified zone academy bonds.'' Under present law, a total of
$400 million of qualified zone academy bonds may be issued in
each of 1998 through 2001. The $400 million aggregate bond
authority is allocated each year to the States according to
their respective populations of individuals below the poverty
line. Each State, in turn, allocates the credit to qualified
zone academies within such State. A State may carry over any
unused allocation for up to two years (three years for
authority arising before 2000).
Certain financial institutions (i.e., banks, insurance
companies, and corporations actively engaged in the business of
lending money) that hold qualified zone academy bonds are
entitled to a nonrefundable tax credit in an amount equal to a
credit rate multiplied by the face amount of the bond. An
eligible financial institution holding a qualified zone academy
bond on the credit allowance date (i.e., each one-year
anniversary of the issuance of the bond) is entitled to a
credit. The credit amount is includible in gross income (as if
it were a taxable interest payment on the bond), and the credit
may be claimed against regular income tax and alternative
minimum tax liability.
The Treasury Department sets the credit rate daily at a
rate estimated to allow issuance of qualified zone academy
bonds without discount and without interest cost to the issuer.
The maximum term of the bonds also is determined by the
Treasury Department, so that the present value of the
obligation to repay the bond is 50 percent of the face value of
the bond. Present value is determined using as a discount rate
the average annual interest rate of tax-exempt obligations with
a term of 10 years or more issued during the month.
``Qualified zone academy bonds'' are defined as bonds
issued by a State or local government, provided that: (1) at
least 95 percent of the proceeds is used for the purpose of
renovating, providing equipment to, developing course materials
for use at, or training teachersand other school personnel in a
``qualified zone academy'' and (2) private entities have promised to
contribute to the qualified zone academy certain equipment, technical
assistance or training, employee services, or other property or
services with a value equal to at least 10 percent of the bond
proceeds.
A school is a ``qualified zone academy'' if (1) the school
is a public school that provides education and training below
the college level, (2) the school operates a special academic
program in cooperation with businesses to enhance the academic
curriculum and increase graduation and employment rates, and
(3) either (a) the school is located in a designated
empowerment zone or a designated enterprise community, or (b)
it is reasonably expected that at least 35 percent of the
students at the school will be eligible for free or reduced-
cost lunches under the school lunch program established under
the National School Lunch Act.

Reasons for Change

The policy underlying the arbitrage rebate exception for
bonds of small governmental units is to reduce complexity for
these entities because they may not have in-house financial
staff to engage in the expenditure and investment tracking
necessary for rebate compliance. The exception further is
justified by the limited potential for arbitrage profits at
small issuance levels and limitation of the provision to
governmental bonds, which typically require voter approval
before issuance. The Committee believes that a limited increase
of $5 million per year for public school construction bonds
will more accurately conform this present-law exception to
current school construction costs.
Further, the Committee wishes to encourage public-private
partnerships to improve educational opportunities. To permit
public-private partnerships to reap the benefit of the implicit
subsidy to capital costs provided through tax-exempt financing,
the Committee determined that it is appropriate to allow the
issuance of tax-exempt private activity bonds for public school
facilities.

Explanation of Provisions

Increase amount of governmental bonds that may be issued by governments
qualifying for the ``small governmental unit'' arbitrage rebate
exception

The additional amount of governmental bonds for public
schools that small governmental units may issue without being
subject to the arbitrage rebate requirements is increased from
$5 million to $10 million. Thus, these governmental units may
issue up to $15 million of governmental bonds in a calendar
year provided that at least $10 million of the bonds are used
to finance public school construction expenditures.

Allow issuance of tax-exempt private activity bonds for public school
facilities

The private activities for which tax-exempt bonds may be
issued are expanded to include elementary and secondary public
school facilities which are owned by private, for-profit
corporations pursuant to public-private partnership agreements
with a State or local educational agency. The term school
facility includes school buildings and functionally related and
subordinate land (including stadiums or other athletic
facilities primarily used for school events) \36\ and
depreciable personal property used in the school facility. The
school facilities for which these bonds are issued must be
operated by a public educational agency as part of a system of
public schools.
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\36\ The present-law limit on the amount of the proceeds of a
private activity bond issue that may be used to finance land
acquisition does not apply to these bonds.
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A public-private partnership agreement is defined as an
arrangement pursuant to which the for-profit corporate party
constructs, rehabilitates, refurbishes or equips a school
facility for a public school agency (typically pursuant to a
lease arrangement). The agreement must provide that, at the end
of the contract term, ownership of the bond-financed property
is transferred to the public school agency party to the
agreement for no additional consideration.
Issuance of these bonds is subject to a separate annual
per-State private activity bond volume limit equal to $10 per
resident ($5 million, if greater) in lieu of the present-law
State private activity bond volume limits. As with the present-
law State private activity bond volume limits, States can
decide how to allocate the bond authority to State and local
government agencies. Bond authority that is unused in the year
in which it arises may be carried forward for up to three years
for public school projects under rules similar to the
carryforward rules of the present-law private activity bond
volume limits.

Effective Date

The provisions are effective for bonds issued after
December 31, 2001.
G. Deduction for Qualified Higher Education Expenses

(Sec. 431 of the bill and new Sec. 222 of the Code)

Present Law

Deduction for education expenses

Under present law, an individual taxpayer generally may not
deduct the education and training expenses of the taxpayer or
the taxpayer's dependents. However, a deduction for education
expenses generally is allowed under Internal Revenue Code
(``the Code'') section 162 if the education or training (1)
maintains or improves a skill required in a trade or business
currently engaged in by the taxpayer, or (2) meets the express
requirements of the taxpayer's employer, or requirements of
applicable law or regulations, imposed as a condition of
continued employment (Treas. Reg. sec. 1.162-5). Education
expenses are not deductible if they relate to certain minimum
educational requirements or to education or training that
enables a taxpayer to begin working in a new trade or business.
In the case of an employee, education expenses (if not
reimbursed by the employer) may be claimed as an itemized
deduction only if such expenses meet the above described
criteria for deductibility under section 162 and only to the
extent that the expenses, along with other miscellaneous
deductions, exceed 2 percent of the taxpayer's adjusted gross
income.

HOPE and Lifetime Learning credits

HOPE credit
Under present law, individual taxpayers are allowed to
claim a nonrefundable credit, the ``HOPE'' credit, against
Federal income taxes of up to $1,500 per student per year for
qualified tuition and related expenses paid for the first two
years of the student's post secondary education in a degree or
certificate program. The HOPE credit rate is 100 percent on the
first $1,000 of qualified tuition and related expenses, and 50
percent on the next $1,000 of qualified tuition and related
expenses.\37\ The qualified tuition and related expenses must
be incurred on behalf of the taxpayer, the taxpayer's spouse,
or a dependent of the taxpayer. The HOPE credit is available
with respect to an individual student for two taxable years,
provided that the student has not completed the first two years
of post-secondary education before the beginning of the second
taxable year.\38\ The HOPE credit that a taxpayer may otherwise
claim is phased-out ratably for taxpayers with modified AGI
between $40,000 and $50,000 ($80,000 and $100,000 for joint
returns). For taxable years beginning after 2001, the $1,500
maximum HOPE credit amount and the AGI phase-out ranges are
indexed for inflation.
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\37\ Thus, an eligible student who incurs $1,000 of qualified
tuition and related expenses is eligible (subject to the AGI phase-out)
for a $1,000 HOPE credit. If an eligible student incurs $2,000 of
qualified tuition and related expenses, then he or she is eligible for
a $1,500 HOPE credit.
\38\ The HOPE credit may not be claimed against a taxpayer's
alternative minimum tax liability.
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The HOPE credit is available for ``qualified tuition and
related expenses,'' which include tuition and fees required to
be paid to an eligible educational institution as a condition
of enrollment or attendance of an eligible student at the
institution. Charges and fees associated with meals, lodging,
insurance, transportation, and similar personal, living, or
family expenses are not eligible for the credit. The expenses
of education involving sports, games, or hobbies are not
qualified tuition and related expenses unless this education is
part of the student's degree program.
Qualified tuition and related expenses generally include
only out-of-pocket expenses. Qualified tuition and related
expenses do not include expenses covered by employer-provided
educational assistance and scholarships that are not required
to be included in the gross income of either the student or the
taxpayer claiming the credit. Thus, total qualified tuition and
related expenses are reduced by any scholarship or fellowship
grants excludable from gross income under section 117 and any
other tax free educational benefits received by the student (or
the taxpayer claiming the credit) during the taxable year.
Lifetime Learning credit
Individual taxpayers are allowed to claim a nonrefundable
credit, the Lifetime Learning credit, against Federal income
taxes equal to 20 percent of qualified tuition and related
expenses incurred during the taxable year on behalf of the
taxpayer, the taxpayer's spouse, or any dependents. For
expenses paid after June 30, 1998, and prior to January 1,
2003, up to $5,000 of qualified tuition and related expenses
per taxpayer return are eligible for the Lifetime Learning
credit (i.e., the maximum credit per taxpayer return is
$1,000). For expenses paid after December 31, 2002, up to
$10,000 of qualified tuition and related expenses per taxpayer
return will be eligible for the Lifetime Learning credit (i.e.,
the maximum credit per taxpayer return will be $2,000).
In contrast to the HOPE credit, a taxpayer may claim the
Lifetime Learning credit for an unlimited number of taxable
years. Also in contrast to the HOPE credit, the maximum amount
of the Lifetime Learning credit that may be claimed on a
taxpayer's return will not vary based on the number of students
in the taxpayer's family--that is, the HOPE credit is computed
on a per student basis, while the Lifetime Learning credit is
computed on a family wide basis. The Lifetime Learning credit
amount that a taxpayer may otherwise claim is phased-out
ratably for taxpayers with modified AGI between $40,000 and
$50,000 ($80,000 and $100,000 for joint returns).

Reasons for Change

The Committee recognizes that in some cases a deduction for
education expenses may provide greater tax relief than the
present-law credits. The Committee wishes to maximize tax
benefits for education, and provide greater choice for
taxpayers in determining which tax benefit is most appropriate
for them.

Explanation of Provision

The bill permits taxpayers an above-the-line deduction for
qualified higher education expenses paid by the taxpayer during
a taxable year. Qualified higher education expenses are defined
in the same manner as for purposes of the HOPE credit.
In 2002 and 2003, taxpayers with adjusted gross income \39\
that does not exceed $65,000 ($130,000 in the case of married
couples filing joint returns) are entitled to a maximum
deduction of $3,000 per year. Taxpayers with adjusted gross
income above these thresholds would not be entitled to a
deduction. In 2004 and 2005, taxpayers with adjusted gross
income that does not exceed $65,000 ($130,000 in the case of
married taxpayers filing joint returns) are entitled to a
maximum deduction of $5,000 and taxpayers with adjusted gross
income that does not exceed $80,000 ($160,000 in the case of
married taxpayers filing joint returns) are entitled to a
maximum deduction of $2,000.
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\39\ The provision contains ordering rules for use in determining
adjusted gross income for purposes of the deduction.
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Taxpayers are not eligible to claim the deduction and a
HOPE or Lifetime Learning Credit in the same year with respect
to the same student. A taxpayer may claim an exclusion for
distributions from a qualified tuition plan, distributions from
an education individual retirement account, or interest on
education savings bonds, as long as both a deduction and an
exclusion are not claimed for the same expenses.

Effective Date

The provision is effective for payments made in taxable
years beginning after December 31, 2001, and before January 1,
2006.

H. Credit for Interest on Qualified Higher Education Loans

(Sec. 432 of the bill and new Sec. 25B of the Code)

Present law

An above-the-line deduction for interest paid on qualified
education loans is permitted during the first 60 months in
which interest payments are required. Required payments of
interest generally do not include voluntary payments, such as
interest payments made during a period of loan forbearance.
Months during which interest payments are not required because
the qualified education loan is in deferral or forbearance do
not count against the 60-month period. No deduction is allowed
to an individual if that individual is claimed as a dependent
on another taxpayer's return for the taxable year.
The maximum allowable annual deduction is $2,500. The
deduction is phased-out ratably for single taxpayers with
modified adjusted gross income between $40,000 and $55,000 and
for married taxpayers filing joint returns with modified
adjusted gross income between $60,000 and $75,000. The income
ranges will be adjusted for inflation after 2002.\40\
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\40\ Another section of the bill makes certain modifications to
present law.
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A qualified education loan generally is defined as any
indebtedness incurred solely to pay for certain costs of
attendance (including room and board) of a student (who may be
the taxpayer, the taxpayer's spouse, or any dependent of the
taxpayer as of the time the indebtedness was incurred) who is
enrolled in a degree program on at least a half-time basis at
(1) an accredited post-secondary educational institution
defined by reference to section 481 of the Higher Education Act
of 1965, or (2) an institution conducting an internship or
residency program leading to a degree or certificate from an
institution of higher education, a hospital, or a health care
facility conducting postgraduate training.

Reasons for Change

The Committee wishes to make the payment of higher
education less costly for taxpayers and to give taxpayers a
choice in maximizing their tax benefits. A credit for interest
paid on qualified higher education loans will in many cases
give taxpayers a greater tax benefit than the deduction.

Explanation of Provision

The bill permits taxpayers a nonrefundable personal credit
for interest paid on qualified education loans during the first
60 months in which interest payments are required. The maximum
annual credit available would be $500.
The credit is phased-out for single taxpayers with modified
adjusted gross income between $35,000 and $45,000 and for
married taxpayers filing joint returns with modified adjusted
gross income between $70,000 and $90,000. These income phase-
out ranges would be adjusted annually for inflation after 2009.
A taxpayer taking the credit in a taxable year for payment
of interest on a qualified education loan would not be allowed
a student loan interest deduction in such taxable year.
Similarly, if the taxpayer took a deduction, the taxpayer would
not qualify for the credit.

Effective Date

The provision is effective for taxable years beginning
after December 31, 2008.

I. Compliance With Congressional Budget Act

(Secs. 441 and 442 of the bill)

Present Law

Reasons for Change

Explanation of Provision

Sunset of provisions

To ensure compliance with the Budget Act, the bill provides
that all provisions of, and amendments made by, the bill
relating to education which are in effect on September 30,
2011, shall cease to apply as of the close of September 30,
2011.

Restoration of provisions

All provisions of, and amendments made by, the bill
relating to education which were terminated under the sunset
provision shall begin to apply again as of October 1, 2011, as
provided in each such provision or amendment.

V. ESTATE, GIFT, AND GENERATION-SKIPPING TRANSFER TAX PROVISIONS

A. Phaseout and Repeal of Estate and Generation-Skipping Transfer
Taxes; Increase in Gift Tax Unified Credit Effective Exemption

(Secs. 501-542 of the bill, Secs. 121, 684, 1014, 1040, 1221, 2001-
2210, 2501, 2502, 2503, 2505, 2511, 2601-2663, 4947, 6018, 6019, and
7701 of the Code, and new Secs. 1022, 2058, 2210, 2664, and 6716 of the
Code)

present law

Estate and gift tax rules
In general
Under present law, a gift tax is imposed on lifetime
transfers and an estate tax is imposed on transfers at death.
The gift tax and the estate tax are unified so that a single
graduated rate schedule applies to cumulative taxable transfers
made by a taxpayer during his or her lifetime and at death. 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. In
addition, a 5-percent surtax is imposed on cumulative taxable
transfers between $10 million and $17,184,000, which has the
effect of phasing out the benefit of the graduated rates. Thus,
these estates are subject to a top marginal rate of 60 percent.
Estates over $17,184,000 are subject to a flat rate of 55
percent, as the benefit of the graduated rates has been phased
out.
Gift tax annual exclusion
Donors of lifetime gifts are provided an annual exclusion
of $10,000 (indexed for inflation occurring after 1997) of
transfers of present interests in property to any one donee
during the taxable year. If the non-donor spouse consents to
split the gift with the donor spouse, then the annual exclusion
is $20,000. Unlimited transfers between spouses are permitted
without imposition of a gift tax.
Unified credit
A unified credit is available with respect to taxable
transfers by gift and at death. The unified credit amount
effectively exempts from tax transfers totaling $675,000 in
2001, $700,000 in 2002 and 2003, $850,000 in 2004, $950,000 in
2005, and $1 million in 2006 and thereafter. The benefit of the
unified credit applies at the lowest estate and gift tax rates.
For example, in 2001, the unified credit applies between the
18-percent and 37-percent estate and gift tax rates. Thus, in
2001, taxable transfers, after application of the unified
credit, are effectively subject to estate and gift tax rates
beginning at 37 percent.
Transfers to a surviving spouse
In general.--A 100-percent marital deduction generally is
permitted for the value of property transferred between
spouses. In addition, transfers of a ``qualified terminable
interest''also are eligible for the marital deduction. A
``qualified terminable interest'' is property: (1) which passes from
the decedent, (2) in which the surviving spouse has a ``qualifying
income interest for life,'' and (3) to which an election under these
rules applies. A ``qualifying income interest for life'' exists if: (1)
the surviving spouse is entitled to all the income from the property
(payable annually or at more frequent intervals) or the right to use
property during the spouse's life, and (2) no person has the power to
appoint any part of the property to any person other than the surviving
spouse.
Transfers to surviving spouses who are not U.S. citizens.--
A marital deduction generally is denied for property passing to
a surviving spouse who is not a citizen of the United States. A
marital deduction is permitted, however, for property passing
to a qualified domestic trust of which the noncitizen surviving
spouse is a beneficiary. A qualified domestic trust is a trust
that has as its trustee at least one U.S. citizen or U.S.
corporation. No corpus may be distributed from a qualified
domestic trust unless the U.S. trustee has the right to
withhold any estate tax imposed on the distribution.
There is an estate tax imposed on (1) any distribution from
a qualified domestic trust before the date of the death of the
noncitizen surviving spouse and (2) the value of the property
remaining in a qualified domestic trust on the date of death of
the noncitizen surviving spouse. The tax is computed as an
additional estate tax on the estate of the first spouse to die.
Expenses, indebtedness, and taxes
An estate tax deduction is allowed for funeral expenses and
administration expenses of an estate. An estate tax deduction
also is allowed for claims against the estate and unpaid
mortgages on, or any indebtedness in respect of, property for
which the value of the decedent's interest therein,
undiminished by the debt, is included in the value of the gross
estate.
If the total amount of claims and debts against the estate
exceeds the value of the property to which the claims relate,
an estate tax deduction for the excess is allowed, provided
such excess is paid before the due date of the estate tax
return. A deduction for claims against the estate generally is
permitted only if the claim is allowable by the law of the
jurisdiction under which the estate is being administered.
A deduction also is allowed for the full unpaid amount of
any mortgage upon, or of any other indebtedness in respect of,
any property included in the gross estate (including interest
which has accrued thereon to the date of the decedent's death),
provided that the full value of the underlying property is
included in the decedent's gross estate.
Basis of property received
In general.--A taxpayer who receives property from a
decedent's estate or from a donor of a lifetime gift may want
to sell or otherwise dispose of the property. Gain or loss, if
any, on the disposition of the property is measured by the
taxpayer's amount realized (e.g., gross proceeds received) on
the disposition, less the taxpayer's basis in such property.
Basis generally represents a taxpayer's investment in
property with certain adjustments required after acquisition.
For example, basis is increased by the cost of capital
improvements made to the property and decreased by depreciation
deductions taken with respect to the property.
Property received from a donor of a lifetime gift takes a
carryover basis. ``Carryover basis'' means that the basis in
the hands of the donee is the same as it was in the hands of
the donor plus any gift tax paid on any unrealized
appreciation. The basis of a lifetime gift, however, generally
cannot exceed the property's fair market value on the date of
the gift. If the basis of the property is greater than the fair
market value of the property on the date of gift, then, for
purposes of determining loss, the basis is the property's fair
market value on the date of gift.
Property passing from a decedent's estate generally takes a
stepped-up basis. ``Stepped-up basis'' for estate tax purposes
means that the basis of property passing from a decedent's
estate generally is the fair market value on the date of the
decedent's death (or, if the alternate valuation date is
elected, the earlier of six months after the decedent's death
or the date the property is sold or distributed by the estate).
This step up (or step down) in basis eliminates the recognition
of any income on the appreciation of the property that occurred
prior to the decedent's death, and has the effect of
eliminating the tax benefit from any unrealized loss.
Special rule for community property.--In community property
states, a surviving spouse's one-half share of community
property held by the decedent and the surviving spouse (under
the community property laws of any State, U.S. possession, or
foreign country) generally is treated as having passed from the
decedent, and thus is eligible for stepped-up basis. This rule
applies if at least one-half of the whole of the community
interest is includible in the decedent's gross estate.
Special rules for interests in certain foreign entities.--
Stepped-up basis treatment generally is denied to certain
interests in foreign entities. Under present law, stock or
securities in a foreign personal holding company take a
carryover basis. Stock in a foreign investment company takes a
stepped up basis reduced by the decedent's ratable share of
accumulated earnings and profits. In addition, stock in a
passive foreign investment company (including those for which a
mark-to-market election has been made) generally takes a
carryover basis, except that a passive foreign investment
company for which a decedent shareholder had made a qualified
electing fund election is allowed a stepped up basis. Stock
owned by a decedent in a domestic international sales
corporation (or former domestic international sales
corporation) takes a stepped up basis reduced by the amount (if
any) which would have been included in gross income under
section 995(c) as a dividend if the decedent had lived and sold
the stock at its fair market value on the estate tax valuation
date (i.e., generally the date of the decedent's death unless
an alternate valuation date is elected).
Provisions affecting small and family-owned businesses and
farms
Special-use valuation.--An executor can elect for estate
tax purposes to value certain ``qualified real property'' used
in farming or another qualifying closely-held trade or business
at its current-use value, rather than its fair market value.
The maximum reduction in value for such real property is
$750,000 (adjusted for inflation occurring after 1997). Real
property generally can qualify for special-use valuation if at
least 50 percent of the adjusted value of the decedent's gross
estate consists of a farm or closely-held business assets in
the decedent's estate (includingboth real and personal
property) and at least 25 percent of the adjusted value of the gross
estate consists of farm or closely-held business property. In addition,
the property must be used in a qualified use (e.g., farming) by the
decedent or a member of the decedent's family for five of the eight
years before the decedent's death.
If, after a special-use valuation election is made, the
heir who acquired the real property ceases to use it in its
qualified use within 10 years of the decedent's death, an
additional estate tax is imposed in order to recapture the
entire estate-tax benefit of the special-use valuation.
Family-owned business deduction.--An estate is permitted to
deduct the adjusted value of a qualified-family owned business
interest of the decedent, up to $675,000.\41\ A qualified
family-owned business interest is defined as any interest in a
trade or business (regardless of the form in which it is held)
with a principal place of business in the United States if the
decedent's family owns at least 50 percent of the trade or
business, two families own 70 percent, or three families own 90
percent, as long as the decedent's family owns at least 30
percent of the trade or business. An interest in a trade or
business does not qualify if any interest in the business (or a
related entity) was publicly-traded at any time within three
years of the decedent's death. An interest in a trade or
business also does not qualify if more than 35 percent of the
adjusted ordinary gross income of the business for the year of
the decedent's death was personal holding company income. In
the case of a trade or business that owns an interest in
another trade or business (i.e., ``tiered entities''), special
look-through rules apply. The value of a trade or business
qualifying as a family-owned business interest is reduced to
the extent the business holds passive assets or excess cash or
marketable securities.
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\41\ The qualified family-owned business deduction and the unified
credit effective exemption amount are coordinated. If the maximum
deduction amount of $675,000 is elected, then the unified credit
effective exemption amount is $625,000, for a total of $1.3 million. If
the qualified family-owned business deduction is less than $675,000,
then the unified credit effective exemption amount is equal to
$625,000, increased by the difference between $675,000 and the amount
of the qualified family-owned business deduction. However, the unified
credit effective exemption amount cannot be increased above the
generally applicable exemption amount in effect for the taxable year.
---------------------------------------------------------------------------
To qualify for the exclusion, the decedent (or a member of
the decedent's family) must have owned and materially
participated in the trade or business for at least five of the
eight years preceding the decedent's date of death. In
addition, at least one qualified heir (or member of the
qualified heir's family) is required to materially participate
in the trade or business for at least 10 years following the
decedent's death.
The qualified family-owned business rules provide a
graduated recapture based on the number of years after the
decedent's death in which the disqualifying event occurred.
Under the provision, if the disqualifying event occurred within
six years of the decedent's death, then 100 percent of the tax
is recaptured. The remaining percentage of recapture based on
the year after the decedent's death in which a disqualifying
event occurs is as follows: the disqualifying event occurs
during the seventh year after the decedent's death, 80 percent;
during the eighth year after the decedent's death, 60 percent;
during the ninth year after the decedent's death, 40 percent;
and during the tenth year after the decedent's death, 20
percent. For purposes of the qualified family-owned business
deduction, the contribution of a qualified conservation
easement is not considered a disposition that would trigger
recapture of estate tax.
In general, there is no requirement that the qualified heir
(or members of his or her family) continue to hold or
participate in the trade or business more than 10 years after
the decedent's death. However, the 10-year recapture period can
be extended for a period of up to two years if the qualified
heir does not begin to use the property for a period of up to
two years after the decedent's death.
An estate can claim the benefits of both the qualified
family-owned business deduction and special-use valuation. For
purposes of determining whether the value of the trade or
business exceeds 50 percent of the decedent's gross estate, if
the estate claimed special-use valuation, then the property's
special-use value is used.
State death tax credit
A credit is allowed against the Federal estate tax for any
estate, inheritance, legacy, or succession taxes actually paid
to any State or the District of Columbia with respect to any
property included in the decedent's gross estate. The maximum
amount of credit allowable for State death taxes is determined
under a graduated rate table, the top rate of which is 16
percent, based on the size of the decedent's adjusted taxable
estate. Most States impose a ``pick-up'' or ``soak-up'' estate
tax, which serves to impose a state tax equal to the maximum
Federal credit allowed.
Estate and gift taxation of nonresident noncitizens
Nonresident noncitizens are subject to gift tax with
respect to certain transfers by gift of U.S.-situated property.
Such property includes real estate and tangible property
located within the United States. Nonresident noncitizens
generally are not subject to U.S. gift tax on the transfer of
intangibles, such as stock or securities, regardless of where
such property is situated.
Estates of nonresident noncitizens generally are taxed at
the same estate tax rates applicable to U.S. citizens, but the
taxable estate includes only property situated within the
United States that is owned by the decedent at death. This
includes the value at death of all property, real or personal,
tangible or intangible, situated in the United States. Special
rules apply which treat certain property as being situated
within and without the United States for these purposes.
Unless modified by a treaty, a nonresident who is not a
U.S. citizen generally is allowed a unified credit of $13,000,
which effectively exempts $60,000 in assets from estate tax.

Generation-skipping transfer tax

Selected income tax provisions

Transfers to certain foreign trusts and estates
A transfer (during life or at death) by a U.S. person to a
foreign trust or estate generally is treated as a sale or
exchange of the property for an amount equal to the fair market
value of the transferred property. The amount of gain that must
be recognized by the transferor is equal to the excess of the
fair market value of the property transferred over the adjusted
basis (for purposes of determining gain) of such property in
the hands of the transferor.
Net operating loss and capital loss carryovers
Under present law, a capital loss and net operating loss
from business operations sustained by a decedent during his
last taxable year are deductible only on the final return filed
in his or her behalf. Such losses are not deductible by his or
her estate.
Transfers of property in satisfaction of a pecuniary
bequest
Under present law, gain or loss is recognized on the
transfer of property in satisfaction of a pecuniary bequest
(i.e., a bequest of a specific dollar amount) to the extent
that the fair market value of the property at the time of the
transfer exceeds the basis of the property, which generally is
the basis stepped up to fair market value on the date of the
decedent's death.
Income tax exclusion for the gain on the sale of a
principal residence
A taxpayer generally can exclude up to $250,000 ($500,000
if married filing a joint return) of gain realized on the sale
or exchange of a principal residence. The exclusion is allowed
each time a taxpayer selling or exchanging a principal
residence meets the eligibility requirements, but generally no
more frequently than once every two years.
To be eligible, a taxpayer must have owned the residence
and occupied it as a principal residence for at least two of
the five years prior to the sale or exchange. A taxpayer who
fails to meet these requirements by reason of a change of place
of employment, health, or other unforeseen circumstances is
able to exclude the fraction of the $250,000 ($500,000 if
married filing a joint return) equal to the fraction of two
years that these requirements are met.

Excise tax on nonexempt trusts

Under present law, non-exempt split-interest trusts are
subject to certain restrictions that are applicable to private
foundations if an income, estate, or gift tax charitable
deduction was allowed with respect to the trust. A non-exempt
split-interest trust subject to these rules would be prohibited
from engaging in self-dealing, retaining any excess business
holdings, and from making certain investments or taxable
expenditures. Failure to comply with the restrictions would
subject the trust to certain excise taxes imposed on private
foundations, which include excise taxes on self-dealing, excess
business holdings, investments which jeopardize charitable
purposes, and certain taxable expenditures.

Reasons for Change

The Committee finds that the estate and generation-skipping
transfer taxes are unduly burdensome on affected taxpayers, and
particularly decedents' estates, decedents' heirs, and
businesses, such as small business, family-owned businesses,
and farming businesses. The Committee further believes that it
is inappropriate to impose a tax by reason of the death of a
taxpayer. In addition, the Committee believes that increasing
the gift tax unified credit effective exemption amount and
reducing gift tax rates will lessen the burden that gift taxes
impose on all taxpayers and promote simplification for those
taxpayers who would no longer be subject to the gift tax.

Explanation of Provision

Overview of the bill

Beginning in 2011, the estate and generation-skipping
transfers taxes are repealed. After repeal, the basis of assets
received from a decedent generally will equal the basis of the
decedent (i.e., carryover basis) at death. However, a
decedent's estate is permitted to increase the basis of assets
transferred by up to a total of $1.3 million. The basis of
property transferred to a surviving spouse can be increased
(i.e., stepped up) by an additional $3 million. Thus, the basis
of property transferred to a surviving spouse can be increased
(i.e., stepped up) by a total of $4.3 million. In no case can
the basis of an asset be adjusted above its fair market value.
For these purposes, the executor will determine which assets
and to what extent each asset receives a basis increase. The
$1.3 million and $3 million amounts are adjusted annually for
inflation occurring after 2010.
From 2002 and through 2010, the estate and gift tax rates
are reduced, the unified credit effective exemption amount are
increased (from up to $1 million for lifetime transfers in 2004
to up to $4 million for deathtime transfers in 2010), the
generation-skipping transfer tax exemption amount is increased,
and the state death tax credit is phased out (and repealed in
2005).

Phaseout and repeal of estate and generation-skipping transfer taxes

In general
In 2002, the 5-percent surtax (which phases out the benefit
of the graduated rates) and the rates in excess of 50 percent
are repealed. In addition, in 2002, the unified credit
effective exemption amount (for both estate and gift tax
purposes) is increased to $1 million. In 2003, the estate and
gift tax rates in excess of 49 percent are repealed. In 2004,
the estate and gift tax rates in excess of 48 percent are
repealed, the unified credit effective exemption amount for
estate tax purposes is increased to $2 million. (The unified
credit effective exemption amount for gift tax purposes remains
at $1 million as increased in 2002.) In addition, in 2004, the
qualified family-owned business deduction is repealed. In 2005,
the estate and gift tax rates in excess of 47 percent are
repealed, and the unified credit effective exemption amount for
estate tax purposes is increased to $3 million. In 2006, the
estate and gift tax rates in excess of 46 percent are repealed.
In 2007, the estate and gift tax rates in excess of 45 percent
are repealed. In 2009, the unified credit effective exemption
amount for estate tax purposes is increased to $3.5 million. In
2010, the unified credit effective amount for estate tax
purposes is increased to $4 million.
Table 8, below, summarizes the unified credit effective
exemption amounts and the highest estate and gift tax rates
under the bill.

TABLE 8.--UNIFIED CREDIT EXEMPTION AMOUNTS AND HIGHEST ESTATE AND GIFT
TAX RATES
[Dollars in millions]
------------------------------------------------------------------------
Estate and GST Highest estate
Tax deathtime and gift tax
Calendar year transfer rates
exemption (percent)
------------------------------------------------------------------------
2002.................................... $1 50
2003.................................... 1 49
2004.................................... 2 48
2005.................................... 3 47
2006.................................... 3 46
2007.................................... 3 45
2008.................................... 3 45
2009.................................... 3.5 45
2010.................................... 4 45
2011.................................... \1\ N/A \2\ 40
------------------------------------------------------------------------
\1\ Taxes repealed.
\2\ Gift tax only.

Repeal of estate and generation-skipping transfer taxes;
modifications to gift tax
The generation-skipping transfer tax exemption and tax rate
for a given year (prior to repeal) be equal the unified credit
effective exemption for estate tax purposes. In addition, as
under present law, the generation-skipping transfer tax rate
for a given year will be the highest estate and gift tax rate
in effect for such year.
In 2011, the estate and generation-skipping transfer taxes
are repealed. Also beginning in 2011, the top gift tax rate
will be 40 percent, and, except as provided in regulations, a
transfer to a trust will be treated as a taxable gift, unless
the trust is treated as wholly owned by the donor or the
donor's spouse under the grantor trust provisions of the Code.
Reduction in State death tax credit; deduction for State
death taxes paid
From 2002 through 2004, the top State death tax credit rate
is decreased from 16 percent as follows: to 8 percent in 2002,
to 7.2 percent in 2003, and to 7.04 percent in 2004. In 2005,
after the state death tax credit is repealed, there will be a
deduction for death taxes (e.g., any estate, inheritance,
legacy, or succession taxes) actually paid to any State or the
District of Columbia, in respect of property included in the
gross estate of the decedent. Such State taxes must have been
paid and claimed before the later of: (1) four years after the
filing of the estate tax return; or (2) (a) 60 days after a
decision of the U.S. Tax Court determining the estate tax
liability becomes final, (b) the expiration of the period of
extension to pay estate taxes over time under section 6166, or
(c) the expiration of the period of limitations in which to
file a claim for refund or 60 days after a decision of a court
in which such refund suit has been filed becomes final.

Basis of property acquired from a decedent

In general
Beginning in 2011, after the estate and generation-skipping
transfer taxes have been repealed, the present-law rules
providing for a fair market value basis for property acquired
from a decedent are repealed. Instead, a modified carryover
basis regime generally takes effect. Recipients of property
transferred at the decedent's death will receive a basis equal
to the lesser of the adjusted basis of the decedent or the fair
market value of the property on the date of the decedent's
death.
The modified carryover basis rules apply to: (1) property
acquired from bequest, devise, or inheritance, or by the
decedent's estate from the decedent; (2) property passing from
the decedent to the extent such property passed without
consideration; and (3) certain other property to which the
present law rules apply.\42\
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\42\ Sec. 1014(b)(2) and (3).
---------------------------------------------------------------------------
Property acquired from a decedent is treated as if the
property had been acquired by gift. Thus, the character of gain
on the sale of property received from a decedent's estate is
carried over to the heir. For example, real estate that has
been depreciated and would be subject to recapture if sold by
the decedent will be subject to recapture if sold by the heir.
Property to which the modified carryover basis rules apply
The modified carryover basis rules apply to property
acquired from the decedent. Property acquired from the decedent
is (1) property acquired by bequest, devise, or inheritance,
(2) property acquired by the decedent's estate from the
decedent, (3) property transferred by the decedent to a
qualified revocable trust (as defined in section 645), (4)
property transferred by the decedent during his lifetime in
trust with the right reserved to the decedent at all times
before his death to make any change to the enjoyment thereof
through the exercise of a power to alter, amend, or terminate
the trust,\43\ (5) property passing from the decedent by reason
of the decedent's death to the extent such property passed
without consideration (e.g., property held as joint tenants
with right of survivorship or as tenants by the entireties),
and (6) the surviving spouse's one-half share of certain
community property held by the decedent and the surviving
spouse as community property.
---------------------------------------------------------------------------
\43\ This is the same property the basis of which is stepped up to
date of death fair market value under present law sec. 1014(b)(3).
---------------------------------------------------------------------------
Basis increase for certain property
Amount of basis increase.--The bill allows an executor to
increase (i.e., step up) the basis in assets owned by the
decedent and acquired by the beneficiaries at death. Under this
rule, each decedent's estate generally is permitted to increase
(i.e., step up) the basis of assets transferred by up to a
total of $1.3 million. The $1.3 million is increased by the
amount of unused capital losses, net operating losses, and
certain ``built-in'' losses of the decedent. In addition, the
basis ofproperty transferred to a surviving spouse can be
increased by an additional $3 million. Thus, the basis of property
transferred to surviving spouses can be increased by a total of $4.3
million. Nonresidents who are not U.S. citizens will be allowed to
increase the basis of property by up to $60,000. The $60,000, $1.3
million, and $3 million amounts are adjusted annually for inflation
occurring after 2010.
Property eligible for basis increase.--In general, the
basis of property may be increased above the decedent's
adjusted basis in that property only if the property is owned,
or is treated as owned, by the decedent at the time of the
decedent's death. In the case of property held as joint tenants
or tenants by the entireties with the surviving spouse, one-
half of the property is treated as having been owned by the
decedent and is thus eligible for the basis increase. In the
case of property held jointly with a person other than the
surviving spouse, the portion of the property attributable to
the decedent's consideration furnished is treated has having
been owned by the decedent and will be eligible for a basis
increase. The decedent also is treated as the owner of property
(which will be eligible for a basis increase) if the property
was transferred by the decedent during his lifetime to a
revocable trust (as defined in section 645). The decedent also
is treated as having owned the surviving spouse's one-half
share of community property (which will be eligible for a basis
increase) if at least one-half of the property was owned by,
and acquired from, the decedent.\44\ The decedent shall not,
however, be treated as owning any property solely by reason of
holding a power of appointment with respect to such property.
---------------------------------------------------------------------------
\44\ Thus, similar to the present law rule in sec. 1014(b)(6), both
the decedent's and the surviving spouse's share of community property
could be eligible for a basis increase.
---------------------------------------------------------------------------
Certain property is not eligible for a basis increase. This
includes: (1) property that was acquired by the decedent by
gift (other than from his or her spouse) during the three-year
period ending on the date of the decedent's death; (2) property
that constitutes a right to receive income in respect of a
decedent; (3) stock or securities of a foreign personal holding
company; (4) stock of a domestic international sales
corporation (or former domestic international sales
corporation); (5) stock of a foreign investment company; and
(6) stock of a passive foreign investment company (except for
which a decedent shareholder had made a qualified electing fund
election).
Rules applicable to basis increase.--Basis increase will be
allocable on an asset-by-asset basis (in addition, basis
increase could be allocated to a share of stock or a block of
stock). However, in no case can the basis of an asset be
adjusted above its fair market value. If the amount of basis
increase is less than the fair market value of assets whose
bases are eligible to be increased under these rules, the
executor will determine which assets and to what extent each
asset receives a basis increase.

Reporting requirements

Lifetime gifts
A donor is required to provide to recipients of property by
gift the information relating to the property (e.g., the fair
market value and basis of property) that was reported on the
donor's gift tax return with respect to such property.
Transfers at death
For transfers at death of non-cash assets in excess of $1.3
million and generally for appreciated property acquired by the
decedent within three years of death for which a gift tax
return was required to have been filed by the donor, the
executor of the estate (or the trustee of a revocable trust)
would report to the IRS and any beneficiaries of the estate:
the name and taxpayer identification number of
the recipient of the property,
an accurate description of the property,
the adjusted basis of the property in the
hands of the decedent and its fair market value at the
time of death,
the decedent's holding period for the
property,
sufficient information to determine whether
any gain on the sale of the property would be treated
as ordinary income,
the amount of basis increase allocated to the
property, and
any other information as the Treasury
Secretary may prescribe.
Penalties for failure to file required information
Any donor required to provide to recipients of property by
gift the information relating to the property that was reported
on the donor's gift tax return (e.g., the fair market value and
basis of property) with respect to such property who fails to
do so is liable for a penalty of $50 for each failure to report
such information to a donee.
Any person required to report to the IRS transfers at death
of non-cash assets in excess of $1.3 million in value who fails
to do so is liable for a penalty of $10,000 for the failure to
report such information. Any person required to report to the
IRS the receipt by a decedent of appreciated property acquired
by the decedent within three years of death for which a gift
tax return was required to have been filed by the donor who
fails to do so is liable for a penalty of $500 for the failure
to report such information to the IRS. There also is a penalty
of $50 for each failure to report such information to a
beneficiary.
No penalty is imposed with respect to any failure that is
due to reasonable cause. If any failure to report to the IRS or
a beneficiary under the bill is due to intentional disregard of
the rules, then the penalty is five percent of the fair market
value of the property for which reporting was required,
determined at the date of the decedent's death (for property
passing at death) or determined at the time of gift (for a
lifetime gift).

Certain tax benefits extending past the date for repeal of the estate
tax

Prior to repeal of the estate tax, many estates may have
claimed certain estate tax benefits which, upon certain events,
may trigger a recapture tax or other estate tax. Because repeal
of the estate tax is effective for decedents dying after
December 31, 2010, these estate tax recapture provisions
generally will continue to apply to estates of decedents dying
before January 1, 2011.
Qualified conservation easements
A donor may have retained a development right in the
conveyance of a conservation easement that qualified for the
estate tax exclusion. Those with an interest in the land may
later execute an agreement to extinguish the right. If an
agreement to extinguish development rights is not entered into
within the earlier of (1) two years after the date of the
decedent's death or (2) the date of the sale of such land
subject to the conservation easement, then those with an
interest in the land are personally liable for an additional
tax. This provision is retained after repeal of the estate tax,
which will ensure that those persons with an interest in the
land who fail to execute the agreement remain liable for any
additional tax which may be due after repeal.
Special-use valuation
Property may have qualified for special-use valuation prior
to repeal of the estate tax. If such property ceases to qualify
for special-use valuation, for example, because an heir ceases
to use the property in its qualified use within 10 years of the
decedent's death, then the estate tax benefit is required to be
recaptured. The recapture provision is retained after repeal of
the estate tax, which will ensure that those estates that
claimed this benefit prior to repeal of the estate tax will be
subject to recapture if a disqualifying event occurs after
repeal.
Qualified family-owned business deduction
Property may have qualified for the family-owned business
deduction prior to repeal of the qualified family-owned
business deduction and estate tax. If such property ceases to
qualify for the family-owned business deduction, for example,
because an heir ceases to use the property in its qualified use
within 10 years of the decedent's death, then the estate-tax
benefit is required to be recaptured. The recapture provision
would be retained after repeal of the qualified family-owned
business deduction and estate tax, which would ensure that
those estates that claimed this benefit before repeal of the
qualified family-owned business deduction and estate tax would
be subject to recapture if a disqualifying event occurs after
repeal.
Installment payment of estate tax for estates with an
interest in a closely-held business
The present-law installment payment rules are retained so
that those estates that entered into an installment payment
arrangement prior to repeal of the estate tax will continue to
make their payments past the date for repeal.
If more than 50 percent of the value of the closely-held
business is distributed, sold, exchanged, or otherwise disposed
of, the unpaid portion of the tax payable in installments must
be paid upon notice and demand from the Treasury Secretary.
This rule is retained after repeal of the estate tax, which
will ensure that such dispositions that occur after repeal of
the estate tax will continue to subject the estate to the
unpaid portion of the tax upon notice and demand.
Qualified domestic trusts for noncitizen surviving spouses
Under the bill, there will continue to be an estate tax
imposed on (1) any distribution prior to January 1, 2022, from
a qualified domestic trust before the date of the death of the
noncitizen surviving spouse and (2) the value of the property
remaining in a qualified domestic trust on the date of death of
the noncitizen surviving spouse if such surviving spouse dies
before January 1, 2011.

Transfers to foreign trusts, foreign estates, and nonresidents who are
not U.S. citizens

The present-law rule providing that a transfer (during life
or at death) by a U.S. person to a foreign trust or estate
generally is treated as a sale or exchange is expanded. Under
the bill, a transfer by a U.S. person to a nonresident who is
not a U.S. citizen is treated as a sale or exchange of the
property for an amount equal to the fair market value of the
transferred property. The amount of gain that must be
recognized by the transferor is equal to the excess of the fair
market value of the property transferred over the adjusted
basis of such property in the hands of the transferor.

Transfers of property in satisfaction of a pecuniary bequest

Under the bill, gain or loss on the transfer of property in
satisfaction of a pecuniary bequest is recognized only to the
extent that the fair market value of the property at the time
of the transfer exceeds the fair market value of the property
on the date of the decedent's death (not the property's
carryover basis).

Transfer of property subject to a liability

The bill clarifies that gain is not recognized at the time
of death when the estate or heir acquires from the decedent
property subject to a liability that is greater than the
decedent's basis in the property. Similarly, no gain is
recognized by the estate on the distribution of such property
to a beneficiary of the estate by reason of the liability. This
rule does not apply if the transfer is from the decedent's
estate to a tax-exempt beneficiary, which includes (1) the
United States, any State or political subdivision thereof, any
U.S. possessions, any Indian tribal government, or any agency
or instrumentality of the aforementioned; (2) an organization
exempt from tax (other than a farmers' cooperative described in
section 521); or (3) any foreign person or entity.

Income tax exclusion for the gain on the sale of a principal residence

The income tax exclusion of up to $250,000 of gain on the
sale of a principal residence is extended to estates and heirs.
Under the bill, if the decedent's estate or an heir sells the
decedent's principal residence, $250,000 of gain can be
excluded on the sale of the residence, provided the decedent
used the property as a principal residence for two or more
years during the five-year period prior to the sale. In
addition, if an heir occupies the property as a principal
residence, the decedent's period of ownership and occupancy of
the property as a principalresidence can be added to the heir's
subsequent ownership and occupancy in determining whether the property
was owned and occupied for two years as a principal residence.

Excise tax on non-exempt trusts

Under the bill, split-interest trusts are subject to
certain restrictions that are applicable to private foundations
if an income tax charitable deduction, including an income tax
charitable deduction by an estate or trust, was allowed with
respect to transfers to the trust.

effective date

The estate and gift rate reductions, increases in the
estate tax unified credit exemption equivalent amounts and
generation-skipping transfer tax exemption amount, and
reductions in and repeal of the state death tax credit are
phased-in over time, beginning with estates of decedents dying
and gifts and generation-skipping transfers made after December
31, 2001. The repeal of the qualified family-owned business
deduction is effective for estates of decedents dying after
December 31, 2003.
The estate and generation-skipping transfer taxes are
repealed, and the carryover basis regime takes effect for
estates of decedents dying and generation-skipping transfers
made after December 31, 2010. The provisions relating to
recognition of gain on transfers to nonresidents noncitizens is
effective for transfers made after December 31, 2010.
The top gift tax rate will be 40 percent, and transfers to
trusts generally will be treated as a taxable gift unless the
trust is treated as wholly owned by the donor or the donor's
spouse, effective for gifts made after December 31, 2010.
An estate tax on distributions made from a qualified
domestic trust before the date of the death of the surviving
spouse will no longer apply for distributions made after
December 31, 2021. An estate tax on the value of property
remaining in a qualified domestic trust on the date of death of
the surviving spouse will no longer apply after December 31,
2010.

B. Expand Estate Tax Rule for Conservation Easements

(Sec. 551 of the bill and Sec. 2031 of the Code)

present law

In general

An executor can elect to exclude from the taxable estate 40
percent of the value of any land subject to a qualified
conservation easement, up to a maximum exclusion of $100,000 in
1998, $200,000 in 1999, $300,000 in 2000, $400,000 in 2001, and
$500,000 in 2002 and thereafter (Sec. 2031(c)). The exclusion
percentage is reduced by 2 percentage points for each
percentage point (or fraction thereof) by which the value of
the qualified conservation easement is less than 30 percent of
the value of the land (determined without regard to the value
of such easement and reduced by the value of any retained
development right).
A qualified conservation easement is one that meets the
following requirements: (1) the land is located within 25 miles
of a metropolitan area (as defined by the Office of Management
and Budget) or a national park or wilderness area, or within 10
miles of an Urban National Forest (as designated by the Forest
Service of the U.S. Department of Agriculture); (2) the land
has been owned by the decedent or a member of the decedent's
family at all times during the three-year period ending on the
date of the decedent's death; and (3) a qualified conservation
contribution (within the meaning of sec. 170(h)) of a qualified
real property interest (as generally defined in sec.
170(h)(2)(C)) was granted by the decedent or a member of his or
her family. For purposes of the provision, preservation of a
historically important land area or a certified historic
structure does not qualify as a conservation purpose.
In order to qualify for the exclusion, a qualifying
easement must have been granted by the decedent, a member of
the decedent's family, the executor of the decedent's estate,
or the trustee of a trust holding the land, no later than the
date of the election. To the extent that the value of such land
is excluded from the taxable estate, the basis of such land
acquired at death is a carryover basis (i.e., the basis is not
stepped-up to its fair market value at death). Property
financed with acquisition indebtedness is eligible for this
provision only to the extent of the net equity in the property.

Retained development rights

The exclusion for land subject to a conservation easement
does not apply to any development right retained by the donor
in the conveyance of the conservation easement. An example of
such a development right would be the right to extract minerals
from the land. If such development rights exist, then the value
of the conservation easement must be reduced by the value of
any retained development right.
If the donor or holders of the development rights agree in
writing to extinguish the development rights in the land, then
the value of the easement need not be reduced by the
development rights. In such case, those persons with an
interest in the land must execute the agreement no later than
the earlier of (1) two years after the date of the decedent's
death or (2) the date of the sale of such land subject to the
conservation easement. If such agreement is not entered into
within this time, then those with an interest in the land are
personally liable for an additional tax, which is the amount of
tax which would have been due on the retained development
rights subject to the termination agreement.

reasons for change

The Committee believes that expanding the availability of
qualified conservation easements will further ease existing
pressures to develop or sell environmentally significant land
in order to raise funds to pay estate taxes and would, thereby,
advance the preservation of such land. The Committee also
believes it appropriate to clarify the date for determining
easement compliance.

explanation of provision

The bill expands the availability of qualified conservation
easements by eliminating the requirement that the land be
located within a certain distance from a metropolitan area,
national park, wilderness area, or Urban National Forest. Thus,
under the bill, a qualified conservation easement may be
claimed with respect to any land that is located in the United
States or its possessions. The bill also clarifies that the
date for determining easement compliance is the date on which
the donation was made.

effective date

The provisions are effective for estates of decedents dying
after December 31, 2000.

C. Modify Generation-Skipping Transfer Tax Rules

1. Deemed allocation of the generation-skipping transfer tax exemption
to lifetime transfers to trusts that are not direct skips (Sec.
561 of the bill and Sec. 2632 of the Code)

Present Law

A generation-skipping transfer tax generally is imposed on
transfers, either directly or through a trust or similar
arrangement, to a ``skip person'' (i.e., a beneficiary in a
generation more than one generation below that of the
transferor). Transfers subject to the generation-skipping
transfer tax include direct skips, taxable terminations, and
taxable distributions. An exemption of $1 million (indexed
beginning in 1999) is provided for each person making
generation-skipping transfers. The exemption can be allocated
by a transferor (or his or her executor) to transferred
property.
A direct skip is any transfer subject to estate or gift tax
of an interest in property to a skip person. A skip person may
be a natural person or certain trusts. All persons assigned to
the second or more remote generation below the transferor are
skip persons (e.g., grandchildren and great-grandchildren).
Trusts are skip persons if (1) all interests in the trust are
held by skip persons, or (2) no person holds an interest in the
trust and at no time after the transfer may a distribution
(including distributions and terminations) be made to a non-
skip person.
A taxable termination is a termination (by death, lapse of
time, release of power, or otherwise) of an interest in
property held in trust unless, immediately after such
termination, a non-skip person has an interest in the property,
or unless at no time after the termination may a distribution
(including a distribution upon termination) be made from the
trust to a skip person. A taxable distribution is a
distribution from a trust to a skip person (other than a
taxable termination or direct skip).
The tax rate on generation-skipping transfers is a flat
rate of tax equal to the maximum estate and gift tax rate in
effect at the time of the transfer (55 percent under present
law) multiplied by the ``inclusion ratio.'' The inclusion ratio
with respect to any property transferred in a generation-
skipping transfer indicates the amount of ``generation-skipping
transfer tax exemption'' allocated to a trust. The allocation
of generation-skipping transfer tax exemption reduces the 55-
percent tax rate on a generation-skipping transfer.
If an individual makes a direct skip during his or her
lifetime, any unused generation-skipping transfer tax exemption
is automatically allocated to a direct skip to the extent
necessary to make the inclusion ratio for such property equal
to zero. An individual can elect out of the automatic
allocation for lifetime direct skips.
For lifetime transfers made to a trust that are not direct
skips, the transferor must allocate generation-skipping
transfer tax exemption--the allocation is not automatic. If
generation-skipping transfer tax exemption is allocated on a
timely-filed gift tax return, then the portion of the trust
which is exempt from generation-skipping transfer tax is based
on the value of the property at the time of the transfer. If,
however, the allocation is not made on a timely-filed gift tax
return, then the portion of the trust which is exempt from
generation-skipping transfer tax is based on the value of the
property at the time the allocation of generation-skipping
transfer tax exemption was made.
Treas. Reg. sec. 26.2632-1(d) further provides that any
unused generation-skipping transfer tax exemption, which has
not been allocated to transfers made during an individual's
life, is automatically allocated on the due date for filing the
decedent's estate tax return. Unused generation-skipping
transfer tax exemption is allocated pro rata on the basis of
the value of the property as finally determined for estate tax
purposes, first to direct skips treated as occurring at the
transferor's death. The balance, if any, of unused generation-
skipping transfer tax exemption is allocated pro rata, on the
basis of the estate tax value of the nonexempt portion of the
trust property (or in the case of trusts that are not included
in the gross estate, on the basis of the date of death value of
the trust) to trusts with respect to which a taxable
termination may occur or from which a taxable distribution may
be made.

reasons for change

The Committee recognizes that there are situations where a
taxpayer would desire allocation of generation-skipping
transfer tax exemption, yet the taxpayer had missed allocating
generation-skipping transfer tax exemption to an indirect skip,
e.g., because the taxpayer or the taxpayer's advisor
inadvertently omitted making the election on a timely-filed
gift tax return or the taxpayer submitted a defective election.
Thus, the Committee believes that automatic allocation is
appropriate for transfers to a trust from which generation-
skipping transfers are likely to occur.

Explanation of Provision

Under the bill, generation-skipping transfer tax exemption
will be automatically allocated to transfers made during life
that are ``indirect skips.'' An indirect skip is any transfer
of property (that is not a direct skip) subject to the gift tax
that is made to a generation-skipping transfer trust.
A generation-skipping transfer trust is defined as a trust
that could have a generation-skipping transfer with respect to
the transferor (e.g., a taxable termination or taxable
distribution), unless:
the trust instrument provides that more than
25 percent of the trust corpus must be distributed to
or may be withdrawn by 1 or more individuals who are
non-skip persons (a) before the date that the
individual attains age 46, (b) on or before 1 or more
dates specified in the trust instrument that will occur
before the date that such individual attains age 46, or
(c) upon the occurrence of an event that, in accordance
with regulations prescribed by the Treasury Secretary,
may reasonably be expected to occur before the date
that such individual attains age 46;
the trust instrument provides that more than
25 percent of the trust corpus must be distributed to
or may be withdrawn by 1 or more individuals who are
non-skip persons and who are living on the date of
death of another person identified in theinstrument (by
name or by class) who is more than 10 years older than such
individuals;
the trust instrument provides that, if 1 or
more individuals who are non-skip persons die on or
before a date or event described in clause (1) or (2),
more than 25 percent of the trust corpus either must be
distributed to the estate or estates of 1 or more of
such individuals or is subject to a general power of
appointment exercisable by 1 or more of such
individuals;
the trust is a trust any portion of which
would be included in the gross estate of a non-skip
person (other than the transferor) if such person died
immediately after the transfer;
the trust is a charitable lead annuity trust
or a charitable remainder annuity trust or a charitable
unitrust; or
the trust is a trust with respect to which a
deduction was allowed under section 2522 for the amount
of an interest in the form of the right to receive
annual payments of a fixed percentage of the net fair
market value of the trust property (determined yearly)
and which is required to pay principal to a non-skip
person if such person is alive when the yearly payments
for which the deduction was allowed terminate.
If any individual makes an indirect skip during the
individual's lifetime, then any unused portion of such
individual's generation-skipping transfer tax exemption is
allocated to the property transferred to the extent necessary
to produce the lowest possible inclusion ratio for such
property.
An individual can elect not to have the automatic
allocation rules apply to an indirect skip, and such elections
will be deemed timely if filed on a timely-filed gift tax
return for the calendar year in which the transfer was made or
deemed to have been made or on such later date or dates as may
be prescribed by the Treasury Secretary. An individual can
elect not to have the automatic allocation rules apply to any
or all transfers made by such individual to a particular trust
and can elect to treat any trust as a generation-skipping
transfer trust with respect to any or all transfers made by the
individual to such trust, and such election can be made on a
timely-filed gift tax return for the calendar year for which
the election is to become effective.

Effective Date

The provision applies to transfers subject to estate or
gift tax made after December 31, 2000, and to estate tax
inclusion periods ending after December 31, 2000.

2. Retroactive allocation of the generation-skipping transfer tax
exemption (Sec. 561 of the bill and Sec. 2632 of the Code)

Present Law

A taxable termination is a termination (by death, lapse of
time, release of power, or otherwise) of an interest in
property held in trust unless, immediately after such
termination, a non-skip person has an interest in the property,
or unless at no time after the termination may a distribution
(including a distribution upon termination) be made from the
trust to a skip person. A taxable distribution is a
distribution from a trust to a skip person (other than a
taxable termination or direct skip). If a transferor allocates
generation-skipping transfer tax exemption to a trust prior to
the taxable termination or taxable distribution, generation-
skipping transfer tax may be avoided.
A transferor likely will not allocate generation-skipping
transfer tax exemption to a trust that the transferor expects
will benefit only non-skip persons. However, if a taxable
termination occurs because, for example, the transferor's child
unexpectedly dies such that the trust terminates in favor of
the transferor's grandchild, and generation-skipping transfer
tax exemption had not been allocated to the trust, then
generation-skipping transfer tax would be due even if the
transferor had unused generation-skipping transfer tax
exemption.

Reasons for Change

The Committee recognizes that when a transferor does not
expect the second generation (e.g., the transferor's child) to
die before the termination of a trust, the transferor likely
will not allocate generation-skipping transfer tax exemption to
the transfer to the trust. If a transferor knew, however, that
the transferor's child might predecease the transferor and that
there could be a taxable termination as a result thereof, the
transferor likely would have allocated generation-skipping
transfer tax exemption at the time of the transfer to the
trust. The Committee believes it is appropriate to provide that
when there is an unnatural order of death (e.g., when the
second generation dies before the first generation transferor),
the transferor can allocate generation-skipping transfer tax
exemption retroactively to the date of the respective transfer
to trust.

Explanation of Provision

Under the bill, generation-skipping transfer tax exemption
can be allocated retroactively when there is an unnatural order
of death. If a lineal descendant of the transferor predeceases
the transferor, then the transferor can allocate any unused
generation-skipping transfer exemption to any previous transfer
or transfers to the trust on a chronological basis. The
provision allows a transferor to retroactively allocate
generation-skipping transfer exemption to a trust where a
beneficiary (a) is a non-skip person, (b) is a lineal
descendant of the transferor's grandparent or a grandparent of
the transferor's spouse, (c) is a generation younger than the
generation of the transferor, and (d) dies before the
transferor. Exemption is allocated under this rule
retroactively, and the applicable fraction and inclusion ratio
would be determined based on the value of the property on the
date that the property was transferred to trust.

Effective Date

The provision applies to deaths of non-skip persons
occurring after December 31, 2000.

3. Severing of trusts holding property having an inclusion ratio of
greater than zero (Sec. 562 of the bill and Sec. 2642 of the
Code)

Present Law

Reasons for Change

Complexity can be reduced if a generation-skipping transfer
trust is treated as two separate trusts for generation-skipping
transfer tax purposes--one with an inclusion ratio of zero and
one with an inclusion ratio of one. This result can be achieved
by drafting complex documents in order to meet the specific
requirements of severance. The Committee believes it is
appropriate to make the rules regarding severance less
burdensome and less complex.

Explanation of Provision

Under the bill, a trust can be severed in a ``qualified
severance.'' A qualified severance is defined as the division
of a single trust and the creation of two or more trusts if (1)
the single trust was divided on a fractional basis, and (2) the
terms of the new trusts, in the aggregate, provide for the same
succession of interests of beneficiaries as are provided in the
original trust. If a trust has an inclusion ratio of greater
than zero and less than one, a severance is a qualified
severance only if the single trust is divided into two trusts,
one of which receives a fractional share of the total value of
all trust assets equal to the applicable fraction of the single
trust immediately before the severance. In such case, the trust
receiving such fractional share shall have an inclusion ratio
of zero and the other trust shall have an inclusion ratio of
one. Under the provision, a trustee may elect to sever a trust
in a qualified severance at any time.

Effective Date

The provision is effective for severances of trusts
occurring after December 31, 2000.

4. Modification of certain valuation rules (Sec. 563 of the bill and
Sec. 2642 of the Code)

Present Law

Under present law, the inclusion ratio is determined using
gift tax values for allocations of generation-skipping transfer
tax exemption made on timely filed gift tax returns. The
inclusion ratio generally is determined using estate tax values
for allocations of generation-skipping transfer tax exemption
made to transfers at death. Treas. Reg. 26.2642-5(b) provides
that, with respect to taxable terminations and taxable
distributions, the inclusion ratio becomes final on the later
of the period of assessment with respect to the first transfer
using the inclusion ratio or the period for assessing the
estate tax with respect to the transferor's estate.

Reasons for Change

The Committee believes it is appropriate to clarify the
valuation rules relating to timely and automatic allocations of
generation-skipping transfer tax exemption.

Explanation of Provision

Under the bill, in connection with timely and automatic
allocations of generation-skipping transfer tax exemption, the
value of the property for purposes of determining the inclusion
ratio shall be its finally determined gift tax value or estate
tax value depending on the circumstances of the transfer. In
the case of a generation-skipping transfer tax exemption
allocation deemed to be made at the conclusion of an estate tax
inclusion period, the value for purposes of determining the
inclusion ratio shall be its value at that time.

Effective Date

The provision is effective for transfers subject to estate
or gift tax made after December 31, 2000.

5. Relief from late elections (Sec. 564 of the bill and Sec. 2642 of
the Code)

Present Law

Under present law, an election to allocate generation-
skipping transfer tax exemption to a specific transfer may be
made at any time up to the time for filing the transferor's
estate taxreturn. If an allocation is made on a gift tax return
filed timely with respect to the transfer to trust, then the value on
the date of transfer to the trust is used for determining generation-
skipping transfer tax exemption allocation. However, if the allocation
relating to a specific transfer is not made on a timely-filed gift tax
return, then the value on the date of allocation must be used. There is
no statutory provision allowing relief for an inadvertent failure to
make an election on a timely-filed gift tax return to allocate
generation-skipping transfer tax exemption.

Reasons for Change

The Committee believes it is appropriate for the Treasury
Secretary to grant extensions of time to make an election to
allocate generation-skipping transfer tax exemption and to
grant exceptions to the statutory time requirement in
appropriate circumstances, e.g., when the taxpayer intended to
allocate generation-skipping transfer tax exemption and the
failure to timely allocate generation-skipping transfer tax
exemption was inadvertent.

Explanation of Provision

Under the bill, the Treasury Secretary is authorized and
directed to grant extensions of time to make the election to
allocate generation-skipping transfer tax exemption and to
grant exceptions to the time requirement, without regard to
whether any period of limitations has expired. If such relief
is granted, then the gift tax or estate tax value of the
transfer to trust would be used for determining generation-
skipping transfer tax exemption allocation.
In determining whether to grant relief for late elections,
the Treasury Secretary is directed to consider all relevant
circumstances, including evidence of intent contained in the
trust instrument or instrument of transfer and such other
factors as the Treasury Secretary deems relevant. For purposes
of determining whether to grant relief, the time for making the
allocation (or election) is treated as if not expressly
prescribed by statute.

Effective Date

The provision applies to requests pending on, or filed
after, December 31, 2000. No inference is intended with respect
to the availability of relief from late elections prior to the
effective date of the provision.

6. Substantial compliance (Sec. 564 of the bill and Sec. 2642 of the
Code)

Present Law

Under present law, there is no statutory rule which
provides that substantial compliance with the statutory and
regulatory requirements for allocating generation-skipping
transfer tax exemption will suffice to establish that
generation-skipping transfer tax exemption was allocated to a
particular transfer or trust.

Reasons for Change

The Committee recognizes that the rules and regulations
regarding the allocation of generation-skipping transfer tax
exemption are complex. Thus, it is often difficult for
taxpayers to comply with the technical requirements for making
a proper election to allocate generation-skipping transfer tax
exemption. The Committee therefore believes it is appropriate
to provide that generation-skipping transfer tax exemption will
be allocated when a taxpayer substantially complies with the
rules and regulations for allocating generation-skipping
transfer tax exemption.

Explanation of Provision

Under the bill, substantial compliance with the statutory
and regulatory requirements for allocating generation-skipping
transfer tax exemption will suffice to establish that
generation-skipping transfer tax exemption was allocated to a
particular transfer or a particular trust. If a taxpayer
demonstrates substantial compliance, then so much of the
transferor's unused generation-skipping transfer tax exemption
will be allocated to the extent it produces the lowest possible
inclusion ratio. In determining whether there has been
substantial compliance, all relevant circumstances will be
considered, including evidence of intent contained in the trust
instrument or instrument of transfer and such other factors as
the Treasury Secretary deems appropriate.

Effective Date

The provision applies to transfers subject to estate or
gift tax made after December 31, 2000. No inference is intended
with respect to the availability of a rule of substantial
compliance prior to the effective date of the provision.

D. Expand and Modify Availability of Installment Payment of Estate Tax
for Closely-Held Businesses

(Secs. 571 and 572 of the bill and Sec. 6166 of the Code)

Present Law

Under present law, the estate tax generally is due within
nine months of a decedent's death. However, an executor
generally may elect to pay estate tax attributable to an
interest in a closely-held business in 2 or more installments
(but no more than 10). An estate is eligible for payment of
estate tax in installments if the value of the decedent's
interest in a closely-held business exceeds 35 percent of the
decedent's adjusted gross estate (i.e., the gross estate less
certain deductions). If the election is made, the estate may
defer payment of principal and pay only interest for the first
five years, followed by up to 10 annual installments of
principal and interest. This provision effectively extends the
time for paying estate tax by 14 years from the original due
date of the estate tax.\45\ A special two-percent interest rate
applies to the amount of deferred estate tax attributable to
the first $1 million (adjusted annually for inflation occurring
after 1998) in taxable value of a closely-held business. The
interest rate applicable to the amount of estate tax
attributable to the taxable value of the closely-held business
in excess of $1 million is equal to 45 percent of the rate
applicable to underpayments of tax under section 6621 (i.e., 45
percent of the Federal short-term rate plus 3 percentage
points). Interest paid on deferred estate taxes is not
deductible for estate or income tax purposes.
---------------------------------------------------------------------------
\45\ For example, assume estate tax is due in 2001. If interest
only is paid each year for the first five years (2001 through 2005),
and if 10 installments of both principal and interest are paid for the
10 years thereunder (2006 through 2015), then payment of estate tax
would be extended by 14 years from the original due date of 2001.
---------------------------------------------------------------------------
For purposes of these rules, an interest in a closely-held
business is: (1) an interest as a proprietor in a sole
proprietorship, (2) an interest as a partner in a partnership
carrying on a trade or business if 20 percent or more of the
total capital interest of such partnership is included in the
decedent's gross estate or the partnership had 15 or fewer
partners, and (3) stock in a corporation carrying on a trade or
business if 20 percent or more of the value of the voting stock
of the corporation is included in the decedent's gross estate
or such corporation had 15 or fewer shareholders. The decedent
may own the interest directly or, in certain cases, ownership
may be indirect, through a holding company. If ownership is
through a holding company, the stock must be non-readily
tradable. If stock in a holding company is treated as business
company stock for purposes of the installment payment
provisions, the 5-year deferral for principal and the 2-percent
interest rate do not apply. The value of any interest in a
closely-held business does not include the value of that
portion of such interest attributable to passive assets held by
such business.

Reasons for Change

The Committee finds that the present-law installment
payment of estate tax provisions are restrictive and prevent
estates of decedents who otherwise held an interest in a
closely-held business at death from claiming the benefits of
installment payment of estate tax. Thus, theCommittee wishes to
expand and modify availability of the provision to enable more estates
of decedents with an interest in a closely-held business to claim the
benefits of installment payment of estate tax.

Explanation of Provision

The bill expands availability of the installment payment
provisions by providing that an estate of a decedent with an
interest in a qualifying lending and financing business is
eligible for installment payment of the estate tax. The bill
also provides that an estate with an interest in a qualifying
lending and financing business that claims installment payment
of estate tax must make installment payments of estate tax
(which will include both principal and interest) relating to
the interest in a qualifying lending and financing business
over five years.
The bill also clarifies that the installment payment
provisions require that only the stock of holding companies,
not that of operating subsidiaries, must be non-readily
tradable in order to qualify for installment payment of the
estate tax. The bill also provides that an estate with a
qualifying property interest held through holding companies
that claims installment payment of estate tax must make all
installment payments of estate tax (which will include both
principal and interest) relating to a qualifying property
interest held through holding companies over five years.

Effective Date

The provision is effective for decedents dying after
December 31, 2001.

E. Compliance With Congressional Budget Act

(Secs. 581 and 582 of the bill)

Present Law

Reasons for Change

Explanation of Provision

Sunset of provisions

To ensure compliance with the Budget Act, the bill provides
that all provisions of, and amendments made by, the bill
relating to estate, gift, and generation-skipping taxes which
are in effect on September 30, 2011, shall cease to apply as of
the close of September 30, 2011.

Restoration of provisions

All provisions of, and amendments made by, the bill
relating to estate, gift, and generation-skipping taxes which
were terminated under the sunset provision shall begin to apply
again as of October 1, 2011, as provided in each such provision
or amendment.

VI. PENSION AND INDIVIDUAL RETIREMENT ARRANGEMENT PROVISIONS

A. Individual Retirement Arrangements (``IRAs'')

(Secs. 601-603 of the bill and Secs. 219, 408, and 408A of the Code)

present law

In general
There are two general types of individual retirement
arrangements (``IRAs'') under present law: traditional IRAs, to
which both deductible and nondeductible contributions may be
made, and Roth IRAs. The Federal income tax rules regarding
each type of IRA (and IRA contribution) differ.
Traditional IRAs
Under present law, an individual may make deductible
contributions to an IRA up to the lesser of $2,000 or the
individual's compensation if neither the individual nor the
individual's spouse is an active participant in an employer-
sponsored retirement plan. In the case of a married couple,
deductible IRA contributions of up to $2,000 can be made for
each spouse (including, for example, a homemaker who does not
work outside the home), if the combined compensation of both
spouses is at least equal to the contributed amount. If the
individual (or the individual's spouse) is an active
participant in an employer-sponsored retirement plan, the
$2,000 deduction limit is phased-out for taxpayers with
adjusted gross income (``AGI'') over certain levels for the
taxable year.
The AGI phase-out limits for taxpayers who are active
participants in employer-sponsored plans are as follows.
Taxable years beginning in Phase-out range
Single Taxpayers:
2001............................................ $33,000-43,000
2002............................................ 34,000-44,000
2003............................................ 40,000-50,000
2004............................................ 45,000-55,000
2005 and thereafter............................. 50,000-60,000
Joint Returns:
2001............................................ $53,000-63,000
2002............................................ 54,000-64,000
2003............................................ 60,000-70,000
2004............................................ 65,000-75,000
2005............................................ 70,000-80,000
2006............................................ 75,000-85,000
2007 and thereafter............................. 80,000-100,000

The AGI phase-out range for married taxpayers filing a
separate return is $0 to $10,000.
If the individual is not an active participant in an
employer-sponsored retirement plan, but the individual's spouse
is, the $2,000 deduction limit is phased-out for taxpayers with
AGI between $150,000 and $160,000.
To the extent an individual cannot or does not make
deductible contributions to an IRA or contributions to a Roth
IRA, the individual may make nondeductible contributions to a
traditional IRA.
Amounts held in a traditional IRA are includible in income
when withdrawn (except to the extent the withdrawal is a return
of nondeductible contributions). Includible amounts withdrawn
prior to attainment of age 59\1/2\ are subject to an additional
10-percent early withdrawal tax, unless the withdrawal is due
to death or disability, is made in the form of certain periodic
payments, is used to pay medical expenses in excess of 7\1/2\
percent of AGI, is used to purchase health insurance of an
unemployed individual, is used for education expenses, or is
used for first-time homebuyer expenses of up to $10,000.

Roth IRAs

Individuals with AGI below certain levels may make
nondeductible contributions to a Roth IRA. The maximum annual
contribution that may be made to a Roth IRA is the lesser of
$2,000 or the individual's compensation for the year. The
contribution limit is reduced to the extent an individual makes
contributions to any other IRA for the same taxable year. As
under the rules relating to IRAs generally, a contribution of
up to $2,000 for each spouse may be madeto a Roth IRA provided
the combined compensation of the spouses is at least equal to the
contributed amount. The maximum annual contribution that can be made to
a Roth IRA is phased-out for single individuals with AGI between
$95,000 and $110,000 and for joint filers with AGI between $150,000 and
$160,000.
Taxpayers with modified AGI of $100,000 or less generally
may convert a traditional IRA into a Roth IRA. The amount
converted is includible in income as if a withdrawal had been
made, except that the 10-percent early withdrawal tax does not
apply and, if the conversion occurred in 1998, the income
inclusion may be spread ratably over four years. Married
taxpayers who file separate returns cannot convert a
traditional IRA into a Roth IRA.
Amounts held in a Roth IRA that are withdrawn as a
qualified distribution are not includible in income, or subject
to the additional 10-percent tax on early withdrawals. A
qualified distribution is a distribution that (1) is made after
the five-taxable year period beginning with the first taxable
year for which the individual made a contribution to a Roth
IRA, and (2) which is made after attainment of age 59\1/2\, on
account of death or disability, or is made for first-time
homebuyer expenses of up to $10,000.
Distributions from a Roth IRA that are not qualified
distributions are includible in income to the extent
attributable to earnings, and subject to the 10-percent early
withdrawal tax (unless an exception applies).\46\ The same
exceptions to the early withdrawal tax that apply to IRAs apply
to Roth IRAs.
---------------------------------------------------------------------------
\46\ Early distribution of converted amounts may also accelerate
income inclusion of converted amounts that are taxable under the 4-year
rule applicable to 1998 conversions.
---------------------------------------------------------------------------

Taxation of charitable contributions

Generally, a taxpayer who itemizes deductions may deduct
cash contributions to charity, as well as the fair market value
of contributions of property. The amount of the deduction
otherwise allowable for the 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.
For donations of cash by individuals, total deductible
contributions to public charities may not exceed 50 percent of
a taxpayer's adjusted gross income (``AGI'') for a taxable
year. To the extent a taxpayer has not exceeded the 50-percent
limitation, contributions of cash to private foundations and
certain other nonprofit organizations and contributions of
capital gain property to public charities generally may be
deducted up to 30 percent of the taxpayer's AGI. If a taxpayer
makes a contribution in one year that exceeds the applicable
50-percent or 30-percent limitation, the excess amount of the
contribution may be carried over and deducted during the next
five taxable years.
In addition to the percentage limitations imposed
specifically on charitable contributions, present law imposes a
reduction on most itemized deductions, including charitable
contribution deductions, for taxpayers with adjusted gross
income in excess of a threshold amount, which is adjusted
annually for inflation annually for inflation. The threshold
amount for 2001 is $132,950 ($66,475 for married individuals
filing separate returns). For those deductions that are subject
to the limit, the total amount of itemized deductions is
reduced by three percent of AGI over the threshold amount, but
not by more than 80 percent of itemized deductions subject to
the limit. The effect of this reduction may be to limit a
taxpayer's ability to deduct some of his or her charitable
contributions.

Reasons for Change

The Committee is concerned about the low national savings
rate, and that individuals may not be saving adequately for
retirement. The present-law IRA contribution limits have not
been increased since 1981. The Committee believes that the
limits should be raised in order to allow greater savings
opportunities.
The Committee understands that, for a variety of reasons,
older individuals may not have been saving sufficiently for
retirement. For example, some individuals, especially women,
may have left the workforce temporarily in order to care for
children. Such individuals may have missed retirement savings
options that would have been available had they remained in the
workforce. Thus, the Committee believes it appropriate to
accelerate the increase in the IRA contribution limits for such
individuals.

Explanation of Provision

Increase in annual contribution limits

The provision increases the maximum annual dollar
contribution limit for IRA contributions from $2,000 to $2,500
for 2002 through 2005, $3,000 for 2006 and 2007, $3,500 for
2008 and 2009, $4,000 for 2010, and $5,000 for 2011. After
2011, the limit is adjusted annually for inflation in $500
increments.

Additional catch-up contributions

The bill provides that individuals who have attained age 50
may make additional catch-up IRA contributions. The otherwise
maximum contribution limit (before application of the AGI
phase-out limits) for an individual who has attained age 50
before the end of the taxable year is increased by $500 for
2002 through 2005, $1000 for 2006 through 2009, $1,500 for
2010, and $2,000 for 2011 and thereafter.

Deemed IRAs under employer plans

The bill provides that, if an eligible retirement plan
permits employees to make voluntary employee contributions to a
separate account or annuity that (1) is established under the
plan, and (2) meets the requirements applicable to either
traditional IRAs or Roth IRAs, then the separate account or
annuity is deemed a traditional IRA or a Roth IRA, as
applicable, for all purposes of the Code. For example, the
reporting requirements applicable to IRAs apply. The deemed
IRA, and contributions thereto, are not subject to the Code
rules pertaining to the eligible retirement plan. In addition,
the deemed IRA, and contributions thereto, are not taken into
account in applying such rules to any other contributions under
the plan. The deemed IRA, and contributions thereto, are
subject to the exclusive benefit and fiduciary rules of ERISA
to theextent otherwise applicable to the plan, and are not
subject to the ERISA reporting and disclosure, participation, vesting,
funding, and enforcement requirements applicable to the eligible
retirement plan.\47\ An eligible retirement plan is a qualified plan
(Sec. 401(a)), tax-sheltered annuity (Sec. 403(b)), or a governmental
section 457 plan.
---------------------------------------------------------------------------
\47\ The provision does not specify the treatment of deemed IRAs
for purposes other than the Code and ERISA.
---------------------------------------------------------------------------

Tax-free IRA withdrawals for charitable purposes

The bill provides an exclusion from gross income for
qualified charitable distributions from an IRA: (1) to a
charitable organization (as described in sec. 170(c)) to which
deductible contributions may be made; (2) to a charitable
remainder annuity trust or charitable remainder unitrust; (3)
to a pooled income fund (as defined in sec. 642(c)(5)); or (4)
for the issuance of a charitable gift annuity. The exclusion
applies with respect to distributions described in (2), (3), or
(4) only if no person holds an income interest in the trust,
fund, or annuity attributable to such distributions other than
the IRA owner, his or her spouse, or a charitable organization.
In determining the character of distributions from a
charitable remainder annuity trust or a charitable remainder
unitrust to which a qualified charitable distribution from an
IRA is made, the charitable remainder trust is required to
treat as ordinary income the portion of the distribution from
the IRA to the trust that would have been includible in income
but for the provision, and as corpus any remaining portion of
the distribution. Similarly, in determining the amount
includible in gross income by reason of a payment from a
charitable gift annuity purchased with a qualified charitable
distribution from an IRA, the taxpayer is not permitted to
treat the portion of the distribution from the IRA that would
have been taxable but for the provision and that is used to
purchase the annuity as an investment in the annuity contract.
A qualified charitable distribution is any distribution
from an IRA that is made after age 70\1/2\, that qualifies as a
charitable contribution (within the meaning of sec. 170(c)),
and that is made directly to the charitable organization or to
a charitable remainder annuity trust, charitable remainder
unitrust, pooled income fund, or charitable gift annuity (as
described above).\48\ A taxpayer is not permitted to claim a
charitable contribution deduction in any year for amounts
transferred from his or her IRA to a charity or to a trust,
fund, or annuity that, because of the provision, are excluded
from the taxpayer's income. Conversely, if the amounts
transferred are otherwise nontaxable, e.g., a qualified
distribution from a Roth IRA, the regularly applicable
deduction rules apply.
---------------------------------------------------------------------------
\48\ It is intended that, in the case of transfer to a trust, fund,
or annuity, the full amount distributed from an IRA will meet the
definition of a qualified charitable distribution if the charitable
organization's interest in the distribution would qualify as a
charitable contribution under section 170.
---------------------------------------------------------------------------

Effective Date

The provision is generally effective for taxable years
beginning after December 31, 2001. The provision relating to
deemed IRAs under employer plans is effective for plan years
beginning after December 31, 2002. The provision relating to
tax-free IRA withdrawals for charitable purposes is effective
for taxable years beginning after December 31, 2009.

B. Pension Provisions

1. Expanding coverage

(a) Increase in benefit and contribution limits (Sec. 611
of the bill and Secs. 401(a)(17), 402(g), 408(p),
415 and 457 of the Code)

Present Law

In general

Under present law, limits apply to contributions and
benefits under qualified plans (Sec. 415), the amount of
compensation that may be taken into account under a plan for
determining benefits (Sec. 401(a)(17)), the maximum amount of
elective deferrals that an individual may make to a salary
reduction plan or tax sheltered annuity (Sec. 402(g)), and
deferrals under an eligible deferred compensation plan of a
tax-exempt organization or a State or local government (Sec.
457).

Limitations on contributions and benefits

Under present law, the limits on contributions and benefits
under qualified plans are based on the type of plan. Under a
defined contribution plan, the qualification rules limit the
annual additions to the plan with respect to each plan
participant to the lesser of (1) 25 percent of compensation or
(2) $35,000 (for 2001). Annual additions are the sum of
employer contributions, employee contributions, and forfeitures
with respect to an individual under all defined contribution
plans of the same employer. The $35,000 limit is adjusted
annually for inflation for cost-of-living adjustments in $5,000
increments.
Under a defined benefit plan, the maximum annual benefit
payable at retirement is generally the lesser of (1) 100
percent of average compensation, or (2) $140,000 (for 2001).
The dollar limit is adjusted for cost-of-living increases in
$5,000 increments.
Under present law, in general, the dollar limit on annual
benefits is reduced if benefits under the plan begin before the
social security retirement age (currently, age 65) and
increased if benefits begin after social security retirement
age.

Compensation limitation

Under present law, the annual compensation of each
participant that may be taken into account for purposes of
determining contributions and benefits under a plan, applying
the deduction rules, and for nondiscrimination testing purposes
is limited to $170,000 (for 2001). The compensation limit is
adjusted annually for inflation for cost-of-living adjustments
in $10,000 increments.

Elective deferral limitations

Under present law, under certain salary reduction
arrangements, an employee may elect to have the employer make
payments as contributions to a plan on behalf of the employee,
or tothe employee directly in cash. Contributions made at the
election of the employee are called elective deferrals.
The maximum annual amount of elective deferrals that an
individual may make to a qualified cash or deferred arrangement
(a ``section 401(k) plan''), a tax-sheltered annuity (``section
403(b) annuity'') or a salary reduction simplified employee
pension plan (``SEP'') is $10,500 (for 2001). The maximum
annual amount of elective deferrals that an individual may make
to a SIMPLE plan is $6,500 (for 2001). These limits are
adjusted annually for inflation in $500 increments.

Section 457 plans

The maximum annual deferral under a deferred compensation
plan of a State or local government or a tax-exempt
organization (a ``section 457 plan'') is the lesser of (1)
$8,500 (for 2001) or (2) 33\1/3\ percent of compensation. The
$8,500 dollar limit is increased for inflation in $500
increments. Under a special catch-up rule, the section 457 plan
may provide that, for one or more of the participant's last
three years before retirement, the otherwise applicable limit
is increased to the lesser of (1) $15,000 or (2) the sum of the
otherwise applicable limit for the year plus the amount by
which the limit applicable in preceding years of participation
exceeded the deferrals for that year.

Reasons for Change

The tax benefits provided under qualified plans are a
departure from the normally applicable income tax rules. The
special tax benefits for qualified plans are generally
justified on the ground that they serve an important social
policy objective, i.e., the provision of retirement benefits to
a broad group of employees. The limits on contributions and
benefits, elective deferrals, and compensation that may be
taken into account under a qualified plan all serve to limit
the tax benefits associated with such plans. The level at which
to place such limits involves a balancing of different policy
objectives and a judgment as to what limits are most likely to
best further policy goals.
One of the factors that may influence the decision of an
employer, particularly a small employer, to adopt a plan is the
extent to which the owners of the business, the decision-
makers, or other highly compensated employees will benefit
under the plan. The Committee believes that increasing the
dollar limits on qualified plan contributions and benefits will
encourage employers to establish qualified plans for their
employees.
The Committee understands that, in recent years, section
401(k) plans have become increasingly more prevalent. The
Committee believes it is important to increase the amount of
employee elective deferrals allowed under such plans, and other
plans that allow deferrals, to better enable plan participants
to save for their retirement.

Explanation of Provision

Limits on contributions and benefits

The bill provides faster annual adjusting for inflation of
the $35,000 limit on annual additions to a defined contribution
plan. Under the provision this limit amount is adjusted
annually for inflation in $1,000 increments.\49\
---------------------------------------------------------------------------
\49\ The 25 percent of compensation limitation is increased to 100
percent of compensation under another provision of the bill.
---------------------------------------------------------------------------
The provision increases the $140,000 annual benefit limit
under a defined benefit plan to $150,000 for 2002 through 2004
and to $160,000 for 2005 and thereafter. The dollar limit is
reduced for benefit commencement before age 62 and increased
for benefit commencement after age 65.

Compensation limitation

The provision increases the limit on compensation that may
be taken into account under a plan to $180,000 for 2002,
$190,000 for 2003, and $200,000 for 2004 and 2005. After 2005,
this amount is adjusted annually for inflation in $5,000
increments.

Elective deferral limitations

In 2002, the provision increases the dollar limit on annual
elective deferrals under section 401(k) plans, section 403(b)
annuities, and salary reduction SEPs to $11,000. In 2003 and
thereafter, the limits increase in $500 annual increments until
the limits reach $15,000 in 2010, with annual adjustments for
inflation in $500 increments thereafter. The provision
increases the maximum annual elective deferrals that may be
made to a SIMPLE plan to $7,000 for 2002 and 2003, $8,000 for
2004 and 2005, $9,000 for 2006 and 2007, and $10,000 for 2008.
After 2008, the $10,000 dollar limit is adjusted annually for
inflation in $500 increments.

Section 457 plans

The dollar limit on deferrals under a section 457 plan is
increased to $9,000 in 2002, and is increased in $500 annual
increments thereafter until the limit reaches $11,000 in 2006.
Beginning in 2007, the limit is increased in $1,000 annual
increments until it reaches $15,000 in 2010. After 2010, the
limit is adjusted annually for inflation thereafter in $500
increments. The limit is twice the otherwise applicable dollar
limit in the three years prior to retirement.\50\
---------------------------------------------------------------------------
\50\ Another provision increases the 33\1/3\ percentage of
compensation limit to 100 percent.
---------------------------------------------------------------------------

Effective Date

The provision is effective for years beginning after
December 31, 2001.
(b) Plan loans for subchapter S shareholders, partners, and
sole proprietors (Sec. 612 of the bill and Sec.
4975 of the Code)

Present Law

The Internal Revenue Code 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.\51\
Certain types of transactions are exempted from the prohibited
transaction rules, including loans from the plan to plan
participants, if certain requirements are satisfied. In
addition, the Secretary of Labor can grant an administrative
exemption from the prohibited transaction rules if she finds
the exemption is administratively feasible, in the interest of
the plan and plan participants and beneficiaries, and
protective of the rights of participants and beneficiaries of
the plan. Pursuant to this exemption process, the Secretary of
Labor grants exemptions both with respect to specific
transactions and classes of transactions.
---------------------------------------------------------------------------
\51\ Title I of the Employee Retirement Income Security Act of
1974, as amended (``ERISA''), also contains prohibited transaction
rules. The Code and ERISA provisions are substantially similar,
although not identical.
---------------------------------------------------------------------------
The statutory exemptions to the prohibited transaction
rules do not apply to certain transactions in which the plan
makes a loan to an owner-employee.\52\ Loans to participants
other than owner-employees are permitted if loans are available
to all participants on a reasonably equivalent basis, are not
made available to highly compensated employees in an amount
greater than made available to other employees, are made in
accordance with specific provisions in the plan, bear a
reasonable rate of interest, and are adequately secured. In
addition, the Code places limits on the amount of loans and
repayment terms.
---------------------------------------------------------------------------
\52\ Certain transactions involving a plan and S corporation
shareholders are permitted.
---------------------------------------------------------------------------
For purposes of the prohibited transaction rules, an owner-
employee means (1) a sole proprietor, (2) a partner who owns
more than 10 percent of either the capital interest or the
profits interest in the partnership, (3) an employee or officer
of a Subchapter S corporation who owns more than five percent
of the outstanding stock of the corporation, and (4) the owner
of an individual retirement arrangement (``IRA''). The term
owner-employee also includes certain family members of an
owner-employee and certain corporations owned by an owner-
employee.
Under the Internal Revenue Code, a two-tier excise tax is
imposed on disqualified persons who engage in a prohibited
transaction. The first level tax is equal to 15 percent of the
amount involved in the transaction. The second level tax is
imposed if the prohibited transaction is not corrected within a
certain period, and is equal to 100 percent of the amount
involved.

Reasons for Change

The Committee believes that the present-law prohibited
transaction rules regarding loans unfairly discriminate against
the owners of unincorporated businesses and S corporations. For
example, under present law, the sole shareholder of a C
corporation may take advantage of the statutory exemption to
the prohibited transaction rules for loans, but an individual
who does business as a sole proprietor may not.

Explanation of Provision

The provision generally eliminates the special present-law
rules relating to plan loans made to an owner-employee (other
than the owner of an IRA). Thus, the general statutory
exemption applies to such transactions. Present law continues
to apply with respect to IRAs.

Effective Date

The provision is effective with respect to years beginning
after December 31, 2001.
(c) Modification of top-heavy rules (Sec. 613 of the bill
and Sec. 416 of the Code)

Present Law

In general

Under present law, additional qualification requirements
apply to plans that primarily benefit an employer's key
employees (``top-heavy plans''). These additional requirements
provide (1) more rapid vesting for plan participants who are
non-key employees and (2) minimum nonintegrated employer
contributions or benefits for plan participants who are non-key
employees.

Definition of top-heavy plan

A defined benefit plan is a top-heavy plan if more than 60
percent of the cumulative accrued benefits under the plan are
for key employees. A defined contribution plan is top heavy if
the sum of the account balances of key employees is more than
60 percent of the total account balances under the plan. For
each plan year, the determination of top-heavy status generally
is made as of the last day of the preceding plan year (``the
determination date'').
For purposes of determining whether a plan is a top-heavy
plan, benefits derived both from employer and employee
contributions, including employee elective contributions, are
taken into account. In addition, the accrued benefit of a
participant in a defined benefit plan and the account balance
of a participant in a defined contribution plan includes any
amount distributed within the 5-year period ending on the
determination date.
An individual's accrued benefit or account balance is not
taken into account in determining whether a plan is top-heavy
if the individual has not performed services for the employer
during the 5-year period ending on the determination date.
In some cases, two or more plans of a single employer must
be aggregated for purposes of determining whether the group of
plans is top-heavy. The following plans must be aggregated: (1)
plans which cover a key employee (including collectively
bargained plans); and (2) any plan upon which a plan covering a
key employee depends for purposes of satisfying the Code's
nondiscrimination rules. The employer may be required to
include terminated plans inthe required aggregation group. In
some circumstances, an employer may elect to aggregate plans for
purposes of determining whether they are top heavy.
SIMPLE plans are not subject to the top-heavy rules.

Definition of key employee

A key employee is an employee who, during the plan year
that ends on the determination date or any of the four
preceding plan years, is (1) an officer earning over one-half
of the defined benefit plan dollar limitation of section 415
($70,000 for 2001), (2) a 5-percent owner of the employer, (3)
a 1-percent owner of the employer earning over $150,000, or (4)
one of the 10 employees earning more than the defined
contribution plan dollar limit ($35,000 for 2001) with the
largest ownership interests in the employer. A family ownership
attribution rule applies to the determination of 1-percent
owner status, 5-percent owner status, and largest ownership
interest. Under this attribution rule, an individual is treated
as owning stock owned by the individual's spouse, children,
grandchildren, or parents.

Minimum benefit for non-key employees

A minimum benefit generally must be provided to all non-key
employees in a top-heavy plan. In general, a top-heavy defined
benefit plan must provide a minimum benefit equal to the lesser
of (1) two percent of compensation multiplied by the employee's
years of service, or (2) 20 percent of compensation. A top-
heavy defined contribution plan must provide a minimum annual
contribution equal to the lesser of (1) three percent of
compensation, or (2) the percentage of compensation at which
contributions were made for key employees (including employee
elective contributions made by key employees and employer
matching contributions).
For purposes of the minimum benefit rules, only benefits
derived from employer contributions (other than amounts
employees have elected to defer) to the plan are taken into
account, and an employee's social security benefits are
disregarded (i.e., the minimum benefit is nonintegrated).
Employer matching contributions may be used to satisfy the
minimum contribution requirement; however, in such a case the
contributions are not treated as matching contributions for
purposes of applying the special nondiscrimination requirements
applicable to employee elective contributions and matching
contributions under sections 401(k) and (m). Thus, such
contributions would have to meet the general nondiscrimination
test of section 401(a)(4).\53\
---------------------------------------------------------------------------
\53\ Treas. Reg. sec. 1.416-1 Q&A M-19.
---------------------------------------------------------------------------

Top-heavy vesting

Benefits under a top-heavy plan must vest at least as
rapidly as under one of the following schedules: (1) three-year
cliff vesting, which provides for 100 percent vesting after
three years of service; and (2) two-six year graduated vesting,
which provides for 20 percent vesting after two years of
service, and 20 percent more each year thereafter so that a
participant is fully vested after six years of service.\54\
---------------------------------------------------------------------------
\54\ Benefits under a plan that is not top heavy must vest at least
as rapidly as under one of the following schedules: (1) five-year cliff
vesting; and (2) three-seven year graded vesting, which provides for 20
percent vesting after three years and 20 percent more each year
thereafter so that a participant is fully vested after seven years of
service.
---------------------------------------------------------------------------

Qualified cash or deferred arrangements

Under a qualified cash or deferred arrangement (a ``section
401(k) plan''), an employee may elect to have the employer make
payments as contributions to a qualified plan on behalf of the
employee, or to the employee directly in cash. Contributions
made at the election of the employee are called elective
deferrals. A special nondiscrimination test applies to elective
deferrals under cash or deferred arrangements, which compares
the elective deferrals of highly compensated employees with
elective deferrals of nonhighly compensated employees. (This
test is called the actual deferral percentage test or the
``ADP'' test). Employer matching contributions under qualified
defined contribution plans are also subject to a similar
nondiscrimination test. (This test is called the actual
contribution percentage test or the ``ACP'' test.)
Under a design-based safe harbor, a cash or deferred
arrangement is deemed to satisfy the ADP test if the plan
satisfies one of two contribution requirements and satisfies a
notice requirement. A plan satisfies the contribution
requirement under the safe harbor rule for qualified cash or
deferred arrangements if the employer either (1) satisfies a
matching contribution requirement or (2) makes a nonelective
contribution to a defined contribution plan of at least three
percent of an employee's compensation on behalf of each
nonhighly compensated employee who is eligible to participate
in the arrangement without regard to the permitted disparity
rules (Sec. 401(1)). A plan satisfies the matching contribution
requirement if, under the arrangement: (1) 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 deferrals up to three percent of compensation and (b)
50 percent of the employee's elective deferrals from three to
five percent of compensation; and (2), 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. Matching contributions that satisfy the
design-based safe harbor for cash or deferred arrangements are
deemed to satisfy the ACP test. Certain additional matching
contributions are also deemed to satisfy the ACP test.

Reasons for Change

The top-heavy rules primarily affect the plans of small
employers. While the top-heavy rules were intended to provide
additional minimum benefits to rank-and-file employees, the
Committee is concerned that in some cases the top-heavy rules
may act as a deterrent to the establishment of a plan by a
small employer. The Committee believes that simplification of
the top-heavy rules will help alleviate the additional
administrative burdens the rules place on small employers. The
Committee also believes that, in applying the top-heavy minimum
benefit rules,the employer should receive credit for all
contributions the employer makes, including matching contributions.

Explanation of Provision

Definition of top-heavy plan

In determining whether a plan is top-heavy, the bill
provides that distributions during the year ending on the date
the top-heavy determination is being made are taken into
account. The present-law 5-year rule applies with respect to
in-service distributions. Similarly, the bill provides that an
individual's accrued benefit or account balance is not taken
into account if the individual has not performed services for
the employer during the 1-year period ending on the date the
top-heavy determination is being made.

Definition of key employee

The bill (1) provides that an employee is not considered a
key employee by reason of officer status unless the employee
earns more than the compensation limit for determining whether
an employee is highly compensated ($85,000 for 2001) \55\ and
(2) repeals the top-10 owner key employee category. The
provision repeals the 4-year lookback rule for determining key
employee status and provides that an employee is a key employee
only if he or she is a key employee during the preceding plan
year. An employee who was not an employee in the preceding plan
year, or who was an employee only for part of the year, is
treated as a key employee if it can be reasonably anticipated
that the employee will meet the definition of a key employee
for the current plan year.
---------------------------------------------------------------------------
\55\ The compensation limit is determined without regard to the
top-paid group election.
---------------------------------------------------------------------------
Thus, under the provision, an employee generally is
considered a key employee if, during the prior year, the
employee was (1) an officer with compensation in excess of
$85,000, (2) a 5-percent owner, or (3) a 1-percent owner with
compensation in excess of $150,000. The present-law limits on
the number of officers treated as key employees under (1)
continue to apply.

Minimum benefit for nonkey employees

Under the provision, matching contributions are taken into
account in determining whether the minimum benefit requirement
has been satisfied.\56\
---------------------------------------------------------------------------
\56\ Thus, this provision overrides the provision in Treasury
regulations that, if matching contributions are used to satisfy the
minimum benefit requirement, then they are not treated as matching
contributions for purposes of the section 401(m) nondiscrimination
rules.
---------------------------------------------------------------------------
The bill provides that, in determining the minimum benefit
required under a defined benefit plan, a year of service does
not include any year in which no key employee or former key
employee benefits under the plan (as determined under sec.
410).

Effective Date

The provision is effective for years beginning after
December 31, 2001.
(d) Elective deferrals not taken into account for purposes
of deduction limits (Sec. 614 of the bill and Sec.
404 of the Code)

Present Law

Employer contributions to one or more qualified retirement
plans are deductible subject to certain limits. In general, the
deduction limit depends on the kind of plan.
In the case of a defined benefit pension plan or a money
purchase pension plan, the employer generally may deduct the
amount necessary to satisfy the minimum funding cost of the
plan for the year. If a defined benefit pension plan has more
than 100 participants, the maximum amount deductible is at
least equal to the plan's unfunded current liabilities.
In the case of a profit-sharing or stock bonus plan, the
employer generally may deduct an amount equal to 15 percent of
compensation of the employees covered by the plan for the year.
If an employer sponsors both a defined benefit pension plan
and a defined contribution plan that covers some of the same
employees (or a money purchase pension plan and another kind of
defined contribution plan), the total deduction for all plans
for a plan year generally is limited to the greater of (1) 25
percent of compensation or (2) the contribution necessary to
meet the minimum funding requirements of the defined benefit
pension plan for the year (or the amount of the plan's unfunded
current liabilities, in the case of a plan with more than 100
participants).
For purposes of the deduction limits, employee elective
deferral contributions to a section 401(k) plan are treated as
employer contributions and, thus, are subject to the generally
applicable deduction limits.
Subject to certain exceptions, nondeductible contributions
are subject to a 10-percent excise tax.

Reasons for Change

Subjecting elective deferrals to the normally applicable
deduction limits may cause employers to restrict the amount of
elective deferrals an employee may make or to restrict employer
contributions to the plan, thereby reducing participants'
ultimate retirement benefits and their ability to save
adequately for retirement. The Committee believes that the
amount of elective deferrals otherwise allowable should not be
further limited through application of the deduction rules.

Explanation of Provision

Under the provision, the applicable percentage of elective
deferral contributions is not subject to the deduction limits,
and the application of a deduction limitation to any
otheremployer contribution to a qualified retirement plan does not take
into account the applicable percentage of elective deferral
contributions. The applicable percentage is 25 percent for 2002 through
2010, and 100 percent for 2011 and thereafter.

Effective Date

The provision is effective for years beginning after
December 31, 2001.
(e) Repeal of coordination requirements for deferred
compensation plans of State and local governments
and tax-exempt organizations (Sec. 615 of the bill
and Sec. 457 of the Code)

Present Law

Compensation deferred under an eligible deferred
compensation plan of a tax-exempt or State and local government
employer (a ``section 457 plan'') is not includible in gross
income until paid or made available. In general, the maximum
permitted annual deferral under such a plan is the lesser of
(1) $8,500 (in 2001) or (2) 33\1/3\ percent of compensation.
The $8,500 limit is increased for inflation in $500 increments.
Under a special catch-up rule, a section 457 plan may provide
that, for one or more of the participant's last three years
before retirement, the otherwise applicable limit is increased
to the lesser of (1) $15,000 or (2) the sum of the otherwise
applicable limit for the year plus the amount by which the
limit applicable in preceding years of participation exceeded
the deferrals for that year.
The $8,500 limit (as modified under the catch-up rule),
applies to all deferrals under all section 457 plans in which
the individual participates. In addition, in applying the
$8,500 limit, contributions under a tax-sheltered annuity
(``section 403(b) annuity''), elective deferrals under a
qualified cash or deferred arrangement (``section 401(k)
plan''), salary reduction contributions under a simplified
employee pension plan (``SEP''), and contributions under a
SIMPLE plan are taken into account. Further, the amount
deferred under a section 457 plan is taken into account in
applying a special catch-up rule for section 403(b) annuities.

Reasons for Change

The Committee believes that individuals participating in a
section 457 plan should also be able to fully participate in a
section 403(b) annuity or section 401(k) plan of the employer.
Eliminating the coordination rule may also encourage the
establishment of section 403(b) or 401(k) plans by tax-exempt
and governmental employers (to the extent permitted under
present law).

Explanation of Provision

The provision repeals the rules coordinating the section
457 dollar limit with contributions under other types of
plans.\57\
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\57\ The limits on deferrals under a section 457 plan are modified
under other provisions of the provision.
---------------------------------------------------------------------------

Effective Date

The provision is effective for years beginning after
December 31, 2001.
(f) Deduction limits (Sec. 616 of the bill and Sec. 404 of
the Code)

Present Law

Employer contributions to one or more qualified retirement
plans are deductible subject to certain limits. In general, the
deduction limit depends on the kind of plan. Subject to certain
exceptions, nondeductible contributions are subject to a 10-
percent excise tax.
In the case of a defined benefit pension plan or a money
purchase pension plan, the employer generally may deduct the
amount necessary to satisfy the minimum funding cost of the
plan for the year. If a defined benefit pension plan has more
than 100 participants, the maximum amount deductible is at
least equal to the plan's unfunded current liabilities.
In some cases, the amount of deductible contributions is
limited by compensation. In the case of a profit-sharing or
stock bonus plan, the employer generally may deduct an amount
equal to 15 percent of compensation of the employees covered by
the plan for the year.
If an employer sponsors both a defined benefit pension plan
and a defined contribution plan that covers some of the same
employees (or a money purchase pension plan and another kind of
defined contribution plan), the total deduction for all plans
for a plan year generally is limited to the greater of (1) 25
percent of compensation or (2) the contribution necessary to
meet the minimum funding requirements of the defined benefit
pension plan for the year (or the amount of the plan's unfunded
current liabilities, in the case of a plan with more than 100
participants).
In the case of an employee stock ownership plan (``ESOP''),
principal payments on a loan used to acquire qualifying
employer securities are deductible up to 25 percent of
compensation.
For purposes of the deduction limits, employee elective
deferral contributions to a qualified cash or deferred
arrangement (``section 401(k) plan'') are treated as employer
contributions and, thus, are subject to the generally
applicable deduction limits.\58\
---------------------------------------------------------------------------
\58\ Another provision of the bill provides that elective deferrals
are not subject to the deduction limits.
---------------------------------------------------------------------------
For purposes of the deduction limits, compensation means
the compensation otherwise paid or accrued during the taxable
year to the beneficiaries under the plan, and the beneficiaries
under a profit-sharing or stock bonus plan are the employees
who benefit under the plan with respect to the employer's
contribution.\59\ An employee who is eligible to make elective
deferrals under a section 401(k) plan is treated as benefiting
under the arrangement even if the employee elects not to
defer.\60\
---------------------------------------------------------------------------
\59\ Rev. Rul. 65-295, 1965-2 C.B. 148.
\60\ Treas. Reg. sec. 1.410(b)-3.
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For purposes of the deduction rules, compensation generally
includes only taxable compensation, and thus does not include
salary reduction amounts, such as elective deferrals under a
section 401(k) plan or a tax-sheltered annuity (``section
403(b) annuity''), elective contributions under a deferred
compensation plan of a tax-exempt organization or a State or
local government (``section 457 plan''), and salary reduction
contributions under a section 125 cafeteria plan. For purposes
of the contribution limits under section 415, compensation does
include such salary reduction amounts.

Reasons for Change

The Committee believes that compensation unreduced by
employee elective contributions is a more appropriate measure
of compensation for qualified retirement plan purposes,
including deduction limits, than the present-law rule. Applying
the same definition for deduction purposes as is generally used
for other plan purposes will also simplify application of the
qualified plan rules. The Committee also believes that the 15
percent of compensation limit may restrict the amount of
employer contributions to the plan, thereby reducing
participants' ultimate retirement benefits and their ability to
adequately save for retirement.

Explanation of Provision

Under the provision, the definition of compensation for
purposes of the deduction rules includes salary reduction
amounts treated as compensation under section 415. In addition,
the annual limitation on the amount of deductible contributions
to a profit-sharing or stock bonus plan is increased from 15
percent to 25 percent of compensation of the employees covered
by the plan for the year. Also, except to the extent provided
in regulations, a money purchase pension plan is treated like a
profit-sharing or stock bonus plan for purposes of the
deduction rules.

Effective Date

The provision is effective for years beginning after
December 31, 2001.
(g) Option to treat elective deferrals as after-tax Roth
contributions (Sec. 617 of the bill and new Sec.
402A of the Code)

Present Law

A qualified cash or deferred arrangement (``section 401(k)
plan'') or a tax-sheltered annuity (``section 403(b) annuity'')
may permit a participant to elect to have the employer make
payments as contributions to the plan or to the participant
directly in cash. Contributions made to the plan at the
election of a participant are elective deferrals. Elective
deferrals must be nonforfeitable and are subject to an annual
dollar limitation (Sec. 402(g)) and distribution restrictions.
In addition, elective deferrals under a section 401(k) plan are
subject to specialnondiscrimination rules. Elective deferrals
(and earnings attributable thereto) are not includible in a
participant's gross income until distributed from the plan.
Elective deferrals for a taxable year that exceed the
annual dollar limitation (``excess deferrals'') are includible
in gross income for the taxable year. If an employee makes
elective deferrals under a plan (or plans) of a single employer
that exceed the annual dollar limitation (``excess
deferrals''), then the plan may provide for the distribution of
the excess deferrals, with earnings thereon. If the excess
deferrals are made to more than one plan of unrelated
employers, then the plan may permit the individual to allocate
excess deferrals among the various plans, no later than the
March 1 (April 15 under the applicable regulations) following
the end of the taxable year. If excess deferrals are
distributed not later than April 15 following the end of the
taxable year, along with earnings attributable to the excess
deferrals, then the excess deferrals are not again includible
in income when distributed. The earnings are includible in
income in the year distributed. If excess deferrals (and income
thereon) are not distributed by the applicable April 15, then
the excess deferrals (and income thereon) are includible in
income when received by the participant. Thus, excess deferrals
that are not distributed by the applicable April 15th are
taxable both in the taxable year when the deferral was made and
in the year the participant receives a distribution of the
excess deferral.
Individuals with adjusted gross income below certain levels
generally may make nondeductible contributions to a Roth IRA
and may convert a deductible or nondeductible IRA into a Roth
IRA. Amounts held in a Roth IRA that are withdrawn as a
qualified distribution are not includible in income and are not
subject to the additional 10-percent tax on early withdrawals.
A qualified distribution is a distribution that (1) is made
after the 5-taxable year period beginning with the first
taxable year for which the individual made a contribution to a
Roth IRA, and (2) is made after attainment of age 59\1/2\, is
made on account of death or disability, or is a qualified
special purpose distribution (i.e., for first-time homebuyer
expenses of up to $10,000). A distribution from a Roth IRA that
is not a qualified distribution is includible in income to the
extent attributable to earnings, and is subject to the 10-
percent tax on early withdrawals (unless an exception
applies).\61\
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\61\ Early distributions of converted amounts may also accelerate
income inclusion of converted amounts that are taxable under the 4-year
rule applicable to 1998 conversions.
---------------------------------------------------------------------------

Reasons for Change

The recently-enacted Roth IRA provisions have provided
individuals with another form of tax-favored retirement
savings. For a variety of reasons, some individuals may prefer
to save through a Roth IRA rather than a traditional deductible
IRA. The Committee believes that similar savings choices should
be available to participants in section 401(k) plans and tax-
sheltered annuities.

Explanation of Provision

A section 401(k) plan or a section 403(b) annuity is
permitted to include a ``Roth contribution program'' that
permits a participant to elect to have all or a portion of the
participant's elective deferrals under the plan treated as Roth
contributions. Roth contributions are elective deferrals that
the participant designates (at such time and in such manner as
the Secretary may prescribe) \62\ as not excludable from the
participant's gross income.
---------------------------------------------------------------------------
\62\ It is intended that the Secretary generally will not permit
retroactive designations of elective deferrals as Roth contributions.
---------------------------------------------------------------------------
The annual dollar limitation on a participant's Roth
contributions is the section 402(g) annual limitation on
elective deferrals, reduced by the participant's elective
deferrals that the participant does not designate as Roth
contributions. Roth contributions are treated as any other
elective deferral for purposes of nonforfeitability
requirements and distribution restrictions.\63\ Under a section
401(k) plan, Roth contributions also are treated as any other
elective deferral for purposes of the special nondiscrimination
requirements.\64\
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\63\ Similarly, Roth contributions to a section 403(b) annuity are
treated the same as other salary reduction contributions to the annuity
(except that Roth contributions would be includible in income).
\64\ It is intended that the Secretary will provide ordering rules
regarding the return of excess contributions under the special
nondiscrimination rules (pursuant to sec. 401(k)(8)) in the event a
participant makes both regular elective deferrals and Roth
contributions. It is intended that such rules will generally permit a
plan to allow participants to designate which contributions would be
returned first or to permit the plan to specify which contributions
will be returned first.
---------------------------------------------------------------------------
The plan is required to establish a separate account, and
maintain separate recordkeeping, for a participant's Roth
contributions (and earnings allocable thereto). A qualified
distribution from a participant's Roth contribution account is
not includible in the participant's gross income. A qualified
distribution is a distribution that is made after the end of a
specified nonexclusion period and that is (1) made on or after
the date on which the participant attains age 59\1/2\, (2) made
to a beneficiary (or to the estate of the participant) on or
after the death of the participant, or (3) attributable to the
participant being disabled.\65\ The nonexclusion period is the
5-year-taxable period beginning with the earlier of (1) the
first taxable year for which the participant made a Roth
contribution to any Roth contribution account established for
the participant under the plan, or (2) if the participant has
made a rollover contribution to the Roth contribution account
that is the source of the distribution from a Roth contribution
account established for the participant under another plan, the
first taxable year for which the participant made a Roth
contribution to the previously established account.
---------------------------------------------------------------------------
\65\ A qualified special purpose distribution, as defined under the
rules relating to Roth IRAs, does not qualify as a tax-free
distribution from a Roth contribution account.
---------------------------------------------------------------------------
A distribution from a Roth contribution account that is a
corrective distribution of an elective deferral (and income
allocable thereto) that exceeds the section 402(g) annual limit
on elective deferrals or a corrective distribution of an excess
contribution under the special nondiscrimination rules
(pursuant to sec. 401(k)(8) (and income allocable thereto) is
not a qualified distribution. In addition, the treatment of
excess Roth contributions is similar to thetreatment of excess
deferrals attributable to non-Roth contributions. If excess Roth
contributions (including earnings thereon) are distributed no later
than the April 15th following the taxable year, then the Roth
contributions are not includible in gross income as a result of the
distribution, because such contributions are includible in gross income
when made. Earnings on such excess Roth contributions are treated the
same as earnings on excess deferrals distributed no later than April
15th, i.e., they are includible in income when distributed. If excess
Roth contributions are not distributed no later than the applicable
April 15th, then such contributions (and earnings thereon) are taxable
when distributed. Thus, as is the case with excess elective deferrals
that are not distributed by the applicable April 15th, the
contributions are includible in income in the year when made and again
when distributed from the plan. Earnings on such contributions are
taxable when received.
A participant is permitted to roll over a distribution from
a Roth contribution account only to another Roth contribution
account or a Roth IRA of the participant.
The Secretary of the Treasury is directed to require the
plan administrator of each section 401(k) plan or section
403(b) annuity that permits participants to make Roth
contributions to make such returns and reports regarding Roth
contributions to the Secretary, plan participants and
beneficiaries, and other persons that the Secretary may
designate.

Effective Date

The provision is effective for taxable years beginning
after December 31, 2003.
(h) Nonrefundable credit to certain individuals for
elective deferrals and IRA contributions (Sec. 618
of the bill and new Sec. 25C of the Code)

Present Law

Present law provides favorable tax treatment for a variety
of retirement savings vehicles, including employer-sponsored
retirement plans and individual retirement arrangements
(``IRAs'').
Several different types of tax-favored employer-sponsored
retirement plans exist, such as section 401(a) qualified plans
(including plans with a section 401(k) qualified cash-or-
deferred arrangement), section 403(a) qualified annuity plans,
section 403(b) annuities, section 408(k) simplified employee
pensions (``SEPs''), section 408(p) SIMPLE retirement accounts,
and section 457(b) eligible deferred compensation plans. In
general, an employer and, in certain cases, employees,
contribute to the plan. Taxation of the contributions and
earnings thereon is generally deferred until benefits are
distributed from the plan to participants or their
beneficiaries.\66\ Contributions and benefits under tax-favored
employer-sponsored retirement plans are subject to specific
limitations.
---------------------------------------------------------------------------
\66\ In the case of after-tax employee contributions, only earnings
are taxed upon withdrawal.
---------------------------------------------------------------------------
Coverage and nondiscrimination rules also generally apply
to tax-favored employer-sponsored retirement plans to ensure
that plans do not disproportionately cover higher-paid
employees and that benefits provided to moderate- and lower-
paid employees are generally proportional to those provided to
higher-paid employees.
IRAs include both traditional IRAs and Roth IRAs. In
general, an individual makes contributions to an IRA, and
investment earnings on those contributions accumulate on a tax-
deferred basis. Total annual IRA contributions per individual
are limited to $2,000 (or the compensation of the individual or
the individual's spouse, if smaller). Contributions to a
traditional IRA may be deducted from gross income if an
individual's adjusted gross income (``AGI'') is below certain
levels or the individual is not an active participant in
certain employer-sponsored retirement plans. Contributions to a
Roth IRA are not deductible from gross income, regardless of
adjusted gross income. A distribution from a traditional IRA is
includible in the individual's gross income except to the
extent of individual contributions made on a nondeductible
basis. A qualified distribution from a Roth IRA is excludable
from gross income.
Taxable distributions made from employer retirement plans
and IRAs before the employee or individual has reached age
59\1/2\ are subject to a 10-percent additional tax, unless an
exception applies.

Reasons for Change

The Committee recognizes that the rate of private savings
in the United States is low; in particular many low- and
middle-income individuals have inadequate savings or no savings
at all. A key reason for these low levels of saving is that
lower-income families are likely to be more budget constrained
with competing needs such as food, clothing, shelter, and
medical care taking a larger portion of their income. The
Committee believes providing an additional tax incentive for
low- and middle-income individuals will enhance their ability
to save adequately for retirement.

Explanation of Provision

The bill provides a temporary nonrefundable tax credit for
contributions made by eligible taxpayers to a qualified plan.
The maximum annual contribution eligible for the credit is
$2,000. The credit rate depends on the adjusted gross income
(``AGI'') of the taxpayer. Only joint returns with AGI of
$50,000 or less, head of household returns of $37,500 or less,
and single returns of $25,000 or less are eligible for the
credit. The AGI limits applicable to single taxpayers apply to
married taxpayers filing separate returns. The credit is in
addition to any deduction or exclusion that would otherwise
apply with respect to the contribution. The credit offsets
minimum tax liability as well as regular tax liability. The
credit is available to individuals who are 18 or over, other
than individuals who are full-time students or claimed as a
dependent on another taxpayer's return.
The credit is available with respect to elective
contributions to a section 401(k) plan, section 403(b) annuity,
or eligible deferred compensation arrangement of a State or
local government (a ``sec. 457 plan''), SIMPLE, or SEP,
contributions to a traditional or Roth IRA, andvoluntary after-
tax employee contributions to a qualified retirement plan. The present-
law rules governing such contributions continue to apply.
The amount of any contribution eligible for the credit is
reduced by taxable distributions received by the taxpayer and
his or her spouse from any savings arrangement described above
or any other qualified retirement plan during the taxable year
for which the credit is claimed, the two taxable years prior to
the year the credit is claimed, and during the period after the
end of the taxable year and prior to the due date for filing
the taxpayer's return for the year. In the case of a
distribution from a Roth IRA, this rule applies to any such
distributions, whether or not taxable.
The credit rates based on AGI are as follows.

----------------------------------------------------------------------------------------------------------------
Credit rate
Joint filers Heads of households All other filers (percent)
----------------------------------------------------------------------------------------------------------------
$0-$30,000............................... $0-$22,500................. $0-$15,000................. 50
$30,000-$32,500.......................... $22,500-$24,375............ $15,000-$16,250............ 20
$32,500-$50,000.......................... $24,375-$37,500............ $16,250-$25,000............ 10
Over $50,000............................. Over $37,500............... Over $25,000............... 0
----------------------------------------------------------------------------------------------------------------

Effective Date

The provision is effective for taxable years beginning
after December 31, 2001, and before January 1, 2007.
(i) Small business tax credit for qualified retirement plan
contributions (Sec. 619 of the bill and new Sec.
45E of the Code)

Present Law

The timing of an employer's deduction for compensation paid
to an employee generally corresponds to the employee's
recognition of the compensation. However, an employer that
contributes to a qualified retirement plan is entitled to a
deduction (within certain limits) for the employer's
contribution to the plan on behalf of an employee even though
the employee does not recognize income with respect to the
contribution until the amount is distributed to the employee.

Reasons for Change

The Committee understands that many small employers are
reluctant to establish a qualified retirement plan that
provides nonelective or matching contributions to all
employees. Plans that offer only salary reduction contributions
may not provide sufficient incentive for lower- and middle-
income employees to save. The Committee believes that providing
a credit for employers who provide nonelective and matching
contributions for nonhighly compensated employees will result
in greater retirement saving for such employees.

Explanation of Provision

The bill provides a nonrefundable income tax credit for
small employers equal to 50 percent of certain qualifying
employer contributions made to qualified retirement plans on
behalf of nonhighly compensated employees. The credit is not
available with respect to contributions to a SIMPLE IRA or SEP.
For purposes of the provision, a small employer means an
employer with no more than 20 employees who received at least
$5,000 of earnings in the preceding year. A nonhighly
compensated employee is defined as an employee who neither (1)
was a five-percent owner of the employer at any time during the
current year or the preceding year, or (2) for the preceding
year, had compensation in excess of $80,000 (adjusted annually
for inflation, this amount is $85,000 for 2001).\67\ The credit
is available for the first three plan years of the plan.
---------------------------------------------------------------------------
\67\ The top paid group election, which under present law permits
an employer to classify an employee as a nonhighly compensated employee
if the employee had compensation in excess of $80,000 (adjusted
annually for inflation) during the preceding year but was not among the
top 20 percent of employees of the employer when ranked on the basis of
compensation paid to employees during the preceding year, is not taken
into account in determining nonhighly compensated employees for
purposes of the provision.
---------------------------------------------------------------------------
The provision requires a small employer to make nonelective
contributions equal to at least one percent of compensation to
qualify for the credit. The credit applies to both qualifying
nonelective employer contributions and qualifying employer
matching contributions, but only up to a total of three percent
of the nonhighly compensated employee's compensation. The
credit is available for 50 percent of qualifying benefit
accruals under a nonintegrated defined benefit plan if the
benefits are equivalent, as defined in regulations, to a three-
percent nonelective contribution to a defined contribution
plan.
To qualify for the credit, the nonelective and matching
contributions to a defined contribution plan and the benefit
accruals under a defined benefit plan are required to vest at
least as rapidly as under either a three-year cliff vesting
schedule or a graded schedule that provides 20-percent vesting
per year for five years. In order to qualify for the credit,
contributions to plans other than pension plans must be subject
to the same distribution restrictions that apply to qualified
nonelective employer contributions to a section 401(k) plan,
i.e., distribution only upon separation from service, death,
disability, attainment of age 59\1/2\, plan termination without
a successor plan, or acquisition of a subsidiary or
substantially all the assets of a trade or business that
employs the participant.\68\ Qualifying contributions to
pension plans are subject to the distribution restrictions
applicable to such plans.
---------------------------------------------------------------------------
\68\ The rules relating to distribution upon separation from
service are modified under another provision of the bill.
---------------------------------------------------------------------------
A defined contribution plan to which the small employer
makes the qualifying contributions (and any plan aggregated
with that plan for nondiscrimination testing purposes) is
required to allocate any nonelective employer contributions
proportionally to participants' compensation from the employer
(or on a flat-dollar basis) and, accordingly, without the use
of permitted disparity or cross-testing. An equivalent
requirement must be met with respect to a defined benefit plan.
Forfeited nonvested qualifying contributions or accruals
for which the credit was claimed generally result in recapture
of the credit at a rate of 35 percent. However, recapture does
notapply to the extent that forfeitures of contributions are
reallocated to nonhighly compensated employees or applied to future
contributions on behalf of nonhighly compensated employees. The
Secretary of the Treasury is authorized to issue administrative
guidance, including de minimis rules, to simplify or facilitate
claiming and recapturing the credit.
The credit is a general business credit.\69\ The 50 percent
of qualifying contributions that are effectively offset by the
tax credit are not deductible; the other 50 percent of the
qualifying contributions (and other contributions) are
deductible to the extent permitted under present law.
---------------------------------------------------------------------------
\69\ The credit cannot be carried back to years before the
effective date.
---------------------------------------------------------------------------

Effective Date

The credit is effective with respect to contributions paid
or incurred in taxable years beginning after December 31, 2002,
with respect to plans established after such date.
(j) Small business tax credit for new retirement plan
expenses (Sec. 620 of the bill and new Sec. 45F of
the Code)

Present Law

The costs incurred by an employer related to the
establishment and maintenance of a retirement plan (e.g.,
payroll system changes, investment vehicle set-up fees,
consulting fees) generally are deductible by the employer as
ordinary and necessary expenses in carrying on a trade or
business.

Reasons for Change

One of the reasons some small employers may not adopt a
tax-favored retirement plan is the administrative costs
associated with such plans. The Committee believes that
providing a tax credit for certain administrative costs will
reduce one of the barriers to retirement plan coverage.

Explanation of Provision

The bill provides a nonrefundable income tax credit for 50
percent of the administrative and retirement-education expenses
for any small business that adopts a new qualified defined
benefit or defined contribution plan (including a section
401(k) plan), SIMPLE plan, or simplified employee pension
(``SEP''). The credit applies to 50 percent of the first $1,000
in administrative and retirement-education expenses for the
plan for each of the first three years of the plan.
The credit is available to an employer that did not employ,
in the preceding year, more than 100 employees with
compensation in excess of $5,000. In order for an employer to
be eligible for the credit, the plan must cover at least one
nonhighly compensated employee. In addition, if the credit is
for the cost of a payroll deduction IRA arrangement, the
arrangement must be made available to all employees of the
employer who have worked with the employer for at least three
months.
The credit is a general business credit.\70\ The 50 percent
of qualifying expenses that are effectively offset by the tax
credit are not deductible; the other 50 percent of the
qualifying expenses (and other expenses) are deductible to the
extent permitted under present law.
---------------------------------------------------------------------------
\70\ The credit cannot be carried back to years before the
effective date.
---------------------------------------------------------------------------

Effective Date

The credit is effective with respect to costs paid or
incurred in taxable years beginning after December 31, 2001,
with respect to plans established after such date.
(k) Eliminate IRS user fees for certain determination
letter requests regarding employer plans (Sec. 621
of the bill)

Present Law

An employer that maintains a retirement plan for the
benefit of its employees may request from the Internal Revenue
Service (``IRS'') a determination as to whether the form of the
plan satisfies the requirements applicable to tax-qualified
plans (Sec. 401(a)). In order to obtain from the IRS a
determination letter on the qualified status of the plan, the
employer must pay a user fee. The user fee may range from $125
to $1,250, depending upon the scope of the request and the type
and format of the plan.\71\
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\71\ Authorization for the user fees was originally enacted in
section 10511 of the Revenue Act of 1987 (Pub. L. No. 100-203, December
22, 1987). The authorization was extended through September 30, 2003,
by Public Law Number 104-117 (An Act to provide that members of the
Armed Forces performing services for the peacekeeping efforts in Bosnia
and Herzegovina, Croatia, and Macedonia shall be entitled to tax
benefits in the same manner as if such services were performed in a
combat zone, and for other purposes (March 20, 1996)).
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Present law provides that plans that do not meet the
qualification requirements will be treated as meeting such
requirements if appropriate retroactive plan amendments are
made during the remedial amendment period. In general, the
remedial amendment period ends on the due date for the
employer's tax return (including extensions) for the taxable
year in which the event giving rise to the disqualifying
provision occurred (e.g., a plan amendment or a change in the
law). The Secretary may provide for general extensions of the
remedial amendment period or for extensions in certain cases.
For example, the remedial amendment period with respect to
amendments relating to the qualification requirements affected
by the General Agreements on Tariffs and Trade, the Uniformed
Services Employment and Reemployment Rights Act of 1994, the
Small Business Job Protection Act of 1996, the Taxpayer Relief
Act of 1997, and the Internal Revenue Service Restructuring and
Reform Act of 1998 generally ends the last day of the first
plan year beginning on or after January 1, 2001.\72\
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\72\ Rev. Proc. 2000-27, 2000-26 I.R.B. 1272.
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Reasons for Change

One of the factors affecting the decision of a small
employer to adopt a plan is the level of administrative costs
associated with the plan. The Committee believes that reducing
administrative costs, such as IRS user fees, will help further
the establishment of qualified plans by small employers.

Explanation of Provision

An eligible employer is not required to pay a user fee for
a determination letter request with respect to the qualified
status of a new retirement plan that the employer maintains and
with respect to which the employer has not previously made a
determination letter request. An employer is eligible under the
provision if (1) the employer has no more than 100 employees,
(2) the employer has at least one nonhighly compensated
employee who is participating in the plan, and (3) during the
three-taxable year period immediately preceding the taxable
year in which the request is made, neither the employer nor a
related employer established or maintained a qualified plan
with respect to which contributions were made or benefits were
accrued for substantially the same employees covered under the
plan with respect to which the request is made. In addition,
determination letter requests for which user fees are not
required under the provision are not taken into account in
determining average user fees. The provision applies only to
requests by employers for determination letters concerning the
qualified retirement plans they maintain. Therefore, a sponsor
of a prototype plan is required to pay a user fee for a request
for a notification letter, opinion letter, or similar ruling.
An employer that adopts a prototype plan, however, is not
required to pay a user fee for a determination letter request
with respect to the employer's plan.

Effective Date

The provision is effective for determination letter
requests made after December 31, 2001.
(l) Treatment of nonresident aliens engaged in
international transportation services (Sec. 622 of
the bill and Sec. 861(a)(3) of the Code)

Present Law

Generally, compensation for services performed in the
United States is treated as U.S. source income. Under a special
rule, compensation is not treated as U.S. source income if the
compensation is paid for labor or services performed by a
nonresident alien in connection with the individual's temporary
presence in the United States as a regular member of the crew
of a foreign vessel engaged in transportation between the
United States and a foreign country or a possession of the
United States. However, this special rule does not apply for
purposes of qualified retirement plans (including the minimum
coverage and nondiscrimination requirements applicable to such
plans), employer-provided group-term life insurance, or
employer-provided accident and health plans.

Reasons for Change

The Committee believes that nonresident aliens who are in
the United States temporarily as crew members of foreign
vessels engaged in transportation between the United States and
a foreign country or a possession of the United States and who
otherwise have no U.S. source income for Federal tax purposes
should be disregarded in applying the nondiscrimination and
other requirements applicable to employee benefit plans.

Explanation of Provision

Under the provision, the special rule relating to
compensation paid for labor or services performed by a
nonresident alien in connection with the individual's temporary
presence in the United States as a regular member of the crew
of a foreign vessel engaged in transportation between the
United States and a foreign country or a possession of the
United States compensation is extended in order to apply for
purposes of qualified retirement plans, employer-provided
group-term life insurance, and employer-provided accident and
health plans. Therefore, such compensation is not treated as
U.S. source income for any purpose under such plans, including
the application of the qualified retirement plan minimum
coverage and nondiscrimination requirements.

Effective Date

The provision is effective with respect to remuneration for
services performed in plan years beginning after December 31,
2001.

2. Enhancing fairness for women

(a) Additional salary reduction catch-up contributions
(Sec. 631 of the bill and Sec. 414 of the Code)

Present Law

Elective deferral limitations

Under present law, under certain salary reduction
arrangements, an employee may elect to have the employer make
payments as contributions to a plan on behalf of the employee,
or to the employee directly in cash. Contributions made at the
election of the employee are called elective deferrals.
The maximum annual amount of elective deferrals that an
individual may make to a qualified cash or deferred arrangement
(a ``401(k) plan''), a tax-sheltered annuity (``section 403(b)
annuity'') or a salary reduction simplified employee pension
plan (``SEP'') is $10,500 (for 2001). The maximum annual amount
of elective deferrals that an individual may make to a SIMPLE
plan is $6,500 (for 2001). These limits are adjusted annually
for inflation for inflation in $500 increments.

Section 457 plans

Reasons for Change

Although the Committee believes that individuals should be
saving for retirement throughout their working lives, as a
practical matter, many individuals simply do not focus on the
amount of retirement savings they need until they near
retirement. In addition, many individuals may have difficulty
saving more in earlier years, e.g., because an employee leaves
the workplace to care for a family. Some individuals may have a
greater ability to save as they near retirement.
The Committee believes that the pension laws should assist
individuals who are nearing retirement to save more for their
retirement.

Explanation of Provision

The bill provides that the otherwise applicable dollar
limit on elective deferrals under a section 401(k) plan,
section 403(b) annuity, SEP, or SIMPLE, or deferrals under a
section 457 plan is increased for individuals who have attained
age 50 by the end of the year.\73\ Additional contributions
could be made by an individual who has attained age 50 before
the end of the plan year and with respect to whom no other
elective deferrals may otherwise be made to the plan for the
year because of the application of any limitation of the Code
(e.g., the annual limit on elective deferrals) or of the plan.
Under the provision, the additional amount of elective
contributions that could be made by an eligible individual
participating in such a plan is the lesser of (1) the
applicable dollar amount or (2) the participant's compensation
for the year reduced by any other elective deferrals of the
participant for the year.\74\ The applicable dollar amount is
$500 for 2002 through 2004, $1,000 for 2005 and 2006, $2,000
for 2007, $3,000 for 2008, $4,000 for 2009, and $7,500 for 2010
and thereafter.
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\73\ Another provision increases the dollar limit on elective
deferrals under such arrangements.
\74\ In the case of a section 457 plan, this catch-up rule does not
apply during the participant's last three years before retirement (in
those years, the regularly applicable dollar limit is doubled).
---------------------------------------------------------------------------
Catch-up contributions made under the provision are not
subject to any other contribution limits and are not taken into
account in applying other contribution limits. In addition,
such contributions are not subject to applicable
nondiscrimination rules.\75\
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\75\ Another provision increases the dollar limit on elective
deferrals under such arrangements.
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An employer is permitted to make matching contributions
with respect to catch-up contributions. Any such matching
contributions are subject to the normally applicable rules.
The following examples illustrate the application of the
provision, after the catch-up is fully phased-in.
Example 1: Employee A is a highly compensated employee who
is over 50 and who participates in a section 401(k) plan
sponsored by A's employer. The maximum annual deferral limit
(without regard to the provision) is $15,000. After application
of the special nondiscrimination rules applicable to section
401(k) plans, the maximum elective deferral A may make for the
year is $8,000. Under the provision, A is able to make
additional catch-up salary reduction contributions of $7,500.
Example 2: Employee B, who is over 50, is a participant in
a section 401(k) plan. B's compensation for the year is
$30,000. The maximum annual deferral limit (without regard to
the provision) is $15,000. Under the terms of the plan, the
maximum permitted deferral is 10 percent of compensation or, in
B's case, $3,000. Under the provision, B can contribute up to
$10,500 for the year ($3,000 under the normal operation of the
plan, and an additional $7,500 under the provision).

Effective Date

The provision is effective for taxable years beginning
after December 31, 2001.
(b) Equitable treatment for contributions of employees to
defined contribution plans (Sec. 632 of the bill
and Secs. 403(b), 415, and 457 of the Code)

Present Law

Present law imposes limits on the contributions that may be
made to tax-favored retirement plans.

Defined contribution plans

In the case of a tax-qualified defined contribution plan,
the limit on annual additions that can be made to the plan on
behalf of an employee is the lesser of $35,000 (for 2001) or 25
percent of the employee's compensation (Sec. 415(c)). Annual
additions include employer contributions, including
contributions made at the election of the employee (i.e.,
employee elective deferrals), after-tax employee contributions,
and any forfeitures allocated to the employee. For this
purpose, compensation means taxable compensation of the
employee, pluselective deferrals, and similar salary reduction
contributions. A separate limit applies to benefits under a defined
benefit plan.
For years before January 1, 2000, an overall limit applied
if an employee was a participant in both a defined contribution
plan and a defined benefit plan of the same employer.

Tax-sheltered annuities

In the case of a tax-sheltered annuity (a ``section 403(b)
annuity''), the annual contribution generally cannot exceed the
lesser of the exclusion allowance or the section 415(c) defined
contribution limit. The exclusion allowance for a year is equal
to 20 percent of the employee's includible compensation,
multiplied by the employee's years of service, minus excludable
contributions for prior years under qualified plans, tax-
sheltered annuities or section 457 plans of the employer.
In addition to this general rule, employees of nonprofit
educational institutions, hospitals, home health service
agencies, health and welfare service agencies, and churches may
elect application of one of several special rules that increase
the amount of the otherwise permitted contributions. The
election of a special rule is irrevocable; an employee may not
elect to have more than one special rule apply.
Under one special rule, in the year the employee separates
from service, the employee may elect to contribute up to the
exclusion allowance, without regard to the 25 percent of
compensation limit under section 415. Under this rule, the
exclusion allowance is determined by taking into account no
more than 10 years of service.
Under a second special rule, the employee may contribute up
to the lesser of: (1) the exclusion allowance; (2) 25 percent
of the participant's includible compensation; or (3) $15,000.
Under a third special rule, the employee may elect to
contribute up to the section 415(c) limit, without regard to
the exclusion allowance. If this option is elected, then
contributions to other plans of the employer are also taken
into account in applying the limit.
For purposes of determining the contribution limits
applicable to section 403(b) annuities, includible compensation
means the amount of compensation received from the employer for
the most recent period which may be counted as a year of
service under the exclusion allowance. In addition, includible
compensation includes elective deferrals and similar salary
reduction amounts.
Treasury regulations include provisions regarding
application of the exclusion allowance in cases where the
employee participates in a section 403(b) annuity and a defined
benefit plan. The Taxpayer Relief Act of 1997 directed the
Secretary of the Treasury to revise these regulations,
effective for years beginning after December 31, 1999, to
reflect the repeal of the overall limit on contributions and
benefits.

Section 457 plans

Compensation deferred under an eligible deferred
compensation plan of a tax-exempt or State and local
governmental employer (a ``section 457 plan'') is not
includible in gross income until paid or made available. In
general, the maximum permitted annual deferral under such a
plan is the lesser of (1) $8,500 (in 2001) or (2) 33\1/3\
percent of compensation. The $8,500 limit is increased for
inflation in $500 increments.

Reasons for Change

The present-law rules that limit contributions to defined
contribution plans by a percentage of compensation reduce the
amount that lower- and middle-income workers can save for
retirement. The present-law limits may not allow such workers
to accumulate adequate retirement benefits, particularly if a
defined contribution plan is the only type of retirement plan
maintained by the employer.
Conforming the contribution limits for tax-sheltered
annuities to the limits applicable to retirement plans will
simplify the administration of the pension laws, and provide
more equitable treatment for participants in similar types of
plans.

Explanation of Provision

Increase in defined contribution plan limit

The provision increases the 25 percent of compensation
limitation on annual additions under a defined contribution
plan to 50 percent for 2002 through 2010, and 100 percent for
2011 and thereafter.\76\
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\76\ Another provision increases the defined contribution plan
dollar limit.
---------------------------------------------------------------------------

Conforming limits on tax-sheltered annuities

The provision repeals the exclusion allowance applicable to
contributions to tax-sheltered annuities. Thus, such annuities
are subject to the limits applicable to tax-qualified plans.
The provision also directs the Secretary of the Treasury to
revise the regulations relating to the exclusion allowance
under section 403(b)(2) to render void the requirement that
contributions to a defined benefit plan be treated as
previously excluded amounts for purposes of the exclusion
allowance. For taxable years beginning after December 31, 2000,
the regulatory provisions regarding the exclusion allowance are
applied as if the requirement that contributions to a defined
benefit plan be treated as previously excluded amounts for
purposes of the exclusion allowance were void.

Section 457 plans

The provision increases the 33\1/3\ percent of compensation
limitation on deferrals under a section 457 plan to 50 percent
for 2002 through 2010, and 100 percent for 2011 and thereafter.

Effective Date

The provision generally is effective for years beginning
after December 31, 2001. The provision regarding the
regulations under section 403(b)(2) is effective on the date of
enactment. The provision regarding the repeal of the exclusion
allowance applicable to tax-sheltered annuities is effective
for years beginning after December 31, 2010.
(c) Faster vesting of employer matching contributions (Sec.
633 of the bill and Sec. 411 of the Code)

Present Law

Under present law, 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 completion of five 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 three years of service, 40 percent after
four years of service, 60 percent after five years of service,
80 percent after six years of service, and 100 percent after
seven years of service.\77\
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\77\ The minimum vesting requirements are also contained in Title I
of ERISA.
---------------------------------------------------------------------------

Reasons for Change

The Committee understands that many employees, particularly
lower- and middle-income employees, do not take full advantage
of the retirement savings opportunities provided by their
employer's section 401(k) plan. The Committee believes that
providing faster vesting for matching contributions will make
section 401(k) plans more attractive for employees,
particularly lower- and middle-income employees, and will
encourage employees to save more for their own retirement. In
addition, faster vesting for matching contributions will enable
short-service employees to accumulate greater retirement
savings.

Explanation of Provision

The provision applies faster vesting schedules to employer
matching contributions. Under the provision, employer matching
contributions must vest at least as rapidly as under one of the
following two alternative minimum vesting schedules. A plan
satisfies the first schedule if a participant acquires a
nonforfeitable right to 100 percent of employer matching
contributions upon the completion of three years of service. A
plan satisfies the second schedule if a participant has a
nonforfeitable right to 20 percent of employer matching
contributions for each year of service beginning with the
participant's second year of service and ending with 100
percent after six years of service.

Effective Date

The provision is effective for contributions for plan years
beginning after December 31, 2001, with a delayed effective
date for plans maintained pursuant to a collective bargaining
agreement. The provision does not apply to any employee until
the employee has an hour of service after the effective date.
In applying the new vesting schedule, service before the
effective date is taken into account.
(d) Modifications to minimum distribution rules (Sec. 634
of the bill and Sec. 401(a)(9) of the Code)

Present Law

In general

Minimum distribution rules apply to all types of tax-
favored retirement vehicles, including qualified plans,
individual retirement arrangements (``IRAs''), tax-sheltered
annuities (``section 403(b) annuities''), and eligible deferred
compensation plans of tax-exempt and State and local government
employers (``section 457 plans''). In general, under these
rules, distribution of minimum benefits must begin no later
than the required beginning date. Minimum distribution rules
also apply to benefits payable with respect to a plan
participant who has died. Failure to comply with the minimum
distribution rules results in an excise tax imposed on the
individual plan participant equal to 50 percent of the required
minimum distribution not distributed for the year. The excise
tax may be waived if the individual establishes to the
satisfaction of the Commissioner that the shortfall in the
amount distributed was due to reasonable error and reasonable
steps are being taken to remedy the shortfall. Under certain
circumstances following the death of a participant, the excise
tax is automatically waived under proposed Treasury
regulations.

Distributions prior to the death of the individual

In the case of distributions prior to the death of the plan
participant, the minimum distribution rules are satisfied if
either (1) the participant's entire interest in the plan is
distributed by the required beginning date, or (2) the
participant's interest in the plan is to be distributed (in
accordance with regulations), beginning not later than the
required beginning date, over a permissible period. The
permissible periods are (1) the life of the participant, (2)
the lives of the participant and a designated beneficiary, (3)
the life expectancy of the participant, or (4) the joint life
and last survivor expectancy of the participant and a
designated beneficiary. In calculating minimum required
distributions, life expectancies of the participant and the
participant's spouse may be recomputed annually.
In the case of qualified plans, tax-sheltered annuities,
and section 457 plans, the required beginning date is the April
1 of the calendar year following the later of (1) the calendar
year in which the employee attains age 70\1/2\ or (2) 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\. If commencement of benefits is delayed beyond age
70\1/2\ from a defined benefit plan, then the accrued benefit
of the employee must be actuarially increased to take into
accountthe period after age 70\1/2\ in which the employee was
not receiving benefits under the plan.\78\ In the case of distributions
from an IRA other than a Roth IRA, the required beginning date is the
April 1 following the calendar year in which the IRA owner attains age
70\1/2\. The pre-death minimum distribution rules do not apply to Roth
IRAs.
---------------------------------------------------------------------------
\78\ State and local government plans and church plans are not
required to actuarially increase benefits that begin after age 70\1/2\.
---------------------------------------------------------------------------
In general, under proposed Treasury regulations, in order
to satisfy the minimum distribution rules, annuity payments
under a defined benefit plan must be paid in periodic payments
made at intervals not longer than one year over a permissible
period, and must be nonincreasing, or increase only as a result
of the following: (1) cost-of-living adjustments; (2) cash
refunds of employee contributions; (3) benefit increases under
the plan; or (4) an adjustment due to death of the employee's
beneficiary. In the case of a defined contribution plan, the
minimum required distribution is determined by dividing the
employee's benefit by an amount from the uniform table provided
in the proposed regulations.

Distributions after the death of the plan participant

The minimum distribution rules also apply to distributions
to beneficiaries of deceased participants. In general, if the
participant dies after minimum distributions have begun, the
remaining interest must be distributed at least as rapidly as
under the minimum distribution method being used as of the date
of death. If the participant dies before minimum distributions
have begun, then the entire remaining interest must generally
be distributed within five years of the participant's death.
The five-year rule does not apply if distributions begin within
one year of the participant's death and are payable over the
life of a designated beneficiary or over the life expectancy of
a designated beneficiary. A surviving spouse beneficiary is not
required to begin distribution until the date the deceased
participant would have attained age 70\1/2\.

Special rules for section 457 plans

Eligible deferred compensation plans of State and local and
tax-exempt employers (``section 457 plans'') are subject to the
minimum distribution rules described above. Such plans are also
subject to additional minimum distribution requirements (Sec.
457(d)(2)(b)).

Reasons for Change

For many years, the minimum distribution rules have been
among the most complex of the rules relating to tax-favored
arrangements. On January 17, 2001, the Secretary of the
Treasury issued revised proposed regulations relating to the
minimum distribution rules. The Committee believes that the
implementation of these revised proposed regulations, along
with additional statutory modifications of the minimum
distribution rules, will result in significant simplification
for individuals and plan administrators.

Explanation of Provision

The provision applies the present-law rules applicable if
the participant dies before distribution of minimum benefits
has begun to all post-death distributions. Thus, in general, if
the employee dies before his or her entire interest has been
distributed, distribution of the remaining interest is required
to be made within five years of the date of death, or begin
within one year of the date of death and paid over the life or
life expectancy of a designated beneficiary. In the case of a
surviving spouse, distributions are not required to begin until
the surviving spouse attains age 70\1/2\. The provision
includes a transition rule with respect to the provision
providing that the required beginning date in the case of a
surviving spouse is no earlier than the April 1 of the calendar
year following the calendar year in which the surviving spouse
attains age 70\1/2\. In the case of an individual who died
before the date of enactment and prior to his or her required
beginning date and whose beneficiary is the surviving spouse,
minimum distributions to the surviving spouse are not required
to begin earlier than the date distributions would have been
required to begin under present law.
In addition, the Treasury is directed to revise the life
expectancy tables under the applicable regulations to reflect
current life expectancy.

Effective Date

The provision is effective for years beginning after
December 31, 2001.
(e) Clarification of tax treatment of division of section
457 plan benefits upon divorce (Sec. 635 of the
bill and Secs. 414(p) and 457 of the Code)

Present Law

Under present law, benefits provided under a qualified
retirement plan for a participant may not be assigned or
alienated to creditors of the participant, except in very
limited circumstances. One exception to the prohibition on
assignment or alienation rule is a qualified domestic relations
order (``QDRO''). A QDRO is a domestic relations order that
creates or recognizes a right of an alternate payee to any plan
benefit payable with respect to a participant, and that meets
certain procedural requirements.
Under present law, a distribution from a governmental plan
or a church plan is treated as made pursuant to a QDRO if it is
made pursuant to a domestic relations order that creates or
recognizes a right of an alternate payee to any plan benefit
payable with respect to a participant. Such distributions are
not required to meet the procedural requirements that apply
with respect to distributions from qualified plans.
Under present law, amounts distributed from a qualified
plan generally are taxable to the participant in the year of
distribution. However, if amounts are distributed to the spouse
(or former spouse) of the participant by reason of a QDRO, the
benefits are taxable to the spouse (or former spouse). Amounts
distributed pursuant to a QDRO to an alternate payee other than
the spouse (or former spouse) are taxable to the plan
participant.
Section 457 of the Internal Revenue Code provides rules for
deferral of compensation by an individual participating in an
eligible deferred compensation plan (``section 457 plan'') of a
tax-exempt or State and local government employer. The QDRO
rules do not apply to section 457 plans.

reasons for change

The Committee believes that the rules regarding qualified
domestic relations orders should apply to all types of
employer-sponsored retirement plans.

explanation of provision

The provision applies the taxation rules for qualified plan
distributions pursuant to a QDRO to distributions made pursuant
to a domestic relations order from a section 457 plan. In
addition, a section 457 plan is not treated as violating the
restrictions on distributions from such plans due to payments
to an alternate payee under a QDRO. The special rule applicable
to governmental plans and church plans applies for purposes of
determining whether a distribution is pursuant to a QDRO.

effective date

The provision relating to tax treatment of distributions
made pursuant to a domestic relations order from a section 457
plan is effective for transfers, distributions, and payments
made after December 31, 2001. The provisions relating to the
waiver of restrictions on distributions and the application of
the special rule for determining whether a distribution is
pursuant to a QDRO is effective on January 1, 2002, except that
in the case of a domestic relations order entered before
January 1, 2002, the plan administrator (1) is required to
treat such order as a QDRO if the administrator is paying
benefits pursuant to such order on January 1, 2002, and (2) is
permitted to treat any other such order entered before January
1, 2002, as a QDRO even if such order does not meet the
relevant requirements of the provision.
(f) Provisions relating to hardship withdrawals (Sec. 636
of the bill and Secs. 401(k) and 402 of the Code)

present law

Elective deferrals under a qualified cash or deferred
arrangement (a ``section 401(k) plan'') may not be
distributable prior to the occurrence of one or more specified
events. One event upon which distribution is permitted is the
financial hardship of the employee. Applicable Treasury
regulations\79\ provide that a distribution is made on account
of hardship only if the distribution is made on account of an
immediate and heavy financial need of the employee and is
necessary to satisfy the heavy need.
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\79\ Treas. Reg. sec. 1.401(k)-1.
---------------------------------------------------------------------------
The Treasury regulations provide a safe harbor under which
a distribution may be deemed necessary to satisfy an immediate
and heavy financial need. One requirement of this safe harbor
is that the employee be prohibited from making elective
contributions and employee contributions to the plan and all
other plans maintained by the employer for at least 12 months
after receipt of the hardship distribution.
Under present law, hardship withdrawals of elective
deferrals from a qualified cash or deferred arrangement (or
403(b) annuity) are not eligible rollover distributions. Other
types of hardship distributions, e.g., employer matching
contributions distributed on account of hardship, are eligible
rollover distributions. Different withholding rules apply to
distributions that are eligible rollover distributions and to
distributions that are not eligible rollover distributions.
Eligible rollover distributions that are not directly rolled
over are subject to withholding at a flat rate of 20-percent.
Distributions that are not eligible rollover distributions are
subject to elective withholding. Periodic distributions are
subject to withholding as if the distribution were wages;
nonperiodic distributions are subject to withholding at a rate
of 10 percent. In either case, the individual may elect not to
have withholding apply.

reasons for change

Although the Committee believes that it is appropriate to
restrict the circumstances in which an in-service distribution
from a 401(k) plan is permitted and to encourage participants
to take such distributions only when necessary to satisfy an
immediate and heavy financial need, the Committee is concerned
about the impact that a 12-month suspension of contributions
may have on the retirement savings of a participant who
experiences a hardship. The Committee believes that the
combination of a six-month contribution suspension and the
other elements of the regulatory safe harbor will provide an
adequate incentive for a participant to seek sources of funds
other than his or her 401(k) plan account balance in order to
satisfy financial hardships.
The present-law rules regarding the ability to rollover
hardship distributions create administrative burdens for plan
administrators and confusion on the part of plan participants.
The Committee believes that providing a uniform rule for all
hardship distributions will simplify application of the
rollover rules.

explanation of provision

The Secretary of the Treasury is directed to revise the
applicable regulations to reduce from 12 months to six months
the period during which an employee must be prohibited from
making elective contributions and employee contributions in
order for a distribution to be deemed necessary to satisfy an
immediate and heavy financial need. The revised regulations are
effective for years beginning after December 31, 2001.
In addition, any distribution made upon hardship of an
employee is not an eligible rollover distribution. Thus, such
distributions are not permitted to be rolled over, and are
subject to the withholding rules applicable to distributions
that are not eligible rollover distributions. The provision
does not modify the rules under which hardship distributions
may be made. For example, as under present law, hardship
distributions of qualified employer matching contributions are
only permitted under the rules applicable to elective
deferrals.
The provision is intended to clarify that all assets
distributed as a hardship withdrawal, including assets
attributable to employee elective deferrals and those
attributable to employermatching or nonelective contributions,
are ineligible for rollover. This rule is intended to apply to all
hardship distributions from any tax qualified plan, including those
made pursuant to standards set forth in section 401(k)(2)(B)(i)(IV)
(which are applicable to section 401(k) plans and section 403(b)
annuities) and to those treated as hardship distributions under any
profit-sharing plan (whether or not in accordance with the standards
set forth in section 401(k)(2)(B)(i)(IV)). For this purpose, a
distribution that could be made either under the hardship provisions of
a plan or under other provisions of the plan (such as provisions
permitting in-service withdrawal of assets attributable to employer
matching or nonelective contributions after a fixed period of years)
could be treated as made upon hardship of the employee if the plan
treats it that way. For example, if a plan makes an in-service
distribution that consists of assets attributable to both elective
deferrals (in circumstances where those assets could be distributed
only upon hardship) and employer matching or nonelective contributions
(which could be distributed in nonhardship circumstances under the
plan), the plan is permitted to treat the distribution in its entirety
as made upon hardship of the employee.

effective date

The provision directing the Secretary to revise the rules
relating to safe harbor hardship distributions is effective on
the date of enactment. The provision providing that hardship
distributions are not eligible rollover distributions is
effective distributions made after December 31, 2001. The
Secretary is authorized to issue transitional guidance with
respect to the provision of the bill providing that hardship
distributions are not eligible rollover distributions to
provide sufficient time for plans to implement the new rule.
(g) Pension coverage for domestic and similar workers (Sec.
637 of the bill and Sec. 4972(c)(6) of the Code)

present law

Under present law, within limits, employers may make
deductible contributions to qualified retirement plans for
employees. Subject to certain exception, a 10-percent excise
tax applies to nondeductible contributions to such plans.
Employers of household workers may establish a pension plan
for their employees. Contributions to such plans are not
deductible because they are not made in connection with a trade
or business of the employer.

reasons for change

Under present law, individuals who employ domestic and
similar workers may be discouraged from providing pension plan
coverage for such employees because of the possible adverse tax
consequences from making nondeductible contributions. As a
result, such workers, who are typically lower income, may be
denied the opportunity for tax-favored retirement savings. The
Committee believes that such individuals who employ such
workers should be encouraged to provide pension coverage.

explanation of provision

Under the provision, the 10-percent excise tax on
nondeductible contributions does not apply to contributions to
a SIMPLE plan or a SIMPLE individual retirement account, which
are nondeductible solely because the contributions are not a
trade or business expense under section 162. Thus, for example,
employers of household workers are able to make contributions
to such plans without imposition of the excise tax. As under
present law, the contributions are not deductible. The present-
law rules applicable to such plans, e.g., contribution limits
and nondiscrimination rules, continue to apply. The provision
does not apply with respect to contributions on behalf of the
individual and members of his or her family.
No inference is intended with respect to the application of
the excise tax under present law to contributions that are not
deductible because they are not made in connection with a trade
or business of the employer.
As under present law, a plan covering domestic workers is
not qualified unless the coverage rules are satisfied by
aggregating all employees of family members taken into account
under the attribution rules in section 414(c), but disregarding
employees employed by a controlled group of corporations or a
trade or business.

effective date

The provision is effective for taxable years beginning
after December 31, 2001.

3. Increasing portability for participants

(a) Rollovers of retirement plan and IRA distributions
(Secs. 641-643 and 649 of the bill and Secs. 401,
402, 403(b), 408, 457, and 3405 of the Code)

present law

In general

Present law permits the rollover of funds from a tax-
favored retirement plan to another tax-favored retirement plan.
The rules that apply depend on the type of plan involved.
Similarly, the rules regarding the tax treatment of amounts
that are not rolled over depend on the type of plan involved.

Distributions from qualified plans

Under present law, an ``eligible rollover distribution''
from a tax-qualified employer-sponsored retirement plan may be
rolled over tax free to a traditional individual retirement
arrangement (``IRA'')\80\ or another qualified plan.\81\ An
``eligible rollover distribution'' means any distribution to an
employee of all or any portion of the balance to the credit of
the employee in a qualified plan, except the term does not
include (1) any distribution which is one of a series of
substantially equal periodic payments made (a) for the life (or
life expectancy) of the employee or the joint lives (or joint
life expectancies) of the employee and the employee's
designated beneficiary, or (b) for a specified period of 10
years or more, (2) any distribution to the extent such
distribution is required under the minimum distribution rules,
and (3) certain hardship distributions. The maximum amount that
can be rolled over is the amount of the distribution includible
in income, i.e., after-tax employee contributions cannot be
rolled over. Qualified plans are not required to accept
rollovers.
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\80\ A ``traditional'' IRA refers to IRAs other than Roth IRAs or
SIMPLE IRAs. All references to IRAs refer only to traditional IRAs.
\81\ An eligible rollover distribution may either be rolled over
by the distributee within 60 days of the date of the distribution or,
as described below, directly rolled over by the distributing plan.
---------------------------------------------------------------------------

Distributions from tax-sheltered annuities

Eligible rollover distributions from a tax-sheltered
annuity (``section 403(b) annuity'') may be rolled over into an
IRA or another section 403(b) annuity. Distributions from a
section 403(b) annuity cannot be rolled over into a tax-
qualified plan. Section 403(b) annuities are not required to
accept rollovers.

IRA distributions

Distributions from a traditional IRA, other than minimum
required distributions, can be rolled over into another IRA. In
general, distributions from an IRA cannot be rolled over into a
qualified plan or section 403(b) annuity. An exception to this
rule applies in the case of so-called ``conduit IRAs.'' Under
the conduit IRA rule, amounts can be rolled from a qualified
plan into an IRA and then subsequently rolled back to another
qualified plan if the amounts in the IRA are attributable
solely to rollovers from a qualified plan. Similarly, an amount
may be rolled over from a section 403(b) annuity to an IRA and
subsequently rolled back into a section 403(b) annuity if the
amounts in the IRA are attributable solely to rollovers from a
section 403(b) annuity.

Distributions from section 457 plans

A ``section 457 plan'' is an eligible deferred compensation
plan of a State or local government or tax-exempt employer that
meets certain requirements. In some cases, different rules
apply under section 457 to governmental plans and plans of tax-
exempt employers. For example, governmental section 457 plans
are like qualified plans in that plan assets are required to be
held in a trust for the exclusive benefit of plan participants
and beneficiaries. In contrast, benefits under a section 457
plan of a tax-exempt employer are unfunded, like nonqualified
deferred compensation plans of private employers.
Section 457 benefits can be transferred to another section
457 plan. Distributions from a section 457 plan cannot be
rolled over to another section 457 plan, a qualified plan, a
section 403(b) annuity, or an IRA.

Rollovers by surviving spouses

A surviving spouse that receives an eligible rollover
distribution may roll over the distribution into an IRA, but
not a qualified plan or section 403(b) annuity.

Direct rollovers and withholding requirements

Qualified plans and section 403(b) annuities are required
to provide that a plan participant has the right to elect that
an eligible rollover distribution be directly rolled over to
another eligible retirement plan. If the plan participant does
not elect the direct rollover option, then withholding is
required on the distribution at a 20-percent rate.

Notice of eligible rollover distribution

The plan administrator of a qualified plan or a section
403(b) annuity is required to provide a written explanation of
rollover rules to individuals who receive a distribution
eligible for rollover. In general, the notice is to be provided
within a reasonable period of time before making the
distribution and is to include an explanation of (1) the
provisions under which the individual may have the distribution
directly rolled over to another eligible retirement plan, (2)
the provision that requires withholding if the distribution is
not directly rolled over, (3) the provision under which the
distribution may be rolled over within 60 days of receipt, and
(4) if applicable, certain other rules that may apply to the
distribution. The Treasury Department has provided more
specific guidance regarding timing and content of the notice.

Taxation of distributions

As is the case with the rollover rules, different rules
regarding taxation of benefits apply to different types of tax-
favored arrangements. In general, distributions from a
qualified plan, section 403(b) annuity, or IRA are includible
in income in the year received. In certain cases, distributions
from qualified plans are eligible for capital gains treatment
and averaging. These rules do not apply to distributions from
another type of plan. Distributions from a qualified plan, IRA,
and section 403(b) annuity generally are subject to an
additional 10-percent early withdrawal tax if made before age
59\1/2\. There are a number of exceptions to the early
withdrawal tax. Some of the exceptions apply to all three types
of plans, and others apply only to certain types of plans. For
example, the 10-percent early withdrawal tax does not apply to
IRA distributions for educational expenses, but does apply to
similar distributions from qualified plans and section 403(b)
annuities. Benefits under a section 457 plan are generally
includible in income when paid or made available. The 10-
percent early withdrawal tax does not apply to section 457
plans.

Reasons for Change

Present law encourages individuals who receive
distributions from qualified plans and similar arrangements to
save those distributions for retirement by facilitating tax-
free rollovers to an IRA or another qualified plan. The
Committee believes that expanding the rollover options for
individuals in employer-sponsored retirement plans and owners
of IRAs will provide further incentives for individuals to
continue to accumulate funds for retirement. The Committee
believes it appropriate to extend the same rollover rules to
governmental section 457 plans; like qualified plans, such
plans are required to hold plan assets in trust for employees.

Explanation of Provision

In general

The bill provides that eligible rollover distributions from
qualified retirement plans, section 403(b) annuities, and
governmental section 457 plans generally may be rolled over to
any of such plans or arrangements.\82\ Similarly, distributions
from an IRA generally are permitted to be rolled over into a
qualified plan, section 403(b) annuity, or governmental section
457 plan. The direct rollover and withholding rules are
extended to distributions from a governmental section 457 plan,
and such plans are required to provide the written notification
regarding eligible rollover distributions. The rollover notice
(with respect to all plans) is required to include a
description of the provisions under which distributions from
the plan to which the distribution is rolled over may be
subject to restrictions and tax consequences different than
those applicable to distributions from the distributing plan.
Qualified plans, section 403(b) annuities, and section 457
plans are not required to accept rollovers.
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\82\ Hardship distributions from governmental section 457 plans are
considered eligible rollover distributions.
---------------------------------------------------------------------------
Some special rules apply in certain cases. A distribution
from a qualified plan is not eligible for capital gains or
averaging treatment if there was a rollover to the plan that
would not have been permitted under present law. Thus, in order
to preserve capital gains and averaging treatment for a
qualified plan distribution that is rolled over, the rollover
must be made to a ``conduit IRA'' as under present law, and
then rolled back into a qualified plan. Amounts distributed
from a section 457 plan are subject to the early withdrawal tax
to the extent the distribution consists of amounts attributable
to rollovers from another type of plan. Section 457 plans are
required to separately account for such amounts.

Rollover of after-tax contributions

The bill provides that employee after-tax contributions may
be rolled over into another qualified plan or a traditional
IRA. In the case of a rollover from a qualified plan to another
qualified plan, the rollover is permitted to be accomplished
only through a direct rollover. In addition, a qualified plan
is not permitted to accept rollovers of after-tax contributions
unless the plan provides separate accounting for such
contributions (and earnings thereon). After-tax contributions
(including nondeductible contributions to an IRA) are not
permitted to be rolled over from an IRA into a qualified plan,
tax-sheltered annuity, or section 457 plan.
In the case of a distribution from a traditional IRA that
is rolled over into an eligible rollover plan that is not an
IRA, the distribution is attributed first to amounts other than
after-tax contributions.

Expansion of spousal rollovers

The bill provides that surviving spouses may roll over
distributions to a qualified plan, section 403(b) annuity, or
governmental section 457 plan in which the spouse participates.

Treasury regulations

The Secretary is directed to prescribe rules necessary to
carry out the provisions. Such rules may include, for example,
reporting requirements and mechanisms to address mistakes
relating to rollovers. It is anticipated that the IRS will
develop forms to assist individuals who roll over after-tax
contributions to an IRA in keeping track of such contributions.
Such forms could, for example, expand Form 8606--Nondeductible
IRAs, to include information regarding after-tax contributions.

Effective Date

The provision is effective for distributions made after
December 31, 2001.
(b) Waiver of 60-day rule (sec. 644 of the bill and Secs.
402 and 408 of the Code)

Present Law

Under present law, amounts received from an IRA or
qualified plan may be rolled over tax free if the rollover is
made within 60 days of the date of the distribution. The
Secretary does not have the authority to waive the 60-day
requirement, except during military service in a combat zone or
by reason of a Presidentially declared disaster. The Secretary
has issued regulations postponing the 60-day rule in such
cases.

Reasons for Change

The inability of the Secretary to waive the 60-day rollover
period may result in adverse tax consequences for individuals.
The Committee believes such harsh results are inappropriate and
that providing for waivers of the rule will help facilitate
rollovers.

Explanation of Provision

The bill provides that the Secretary may waive the 60-day
rollover period if the failure to waive such requirement would
be against equity or good conscience, including cases of
casualty, disaster, or other events beyond the reasonable
control of the individual subject to such requirement. For
example, the Secretary may issue guidance that includes
objective standards for a waiver of the 60-day rollover period,
such as waiving the rule due to military service in a combat
zone or during a Presidentially declared disaster (both of
which are provided for under present law), or for a period
during which the participant has received payment in the form
of a check, but has not cashed the check, or for errors
committed by a financial institution.

Effective Date

The provision applies to distributions made after December
31, 2001.
(c) Treatment of forms of distribution (Sec. 645 of the
bill and Sec. 411(d)(6) of the Code)

Present Law

An amendment of a qualified retirement plan may not
decrease the accrued benefit of a plan participant. An
amendment is treated as reducing an accrued benefit if, with
respect to benefits accrued before the amendment is adopted,
the amendment has the effect of either (1) eliminating or
reducing an early retirement benefit or a retirement-type
subsidy, or (2) except as provided by Treasury regulations,
eliminating an optional form of benefit (Sec. 411(d)(6)).\83\
---------------------------------------------------------------------------
\83\ A similar provision is contained in Title I of ERISA.
---------------------------------------------------------------------------
Under regulations recently issued by the Secretary,\84\
this prohibition against the elimination of an optional form of
benefit does not apply in the case of (1) a defined
contribution plan that offers a lump sum at the same time as
the form being eliminated if the participant receives at least
90 days' advance notice of the elimination, or (2) a voluntary
transfer between defined contribution plans, subject to the
requirements that a transfer from a money purchase pension
plan, an ESOP, or a section 401(k) plan must be to a plan of
the same type and that the transfer be made in connection with
certain corporate mergers, acquisitions, or similar
transactions or changes in employment status.
---------------------------------------------------------------------------
\84\ Treas. Reg. sec. 1.411(d)-4, Q&A-2(e) and Q&A-(3)(b).
---------------------------------------------------------------------------

Reasons for Change

The Committee understands that the application of the
prohibition against the elimination of any optional form of
benefit frequently results in complexity and confusion,
especially in the context of business acquisitions and similar
transactions, and makes it difficult for participants to
understand their benefit options and make choices that are
best-suited to their needs. The Committee believes that it is
appropriate to permit the elimination of duplicative benefit
options that develop following plan mergers and similar events
while ensuring that meaningful early retirement benefit payment
options and subsidies may not be eliminated.

Explanation of Provision

A defined contribution plan to which benefits are
transferred is not treated as reducing a participant's or
beneficiary's accrued benefit even though it does not provide
all of the forms of distribution previously available under the
transferor plan if (1) the plan receives from another defined
contribution plan a direct transfer of the participant's or
beneficiary's benefit accrued under the transferor plan, or the
plan results from a merger or other transaction that has the
effect of a direct transfer (including consolidations of
benefits attributable to different employers within a multiple
employer plan), (2) the terms of both the transferor plan and
the transferee plan authorize the transfer, (3) the transfer
occurs pursuant to a voluntary election by the participant or
beneficiary that is made after the participant or beneficiary
received a notice describing the consequences of making the
election, and (4) the transferee plan allows the participant
orbeneficiary to receive distribution of his or her benefit under the
transferee plan in the form of a single sum distribution.
Furthermore, the provision directs the Secretary of the
Treasury to provide by regulations that the prohibitions
against eliminating or reducing an early retirement benefit, a
retirement-type subsidy, or an optional form of benefit do not
apply to plan amendments that eliminate or reduce early
retirement benefits, retirement-type subsidies, and optional
forms of benefit that create significant burdens and
complexities for a plan and its participants, but only if such
an amendment does not adversely affect the rights of any
participant in more than a de minimis manner.
It is intended that the factors to be considered in
determining whether an amendment has more than a de minimis
adverse effect on any participant will include (1) all of the
participant's early retirement benefits, retirement-type
subsidies, and optional forms of benefits that are reduced or
eliminated by the amendment, (2) the extent to which early
retirement benefits, retirement-type subsidies, and optional
forms of benefit in effect with respect to a participant after
the amendment effective date provide rights that are comparable
to the rights that are reduced or eliminated by the plan
amendment, (3) the number of years before the participant
attains normal retirement age under the plan (or early
retirement age, as applicable), (4) the size of the
participant's benefit that is affected by the plan amendment,
in relation to the amount of the participant's compensation,
and (5) the number of years before the plan amendment is
effective.
The Secretary is directed to issue, not later than December
31, 2002, final regulations under section 411(d)(6), including
regulations required under the provision.

Effective Date

The provision is effective for years beginning after
December 31, 2001, except that the direction to the Secretary
is effective on the date of enactment.
(d) Rationalization of restrictions on distributions (Sec.
646 of the bill and Secs. 401(k), 403(b), and 457
of the Code)

Present Law

Elective deferrals under a qualified cash or deferred
arrangement (``section 401(k) plan''), tax-sheltered annuity
(``section 403(b) annuity''), or an eligible deferred
compensation plan of a tax-exempt organization or State or
local government (``section 457 plan''), may not be
distributable prior to the occurrence of one or more specified
events. These permissible distributable events include
``separation from service.''
A separation from service occurs only upon a participant's
death, retirement, resignation or discharge, and not when the
employee continues on the same job for a different employer as
a result of the liquidation, merger, consolidation or other
similar corporate transaction. A severance from employment
occurs when a participant ceases to be employed by the employer
that maintains the plan. Under a so-called ``same desk rule,''
a participant's severance from employment does not necessarily
result in a separation from service.
In addition to separation from service and other events, a
section 401(k) plan that is maintained by a corporation may
permit distributions to certain employees who experience a
severance from employment with the corporation that maintains
the plan but do not experience a separation from service
because the employees continue on the same job for a different
employer as a result of a corporate transaction. If the
corporation disposes of substantially all of the assets used by
the corporation in a trade or business, a distributable event
occurs with respect to the accounts of the employees who
continue employment with the corporation that acquires the
assets. If the corporation disposes of its interest in a
subsidiary, a distributable event occurs with respect to the
accounts of the employees who continue employment with the
subsidiary. Under a recent IRS ruling, a person is generally
deemed to have separated from service if that person is
transferred to another employer in connection with a sale of
less than substantially all the assets of a trade or
business.\85\
---------------------------------------------------------------------------
\85\ Rev. Rul. 2000-27, 2000-21 I.R.B. 1016.
---------------------------------------------------------------------------

Reasons for Change

The Committee believes that application of the ``same
desk'' rule is inappropriate because it hinders portability of
retirement benefits, creates confusion for employees, and
results in significant administrative burdens for employers
that engage in business acquisition transactions.

Explanation of Provision

The provision modifies the distribution restrictions
applicable to section 401(k) plans, section 403(b) annuities,
and section 457 plans to provide that distribution may occur
upon severance from employment rather than separation from
service. In addition, the provisions for distribution from a
section 401(k) plan based upon a corporation's disposition of
its assets or a subsidiary are repealed; this special rule is
no longer necessary under the provision.

Effective Date

The provision is effective for distributions after December
31, 2001, regardless of when the severance of employment
occurred.
(e) Purchase of service credit under governmental pension
plans (Sec. 647 of the bill and Secs. 403(b) and
457 of the Code)

Present Law

A qualified retirement plan maintained by a State or local
government employer may provide that a participant may make
after-tax employee contributions in order to purchase
permissive service credit, subject to certain limits (Sec.
415). Permissive service credit means credit for a period of
service recognized by the governmental plan only if the
employee voluntarily contributes to the plan an amount (as
determined by the plan) that does not exceed the amount
necessary to fund the benefit attributable to the period of
service and that is in addition to the regular employee
contributions, if any, under the plan.
In the case of any repayment of contributions and earnings
to a governmental plan with respect to an amount previously
refunded upon a forfeiture of service credit under the plan (or
another plan maintained by a State or local government employer
within the same State), any such repayment is not taken into
account for purposes of the section 415 limits on contributions
and benefits. Also, service credit obtained as a result of such
a repayment is not considered permissive service credit for
purposes of the section 415 limits.
A participant may not use a rollover or direct transfer of
benefits from a tax-sheltered annuity (``section 403(b)
annuity'') or an eligible deferred compensation plan of a tax-
exempt organization of a State or local government (``section
457 plan'') to purchase permissive service credits or repay
contributions and earnings with respect to a forfeiture of
service credit.

Reasons for Change

The Committee understands that many employees work for
multiple State or local government employers during their
careers. The Committee believes that allowing such employees to
use their section 403(b) annuity and section 457 plan accounts
to purchase permissive service credits or make repayments with
respect to forfeitures of service credit will result in more
significant retirement benefits for employees who would not
otherwise be able to afford such credits or repayments.

Explanation of Provision

A participant in a State or local governmental plan is not
required to include in gross income a direct trustee-to-trustee
transfer to a governmental defined benefit plan from a section
403(b) annuity or a section 457 plan if the transferred amount
is used (1) to purchase permissive service credits under the
plan, or (2) to repay contributions and earnings with respect
to an amount previously refunded under a forfeiture of service
credit under the plan (or another plan maintained by a State or
local government employer within the same State).

Effective Date

The provision is effective for transfers after December 31,
2001.
(f) Employers may disregard rollovers for purposes of cash-
out rules (Sec. 648 of the bill and Sec. 411(a)(11)
of the Code)

Present Law

If a qualified retirement plan participant ceases to be
employed by the employer that maintains the plan, the plan may
distribute the participant's nonforfeitable accrued benefit
without the consent of the participant and, if applicable, the
participant's spouse, if the present value of the benefit does
not exceed $5,000. If such an involuntary distribution occurs
and the participant subsequently returns to employment covered
by the plan, then service taken into account in computing
benefits payable under the plan after the return need not
include service with respect to which a benefit was
involuntarily distributed unless the employee repays the
benefit.\86\
---------------------------------------------------------------------------
\86\ A similar provision is contained in Title I of ERISA.
---------------------------------------------------------------------------
Generally, a participant may roll over an involuntary
distribution from a qualified plan to an IRA or to another
qualified plan.\87\
---------------------------------------------------------------------------
\87\ Other provisions expand the kinds of plans to which benefits
may be rolled over.
---------------------------------------------------------------------------

Reasons for Change

The present-law cash-out rule reflects a balancing of
various policies. On the one hand is the desire to assist
individuals to save for retirement by making it easier to keep
retirement funds in tax-favored vehicles. On the other hand is
the recognition that keeping track of small account balances of
former employees creates administrative burdens for plans.
The Committee is concerned that, in some cases, the cash-
out rule may discourage plans from accepting rollovers because
the rollover will increase participants' benefits to above the
cash-out amount, and increase administrative burdens. The
Committee believes that disregarding rollovers for purposes of
the cash-out rule will further the intent of the cash-out rule
by removing a possible disincentive for plans to accept
rollovers.

Explanation of Provision

A plan is permitted to provide that the present value of a
participant's nonforfeitable accrued benefit is determined
without regard to the portion of such benefit that is
attributable to rollover contributions (and any earnings
allocable thereto).

Effective Date

The provision is effective for distributions after December
31, 2001.
(g) Minimum distribution and inclusion requirements for
section 457 plans (Sec. 649 of the bill and Sec.
457 of the Code)

Present Law

A ``section 457 plan'' is an eligible deferred compensation
plan of a State or local government or tax-exempt employer that
meets certain requirements. For example, amounts deferred under
a section 457 plan cannot exceed certain limits. Amounts
deferred under a section 457 plan are generally includible in
income when paid or made available. Amounts deferred under a
plan of deferred compensation of a State or local government or
tax-exempt employer that does not meet the requirements of
section 457 are includible in income when theamounts are not
subject to a substantial risk of forfeiture, regardless of whether the
amounts have been paid or made available.\88\
---------------------------------------------------------------------------
\88\ This rule of inclusion does not apply to amounts deferred
under a tax-qualified retirement plan or similar plans.
---------------------------------------------------------------------------
Section 457 plans are subject to the minimum distribution
rules applicable to tax-qualified pension plans. In addition,
such plans are subject to additional minimum distribution rules
(Sec. 457(d)(2)(B)).

Reasons for Change

The Committee believes that the rules for timing of
inclusion of benefits under a governmental section 457 plan
should be conformed to the rules relating to qualified plans.
The Committee also believes that section 457 plans should be
subject to the same minimum distribution rules applicable to
qualified plans.

Explanation of Provision

The bill provides that amounts deferred under a section 457
plan of a State or local government are includible in income
when paid. The provision also repeals the special minimum
distribution rules applicable to section 457 plans. Thus, such
plans are subject to the minimum distribution rules applicable
to qualified plans.

Effective Date

The provision is effective for distributions after December
31, 2001.

4. Strengthening pension security and enforcement

(a) Phase-in repeal of 160 percent of current liability
funding limit; deduction for contributions to fund
termination liability (Secs. 651 and 652 of the
bill and Secs. 404(a)(1), 412(c)(7), and 4972(c) of
the Code)

Present Law

Under present law, defined benefit pension plans are
subject to minimum funding requirements designed to ensure that
pension plans have sufficient assets to pay benefits. A defined
benefit pension plan is funded using one of a number of
acceptable actuarial cost methods.
No contribution is required under the minimum funding rules
in excess of the full funding limit. The full funding limit is
generally defined as the excess, if any, of (1) the lesser of
(a) the accrued liability under the plan (including normal
cost) or (b) 160 percent of the plan's current liability, over
(2) the value of the plan's assets (Sec. 412(c)(7)).\89\ In
general, current liability is all liabilities to plan
participants and beneficiaries accrued to date, whereas the
accrued liability full funding limit is based on projected
benefits. The current liability full funding limit is scheduled
to increase as follows: 165 percent for plan years beginning in
2003 and 2004, and 170 percent for plan years beginning in 2005
and thereafter.\90\ In no event is a plan's full funding limit
less than 90 percent of the plan's current liability over the
value of the plan's assets.
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\89\ The minimum funding requirements, including the full funding
limit, are also contained in title I of ERISA.
\90\ As originally enacted in the Pension Protection Act of 1997,
the current liability full funding limit was 150 percent of current
liability. The Taxpayer Relief Act of 1997 increased the current
liability full funding limit to 155 percent in 1999 and 2000, 160
percent in 2001 and 2002, and adopted the scheduled increases described
in the text.
---------------------------------------------------------------------------
An employer sponsoring a defined benefit pension plan
generally may deduct amounts contributed to satisfy the minimum
funding standard for the plan year. Contributions in excess of
the full funding limit generally are not deductible. Under a
special rule, an employer that sponsors a defined benefit
pension plan (other than a multiemployer plan) which has more
than 100 participants for the plan year may deduct amounts
contributed of up to 100 percent of the plan's unfunded current
liability.

Reasons for Change

The Committee is concerned that the current liability full
funding limit, which focuses on current but not projected
benefits, may result in inadequate funding of pension plans and
thus jeopardize pension security. The Committee believes that
repealing the current liability full funding limit will
encourage responsible pension funding and help ensure that plan
participants receive promised benefits. Also, the Committee
believes that the special deduction rule should be expanded to
give more plan sponsors incentives to adequately fund their
plans.

Explanation of Provision

Current liability full funding limit

The provision gradually increases and then repeals the
current liability full funding limit. The current liability
full funding limit is 160 percent of current liability for plan
years beginning in 2002, 165 percent for plan years beginning
in 2003, and 170 percent for plan years beginning in 2004. The
current liability full funding limit is repealed for plan years
beginning in 2005 and thereafter. Thus, in 2005 and thereafter,
the full funding limit is the excess, if any, of (1) the
accrued liability under the plan (including normal cost), over
(2) the value of the plan's assets.

Deduction for contributions to fund termination liability

The special rule allowing a deduction for unfunded current
liability generally is extended to all defined benefit pension
plans, i.e., the provision applies to multiemployer plans and
plans with 100 or fewer participants. The special rule does not
apply to plans not covered by the PBGC termination insurance
program.\91\
---------------------------------------------------------------------------
\91\ The PBGC termination insurance program does not cover plans of
professional service employers that have fewer than 25 participants.
---------------------------------------------------------------------------
The provision also modifies the special rule by providing
that the deduction is for up to 100 percent of unfunded
termination liability, determined as if the plan terminated at
the end of the plan year. In the case of a plan with less than
100 participants for the plan year, termination liability does
not include the liability attributable to benefit increases for
highly compensated employees resulting from a plan amendment
which was made or became effective, whichever is later, within
the last two years.

Effective Date

The provision is effective for plan years beginning after
December 31, 2001.
(b) Excise tax relief for sound pension funding (Sec. 653
of the bill and Sec. 4972 of the Code)

Present Law

Under present law, defined benefit pension plans are
subject to minimum funding requirements designed to ensure that
pension plans have sufficient assets to pay benefits. A defined
benefit pension plan is funded using one of a number of
acceptable actuarial cost methods.
No contribution is required under the minimum funding rules
in excess of the full funding limit. The full funding limit is
generally defined as the excess, if any, of (1) the lesser of
(a) the accrued liability under the plan (including normal
cost) or (b) 160 percent of the plan's current liability, over
(2) the value of the plan's assets (Sec. 412(c)(7)). In
general, current liability is all liabilities to plan
participants and beneficiaries accrued to date, whereas the
accrued liability full funding limit is based on projected
benefits. The current liability full funding limit is scheduled
to increase as follows: 165 percent for plan years beginning in
2003 and 2004, and 170 percent for plan years beginning in 2005
and thereafter.\92\ In no event is a plan's full funding limit
less than 90 percent of the plan's current liability over the
value of the plan's assets.
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\92\ As originally enacted in the Pension Protection Act of 1997,
the current liability full funding limit was 150 percent of current
liability. The Taxpayer Relief Act of 1997 increased the current
liability full funding limit to 155 percent in 1999 and 2000, 160
percent in 2001 and 2002, and adopted the scheduled increases described
in the text. Another provision gradually increases and then repeals the
current liability full funding limit.
---------------------------------------------------------------------------
An employer sponsoring a defined benefit pension plan
generally may deduct amounts contributed to satisfy the minimum
funding standard for the plan year. Contributions in excess of
the full funding limit generally are not deductible. Under a
special rule, an employer that sponsors a defined benefit
pension plan (other than a multiemployer plan) which has more
than 100 participants for the plan year may deduct amounts
contributed of up to 100 percent of the plan's unfunded current
liability.
Present law also provides that contributions to defined
contribution plans are deductible, subject to certain
limitations.
Subject to certain exceptions, an employer that makes
nondeductible contributions to a plan is subject to an excise
tax equal to 10 percent of the amount of the nondeductible
contributions for the year. The 10-percent excise tax does not
apply to contributions to certain terminating defined benefit
plans. The 10-percent excise tax also does not apply to
contributions of up to six percent of compensation to a defined
contribution plan for employer matching and employee elective
deferrals.

Reasons for Change

The Committee believes that employers should be encouraged
to adequately fund their pension plans. Therefore, the
Committee does not believe that an excise tax should be imposed
on employer contributions that do not exceed the accrued
liability full funding limit.

Explanation of Provision

In determining the amount of nondeductible contributions,
the employer is permitted to elect not to take into account
contributions to a defined benefit pension plan except to the
extent they exceed the accrued liability full funding limit.
Thus, if an employer elects, contributions in excess of the
current liability full funding limit are not subject to the
excise tax on nondeductible contributions. An employer making
such an election for a year is not permitted to take advantage
of the present-law exceptions for certain terminating plans and
certain contributions to defined contribution plans.

Effective Date

The provision is effective for years beginning after
December 31, 2001.
(c) Modifications to section 415 limits for multiemployer
plans (Sec. 654 of the bill and Sec. 415 of the
Code)

Present Law

Under present law, limits apply to contributions and
benefits under qualified plans (Sec. 415). The limits on
contributions and benefits under qualified plans are based on
the type of plan.
Under a defined benefit plan, the maximum annual benefit
payable at retirement is generally the lesser of (1) 100
percent of average compensation for the highest three years, or
(2) $140,000 (for 2001). The dollar limit is adjusted for cost-
of-living increases in $5,000 increments. The dollar limit is
reduced in the case of retirement before the social security
retirement age and increases in the case of retirement after
the social security retirement age.
A special rule applies to governmental defined benefit
plans. In the case of such plans, the defined benefit dollar
limit is reduced in the case of retirement before age 62 and
increased in the case of retirement after age 65. In addition,
there is a floor on early retirement benefits. Pursuant to this
floor, the minimum benefit payable at age 55 is $75,000.
In the case of a defined contribution plan, the limit on
annual is additions if the lesser of (1) 25 percent of
compensation \93\ or (2) $35,000 (for 2001).
---------------------------------------------------------------------------
\93\ Another provision increases this limit to 100 percent of
compensation.
---------------------------------------------------------------------------
In applying the limits on contributions and benefits, plans
of the same employer are aggregated. That is, all defined
benefit plans of the same employer are treated as a single
plan, and all defined contribution plans of the same employer
are treated as a single plan. Under Treasury regulations,
multiemployer plans are not aggregated with other multiemployer
plans. However, if an employer maintains both a plan that is
not a multiemployer plan and a mulitemployer plan, the plan
that is not a multiemployer plan is aggregated with the
multiemployer plan to the extent that benefits provided under
the multiemployer plan are provided with respect to a common
participant.\94\
---------------------------------------------------------------------------
\94\ Treas. Reg. sec. 1.415-8(e).
---------------------------------------------------------------------------

Reasons for Change

The Committee understands that, because pension benefits
under multiemployer plans are typically based upon factors
other than compensation, the section 415 benefit limits
frequently result in benefit reductions for employees in
industries in which wages vary annually.

Explanation of Provision

Under the provision, the 100 percent of compensation
defined benefit plan limit does not apply to multiemployer
plans. With respect to aggregation of multiemployer plans with
other plans, the bill provides that multiemployer plans are not
aggregated with single-employer defined benefit plans
maintained by an employer contributing to the multiemployer
plan for purposes of applying the 100 percent of compensation
limit to such single-employer plan.

Effective Date

The provision is effective for years beginning after
December 31, 2001.
(d) Investment of employee contributions in 401(k) plans
(Sec. 655 of the bill and Sec. 1524(b) of the
Taxpayer Relief Act of 1997)

Present Law

The Employee Retirement Income Security Act of 1974, as
amended (``ERISA'') prohibits certain employee benefit plans
from acquiring securities or real property of the employer who
sponsors the plan if, after the acquisition, the fair market
value of such securities and property exceeds 10 percent of the
fair market value of plan assets. The 10-percent limitation
does not apply to any ``eligible individual account plans''
that specifically authorize such investments. Generally,
eligible individual account plans are defined contribution
plans, including plans containing a cash or deferred
arrangement (``401(k) plans'').
The term ``eligible individual account plan'' does not
include the portion of a plan that consists of elective
deferrals (and earnings on the elective deferrals) made under
section 401(k) if elective deferrals equal to more than one
percent of any employee's eligible compensation are required to
be invested in employer securities and employer real property.
Eligible compensation is compensation that is eligible to be
deferred under the plan. The portion of the plan that consists
of elective deferrals (and earnings thereon) is still treated
as an individual account plan, and the 10-percent limitation
does not apply, as long as elective deferrals (and earnings
thereon) are not required to be invested in employer securities
or employer real property.
The rule excluding elective deferrals (and earnings
thereon) from the definition of individual account plan does
not apply if individual account plans are a small part of the
employer's retirement plans. In particular, that rule does not
apply to an individual account plan for a plan year if the
value of the assets of all individual account plans maintained
by the employer do not exceed 10 percent of the value of the
assets of all pension plans maintained by the employer
(determined as of the last day of the preceding plan year).
Multiemployer plans are not taken into account in determining
whether the value of the assets of all individual account plans
maintained by the employer exceed 10 percent of the value of
the assets of all pension plans maintained by the employer. The
rule excluding elective deferrals (and earnings thereon) from
the definition of individual account plan does not apply to an
employee stock ownership plan as defined in section 4975(e)(7)
of the Internal Revenue Code.
The rule excluding elective deferrals (and earnings
thereon) from the definition of individual account plan applies
to elective deferrals for plan years beginning after December
31, 1998 (and earnings thereon). It does not apply with respect
to earnings on elective deferrals for plan years beginning
before January 1, 1999.

Reasons for Change

The Committee believes that the effective date provided in
the Taxpayer Relief Act of 1997 with respect to the rule
excluding elective deferrals (and earnings thereon) from the
definition of individual account plan has produced unintended
results.

Explanation of Provision

The provision modifies the effective date of the rule
excluding certain elective deferrals (and earnings thereon)
from the definition of individual account plan by providing
that the rule does not apply to any elective deferral used to
acquire an interest in the income or gain from employer
securities or employer real property acquired (1) before
January 1, 1999, or (2) after such date pursuant to a written
contract which was binding on such date and at all times
thereafter.

Effective Date

The provision is effective as if included in the section of
the Taxpayer Relief Act of 1997 that contained the rule
excluding certain elective deferrals (and earnings thereon).
(e) Prohibited allocations of stock in an S corporation
ESOP (Sec. 656 of the bill and Secs. 409 and 4979A
of the Code)

Present Law

The Small Business Job Protection Act of 1996 allowed
qualified retirement plan trusts described in section 401(a) to
own stock in an S corporation. That Act treated the plan's
share of the S corporation's income (and gain on the
disposition of the stock) as includible in full in the trust's
unrelated business taxable income (``UBTI'').
The Tax Relief Act of 1997 repealed the provision treating
items of income or loss of an S corporation as UBTI in the case
of an employee stock ownership plan (``ESOP''). Thus, the
income of an S corporation allocable to an ESOP is not subject
to current taxation.
Present law provides a deferral of income on the sales of
certain employer securities to an ESOP (Sec. 1042). A 50-
percent excise tax is imposed on certain prohibited allocations
of securities acquired by an ESOP in a transaction to which
section 1042 applies. In addition, such allocations are
currently includible in the gross income of the individual
receiving the prohibited allocation.

Reasons for Change

In enacting the 1996 Act provision allowing ESOPs to be
shareholders of S corporations, the Congress intended to
encourage employee ownership of closely-held businesses, and to
facilitate the establishment of ESOPs by S corporations. At the
same time, the Congress provided that all income flowing
through to an ESOP (or other tax-exempt S shareholder), and
gains and losses from the disposition of the stock, was treated
as unrelated business taxable income. This treatment was
consistent with the premise underlying the S corporation rules
that all income of an S corporation (including all gains of the
sale of the stock of the corporation) should be subject to a
shareholder-level tax.
In enacting the present-law rule relating to S corporation
ESOPs in 1997, the Congress was concerned that the 1996 Act
rule imposed double taxation on such ESOPs and ESOP
participants. The Congress believed such a result was
inappropriate. Since the enactment of the 1997 Act, however,
the Committee has become aware that the present-law rules allow
inappropriate deferral and possibly tax avoidance in some
cases.
The Committee continues to believe that S corporations
should be able to encourage employee ownership through an ESOP.
The Committee does not believe, however, that ESOPs should be
used by S corporations owners to obtain inappropriate tax
deferral or avoidance.
Specifically, the Committee believes that the tax deferral
opportunities provided by an S corporation ESOP should be
limited to those situations in which there is broad-based
employee coverage under the ESOP and the ESOP benefits rank-
and-file employees as well as highly compensated employees and
historical owners.

Explanation of Provision

In general

Under the provision, if there is a nonallocation year with
respect to an ESOP maintained by an S corporation: (1) the
amount allocated in a prohibited allocation to an individual
who is a disqualified person is treated as distributed to such
individual (i.e., the value of the prohibited allocation is
includible in the gross income of the individual receiving the
prohibited allocation); (2) an excise tax is imposed on the S
corporation equal to 50 percent of the amount involved in a
prohibited allocation; and (3) an excise tax is imposed on the
S corporation with respect to any synthetic equity owned by a
disqualified person.\95\
---------------------------------------------------------------------------
\95\ The plan is not disqualified merely because an excise tax is
imposed under the provision.
---------------------------------------------------------------------------
It is intended that the provision will limit the
establishment of ESOPs by S corporations to those that provide
broad-based employee coverage and that benefit rank-and-file
employees as well as highly compensated employees and
historical owners.

Definition of nonallocation year

A nonallocation year means any plan year of an ESOP holding
shares in an S corporation if, at any time during the plan
year, disqualified persons own at least 50 percent of the
number of outstanding shares of the S corporation.
A person is a disqualified person if the person is either
(1) a member of a ``deemed 20-percent shareholder group'' or
(2) a ``deemed 10-percent shareholder.'' A person is a member
of a ``deemed 20-percent shareholder group'' if the aggregate
number of deemed-owned shares of the person and his or her
family members is at least 20 percent of the number of deemed-
owned shares of stock in the S corporation.\96\ A person is a
deemed 10-percent shareholder if the person is not a member of
a deemed 20-percent shareholder group and the number of the
person's deemed-owned shares is at least 10 percent of the
number of deemed-owned shares of stock of the corporation.
---------------------------------------------------------------------------
\96\ A family member of a member of a ``deemed 20-percent
shareholder group'' with deemed owned shares is also treated as a
disqualified person.
---------------------------------------------------------------------------
In general, ``deemed-owned shares'' means: (1) stock
allocated to the account of an individual under the ESOP, and
(2) an individual's share of unallocated stock held by the
ESOP. An individual's share of unallocated stock held by an
ESOP is determined in the same manner as the most recent
allocation of stock under the terms of the plan.
For purposes of determining whether there is a
nonallocation year, ownership of stock generally is attributed
under the rules of section 318,\97\ except that: (1) the family
attribution rules is modified to include certain other family
members, as described below, (2) option attribution do not
apply (but instead special rules relating to synthetic equity
described below apply), and (3) ``deemed-owned shares'' held by
the ESOP are treated as held by the individual with respect to
whom they are deemed owned.
---------------------------------------------------------------------------
\97\ These attribution rules also apply to stock treated as owned
by reason of the ownership of synthetic equity.
---------------------------------------------------------------------------
Under the provision, family members of an individual
include (1) the spouse \98\ of the individual, (2) an ancestor
or lineal descendant of the individual or his or her spouse,
(3) a sibling of the individual (or the individual's spouse)
and any lineal descendant of the brother or sister, and (4) the
spouse of any person described in (2) or (3).
---------------------------------------------------------------------------
\98\ As under section 318, an individual's spouse is not treated as
a member of the individual's family if the spouses are legally
separated.
---------------------------------------------------------------------------
The provision contains special rules applicable to
synthetic equity interests. Except to the extent provided in
regulations, the stock on which a synthetic equity interest is
based is treated as outstanding stock of the S corporation and
as deemed-owned shares of the person holding the synthetic
equity interest if such treatment results in the treatment of
any person as a disqualified person or the treatment of any
year as a nonallocation year. Thus, for example, disqualified
persons for a year includes those individuals who are
disqualified persons under the general rule(i.e., treating only
those shares held by the ESOP as deemed-owned shares) and those
individuals who are disqualified individuals if synthetic equity
interests are treated as deemed-owned shares.
``Synthetic equity'' means any stock option, warrant,
restricted stock, deferred issuance stock right, or similar
interest that gives the holder the right to acquire or receive
stock of the S corporation in the future. Except to the extent
provided in regulations, synthetic equity also includes a stock
appreciation right, phantom stock unit, or similar right to a
future cash payment based on the value of such stock or
appreciation in such value.\99\
---------------------------------------------------------------------------
\99\ The provisions relating to synthetic equity do not modify the
rules relating to S corporations, e.g., the circumstances in which
options or similar interests are treated as creating a second class of
stock.
---------------------------------------------------------------------------
Ownership of synthetic equity is attributed in the same
manner as stock is attributed under the provision (as described
above). In addition, ownership of synthetic equity is
attributed under the rules of section 318(a)(2) and (3) in the
same manner as stock.

Definition of prohibited allocation

An ESOP of an S corporation is required to provide that no
portion of the assets of the plan attributable to (or allocable
in lieu of) S corporation stock may, during a nonallocation
year, accrue (or be allocated directly or indirectly under any
qualified plan of the S corporation) for the benefit of a
disqualified person. A ``prohibited allocation'' refers to
violations of this provision. A prohibited allocation occurs,
for example, if income on S corporation stock held by an ESOP
is allocated to the account of an individual who is a
disqualified person.

Application of excise tax

In the case of a prohibited allocation, the S corporation
is liable for an excise tax equal to 50 percent of the amount
of the allocation. For example, if S corporation stock is
allocated in a prohibited allocation, the excise tax equals 50
percent of the fair market value of such stock.
A special rule applies in the case of the first
nonallocation year, regardless of whether there is a prohibited
allocation. In that year, the excise tax also applies to the
fair market value of the deemed-owned shares of any
disqualified person held by the ESOP, even though those shares
are not allocated to the disqualified person in that year.
As mentioned above, the S corporation also is liable for an
excise tax with respect to any synthetic equity interest owned
by any disqualified person in a nonallocation year. The excise
tax is 50 percent of the value of the shares on which synthetic
equity is based.

Treasury regulations

The Treasury Department is given the authority to prescribe
such regulations as may be necessary to carry out the purposes
of the provision.

Effective Date

The provision generally is effective with respect to plan
years beginning after December 31, 2002. In the case of an ESOP
established after July 11, 2000, or an ESOP established on or
before such date if the employer maintaining the plan was not
an S corporation on such date, the provision is effective with
respect to plan years ending after July 11, 2000.
(f) Automatic rollovers of certain mandatory distributions
(Sec. 657 of the bill and Secs. 401(a)(31) and
402(f)(1) of the Code and Sec. 404(c) of ERISA)

Present Law

If a qualified retirement plan participant ceases to be
employed by the employer that maintains the plan, the plan may
distribute the participant's nonforfeitable accrued benefit
without the consent of the participant and, if applicable, the
participant's spouse, if the present value of the benefit does
not exceed $5,000. If such an involuntary distribution occurs
and the participant subsequently returns to employment covered
by the plan, then service taken into account in computing
benefits payable under the plan after the return need not
include service with respect to which a benefit was
involuntarily distributed unless the employee repays the
benefit.
Generally, a participant may roll over an involuntary
distribution from a qualified plan to an IRA or to another
qualified plan. Before making a distribution that is eligible
for rollover, a plan administrator must provide the participant
with a written explanation of the ability to have the
distribution rolled over directly to an IRA or another
qualified plan and the related tax consequences.

Reasons for Change

The Committee believes that present law does not adequately
encourage rollovers of involuntary distribution amounts.
Failure to roll over these amounts can significantly reduce the
retirement income that would otherwise be accumulated by
workers who change jobs frequently. The Committee believes that
making a direct rollover the default option for involuntary
distributions will increase the preservation of retirement
savings.

Explanation of Provision

The provision makes a direct rollover the default option
for involuntary distributions that exceed $1,000 and that are
eligible rollover distributions from qualified retirement
plans. The distribution must be rolled over automatically to a
designated IRA, unless the participant affirmatively elects to
have the distribution transferred to a different IRA or a
qualified plan or to receive it directly.
The written explanation provided by the plan administrator
is required to explain that an automatic direct rollover will
be made unless the participant elects otherwise. The plan
administrator is also required to notify the participant in
writing (as part of the general written explanation or
separately) that the distribution may be transferred without
cost to another IRA.
The provision amends the fiduciary rules of ERISA so that,
in the case of an automatic direct rollover, the participant is
treated as exercising control over the assets in the IRA upon
the earlier of (1) the rollover of any portion of the assets to
another IRA, or (2) one year after the automatic rollover.
The provision directs the Secretary of Labor to issue safe
harbors under which the designation of an institution and
investment of funds in accordance with the provision are deemed
to satisfy the requirements of section 404(a) of ERISA. In
addition, the provision authorizes and directs the Secretary of
the Treasury and the Secretary of Labor to give consideration
to providing special relief with respect to the use of low-cost
individual retirement plans for purposes of the provision and
for other uses that promote the preservation of tax-qualified
retirement assets for retirement income purposes.

Effective date

The provision applies to distributions that occur after the
Department of Labor has adopted final regulations implementing
the provision.
(g) Clarification of treatment of contributions to a
multiemployer plan (Sec. 658 of the bill)

Present Law

Employer contributions to one or more qualified retirement
plans are deductible subject to certain limits. In general,
contributions are deductible for the taxable year of the
employer in which the contributions are made. Under a special
rule, an employer may be deemed to have made a contribution on
the last day of the preceding taxable year if the contribution
is on account of the preceding taxable year and is made not
later than the time prescribed by law for filing the employer's
income tax return for that taxable year (including
extensions).\100\
---------------------------------------------------------------------------
\100\ Section 404(a)(6).
---------------------------------------------------------------------------
A change in method of accounting includes a change in the
overall plan of accounting for gross income or deductions or a
change in the treatment of any material item used in such
overall plan. A material item is any item that involves the
proper time for the inclusion of the item in income or taking
of a deduction.\101\ A change in method of accounting does not
include correction of mathematical or posting errors, or errors
in the computation of tax liability. Also, a change in method
of accounting does not include adjustment of any item of income
or deduction that does not involve the proper time for the
inclusion of the item of income or the taking of a deduction. A
change in method of accounting also does not include a change
in treatment resulting from a change in underlying facts.
---------------------------------------------------------------------------
\101\ Treas. Reg. sec. 1.446-1(e)(2)(ii)(a).
---------------------------------------------------------------------------

Reasons for Change

The Committee is aware that the interaction of the rules
regarding employer contributions to qualified retirement plans
and the rules regarding what constitutes a method of accounting
has resulted in some uncertainty for taxpayers. Specifically,
there is some uncertainty regarding whether the determination
of whether a contribution to a multiemployer pension plan is on
account of a prior year under section 404(a)(6) is considered a
method of accounting. The uncertainty regarding this issue has
resulted in disputes between taxpayers and the IRS that the
Committee believes can be avoided by eliminating the
uncertainty.

Explanation of Provision

The provision clarifies that a determination of whether
contributions to multiemployer pension plans are on account of
a prior year under section 404(a)(6) is not a method of
accounting. Thus, any taxpayer that begins to deduct
contributions to multiemployer plans as provided in section
404(a)(6) has not changed its method of accounting and is not
subject to an adjustment under section 481. The provision is
intended to respect, not disturb, the effect of the statute of
limitations. The provision is not intended to permit, as of the
end of the taxable year, aggregate deductions for contributions
to a qualified plan in excess of the amounts actually
contributed or deemed contributed to the plan by the taxpayer.
The Secretary of the Treasury is authorized to promulgate
regulations to clarify that, in the aggregate, no taxpayer will
be permitted deductions in excess of amounts actually
contributed to multiemployer plans, taking into account the
provisions of section 404(a)(6).
No inference is intended regarding whether the
determination of whether a contribution to a multiemployer
pension plan on account of a prior year under section 404(a)(6)
is a method of accounting prior to the effective date of the
provision.

Effective Date

The provision is effective after the date of enactment.
(h) Notice of significant reduction in plan benefit
accruals (Sec. 659 of the bill and new Sec. 4980F
of the Code)

Present Law

Section 204(h) of Title I of ERISA provides that a defined
benefit pension plan or a money purchase pension plan may not
be amended so as to provide for a significant reduction in the
rate of future benefit accrual, unless, after adoption of the
plan amendment and not less than 15 days before the effective
date of the plan amendment, the plan administrator provides a
written notice (``section 204(h) notice''), setting forth the
plan amendment (or a summary of the amendment written in a
manner calculated to be understood by the average plan
participant) and its effective date. The plan administrator
must provide the section 204(h) notice to each plan
participant, each alternate payee under an applicable qualified
domestic relations order (``QDRO''), and each employee
organization representing participants in the plan.
Theapplicable Treasury regulations \102\ provide, however, that a plan
administrator need not provide the section 204(h) notice to any
participant or alternate payee whose rate of future benefit accrual is
reasonably expected not to be reduced by the amendment, nor to an
employee organization that does not represent a participant to whom the
section 204(h) notice must be provided. In addition, the regulations
provide that the rate of future benefit accrual is determined without
regard to optional forms of benefit, early retirement benefits,
retirement-type subsidiaries, ancillary benefits, and certain other
rights and features.
---------------------------------------------------------------------------
\102\ Treas. Reg. sec. 1.411(d)-6.
---------------------------------------------------------------------------
A covered amendment generally will not become effective
with respect to any participants and alternate payees whose
rate of future benefit accrual is reasonably expected to be
reduced by the amendment but who do not receive a section
204(h) notice. An amendment will become effective with respect
to all participants and alternate payees to whom the section
204(h) notice was required to be provided if the plan
administrator (1) has made a good faith effort to comply with
the section 204(h) notice requirements, (2) has provided a
section 204(h) notice to each employee organization that
represents any participant to whom a section 204(h) notice was
required to be provided, (3) has failed to provide a section
204(h) notice to no more than a de minimis percentage of
participants and alternate payees to whom a section 204(h)
notice was required to be provided, and (4) promptly upon
discovering the oversight, provides a section 204(h) notice to
each omitted participant and alternate payee.
The Internal Revenue Code does not require any notice
concerning a plan amendment that provides for a significant
reduction in the rate of future benefit accrual.

Reasons for Change

The Committee is aware of recent significant publicity
concerning conversions of traditional defined benefit pension
plans to ``cash balance'' plans, with particular focus on the
impact such conversions have on affected workers. Several
legislative proposals have been introduced to address some of
the issues relating to such conversions.
The Committee believes that employees are entitled to
meaningful disclosure concerning plan amendments that may
result in reductions of future benefit accruals. The Committee
has determined that present law does not require employers to
provide such disclosure, particularly in cases where
traditional defined benefit plans are converted to cash balance
plans. The Committee also believes that any disclosure
requirements applicable to plan amendments should strike a
balance between providing meaningful disclosure and avoiding
the imposition of unnecessary administrative burdens on
employers, and that this balance may best be struck through the
regulatory process with an opportunity for input from affected
parties.
The Committee understands that there are other issues in
addition to disclosure that have arisen with respect to the
conversion of defined benefit plans to cash balance or other
hybrid plans, particularly situations in which plan
participants do not earn any additional benefit under the plan
for some time after conversion (called a ``wear away''). The
Committee believes that this issue should be further studied by
the Treasury in order to provide guidance to the Congress.

Explanation of Provision

The provision adds to the Internal Revenue Code a
requirement that the plan administrator of a defined benefit
pension plan furnish a written notice concerning a plan
amendment that provides for a significant reduction in the rate
of future benefit accrual, including any elimination or
reduction of an early retirement benefit or retirement-type
subsidy.\103\ The notice is required to set forth: (1) a
summary of the plan amendment and the effective date of the
amendment; (2) a statement that the amendment is expected to
significantly reduce the rate of future benefit accrual; (3) a
description of the classes of employees reasonably expected to
be affected by the reduction in the rate of future benefit
accrual; (4) examples illustrating the plan changes for these
classes of employees; (5) in the event of an amendment that
results in the significant restructuring of the plan benefit
formula, as determined under regulations prescribed by the
Secretary (a ``significant restructuring amendment''), a notice
that the plan administrator will provide, generally no later
than 15 days prior to the effective date of the amendment, a
``benefit estimation tool kit'' (described below) that will
enable employees who have completed at least one year of
participation to personalize the illustrative examples; and (6)
notice of each affected participant's right to request, and of
the procedures for requesting, an annual benefit statement as
provided under present law. The plan administrator is required
to provide the notice not less than 45 days before the
effective date of the plan amendment.
---------------------------------------------------------------------------
\103\ The provision also modifies the present-law notice
requirement contained in section 204(h) of Title I of ERISA to provide
that an applicable pension plan may not be amended to provide for a
significant reduction in the rate of future benefit accrual in the
event of a failure by the plan administrator to exercise due diligence
in meeting a notice requirement similar to the notice requirement that
the provision adds to the Internal Revenue Code. In addition, the
provision expands the current ERISA notice requirement regarding
significant reductions in normal retirement benefit accrual rates to
early retirement benefits and retirement-type subsidies.
---------------------------------------------------------------------------
The notice requirement does not apply to governmental plans
or church plans with respect to which an election to have the
qualified plan participation, vesting, and funding rules apply
has not been made (Sec. 410(d)).
The plan administrator is required to provide this
generalized notice to each affected participant and each
affected alternate payee. For purposes of the provision, an
affected participant or alternate payee is a participant or
alternate payee to whom the significant reduction in the rate
of future benefit accrual is reasonably expected to apply.
As noted above, the provision requires the plan
administrator to provide a benefit estimation tool kit, no
later than 15 days prior to the amendment effective date, to a
participant for whom the amendment may reasonably be expected
to produce a significant reduction in the rate of future
benefit accrual if the amendment is a significant restructuring
amendment. The plan administrator is not required to provide
this benefit estimation tool kit to any participant who has
less than one year of participation in the plan.
The benefit estimation tool kit is designed to enable
participants to estimate benefits under the old and new plan
provisions. The provision permits the tool kit to be in the
form ofsoftware (for use at home, at a workplace kiosk, or on a
company intranet), worksheets, or calculation instructions, or other
formats to be determined by the Secretary of the Treasury. The tool kit
is required to include any necessary actuarial assumptions and formulas
and to permit the participant to estimate both a single life annuity at
appropriate ages and, when available, a lump sum distribution. The tool
kit is required to disclose the interest rate used to compute a lump
sum distribution and whether the value of early retirement benefits is
included in the lump sum distribution.
The provision requires the benefit estimation tool kit to
accommodate employee-provided variables with respect to age,
years of service, retirement age, covered compensation, and
interest rate (when variable rates apply). The tool kit is
required to permit employees to recalculate estimated benefits
by changing the values of these variables. The provision does
not require the tool kit to accommodate employee variables with
respect to qualified domestic relations orders, factors that
result in unusual patterns of credited service (such as
extended time away from the job), special benefit formulas for
unusual situations, offsets from other plans, and forms of
annuity distributions.
In the case of a significant restructuring amendment that
occurs in connection with a business disposition or acquisition
transaction and within one year following the date of the
transaction, the provision requires the plan administrator to
provide the benefit estimation tool kit prior to the date that
is 12 months after the date on which the generalized notice of
the amendment is given to the affected participants.
The provision permits a plan administrator to provide any
notice required under the provision to a person designated in
writing by the individual to whom it would otherwise be
provided. In addition, the provision authorizes the Secretary
of the Treasury to allow any notice required under the
provision to be provided by using new technologies, provided
that at least one option for providing notice is not dependent
upon new technologies.
The provision imposes on a plan administrator that fails to
comply with the notice requirement an excise tax equal to $100
per day per omitted participant and alternate payee. No excise
tax is imposed during any period during which any person
subject to liability for the tax did not know that the failure
existed and exercised reasonable diligence to meet the notice
requirement. In addition, no excise tax is imposed on any
failure if any person subject to liability for the tax
exercised reasonable diligence to meet the notice requirement
and such person provides the required notice during the 30-day
period beginning on the first date such person knew, or
exercising reasonable diligence would have known, that the
failure existed. Also, if the person subject to liability for
the excise tax exercised reasonable diligence to meet the
notice requirement, the total excise tax imposed during a
taxable year of the employer will not exceed $500,000.
Furthermore, in the case of a failure due to reasonable cause
and not to willful neglect, the Secretary of the Treasury is
authorized to waive the excise tax to the extent that the
payment of the tax is excessive relative to the failure
involved.
The provision directs the Secretary of the Treasury to
issue, not later than one year after the date of enactment,
regulations with respect to early retirement benefits or
retirement-type subsidies, the determination of a significant
restructuring amendment, and the examples that are required
under the generalized notice and the benefit estimation tool
kit.
In addition, the provision directs the Secretary of the
Treasury to prepare a report on the effects of significant
restructurings of plan benefit formulas of traditional defined
benefit plans. Such study is to examine the effect of such
restructurings on longer service participants, including the
incidence and effects of ``wear away'' provisions under which
participants earn no additional benefits for a period of time
after the restructuring. The Secretary is directed to submit
such report, together with recommendations thereon, to the
Committee on Ways and Means and the Committee on Education and
the Workforce of the House of Representatives and the Committee
on Finance and the Committee on Health, Education, Labor, and
Pensions of the Senate as soon as practicable, but not later
than one year after the date of enactment.

Effective Date

The provision is effective for plan amendments taking
effect on or after the date of enactment. The period for
providing any notice required under the provision will not end
before the last day of the 3-month period following the date of
enactment. Prior to the issuance of Treasury regulations, a
plan is treated as meeting the requirements of the provision if
the plan makes a good faith effort to comply with such
requirements.

5. Reducing regulatory burdens

(a) Modification of timing of plan valuations (Sec. 661 of
the bill and Sec. 412 of the Code)

Present Law

Under present law, plan valuations are generally required
annually for plans subject to the minimum funding rules. Under
proposed Treasury regulations, except as provided by the
Commissioner, the valuation must be as of a date within the
plan year to which the valuation refers or within the month
prior to the beginning of that year.\104\
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\104\ Prop. Treas. Reg. sec. 1.412(c)(9)-1(b)(1).
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Reasons for Change

While plan valuations are necessary to ensure adequate
funding of defined benefit pension plans, they also create
administrative burdens for employers. The Committee believes
that permitting limited elections to use as the valuation date
for a plan year any date within the immediately preceding plan
year in the case of well-funded plans strikes an appropriate
balance between funding concerns and employer concerns about
plan administrative burdens.

Explanation of Provision

The provision incorporates into the statute the proposed
regulation regarding the date of valuations. The provision also
provides, as an exception to this general rule, that the
valuation date with respect to a plan year may be any date
within the immediately preceding plan year if, as of such date,
plan assets are not less than 125 percent of the plan's current
liability. Information determined as of such date is required
to be adjusted actuarially, in accordance withTreasury
regulations, to reflect significant differences in plan participants.
An election to use a prior plan year valuation date, once made, could
only be revoked with the consent of the Secretary.

Effective Date

The provision is effective for plan years beginning after
December 31, 2001.
(b) ESOP dividends may be reinvested without loss of
dividend deduction (Sec. 662 of the bill and Sec.
404 of the Code)

Present Law

An employer is entitled to deduct certain dividends paid in
cash during the employer's taxable year with respect to stock
of the employer that is held by an employee stock ownership
plan (``ESOP''). The deduction is allowed with respect to
dividends that, in accordance with plan provisions, are (1)
paid in cash directly to the plan participants or their
beneficiaries, (2) paid to the plan and subsequently
distributed to the participants or beneficiaries in cash no
later than 90 days after the close of the plan year in which
the dividends are paid to the plan, or (3) used to make
payments on loans (including payments of interest as well as
principal) that were used to acquire the employer securities
(whether or not allocated to participants) with respect to
which the dividend is paid.
The Secretary may disallow the deduction for any ESOP
dividend if he determines that the dividend constitutes, in
substance, an evasion of taxation (Sec. 404(k)(5)).

Reasons for Change

The Committee believes that it is appropriate to provide
incentives for the accumulation of retirement benefits and
expansion of employee ownership. The Committee has determined
that the present-law rules concerning the deduction of
dividends on employer stock held by an ESOP discourage
employers from permitting such dividends to be reinvested in
employer stock and accumulated for retirement purposes.

Explanation of Provision

In addition to the deductions permitted under present law
for dividends paid with respect to employer securities that are
held by an ESOP, an employer is entitled to deduct the
applicable percentage of dividends that, at the election of
plan participants or their beneficiaries, are (1) payable in
cash directly to plan participants or beneficiaries, (2) paid
to the plan and subsequently distributed to the participants or
beneficiaries in cash no later than 90 days after the close of
the plan year in which the dividends are paid to the plan, or
(3) paid to the plan and reinvested in qualifying employer
securities. The applicable percentage is 25 percent for 2002
through 2004, 50 percent for 2005 through 2007, 75 percent for
2008 through 2010 and 100 percent for 2011 and thereafter.

Effective Date

The provision is effective for taxable years beginning
after December 31, 2001.
(c) Repeal transition rule relating to certain highly
compensated employees (Sec. 663 of the bill and
Sec. 1114(c)(4) of the Tax Reform Act of 1986)

Present Law

Under present law, for purposes of the rules relating to
qualified plans, a highly compensated employee is generally
defined as an employee \105\ who (1) was a five-percent owner
of the employer at any time during the year or the preceding
year or (2) either (a) had compensation for the preceding year
in excess of $85,000 (for 2001) or (b) at the election of the
employer, had compensation in excess of $85,000 for the
preceding year and was in the top 20 percent of employees by
compensation for such year.
---------------------------------------------------------------------------
\105\ An employee includes a self-employed individual.
---------------------------------------------------------------------------
Under a rule enacted in the Tax Reform Act of 1986, a
special definition of highly compensated employee applies for
purposes of the nondiscrimination rules relating to qualified
cash or deferred arrangements (``section 401(k) plans'') and
matching contributions. This special definition applies to an
employer incorporated on December 15, 1924, that meets certain
specific requirements.

Reasons for Change

The Committee believes it appropriate to repeal the special
definition of highly compensated employee in light of the
substantial modification of the general definition of highly
compensated employee in the Small Business Job Protection Act
of 1996.

Explanation of Provision

The provision repeals the special definition of highly
compensated employee under the Tax Reform Act of 1986. Thus,
the present-law definition applies.

Effective Date

The provision is effective for plan years beginning after
December 31, 2001.
(d) Employees of tax-exempt entities (Sec. 664 of the bill)

Present Law

The Tax Reform Act of 1986 provided that nongovernmental
tax-exempt employers were not permitted to maintain a qualified
cash or deferred arrangement (``section 401(k) plan''). This
prohibition was repealed, effective for years beginning after
December 31, 1996, by the Small Business Job Protection Act of
1996.
Treasury regulations provide that, in applying the
nondiscrimination rules to a section 401(k) plan (or a section
401(m) plan that is provided under the same general arrangement
as the section 401(k) plan), the employer may treat as
excludable those employees of a tax-exempt entity who could not
participate in the arrangement due to the prohibition on
maintenance of a section 401(k) plan by such entities. Such
employees may be disregarded only if more than 95 percent of
the employees who could participate in the section 401(k) plan
benefit under the plan for the plan year.\106\
---------------------------------------------------------------------------
\106\ Treas. Reg. sec. 1.410(b)-6(g).
---------------------------------------------------------------------------
Tax-exempt charitable organizations may maintain a tax-
sheltered annuity (a ``section 403(b) annuity'') that allows
employees to make salary reduction contributions.

Reasons for Change

The Committee believes it appropriate to modify the special
rule regarding the treatment of certain employees of a tax-
exempt organization as excludable for section 401(k) plan
nondiscrimination testing purposes in light of the provision of
the Small Business Job Protection Act of 1996 that permits such
organizations to maintain section 401(k) plans.

Explanation of Provision

The Treasury Department is directed to revise its
regulations under section 410(b) to provide that employees of a
tax-exempt charitable organization who are eligible to make
salary reduction contributions under a section 403(b) annuity
may be treated as excludable employees for purposes of testing
a section 401(k) plan, or a section 401(m) plan that is
provided under the same general arrangement as the section
401(k) plan of the employer if (1) no employee of such tax-
exempt entity is eligible to participate in the section 401(k)
or 401(m) plan and (2) at least 95 percent of the employees who
are not employees of the charitable employer are eligible to
participate in such section 401(k) plan or section 401(m) plan.
The revised regulations will be effective for years
beginning after December 31, 1996.

Effective Date

The provision is effective on the date of enactment.
(e) Treatment of employer-provided retirement advice (Sec.
665 of the bill and Sec. 132 of the Code)

Present Law

Under present law, certain employer-provided fringe
benefits are excludable from gross income (Sec. 132) and wages
for employment tax purposes. These excludable fringe benefits
include working condition fringe benefits and de minimis
fringes. In general, a working condition fringe benefit is any
property or services provided by an employer to an employee to
the extent that, if the employee paid for such property or
services, such payment is allowable as a deduction as a
business expense. A de minimis fringe benefit is any property
or services provided by the employer the value of which, after
taking into account the frequency with which similar fringes
are provided, is so small as to make accounting for it
unreasonable or administratively impracticable.
In addition, if certain requirements are satisfied, up to
$5,250 annually of employer-provided educational assistance is
excludable from gross income (Sec. 127) and wages. This
exclusion expires with respect to courses beginning after
December 31, 2001.\107\ Education not excludable under section
127 may be excludable as a working condition fringe.
---------------------------------------------------------------------------
\107\ The exclusion does not apply with respect to graduate-level
courses.
---------------------------------------------------------------------------
There is no specific exclusion under present law for
employer-provided retirement planning services. However, such
services may be excludable as employer-provided educational
assistance or a fringe benefit.

Reasons for Change

In order to plan adequately for retirement, individuals
must anticipate retirement income needs and understand how
their retirement income goals can be achieved. Employer-
sponsored plans are a key part of retirement income planning.
The Committee believes that employers sponsoring retirement
plans should be encouraged to provide retirement planning
services for their employees in order to assist them in
preparing for retirement.

Explanation of Provision

Qualified retirement planning services provided to an
employee and his or her spouse by an employer maintaining a
qualified plan are excludable from income and wages. The
exclusion does not apply with respect to highly compensated
employees unless the services are available on substantially
the same terms to each member of the group of employees
normally provided education and information regarding the
employer's qualified plan. The exclusion is intended to allow
employers to provide advice and information regarding
retirement planning. The exclusion is not limited to
information regarding the qualified plan, and, thus, for
example, applies to advice and information regarding retirement
income planning for an individual and his or her spouse and how
the employer's plan fits into the individual's overall
retirement income plan. On the other hand, the exclusion is not
intended to apply to services that may be related to retirement
planning, such as tax preparation, accounting, legal or
brokerage services.

Effective Date

The provision is effective with respect to taxable years
beginning after December 31, 2001.
(f) Reporting simplification (Sec. 666 of the bill)

Present Law

A plan administrator of a pension, annuity, stock bonus,
profit-sharing or other funded plan of deferred compensation
generally must file with the Secretary of the Treasury an
annual return for each plan year containing certain information
with respect to the qualification, financial condition, and
operation of the plan. Title I of ERISA also may require the
plan administrator to file annual reports concerning the plan
with the Department of Labor and the Pension Benefit Guaranty
Corporation (``PBGC''). The plan administrator must use the
Form 5500 series as the format for the required annual
return.\108\ The Form 5500 series annual return/report, which
consists of a primary form and various schedules, includes the
information required to be filed with all three agencies. The
plan administrator satisfies the reporting requirement with
respect to each agency by filing the Form 5500 series annual
return/report with the Department of Labor, which forwards the
form to the Internal Revenue Service and the PBGC.
---------------------------------------------------------------------------
\108\ Treas. Reg. sec. 301.6058-1(a).
---------------------------------------------------------------------------
The Form 5500 series consists of two different forms: Form
5500 and Form 5500-EZ. Form 5500 is the more comprehensive of
the forms and requires the most detailed financial information.
A plan administrator generally may file Form 5500-EZ, which
consists of only one page, if (1) the only participants in the
plan are the sole owner of a business that maintains the plan
(and such owner's spouse), or partners in a partnership that
maintains the plan (and such partners' spouses), (2) the plan
is not aggregated with another plan in order to satisfy the
minimum coverage requirements of section 410(b), (3) the
employer is not a member of a related group of employers, and
(4) the employer does not receive the services of leased
employees. If the plan satisfies the eligibility requirements
for Form 5500-EZ and the total value of the plan assets as of
the end of the plan year and all prior plan years beginning on
or after January 1, 1994, does not exceed $100,000, the plan
administrator is not required to file a return.
With respect to a plan that does not satisfy the
eligibility requirements for Form 5500-EZ, the characteristics
and the size of the plan determine the amount of detailed
financial information that the plan administrator must provide
on Form 5500. If the plan has more than 100 participants at the
beginning of the plan year, the plan administrator generally
must provide more information.

Reasons for Change

The Committee believes that it is appropriate to simplify
the reporting requirements for plans eligible to file Form
5500-EZ, because such plans do not cover any employees of the
business owner.

Explanation of Provision

The Secretary of the Treasury is directed to modify the
annual return filing requirements with respect to plans that
satisfy the eligibility requirements for Form 5500-EZ to
provide that if the total value of the plan assets of such a
plan as of the end of the plan year and all prior plan years
beginning on or after January 1, 1994, does not exceed
$250,000, the plan administrator is not required to file a
return.

Effective Date

The provision is effective on January 1, 2002.
(g) Improvement to Employee Plans Compliance Resolution
System (Sec. 667 of the bill)

Present Law

A retirement plan that is intended to be a tax-qualified
plan provides retirement benefits on a tax-favored basis if the
plan satisfies all of the requirements of section 401(a).
Similarly, an annuity that is intended to be a tax-sheltered
annuity provides retirement benefits on a tax-favored basis if
the program satisfies all of the requirements of section
403(b). Failure to satisfy all of the applicable requirements
of section 401(a) or section 403(b) may disqualify a plan or
annuity for the intended tax-favored treatment.
The Internal Revenue Service (``IRS'') has established the
Employee Plans Compliance Resolution System (``EPCRS''), which
is a comprehensive system of correction programs for sponsors
of retirement plans and annuities that are intended, but have
failed, to satisfy the requirements of section 401(a), section
403(a), or section 403(b), as applicable.\109\ EPCRS permits
employers to correct compliance failures and continue to
provide their employees with retirement benefits on a tax-
favored basis.
---------------------------------------------------------------------------
\109\ Rev. Proc. 2001-17, 2001-7 I.R.B. 589.
---------------------------------------------------------------------------
The IRS has designed EPCRS to (1) encourage operational and
formal compliance, (2) promote voluntary and timely correction
of compliance failures, (3) provide sanctions for compliance
failures identified on audit that are reasonable in light of
the nature, extent, and severity of the violation, (4) provide
consistent and uniform administration of the correction
programs, and (5) permit employers to rely on the availability
of EPCRS in taking corrective actions to maintain the tax-
favored status of their retirement plans and annuities.
The basic elements of the programs that comprise EPCRS are
self-correction, voluntary correction with IRS approval, and
correction on audit. The Self-Correction Program (``SCP'')
generally permits a plan sponsor that has established
compliance practices to correct certain insignificant failures
at any time (including during an audit), and certain
significant failures within a 2-year period, without payment of
any fee or sanction. The Voluntary Correction Program (``VCP'')
program permits an employer, at any time before an audit, to
pay a limited fee and receive IRS approval of a correction. For
a failure that is discovered on audit and corrected, the Audit
Closing Agreement Program (``Audit CAP'') provides for a
sanction that bears a reasonable relationship to the nature,
extent, and severity of the failure and that takes into account
the extent to which correction occurred before audit.
The IRS has expressed its intent that EPCRS will be updated
and improved periodically in light of experience and comments
from those who use it.

Reasons for Change

The Committee commends the IRS for the establishment of
EPCRS and agrees with the IRS that EPCRS should be updated and
improved periodically. The Committee believes that future
improvements should facilitate use of the compliance and
correction programs by small employers and expand the
flexibility of the programs.

Explanation of Provision

The Secretary of the Treasury is directed to continue to
update and improve EPCRS, giving special attention to (1)
increasing the awareness and knowledge of small employers
concerning the availability and use of EPCRS, (2) taking into
account special concerns and circumstances that small employers
face with respect to compliance and correction of compliance
failures, (3) extending the duration of the self-correction
period under SCP for significant compliance failures, (4)
expanding the availability to correct insignificant compliance
failures under SCP during audit, and (5) assuring that any tax,
penalty, or sanction that is imposed by reason of a compliance
failure is not excessive and bears a reasonable relationship to
the nature, extent, and severity of the failure.

Effective Date

The provision is effective on the date of enactment.
(h) Repeal of the multiple use test (Sec. 668 of the bill
and Sec. 401(m) of the Code)

Present Law

Elective deferrals under a qualified cash or deferred
arrangement (``section 401(k) plan'') are subject to a special
annual nondiscrimination test (``ADP test''). The ADP test
compares the actual deferral percentages (``ADPs'') of the
highly compensated employee group and the nonhighly compensated
employee group. The ADP for each group generally is the average
of the deferral percentages separately calculated for the
employees in the group who are eligible to make elective
deferrals for all or a portion of the relevant plan year. Each
eligible employee's deferral percentage generally is the
employee's elective deferrals for the year divided by the
employee's compensation for the year.
The plan generally satisfies the ADP test if the ADP of the
highly compensated employee group for the current plan year is
either (1) not more than 125 percent of the ADP of the
nonhighly compensated employee group for the prior plan year,
or (2) not more than 200 percent of the ADP of the nonhighly
compensated employee group for the prior plan year and not more
than two percentage points greater than the ADP of the
nonhighly compensated employee group for the prior plan year.
Employer matching contributions and after-tax employee
contributions under a defined contribution plan also are
subject to a special annual nondiscrimination test (``ACP
test''). The ACP test compares the actual deferral percentages
(``ACPs'') of the highly compensated employee group and the
nonhighly compensated employee group. The ACP for each group
generally is the average of the contribution percentages
separately calculated for the employees in the group who are
eligible to make after-tax employee contributions or who are
eligible for an allocation of matching contributions for all or
a portion of the relevant plan year. Each eligible employee's
contribution percentage generally is the employee's aggregate
after-tax employee contributions and matching contributions for
the year divided by the employee's compensation for the year.
The plan generally satisfies the ACP test if the ACP of the
highly compensated employee group for the current plan year is
either (1) not more than 125 percent of the ACP of the
nonhighly compensated employee group for the prior plan year,
or (2) not more than 200 percent of the ACP of the nonhighly
compensated employee group for the prior plan year and not more
than two percentage points greater than the ACP of the
nonhighly compensated employee group for the prior plan year.
For any year in which (1) at least one highly compensated
employee is eligible to participate in an employer's plan or
plans that are subject to both the ADP test and the ACP test,
(2) the plan subject to the ADP test satisfies the ADP test but
the ADP of the highly compensated employee group exceeds 125
percent of the ADP of the nonhighly compensated employee group,
and (3) the plan subject to the ACP test satisfies the ACP test
but the ACP of the highly compensated employee group exceeds
125 percent of the ACP of the nonhighly compensated employee
group, an additional special nondiscrimination test (``multiple
use test'') applies to the elective deferrals, employer
matching contributions, and after-tax employee contributions.
The plan or plans generally satisfy the multiple use test if
the sum of the ADP and the ACP of the highly compensated
employee group does not exceed the greater of (1) the sum of
(A) 1.25 times the greater of the ADP or the ACP of the
nonhighly compensated employee group, and (B) two percentage
points plus (but not more than two times) the lesser of the ADP
or the ACP of the nonhighly compensated employee group, or (2)
the sum of (A) 1.25 times the lesser of the ADP or the ACP of
the nonhighly compensated employee group, and (B) two
percentage points plus (but not more than two times) the
greater of the ADP or the ACP of the nonhighly compensated
employee group.

Reasons for Change

The Committee believes that the ADP test and the ACP test
are adequate to prevent discrimination in favor of highly
compensated employees under 401(k) plans and has determined
that the multiple use test unnecessarily complicates 401(k)
plan administration.

Explanation of Provision

The provision repeals the multiple use test.

Effective Date

The provision is effective for years beginning after
December 31, 2001.
(i) Flexibility in nondiscrimination, coverage, and line of
business rules (Sec. 669 of the bill and Secs.
401(a)(4), 410(b), and 414(r) of the Code)

Present Law

A plan is not a qualified retirement plan if the
contributions or benefits provided under the plan discriminate
in favor of highly compensated employees (Sec. 401(a)(4)). The
applicable Treasury regulations set forth the exclusive rules
for determining whether a plan satisfies the nondiscrimination
requirement. These regulations state that the form of the plan
and the effect of the plan in operation determine whether the
plan is nondiscriminatory and that intent is irrelevant.
Similarly, a plan is not a qualified retirement plan if the
plan does not benefit a minimum number of employees (Sec.
410(b)). A plan satisfies this minimum coverage requirement if
and only if it satisfies one of the tests specified in the
applicable Treasury regulations. If an employer is treated as
operating separate lines of business, the employer may apply
the minimum coverage requirements to a plan separately with
respect to the employees in each separate line of business
(Sec. 414(r)). Under a so-called ``gateway'' requirement,
however, the plan must benefit a classification of employees
that does not discriminate in favor of highly compensated
employees in order for the employer to apply the minimum
coverage requirements separately for the employees in each
separate line of business. A plan satisfies this gateway
requirement only if it satisfies one of the tests specified in
the applicable Treasury regulations.

Reasons for Change

It has been brought to the attention of the Committee that
some plans are unable to satisfy the mechanical tests used to
determine compliance with the nondiscrimination and line of
business requirements solely as a result of relatively minor
plan provisions. The Committee believes that, in such cases, it
may be appropriate to expand the consideration of facts and
circumstances in the application of the mechanical tests.

Explanation of Provision

The Secretary of the Treasury is directed to modify, on or
before December 31, 2001, the existing regulations issued under
section 414(r) in order to expand (to the extent that the
Secretary may determine to be appropriate) the ability of a
plan to demonstrate compliance with the line of business
requirements based upon the facts and circumstances surrounding
the design and operation of the plan, even though the plan is
unable to satisfy the mechanical tests currently used to
determine compliance.
The Secretary of the Treasury is directed to provide by
regulation applicable to years beginning after December 31,
2001, that a plan is deemed to satisfy the nondiscrimination
requirements of section 401(a)(4) if the plan satisfies the
pre-1994 facts and circumstances test, satisfies the conditions
prescribed by the Secretary to appropriately limit the
availability of such test, and is submitted to the Secretary
for a determination of whether it satisfies such test (to the
extent provided by the Secretary).
Similarly, a plan is deemed to comply with the minimum
coverage requirement of section 410(b) if the plan satisfies
the pre-1989 coverage rules, is submitted to the Secretary for
a determination of whether it satisfies the pre-1989 coverage
rules (to the extent provided by the Secretary), and satisfies
conditions prescribed by the Secretary by regulation that
appropriately limit the availability of the pre-1989 coverage
rules.

Effective Date

The provision relating to the line of business requirements
under section 414(r) is effective on the date of enactment. The
provision relating to the nondiscrimination requirements under
section 401(a)(4) is effective on the date of enactment, except
that any condition of availability prescribed by the Secretary
is not effective before the first year beginning not less than
120 days after the date on which such condition is prescribed.
The provision relating to the minimum coverage requirements
under section 410(b) is effective for years beginning after
December 31, 2001, except that any condition of availability
prescribed by the Secretary by regulation will not apply before
the first year beginning not less than 120 days after the date
on which such condition is prescribed.
(j) Extension to all governmental plans of moratorium on
application of certain nondiscrimination rules
applicable to State and local government plans
(Sec. 670 of the bill, sec. 1505 of the Taxpayer
Relief Act of 1997, and Secs. 401(a) and 401(k) of
the Code)

Present Law

A qualified retirement plan maintained by a State or local
government is exempt from the rules concerning
nondiscrimination (Sec. 401(a)(4)) and minimum participation
(Sec. 401(a)(26)). All other governmental plans are not exempt
from the nondiscrimination and minimum participation rules.

Reasons for Change

The Committee believes that application of the
nondiscrimination and minimum participation rules to
governmental plans is unnecessary and inappropriate in light of
the unique circumstances under which such plans and
organizations operate. Further, the Committee believes that it
is appropriate to provide for consistent application of the
minimum coverage, nondiscrimination, and minimum participation
rules for governmental plans.

Explanation of Provision

The provision exempts all governmental plans (as defined in
sec. 414(d)) from the nondiscrimination and minimum
participation rules.

Effective Date

The provision is effective for plan years beginning after
December 31, 2001.

6. Other ERISA provisions

(a) Extension of PBGC missing participants program (Sec.
681 of the bill and Secs. 206(f) and 4050 of ERISA)

Present Law

The plan administrator of a defined benefit pension plan
that is subject to Title IV of ERISA, is maintained by a single
employer, and terminates under a standard termination is
required to distribute the assets of the plan. With respect to
a participant whom the plan administrator of a single employer
plan cannot locate after a diligent search, the plan
administrator satisfies the distribution requirement only by
purchasing irrevocable commitments from an insurer to provide
all benefit liabilities under the plan or transferring the
participant's designated benefit to the Pension Benefit
Guaranty Corporation (``PBGC''), which holds the benefit of the
missing participant as trustee until the PBGC locates the
missing participant and distributes the benefit.
The PBGC missing participant program is not available to
multiemployer plans or defined contribution plans and other
plans not covered by Title IV of ERISA.

Reasons for Change

The Committee recognizes that no statutory provision or
formal regulatory guidance exists concerning an appropriate
method of handling missing participants in terminated
multiemployer plans or defined contribution plans and other
plans not subject to the PBGC termination insurance program.
Therefore, sponsors of these plans face uncertainty with
respect to missing participants. The Committee believes that it
is appropriate to extend the established PBGC missing
participant program to these plans in order to reduce
uncertainty for plan sponsors and increase the likelihood that
missing participants will receive their retirement benefits.

Explanation of Provision

The provision directs the PBGC to prescribe for terminating
multiemployer plans rules similar to the present-law missing
participant rules applicable to terminating single employer
plans that are subject to Title IV of ERISA.
In addition, plan administrators of certain types of plans
not subject to the PBGC termination insurance program under
present law are permitted, but not required, to elect to
transfer missing participants' benefits to the PBGC upon plan
termination. Specifically, the provision extends the missing
participants program to defined contribution plans, defined
benefit plans that have no more than 25 active participants and
are maintained by professional service employers, and the
portion of defined benefit plans that provide benefits based
upon the separate accounts of participants and therefore are
treated as defined contribution plans under ERISA.

Effective Date

The provision is effective for distributions from
terminating plans that occur after the PBGC has adopted final
regulations implementing the provision.
(b) Reduce PBGC premiums for small and new plans (Secs. 682
and 683 of the bill and Sec. 4006 of ERISA)

Present Law

Under present law, the Pension Benefit Guaranty Corporation
(``PBGC'') provides insurance protection for participants and
beneficiaries under certain defined benefit pension plans by
guaranteeing certain basic benefits under the plan in the event
the plan is terminated with insufficient assets to pay benefits
promised under the plan. The guaranteed benefits are funded in
part by premium payments from employers who sponsor defined
benefit plans. The amount of the required annual PBGC premium
for a single-employer plan is generally a flat rate premium of
$19 per participant and an additional variable-rate premium
based on a charge of $9 per $1,000 of unfunded vested benefits.
Unfunded vested benefits under a plan generally means (1) the
unfunded current liability for vested benefits under the plan,
over (2) the value of the plan's assets, reduced by any credit
balance in the funding standard account. No variable-rate
premium is imposed for a year if contributions to the plan were
at least equal to the full funding limit.
The PBGC guarantee is phased-in ratably in the case of
plans that have been in effect for less than five years, and
with respect to benefit increases from a plan amendment that
was in effect for less than five years before termination of
the plan.

Reasons for Change

The Committee believes that reducing the PBGC premiums for
new plans and small plans will help encourage the establishment
of defined benefit pension plans, particularly by small
employers.

Explanation of Provision

Reduced flat-rate premiums for new plans of small employers

Under the provision, for the first five plan years of a new
single-employer plan of a small employer, the flat-rate PBGC
premium is $5 per plan participant.
A small employer is a contributing sponsor that, on the
first day of the plan year, has 100 or fewer employees. For
this purpose, all employees of the members of the controlled
group of the contributing sponsor are taken into account. In
the case of a plan to which more than one unrelated
contributing sponsor contributes, employees of all contributing
sponsors (and their controlled group members) are taken into
account in determining whether the plan is a plan of a small
employer.
A new plan means a defined benefit plan maintained by a
contributing sponsor if, during the 36-month period ending on
the date of adoption of the plan, such contributing sponsor (or
controlled group member or a predecessor of either) has not
established or maintained a plan subject to PBGC coverage with
respect to which benefits were accrued for substantially the
same employees as are in the new plan.

Reduced variable-rate PBGC premium for new plans

The bill provides that the variable-rate premium is phased-
in for new defined benefit plans over a six-year period
starting with the plan's first plan year. The amount of the
variable-rate premium is a percentage of the variable premium
otherwise due, as follows: 0 percent of the otherwise
applicable variable-rate premium in the first plan year; 20
percent in the second plan year; 40 percent in the third plan
year; 60 percent in the fourth plan year; 80 percent in the
fifth plan year; and 100 percent in the sixth plan year (and
thereafter).
A new defined benefit plan is defined as described above
under the flat-rate premium provision relating to new small
employer plans.

Reduced variable-rate PBGC premium for small plans

In the case of a plan of a small employer, the variable-
rate premium is no more than $5 multiplied by the number of
plan participants in the plan at the end of the preceding plan
year. For purposes of the provision, a small employer is a
contributing sponsor that, on the first day of the plan year,
has 25 or fewer employees. For this purpose, all employees of
the members of the controlled group of the contributing sponsor
are taken into account. In the case of a plan to which more
than one unrelated contributing sponsor contributes, employees
of all contributing sponsors (and their controlled group
members) are taken into account in determining whether the plan
is a plan of a small employer.

Effective date

The reduction of the flat-rate premium for new plans of
small employers and the reduction of the variable-rate premium
for new plans is effective with respect to plans established
after December 31, 2001. The reduction of the variable-rate
premium for small plans is effective with respect to plan years
beginning after December 31, 2001.
(c) Authorization for PBGC to pay interest on premium
overpayment refunds (Sec. 684 of the bill and Sec.
4007(b) of ERISA)

Present Law

The PBGC charges interest on underpayments of premiums, but
is not authorized to pay interest on overpayments.

Reasons for Change

The Committee believes that an employer or other person who
overpays PBGC premiums should receive interest on a refund of
the overpayment.

Explanation of Provision

The provision allows the PBGC to pay interest on
overpayments made by premium payors. Interest paid on
overpayments is calculated at the same rate and in the same
manner as interest is charged on premium underpayments.

Effective Date

The provision is effective with respect to interest
accruing for periods beginning not earlier than the date of
enactment.
(d) Rules for substantial owner benefits in terminated
plans (Sec. 685 of the bill and Secs. 4021, 4022,
4043 and 4044 of ERISA)

Present Law

Under present law, the Pension Benefit Guaranty Corporation
(``PBGC'') provides participants and beneficiaries in a defined
benefit pension plan with certain minimal guarantees as to the
receipt of benefits under the plan in case of plan termination.
The employer sponsoring the defined benefit pension plan is
required to pay premiums to the PBGC to provide insurance for
the guaranteed benefits. In general, the PBGC will guarantee
all basic benefits which are payable in periodic installments
for the life (or lives) of the participant and his or her
beneficiaries and are non-forfeitable at the time of plan
termination. The amount of the guaranteed benefit is subject to
certain limitations. One limitation is that the plan (or an
amendment to the plan which increases benefits) must be in
effect for 60 months before termination for the PBGC to
guarantee the full amount of basic benefits for a plan
participant, other than a substantial owner. In the case of a
substantial owner, the guaranteed basic benefit is phased-in
over 30 years beginning with participation in the plan. A
substantial owner is one who owns, directly or indirectly, more
than 10 percent of the voting stock of a corporation or all the
stock of a corporation. Special rules restricting the amount of
benefit guaranteed and the allocation of assets also apply to
substantial owners.

Reasons for Change

The Committee believes that the present-law rules
concerning limitations on guaranteed benefits for substantial
owners are overly complicated and restrictive and thus may
discourage some small business owners from establishing defined
benefit pension plans.

Explanation of Provision

The bill provides that the 60-month phase-in of guaranteed
benefits applies to a substantial owner with less than 50
percent ownership interest. For a substantial owner with a 50
percent or more ownership interest (``majority owner''), the
phase-in depends on the number of years the plan has been in
effect. The majority owner's guaranteed benefit is limited so
that it could not be more than the amount phased-in over 60
months for other participants. The rules regarding allocation
of assets apply to substantial owners, other than majority
owners, in the same manner as other participants.

Effective Date

The provision is effective for plan terminations with
respect to which notices of intent to terminate are provided,
or for which proceedings for termination are instituted by the
PBGC, after December 31, 2001.

7. Miscellaneous provisions

(a) Tax treatment of electing Alaska Native Settlement
Trusts (section 691 of the Bill and new sections
646 and 6039H of the Code, modifying Code sections
including 1(e), 301, 641, 651, 661, and 6034A))

Present Law

An Alaska Native Settlement Corporation (``ANC'') may
establish a Settlement Trust (``Trust'') under section 39 of
the Alaska Native Claims Settlement Act (``ANCSA'') \110\ and
transfer money or other property to such Trust for the benefit
of beneficiaries who constitute all or a class of the
shareholders of the ANC, to promote the health, education and
welfare of the beneficiaries and preserve the heritage and
culture of Alaska Natives.
---------------------------------------------------------------------------
\110\ 43 U.S.C. 1601 et. seq. A Settlement Trust is subject to
certain limitations under ANCSA, including that it may not operate a
business. 43 U.S.C. 1629e(b).
---------------------------------------------------------------------------
With certain exceptions, once an ANC has made a conveyance
to a Trust, the assets conveyed shall not be subject to
attachment, distraint, or sale or execution of judgment, except
with respect to the lawful debts and obligations of the Trust.
The Internal Revenue Service (``IRS'') has indicated that
contributions to a Trust constitute distributions to the
beneficiary-shareholders at the time of the contribution and
are treated as dividends to the extent of earnings and profits
as provided under section 301 of the Code.\111\ Also, a Trust
and its beneficiaries are generally taxed subject to applicable
trust rules.\112\
---------------------------------------------------------------------------
\111\ See, e.g., PLR 9824014; PLR 9433021; PLR 9329026 and PLR
9326019.
\112\ See Subchapter J of the Code (Secs. 641 et. seq.); Treas.
Reg. Sec. 1.301.7701-4.
---------------------------------------------------------------------------

Reasons for Change

The Committee is concerned that present law may inhibit
many ANCs from establishing Settlement Trusts, due to the IRS
present law treatment of a contribution by an ANC to a Trust as
a dividend to the extent the ANC has current or accumulated
earnings and profits in the year of the contribution. So long
as the ANC shareholders or beneficiaries of the Trust do not
receive the money or other property that is contributed to the
Trust, the Committee believes it is appropriate to allow the
transfer to the Trust without causing dividend treatment.
The Committee also believes it is appropriate for a
Settlement Trust to be able to accumulate its earnings at the
lowest individual tax rate rather than the higher rates that
generally apply to trusts, and to distribute earnings taxed at
that rate to Alaska Native beneficiaries without additional
taxation to the beneficiaries.
At the same time, the Committee believes it is appropriate
to require a Settlement Trust to elect to obtain the benefits
of the new provisions, and to provide safeguards for such
electing Trusts that prevent the benefits from being used by
persons other than Alaska Natives, or from being used to
circumvent basic tax law provisions in an unintended manner.

Explanation of Provision

The provision allows an election under which special rules
will apply in determining the income tax treatment of an
electing Trust and of its beneficiaries. An electing Trust will
pay tax on its income at the lowest rate specified for ordinary
income of an individual (or corresponding lower capital gains
rate). The provision also specifies the treatment of
distributions by an electing Trust to beneficiaries, the
reporting requirements associated with such an election, and
the consequences of disqualification for these benefits due to
the allowance of certain impermissible dispositions of Trust
interests or ANC stock.
Under the provision, a trust that is a Settlement Trust
established by an Alaska Native Corporation under section 39 of
ANCSA may make an election for its first taxable year ending
after the date of enactment of the provision to be subject to
the rules of the provision rather than otherwise applicable
income tax rules. If the election is in effect, no amount will
be included in the gross income of a beneficiary of such Trust
by reason of a contribution to the Trust.\113\ In addition,
ordinary income of the electing Trust, whether accumulated or
distributed, will be taxed only to the Trust (and not to
beneficiaries) at the lowest individual tax rate for ordinary
income. Capital gains of the electing Trust will similarly be
taxed to the Trust at the capital gains rate applicable to
individuals subject to such lowest rate. These rates will
apply, rather than the higher rates generally applicable to
trusts or to higher tax bracket beneficiaries. The election is
made on a one-time basis only. The benefits of the election
will terminate, however, and other special rules will apply, if
the electing Trust or the sponsoring ANC fail to satisfy the
restrictions on transferability of Trust beneficial interests
or of ANC stock.
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\113\ If the ANC transfers appreciated property to the Trust,
section 311(b) of the Code will apply to the ANC, as under present law,
so that the ANC will recognize gain as if it had sold the property for
fair market value. The Trust takes the property with a fair market
value basis, pursuant to section 301(d) of the Code.
---------------------------------------------------------------------------
The treatment to beneficiaries of amounts distributed by an
electing Trust depends upon the amount of the distribution.
Solely for purposes of determining what amount has been
distributed and thus which treatment applies under these rules,
the amount of any distribution of property is the fair market
value of the property at the time of the distribution.\114\
---------------------------------------------------------------------------
\114\ Section 661 of the Code, which provides a deduction to the
trust for certain distributions, does not apply to an electing Trust
under the provision unless the election is terminated by
disqualification. Similarly, the inclusion provisions of section 662 of
the Code, relating to amounts to be included in income of
beneficiaries, also do not apply to a qualified electing Trust.
---------------------------------------------------------------------------
Amounts distributed by an electing Trust during any taxable
year are excludable from the gross income of the recipient
beneficiary to the extent of (1) the taxable income of the
Trust for the taxable year and all prior taxable years for
which an election was in effect (decreased by any income tax
paid by the Trust with respect to the income) plus (2) any
amounts excluded from gross income of the Trust under section
103 for those periods.\115\
---------------------------------------------------------------------------
\115\ In the case of any such excludable distribution that involves
a distribution of property other than cash, the basis of such property
in the hands of the recipient beneficiary will generally be the
adjusted basis of the property in the hands of the Trust, unless the
Trust makes an election to pay tax, in which case the basis in the
hands of the beneficiary would be the fair market value of the
property. See Code sections 643(e) and 643(e)(3).
---------------------------------------------------------------------------
If distributions to beneficiaries exceed the excludable
amounts described above, then such excess distributions are
reported and taxed to beneficiaries as if distributed by the
ANC in the year of the distribution by the electing Trust to
the extent the ANC then has current or accumulated earnings and
profits, and are treated as dividends to beneficiaries.\116\
Additional distributions in excess of the current or
accumulated earnings and profits of the ANC are treated by the
beneficiaries as distributions by the Trust in excess of the
distributable net income of the Trust for such year.\117\
---------------------------------------------------------------------------
\116\ The treatment of such amounts distributed by an electing
Trust as a dividend applies even if all or any part of the
contributions by an ANC to a Trust would not have been dividends at the
time of the contribution under present law; for example, because the
ANC had no current or accumulated earnings and profits, or because the
contribution was made from Alaska Native Fund amounts that may not have
been taxable. See 43 U.S.C. 1605.
\117\ Such distributions would not be taxable to the beneficiaries.
In the case of any such nontaxable distribution that involves a
distribution of property other than cash, the basis of such property in
the hands of the recipient beneficiary will generally be the adjusted
basis of the property in the hands of the Trust, unless the Trust makes
an election to pay tax, in which case the basis in the hands of the
beneficiary will be the fair market value of the property. See Code
sections 643(e) and 643(e)(3).
---------------------------------------------------------------------------
The fiduciary of an electing Trust must report to the IRS,
with the Trust tax return, the amount of distributions to each
beneficiary, and the tax treatment to the beneficiary of such
distributions under the provision (either as exempt from tax to
the beneficiary, or as a distribution deemed made by the ANC).
The electing Trust must also furnish such information to the
ANC. In the case of distributions that are treated as if made
by the ANC, the ANC must then report such amounts to the
beneficiaries and must indicate whether they are dividends or
not, in accordance with the earnings and profits of the ANC.
The reporting thus required by an electing Trust will be in
lieu of, and will satisfy, the reporting requirements of
section 6034A (and such other reporting requirements as the
Secretary of the Treasury may deem appropriate).
The earnings and profits of an ANC will not be reduced by
the amount of its contributions to an electing Trust at the
time of the contributions. However, the ANC earnings and
profits will be reduced as and when distributions are
thereafter made by the electing Trust that are taxed to
beneficiaries under the provision as dividends from the ANC to
the Trust beneficiaries.
If in any taxable year the beneficial interests in the
electing Trust may be disposed of to a person in a manner that
would not be permitted under ANCSA if the interests were
Settlement Common Stock (generally, to a person other than an
Alaska Native),\118\ then the special provisions applicable to
electing Trusts, including the favorable ordinary income tax
rate and corresponding lower capital gains tax rate, cease to
apply as of the beginning of such taxable year. The
distributable net income of the Trust is increased up to the
amount of current and accumulated earnings and profits of the
ANC as of the end of that year, but such increase shall not
exceed the fair market value of the assets of the Trust as of
the date the beneficial interests of the Trust became
disposable.\119\ Thereafter, the Trust and its beneficiaries
are generally subject to the rules of subchapter J and to the
generally applicable trust income tax rates. Thus, the increase
in distributable net income will result in the Trust being
taxed at regular trust rates to the extent the recomputed
distributable net income is not distributed to beneficiaries;
and beneficiaries will be taxed to the extent there are
distributions. Normal reporting rules applicable to trusts and
their beneficiaries will apply. The basis of any property
distributed to beneficiaries will also be determined under
normal trust rules. The same rules apply if any stock of the
ANC may be disposed of to a person in a manner that would not
be permitted under ANCSA if the stock were Settlement Common
Stock and the ANC makes a transfer to the Trust.
---------------------------------------------------------------------------
\118\ Under ANSCA, Settlement Common Stock is subject to
restrictions on transferability. If changes are made to permit
additional transferability of such stock, then the Settlement Common
Stock is cancelled and Replacement Common Stock is issued. See 43
U.S.C. 1602(p), 1606(h) and 1629c.
\119\ To the extent the earnings and profits of the ANC increase
distributable net income of the Trust under this provision, the ANC
will have a corresponding adjustment reducing its earnings and profits.
---------------------------------------------------------------------------
The provision contains a special loss disallowance rule
that reduces any loss that would otherwise be recognized by a
shareholder upon the disposition of a share of stock of a
sponsoring ANC by a ``per share loss adjustment factor.'' This
factor reflects the aggregate of all contributions to an
electing Trust sponsored by such ANC made on or after the first
day the trust is treated as an electing Trust, expressed on a
per share basis and determined as of the day of each such
contribution.
The special loss disallowance rule is intended to prevent
the allowance of noneconomic losses if the ANC stock owned by
beneficiaries ever becomes transferable in any type of
transaction that could cause the recognition of taxable gain or
loss, (including a redemption by the ANC) where the basis of
the stock in the hands of the beneficiary (or in the hands of
any transferee of a beneficiary) fails to reflect the allocable
reduction in corporate value attributable to amounts
transferred by the ANC into the Trust.

Effective Date

The provision is effective for taxable years of Settlement
Trusts, their beneficiaries, and sponsoring Alaska Native
Corporations ending after the date of enactment, and to
contributions made to electing Settlement Trusts during such
year and thereafter.

C. Compliance with Congressional Budget Act

(Secs. 695-696 of the bill)

Present Law

Reasons for Change

Explanation of Provision

Sunset of provisions

To ensure compliance with the Budget Act, the bill provides
that all provisions of, and amendments made by, the bill
relating to IRAs and pensions which are in effect on September
30, 2011, shall cease to apply as of the close of September 30,
2011.

Restoration of provisions

All provisions of, and amendments made by, the bill
relating to IRAs and pensions which were terminated under the
sunset provision shall begin to apply again as of October 1,
2011, as provided in each such provision or amendment.

VII. ALTERNATIVE MINIMUM TAX

A. Individual Alternative Minimum Tax Relief

(Sec. 701 of the bill and Sec. 55 of the Code)

present law

Present law imposes an alternative minimum tax (``AMT'') on
individuals to the extent that the tentative minimum tax
exceeds the regular tax. An individual's tentative minimum tax
generally is an amount equal to the sum of (1) 26 percent of
the first $175,000 ($87,500 in the case of a married individual
filing a separate return) of alternative minimum taxable income
(``AMTI'') in excess of an exemption amount and (2) 28 percent
of the remaining AMTI. AMTI is the individual's taxable income
adjusted to take account of specified preferences and
adjustments.
The AMT exemption amounts are: (1) $45,000 in the case of
married individuals filing a joint return and surviving
spouses; (2) $33,750 in the case of other unmarried
individuals; and (3) $22,500 in the case of married individuals
filing a separate return, estates and trusts. The exemption
amounts are phased out by an amount equal to 25 percent of the
amount by which the individual's AMTI exceeds (1) $150,000 in
the case of married individuals filing a joint return and
surviving spouses, (2) $112,500 in the case of other unmarried
individuals, and (3) $75,000 in the case of married individuals
filing separate returns or an estate or a trust. The exemption
amounts, the threshold phase-out amounts, and rate brackets are
not indexed for inflation.

reasons for change

The Committee is concerned about the projected increase in
the number of individuals who will be affected by the
individual alternative minimum tax in future years. The
provision will reduce the number of individuals who would
otherwise be affected by the minimum tax.

explanation of provision

The provision increases the AMT exemption amount for
married couples filing a joint return and surviving spouses by
$4,000. The AMT exemption amounts for other individuals (i.e.,
unmarried individuals and married individuals filing a separate
return) are increased by $2,000.

effective date

The provision applies to taxable years beginning after
December 31, 2000, and before January 1, 2007.

B. Compliance With Congressional Budget Act

(Secs. 711 and 712 of the bill)

present law

reasons for change

explanation of provision

Sunset of provisions
To ensure compliance with the Budget Act, the bill provides
that all provisions of, and amendments made by, the bill
relating to the alternative minimum tax which are in effect on
September 30, 2011, shall cease to apply as of the close of
September 30, 2011.
Restoration of provisions
All provisions of, and amendments made by, the bill
relating to the alternative minimum tax which were terminated
under the sunset provision shall begin to apply again as of
October 1, 2011, as provided in each such provision or
amendment.

VIII. OTHER PROVISIONS

A. Modification to Corporate Estimated Tax Requirements

(Sec. 801 of the bill)

present law

In general, corporations are required to make quarterly
estimated tax payments of their income tax liability (section
6655). For a corporation whose taxable year is a calendar year,
these estimated tax payments must be made by April 15, June 15,
September 15, and December 15.

reasons for change

The Committee believes that it is appropriate to modify
these corporate estimated tax requirements.

explanation of provision

With respect to corporate estimated tax payments due on
September 17, 2001,\120\ 30 percent is required to be paid by
September 17, 2001, and 70 percent is required to be paid by
October 1, 2001. With respect to corporate estimated tax
payments due on September 15, 2004, 80 percent is required to
be paid by September 15, 2004, and 20 percent is required to be
paid by October 1, 2004.
---------------------------------------------------------------------------
\120\ September 15, 2001 will be a Saturday. Under present law,
payments required to be made on a Saturday must be made no later than
the next banking day.
---------------------------------------------------------------------------

effective date

The provision is effective on the date of enactment.

B. Authority To Postpone Certain Tax-Related Deadlines by Reason of
Presidentially Declared Disaster

(Sec. 802 of the bill and Sec. 7508A of the Code)

present law

The Secretary of the Treasury may specify that certain
deadlines are postponed for a period of up to 90 days in the
case of a taxpayer determined to be affected by a
Presidentially declared disaster.\121\ The deadlines that may
be postponed are the same as are postponed by reason of service
in a combat zone. If the Secretary extends the period of time
for filing income tax returns and for paying income tax, the
Secretary must abate related interest for that same period of
time.\122\
---------------------------------------------------------------------------
\121\ Section 7508A.
\122\ Section 6404(h).
---------------------------------------------------------------------------

reasons for change

Disasters can cause a variety of tax-related problems, such
as the loss of records and the inability to meet filing
deadlines. Although the IRS attempts to address such issues
under present law, the Committee believes that the ability of
the IRS to deal with disaster-related tax issues would be
enhanced by the creation of a Disaster Response Team to provide
guidance to taxpayers affected by disasters. In addition, the
Committee believes increasing the maximum time period for which
the Secretary may postpone certain deadlines in the case of a
taxpayer determined to be affected by a Presidentially declared
disaster will help taxpayers in dealing with disasters.

explanation of provision

The bill directs the Secretary to create in the IRS a
Disaster Response Team, which, in coordination with the Federal
Emergency Management Agency, is to assist taxpayers in
clarifying and resolving tax matters associated with a
Presidentially declared disaster. One of the duties of the
Disaster Response Team is to postpone certain tax-related
deadlines for up to 120 days in appropriate cases for taxpayers
determined to be affected by a Presidentially declared
disaster.
It is anticipated that the Disaster Response Team would be
staffed by IRS employees with relevant knowledge and
experience. The Committee anticipates that the Disaster
Response Team would staff a toll-free number dedicated to
responding to taxpayers affected by a Presidentially declared
disaster and provide relevant information via the IRS website.

effective date

The provision is effective on the date of enactment.

C. Compliance With Congressional Budget Act

(Secs. 811-812 of the bill)

Present Law

Reasons for Change

Explanation of Provision

Sunset of provisions

To ensure compliance with the Budget Act, the bill provides
that all provisions of, and amendments made by, the bill
relating to corporate estimated taxes and authority to postpone
tax deadlines because of disasters which are in effect on
September 30, 2011, shall cease to apply as of the close of
September 30, 2011.

Restoration of provisions

All provisions of, and amendments made by, the bill
relating to corporate estimated taxes and authority to postpone
tax deadlines because of disasters which were terminated under
the sunset provision shall begin to apply again as of October
1, 2011, as provided in each such provision or amendment.

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