[JPRT 109-5-05]
[From the U.S. Government Publishing Office]
[JOINT COMMITTEE PRINT]
GENERAL EXPLANATION OF
TAX LEGISLATION
ENACTED IN THE 108TH CONGRESS
----------
Prepared by the Staff
of the
JOINT COMMITTEE ON TAXATION
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
MAY 2005
U.S. GOVERNMENT PRINTING OFFICE
21-118 WASHINGTON : 2005 JCS-5-05
_________________________________________________________________
For sale by the Superintendent of Documents, U.S. Government
Printing Office Internet: bookstore.gpo.gov Phone: toll free
(866) 512-1800; DC area (202) 512-1800 Fax: (202) 512-2250 Mail
Stop SSOP, Washington, DC 20402-0001
ISBN 0-16-072517-8
JOINT COMMITTEE ON TAXATION
109th Congress, 1st Session
------
HOUSE SENATE
WILLIAM M. THOMAS, California, CHARLES E. GRASSLEY, Iowa,
Chairman Vice Chairman
E. CLAY SHAW, Jr., Florida ORRIN G. HATCH, Utah
NANCY L. JOHNSON, Connecticut TRENT LOTT, Mississippi
CHARLES B. RANGEL, New York MAX BAUCUS, Montana
FORTNEY PETE STARK, California JOHN D. ROCKEFELLER IV, West
Virginia
George K. Yin, Chief of Staff
Bernard A. Schmitt, Deputy Chief of Staff
Thomas A. Barthold, Deputy Chief of Staff
C O N T E N T S
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Page
Introduction..................................................... 1
Part One: Jobs and Growth Tax Relief Reconciliation Act of 2003
(Public Law 108-27)............................................ 4
I. Acceleration of Certain Previously Enacted Tax Reductions........4
A. Accelerate the Increase in the Child Tax Credit
(sec. 101 of the Act and sec. 24 of the Code)...... 4
B. Accelerate Marriage Penalty Relief (secs. 102 and
103 of the Act and secs. 1 and 63 of the Code)..... 6
1. Standard deduction marriage penalty relief...... 6
2. Accelerate the expansion of the 15-percent rate
bracket for married couples filing joint
returns........................................ 8
C. Accelerate Reductions in Individual Income Tax Rates
(secs. 104, 105, and 106 of the Act and secs. 1 and
55 of the Code).................................... 10
II. Growth Incentives for Business..................................15
A. Increase and Extension of Bonus Depreciation (sec.
201 of the Act and sec. 168 of the Code)........... 15
B. Increased Expensing for Small Business (sec. 202 of
the Act and sec. 179 of the Code).................. 19
III. Reduction in Taxes on Dividends and Capital Gains...............21
A. Reduction in Capital Gains Rates for Individuals;
Repeal of Five-Year Holding Period Requirement
(sec. 301 of the Act and sec. 1(h) of the Code).... 21
B. Dividend Income of Individuals Taxed at Capital Gain
Rates (sec. 302 of the Act and sec. 1(h) of the
Code).............................................. 23
IV. Corporate Estimated Tax Payments for 2003.......................27
A. Time for Payment of Corporate Estimated Taxes (sec.
501 of the Act).................................... 27
Part Two: Surface Transportation Extension Act of 2003 (Public
Law 108-88).................................................... 28
A. Extension of Highway Trust Fund and Aquatic
Resources Trust Fund Expenditure Authority (sec. 12
of the Act)........................................ 28
Part Three: To Extend the Temporary Assistance for Needy Families
Block Grant Program, and Certain Tax and Trade Programs, and
for Other Purposes (Public Law 108-89)......................... 30
A. Disclosure of Return Information Relating to Student
Loans (sec. 201 of the Act and sec. 6103(l) of the
Code).............................................. 30
B. Extension of IRS User Fees (sec. 202 of the Act and
new sec. 7528 of the Code)......................... 30
C. Extension of Customs User Fees (sec. 301 of the Act) 31
Part Four: Military Family Tax Relief Act of 2003 (Public Law
108-121)....................................................... 32
I. Improving Tax Equity for Military Personnel.....................32
A. Exclusion of Gain on Sale of a Principal Residence
by a Member of the Uniformed Services or the
Foreign Service (sec. 101 of the Act and sec. 121
of the Code)....................................... 32
B. Exclusion from Gross Income of Certain Death
Gratuity Payments (sec. 102 of the Act and sec. 134
of the Code)....................................... 33
C. Exclusion for Amounts Received Under Department of
Defense Homeowners Assistance Program (sec. 103 of
the Act and sec. 132 of the Code).................. 34
D. Expansion of Combat Zone Filing Rules to Contingency
Operations (sec. 104 of the Act and sec. 7508 of
the Code).......................................... 35
E. Modification of Membership Requirement for Exemption
from Tax for Certain Veterans' Organizations (sec.
105 of the Act and sec. 501(c)(19) of the Code).... 37
F. Clarification of Treatment of Certain Dependent Care
Assistance Programs Provided to Members of the
Uniformed Services of the United States (sec. 106
of the Act and sec. 134 of the Code)............... 38
G. Treatment of Service Academy Appointments as
Scholarships for Purposes of Qualified Tuition
Programs and Coverdell Education Savings Accounts
(sec. 107 of the Act and secs. 529 and 530 of the
Code).............................................. 39
H. Suspension of Tax-Exempt Status of Terrorist
Organizations (sec. 108 of the Act and sec. 501 of
the Code).......................................... 41
I. Above-the-Line Deduction for Overnight Travel
Expenses of National Guard and Reserve Members
(sec. 109 of the Act and sec. 162 of the Code)..... 43
J. Extension of Certain Tax Relief Provisions to
Astronauts (sec. 110 of the Act and secs. 101, 692,
and 2201 of the Code).............................. 44
II. Revenue Provision...............................................48
A. Extension of Customs User Fees (sec. 201 of the Act) 48
Part Five: Medicare Prescription Drug, Improvement, and
Modernization Act of 2003 (Public Law 108-173)................. 49
A. Disclosure of Return Information for Purposes of
Providing Transitional Assistance Under Medicare
Discount Card Program (sec. 105(e) of the Act and
sec. 6103(l)(19) of the Code)...................... 49
B. Disclosure of Return Information Relating to Income-
Related Reduction in Part B Premium Subsidy (sec.
811(c) of the Act and sec. 6103(l)(20) of the Code) 50
C. Health Savings Accounts (sec. 1201 of the Act and
new sec. 223 of the Code).......................... 51
D. Exclusion from Gross Income of Certain Federal
Subsidies for Prescription Drug Plans (sec. 1202 of
the Act and new sec. 139A of the Code)............. 59
E. Exception to Information Reporting Requirements for
Certain Health Arrangements (sec. 1203 of the Act
and sec. 6041 of the Code)......................... 60
Part Six: Vision 100--Century of Aviation Reauthorization Act
(Public Law 108-176)........................................... 62
A. Extension of Expenditure Authority (secs. 901 and
902 of the Act).................................... 62
Part Seven: Servicemembers Civil Relief Act (Public Law 108-189). 64
A. Servicemembers Civil Relief (sec. 510 of the Act)... 64
Part Eight: Surface Transportation Extension Act of 2004 (Public
Law 108-202)................................................... 65
A. Extension of Highway Trust Fund and Aquatic
Resources Trust Fund Expenditure Authority (sec. 12
of the Act)........................................ 65
Part Nine: The Social Security Protection Act of 2004 (Public Law
108-203)....................................................... 67
A. Technical Amendment Clarifying Treatment for Certain
Purposes of Individual Work Plans under the Ticket
to Work and Self-Sufficiency Program (sec. 405 of
the Act, sec. 1148(g)(1) of the Social Security
Act, and sec. 51 of the Code)...................... 67
B. Clarification Respecting the FICA and SECA Tax
Exemptions for an Individual Whose Earnings Are
Subject to the Laws of a Totalization Agreement
Partner (sec. 415 of the Act and secs. 1401(c),
3101(c), and 3111(c) of the Code).................. 68
C. Technical Amendments................................ 70
1. Technical correction relating to retirement
benefits of ministers (sec. 422 of the Act and
sec. 211(a)(7) of the Social Security Act)..... 70
2. Technical correction relating to domestic
employment (sec. 423 of the Act, sec.
3121(a)(7)(B) and (g)(5) of the Code, and secs.
209(a)(6)(B) and 210(f)(5) of the Social
Security Act).................................. 71
3. Technical correction of outdated references
(sec. 424 of the Act, sec. 3102(a) of the Code,
and sec. 211(a)(15) of the Social Security Act) 72
4. Technical correction respecting self-employment
income in community property States (sec. 425
of the Act, sec. 1402(a)(5) of the Code, and
sec. 211(a)(5) of the Social Security Act)..... 73
Part Ten: Pension Funding Equity Act of 2004 (Public Law 108-218) 75
I. Pension Funding.................................................75
A. Temporary Replacement of 30-Year Treasury Rate and
Election of Alternative Deficit Reduction
Contribution (secs. 101 and 102 of the Act and
secs. 404, 412 and 415 of the Code)................ 75
B. Multiemployer Plan Funding Notices (sec. 103 of the
Act and secs. 101 and 502 of ERISA)................ 85
C. Election for Deferral of Charge for Portion of Net
Experience Loss of Multiemployer Plans (sec. 104 of
the Act, sec. 302(b)(7) of ERISA, and sec.
412(b)(7) of the Code)............................. 87
II. Other Provisions................................................91
A. Two-Year Extension of Transition Rule to Pension
Funding Requirements for Interstate Bus Company
(sec. 201 of the Act, and sec. 769(c) of the
Retirement Protection Act of 1994 (as added by sec.
1508 of the Taxpayer Relief Act of 1997)).......... 91
B. Procedures Applicable to Disputes Involving Pension
Plan Withdrawal Liability (sec. 202 of the Act and
sec. 4221 of ERISA)................................ 92
C. Sense of Congress Regarding Defined Benefit Pension
System Reform (sec. 203 of the Act)................ 94
D. Extension of Provision Permitting Qualified
Transfers of Excess Pension Assets to Retiree
Health Accounts (sec. 204 of the Act, sec. 420 of
the Code, and secs. 101, 403, and 408 of ERISA).... 94
E. Repeal of Reduction of Deductions for Mutual Life
Insurance Companies (sec. 205 of the Act and sec.
809 of the Code)................................... 96
F. Modify Qualification Rules for Tax-Exempt Property
and Casualty Insurance Companies (sec. 206 of the
Act and secs. 501 and 831 of the Code)............. 97
G. Definition of Insurance Company for Property and
Insurance Company Tax Rules (sec. 206 of the Act
and sec. 831 of the Code).......................... 100
Part Eleven: Surface Transportation Extension Act of 2004, Part
II (Public Law 108-224)........................................ 103
A. Extension of Highway Trust Fund and Aquatic
Resources Trust Fund Expenditure Authority (sec. 10
of the Act)........................................ 103
Part Twelve: Surface Transportation Extension Act of 2004, Part
III (Public Law 108-263)....................................... 105
A. Extension of Highway Trust Fund and Aquatic
Resources Trust Fund Expenditure Authority (sec. 10
of the Act)........................................ 105
Part Thirteen: Surface Transportation Extension Act of 2004, Part
IV (Public Law 108-280)........................................ 107
A. Extension of Highway Trust Fund and Aquatic
Resources Trust Fund Expenditure Authority (sec. 10
of the Act)........................................ 107
Part Fourteen: Surface Transportation Extension Act of 2004, Part
V (Public Law 108-310)......................................... 109
A. Extension of Highway Trust Fund and Aquatic
Resources Trust Fund Expenditure Authority (sec. 13
of the Act)........................................ 109
Part Fifteen: Working Families Tax Relief Act of 2004 (Public Law
108-311)....................................................... 111
I. Extension of Certain Expiring Provisions.......................111
A. Extension of the Child Tax Credit, Acceleration of
Refundability of the Child Tax Credit and Treatment
of Combat Pay as Earned Income for Purposes of the
Child Tax Credit and Earned Income Credit (secs.
101-104 of the Act and sec. 24 and 32 of the Code). 111
B. Extend Marriage Penalty Relief (sec. 101 of the Act
and secs. 1 and 63 of the Code).................... 113
1. Standard deduction marriage penalty relief (sec.
63 of the Code)................................ 113
2. Increase the size of the 15-percent rate bracket
for married couples filing joint returns (sec.
1 of the Code)................................. 115
C. Extend Size of 10-Percent Rate Bracket for
Individuals (sec. 103 of the Act and sec. 1 of the
Code).............................................. 116
D. Extend Alternative Minimum Tax Exemption for
Individuals (sec. 104 of the Act and sec. 55 of the
Code).............................................. 118
II. Uniform Definition of Child....................................119
A. Establish Uniform Definition of a Qualifying Child
(secs. 201-208 of the Act and secs. 2, 21, 24, 32,
151, and 152 of the Code).......................... 119
III. Extensions of Certain Expiring Provisions......................131
A. Extension of the Research Credit (sec. 301 of the
Act and sec. 41 of the Code)....................... 131
B. Extension of Parity in the Application of Certain
Limits to Mental Health Benefits (sec. 302 of the
Act, sec. 9812 of the Code, sec. 712 of ERISA, and
section 2705 of the PHSA).......................... 132
C. Extension of the Work Opportunity Tax Credit (sec.
303 of the Act and sec. 51 of the Code)............ 133
D. Extension of the Welfare-to-Work Tax Credit (sec.
303 of the Act and sec. 51A of the Code)........... 135
E. Qualified Zone Academy Bonds (sec. 304 of the Act
and sec. 1397E of the Code)........................ 136
F. Extension of Cover Over of Excise Tax on Distilled
Spirits to Puerto Rico and Virgin Islands (sec. 305
of the Act and sec. 7652 of the Code).............. 137
G. Charitable Contributions of Computer Technology and
Equipment Used for Educational Purposes (sec. 306
of the Act and sec. 170 of the Code)............... 138
H. Certain Expenses of Elementary and Secondary School
Teachers (sec. 307 of the Act and sec. 62 of the
Code).............................................. 139
I. Expensing of Environmental Remediation Costs (sec.
308 of the Act and sec. 198 of the Code)........... 140
J. New York Liberty Zone Provisions (sec. 309 of the
Act and sec. 1400L of the Code).................... 141
K. Tax Incentives for Investment in the District of
Columbia (sec. 310 of the Act and secs. 1400,
1400A, 1400B, 1400C, and 1400F of the Code)........ 142
L. Combined Employment Tax Reporting (sec. 311 of the
Act and sec. 6103(d)(5) of the Code)............... 142
M. Nonrefundable Personal Credits Allowed Against the
Alternative Minimum Tax (sec. 312 of the Act and
sec. 26 of the Code)............................... 143
N. Extension of Credit for Electricity Produced from
Certain Renewable Resources (sec. 313 of the Act
and sec. 45 of the Code)........................... 144
O. Suspension of 100-Percent-of-Net-Income Limitation
on Percentage Depletion for Oil and Gas from
Marginal Wells (sec. 314 of the Act and sec. 613A
of the Code)....................................... 145
P. Indian Employment Tax Credit (sec. 315 of the Act
and sec. 45A of the Code).......................... 145
Q. Accelerated Depreciation for Business Property on
Indian Reservations (sec. 316 of the Act and sec.
168(j) of the Code)................................ 146
R. Disclosure of Return Information Relating to Student
Loans (sec. 317 of the Act and sec. 6103(l)(13) of
the Code).......................................... 147
S. Credit for Qualified Electric Vehicles (sec. 318 of
the Act and sec. 30 of the Code)................... 148
T. Deduction for Qualified Clean-Fuel Vehicle Property
(sec. 319 of the Act and sec. 179A of the Code).... 149
U. Disclosures Relating to Terrorist Activities (sec.
320 of the Act and secs. 6103(i)(3) and (i)(7) of
the Code).......................................... 149
V. Extension of Joint Review of Strategic Plans and
Budget for the Internal Revenue Service (sec. 321
of the Act and secs. 8021 and 8022 of the Code).... 151
W. Extension of Archer Medical Savings Accounts
(``MSAs'') (sec. 322 of the Act and sec. 220 of the
Code).............................................. 152
IV. Tax Technical Corrections (Secs. 401-408 of the Act)...........155
Part Sixteen: To Clarify the Tax Treatment of Bonds and Other
Obligations Issued by the Government of American Samoa (Public
Law 108-326)................................................... 164
A. Clarification of Tax Treatment of Bonds and Other
Obligations Issued by the Government of American
Samoa (secs. 1 and 2 of the Act)................... 164
Part Seventeen: American Jobs Creation Act of 2004 (Public Law
108-357)....................................................... 166
I. Provisions Relating to Repeal of Exclusion for Extraterritorial
Income.........................................................166
A. Repeal of Extraterritorial Income Regime (sec. 101
of the Act and secs. 114 and 941 through 943 of the
Code).............................................. 166
B. Deduction Relating to Income Attributable to United
States Production Activities (sec. 102 of the Act
and new sec. 199 of the Code)...................... 170
II. Business Tax Incentives........................................178
A. Two-Year Extension of Increased Expensing for Small
Business (sec. 201 of the Act and sec. 179 of the
Code).............................................. 178
B. Depreciation........................................ 180
1. Recovery period for depreciation of certain
leasehold improvements (sec. 211 of the Act and
sec. 168 of the Code).......................... 180
2. Recovery period for depreciation of certain
restaurant improvements (sec. 211 of the Act
and sec. 168 of the Code)...................... 182
C. Community Revitalization............................ 183
1. Modification of targeted areas and low-income
communities designated for new markets tax
credit (sec. 221 of the Act and sec. 45D of the
Code).......................................... 183
2. Expansion of designated renewal community area
based on 2000 census data (sec. 222 of the Act
and sec. 1400E of the Code).................... 185
3. Modification of income requirement for census
tracts within high migration rural counties for
new markets tax credit (sec. 223 of the Act and
sec. 45D of the Code).......................... 186
D. S Corporation Reform and Simplification (secs. 231-
240 of the Act and secs. 1361-1379 and 4975 of the
Code).............................................. 188
1. Members of family treated as one shareholder.... 189
2. Increase in maximum number of shareholders to
100............................................ 190
3. Expansion of bank S corporation eligible
shareholders to include IRAs................... 190
4. Disregard of unexercised powers of appointment
in determining potential current beneficiaries
of ESBT........................................ 191
5. Transfers of suspended losses incident to
divorce, etc................................... 192
6. Use of passive activity loss and at-risk amounts
by qualified subchapter S trust income
beneficiaries.................................. 192
7. Exclusion of investment securities income from
passive investment income test for bank S
corporations................................... 193
8. Relief from inadvertently invalid qualified
subchapter S subsidiary elections and
terminations................................... 194
9. Information returns for qualified subchapter S
subsidiaries................................... 194
10. Repayment of loans for qualifying employer
securities..................................... 194
E. Other Business Incentives........................... 196
1. Repeal certain excise taxes on rail diesel fuel
and inland waterway barge fuels (sec. 241 of
the Act and secs. 4041, 4042, 6421, and 6427 of
the Code)...................................... 196
2. Modification of application of income forecast
method of depreciation (sec. 242 of the Act and
sec. 167 of the Code).......................... 197
3. Improvements related to real estate investment
trusts (sec. 243 of the Act and secs. 856, 857
and 860 of the Code)........................... 199
4. Special rules for certain film and television
production (sec. 244 of the Act and new sec.
181 of the Code)............................... 209
5. Provide a tax credit for maintenance of railroad
track (sec. 245 of the Act and new sec. 45G of
the Code)...................................... 211
6. Suspension of occupational taxes relating to
distilled spirits, wine, and beer (sec. 246 of
the Act and new sec. 5148 of the Code)......... 211
7. Modification of unrelated business income
limitation on investment in certain small
business investment companies (sec. 247 of the
Act and sec. 514 of the Code).................. 213
8. Election to determine taxable income from
certain international shipping activities using
per ton rate (sec. 248 of the Act and new secs.
1352-1359 of the Code)......................... 214
F. Exclusion of Incentive Stock Options and Employee
Stock Purchase Plan Stock Options from Wages (sec.
251 of the Act and secs. 421(b), 423(c), 3121(a),
3231, and 3306(b) of the Code)..................... 218
III. Tax Relief for Agriculture and Small Manufacturers.............220
A. Volumetric Ethanol Excise Tax Credit................ 220
1. Incentives for alcohol and biodiesel fuels (sec.
301 of the Act and secs. 4041, 4081, 4091,
6427, 9503 and new section 6426 of the Code)... 220
2. Biodiesel income tax credit (sec. 302 of the Act
and new sec. 40A of the Code).................. 227
3. Information reporting for persons claiming
certain tax benefits (sec. 303 of the Act and
new sec. 4104 of the Code)..................... 228
B. Agricultural Incentives............................. 229
1. Special rules for livestock sold on account of
weather-related conditions (sec. 311 of the Act
and secs. 451 and 1033 of the Code)............ 229
2. Payment of dividends on stock of cooperatives
without reducing patronage dividends (sec. 312
of the Act and sec. 1388 of the Code).......... 231
3. Small ethanol producer credit (sec. 313 of the
Act and sec. 40 of the Code)................... 232
4. Extend income averaging to fishermen; income
averaging for farmers and fishermen not to
increase alternative minimum tax (sec. 314 of
the Act and sec. 55 of the Code)............... 233
5. Capital gains treatment to apply to outright
sales of timber by landowner (sec. 315 of the
Act and sec. 631(b) of the Code)............... 234
6. Modification to cooperative marketing rules to
include value-added processing involving
animals (sec. 316 of the Act and sec. 1388 of
the Code)...................................... 234
7. Extension of declaratory judgment procedures to
farmers' cooperative organizations (sec. 317 of
the Act and sec. 7428 of the Code)............. 235
8. Certain expenses of rural letter carriers (sec.
318 of the Act and sec. 162(o) of the Code).... 236
9. Treatment of certain income of electric
cooperatives (sec. 319 of the Act and sec. 501
of the Code)................................... 237
10. Exclusion from gross income for amounts paid
under National Health Service Corps loan
repayment program (sec. 320 of the Act and sec.
108 of the Code)............................... 241
11. Modified safe harbor rules for timber REITs
(sec. 321 of the Act and sec. 857 of the Code). 242
12. Expensing of reforestation expenditures (sec.
322 of the Act and secs. 48 and 194 of the
Code).......................................... 246
C. Incentives for Small Manufacturers.................. 247
1. Net income from publicly traded partnerships
treated as qualifying income of regulated
investment company (sec. 331 of the Act and
secs. 851(b), 469(k), 7704(d) and new sec.
851(h) of the Code)............................ 247
2. Simplification of excise tax imposed on bows and
arrows (sec. 332 of the Act and sec. 4161 of
the Code)...................................... 250
3. Reduce rate of excise tax on fishing tackle
boxes to three percent (sec. 333 of the Act and
sec. 4162 of the Code)......................... 251
4. Repeal of excise tax on sonar devices suitable
for finding fish (sec. 334 of the Act and secs.
4161 and 4162 of the Code)..................... 252
5. Charitable contribution deduction for certain
expenses in support of Native Alaskan
subsistence whaling (sec. 335 of the Act and
sec. 170 of the Code).......................... 253
6. Extended placed in service date for bonus
depreciation for certain aircraft (excluding
aircraft used in the transportation industry)
(sec. 336 of the Act and sec. 168 of the Code). 254
7. Special placed in service rule for bonus
depreciation for certain property subject to
syndication (sec. 337 of the Act and sec. 168
of the Code)................................... 257
8. Expensing of capital costs incurred for
production in complying with Environmental
Protection Agency sulfur regulations for small
refiners (sec. 338 of the Act and new sec. 179B
of the Code)................................... 258
9. Credit for small refiners for production of
diesel fuel in compliance with Environmental
Protection Agency sulfur regulations for small
refiners (sec. 339 of the Act and new sec. 45H
of the Code)................................... 259
10. Modification to qualified small issue bonds
(sec. 340 of the Act and sec. 144 of the Code). 260
11. Oil and gas production from marginal wells
(sec. 341 of the Act and new sec. 45I of the
Code).......................................... 261
IV. Tax Reform and Simplification for United States Businesses.....263
A. Interest Expense Allocation Rules (sec. 401 of the
Act and sec. 864 of the Code)...................... 263
B. Recharacterize Overall Domestic Loss (sec. 402 of
the Act and sec. 904 of the Code).................. 267
C. Apply Look-Through Rules for Dividends from
Noncontrolled Section 902 Corporations (sec. 403 of
the Act and sec. 904 of the Code).................. 270
D. Foreign Tax Credit Baskets and ``Base Differences''
(sec. 404 of the Act and sec. 904 of the Code)..... 271
E. Attribution of Stock Ownership Through Partnerships
in Determining Section 902 and 960 Credits (sec.
405 of the Act and sec. 902 of the Code)........... 275
F. Foreign Tax Credit Treatment of Deemed Payments
Under Section 367(d) of the Code (sec. 406 of the
Act and sec. 367(d) of the Code)................... 277
G. United States Property Not to Include Certain Assets
of Controlled Foreign Corporations (sec. 407 of the
Act and sec. 956 of the Code)...................... 278
H. Election Not to Use Average Exchange Rate for
Foreign Tax Paid Other Than in Functional Currency
(sec. 408 of the Act and sec. 986 of the Code)..... 280
I. Eliminate Secondary Withholding Tax with Respect to
Dividends Paid by Certain Foreign Corporations
(sec. 409 of the Act and sec. 871 of the Code)..... 281
J. Equal Treatment for Interest Paid by Foreign
Partnership and Foreign Corporations (sec. 410 of
the Act and sec. 861 of the Code).................. 283
K. Treatment of Certain Dividends of Regulated
Investment Companies (sec. 411 of the Act and secs.
871, 881, 897, and 2105 of the Code)............... 284
L. Look-Through Treatment Under Subpart F for Sales of
Partnership Interests (sec. 412 of the Act and sec.
954 of the Code)................................... 290
M. Repeal of Foreign Personal Holding Company Rules and
Foreign Investment Company Rules (sec. 413 of the
Act and secs. 542, 551-558, 954, 1246, and 1247 of
the Code).......................................... 291
N. Determination of Foreign Personal Holding Company
Income with Respect to Transactions in Commodities
(sec. 414 of the Act and sec. 954 of the Code)..... 292
O. Modifications to Treatment of Aircraft Leasing and
Shipping Income (sec. 415 of the Act and sec. 954
of the Code)....................................... 295
P. Modification of Exceptions Under Subpart F for
Active Financing (sec. 416 of the Act and sec. 954
of the Code)....................................... 298
Q. Ten-Year Foreign Tax Credit Carryover; One-Year
Foreign Tax Credit Carryback (sec. 417 of the Act
and sec. 904 of the Code).......................... 300
R. Modify FIRPTA Rules for Real Estate Investment
Trusts (sec. 418 of the Act and secs. 857 and 897
of the Code)....................................... 302
S. Exclusion of Income Derived from Certain Wagers on
Horse Races and Dog Races from Gross Income of
Nonresident Aliens (sec. 419 of the Act and sec.
872 of the Code)................................... 303
T. Limitation of Withholding on U.S.-Source Dividends
Paid to Puerto Rico Corporation (sec. 420 of the
Act and secs. 881 and 1442 of the Code)............ 305
U. Foreign Tax Credit Under Alternative Minimum Tax
(sec. 421 of the Act and sec. 59 of the Code)...... 306
V. Incentives to Reinvest Foreign Earnings in the
United States (sec. 422 of the Act and new sec. 965
of the Code)....................................... 307
W. Delay in Effective Date of Final Regulations
Governing Exclusion of Income from International
Operations of Ships and Aircraft (sec. 423 of the
Act and sec. 883 of the Code)...................... 311
X. Study of Earnings Stripping Provisions (sec. 424 of
the Act and sec. 163(j) of the Code)............... 312
V. Deduction of State and Local General Sales Taxes...............314
A. Deduction of State and Local General Sales Taxes
(sec. 501 of the Act and sec. 164 of the Code)..... 314
VI. Miscellaneous Provisions.......................................316
A. Brownfields Demonstration Program for Qualified
Green Building and Sustainable Design Projects
(sec. 701 of the Act and secs. 142 and 146 of the
Code).............................................. 316
B. Exclusion of Gain or Loss on Sale or Exchange of
Certain Brownfield Sites from Unrelated Business
Taxable Income (sec. 702 of the Act and secs. 512
and 514 of the Code)............................... 319
C. Civil Rights Tax Relief (sec. 703 of the Act and
sec. 62 of the Code)............................... 326
D. Seven-year Recovery Period for Certain Track
Facilities (sec. 704 of the Act and sec. 168 of the
Code).............................................. 328
E. Distributions to Shareholders From Policyholders
Surplus Account of Life Insurance Companies (sec.
705 of the Act and sec. 815 of the Code)........... 328
F. Treat Certain Alaska Pipeline Property as Seven-Year
Property (sec. 706 of the Act and sec. 168 of the
Code).............................................. 330
G. Enhanced Oil Recovery Credit for Certain Gas
Processing Facilities (sec. 707 of the Act and sec.
43 of the Code).................................... 330
H. Method of Accounting for Naval Shipbuilders (sec.
708 of the Act).................................... 331
I. Minimum Cost Requirement for Excess Pension Asset
Transfers (sec. 709 of the Act and sec. 420 of the
Code).............................................. 332
J. Credit for Electricity Produced from Certain Sources
(sec. 710 of the Act and sec. 45 of the Code)...... 335
K. Allow Certain Business Energy Credits Against the
Alternative Minimum Tax (sec. 711 of the Act and
sec. 38 of the Code)............................... 340
VII. Revenue Provisions.............................................341
A. Provisions to Reduce Tax Avoidance Through
Individual and Corporate Expatriation.............. 341
1. Tax treatment of expatriated entities and their
foreign parents (sec. 801 of the Act and new
sec. 7874 of the Code)......................... 341
2. Excise tax on stock compensation of insiders in
expatriated corporations (sec. 802 of the Act
and secs. 162(m), 275(a), and new sec. 4985 of
the Code)...................................... 345
3. Reinsurance of U.S. risks in foreign
jurisdictions (sec. 803 of the Act and sec.
845(a) of the Code)............................ 350
4. Revision of tax rules on expatriation of
individuals (sec. 804 of the Act and secs. 877,
2107, 2501 and 6039G of the Code).............. 352
5. Reporting of taxable mergers and acquisitions
(sec. 805 of the Act and new sec. 6043A of the
Code).......................................... 357
6. Studies (sec. 806 of the Act)................... 359
B. Provisions Relating to Tax Shelters................. 360
1. Penalty for failure to disclose reportable
transactions (sec. 811 of the Act and new sec.
6707A of the Code)............................. 360
2. Modifications to the accuracy-related penalties
for listed transactions and reportable
transactions having a significant tax avoidance
purpose (sec. 812 of the Act and new sec. 6662A
of the Code)................................... 363
3. Tax shelter exception to confidentiality
privileges relating to taxpayer communications
(sec. 813 of the Act and sec. 7525 of the Code) 367
4. Statute of limitations for unreported listed
transactions (sec. 814 of the Act and sec. 6501
of the Code)................................... 368
5. Disclosure of reportable transactions by
material advisors (secs. 815 and 816 of the Act
and secs. 6111 and 6707 of the Code)........... 369
6. Investor lists and modification of penalty for
failure to maintain investor lists (secs. 815
and 817 of the Act and secs. 6112 and 6708 of
the Code)...................................... 372
7. Penalty on promoters of tax shelters (sec. 818
of the Act and sec. 6700 of the Code).......... 374
8. Modifications of substantial understatement
penalty for nonreportable transactions (sec.
819 of the Act and sec. 6662 of the Code)...... 375
9. Modification of actions to enjoin certain
conduct related to tax shelters and reportable
transactions (sec. 820 of the Act and sec. 7408
of the Code)................................... 376
10. Penalty on failure to report interests in
foreign financial accounts (sec. 821 of the Act
and sec. 5321 of Title 31, United States Code). 377
11. Regulation of individuals practicing before the
Department of the Treasury (sec. 822 of the Act
and sec. 330 of Title 31, United States Code).. 378
12. Treatment of stripped bonds to apply to
stripped interests in bond and preferred stock
funds (sec. 831 of the Act and secs. 305 and
1286 of the Code).............................. 379
13. Minimum holding period for foreign tax credit
with respect to withholding taxes on income
other than dividends (sec. 832 of the Act and
sec. 901 of the Code).......................... 382
14. Treatment of partnership loss transfers and
partnership basis adjustments (sec. 833 of the
Act and secs. 704, 734, 743, and 754 of the
Code).......................................... 384
15. No reduction of basis under section 734 in
stock held by partnership in corporate partner
(sec. 834 of the Act and sec. 755 of the Code). 390
16. Repeal of special rules for FASITs (sec. 835 of
the Act and secs. 860H through 860L of the
Code).......................................... 392
17. Limitation on transfer and importation of
built-in losses (sec. 836 of the Act and secs.
362 and 334 of the Code)....................... 398
18. Clarification of banking business for purposes
of determining investment of earnings in U.S.
property (sec. 837 of the Act and sec. 956 of
the Code)...................................... 400
19. Denial of deduction for interest on
underpayments attributable to nondisclosed
reportable transactions (sec. 838 of the Act
and sec. 163 of the Code)...................... 402
20. Clarification of rules for payment of estimated
tax for certain deemed asset sales (sec. 839 of
the Act and sec. 338 of the Code).............. 402
21. Exclusion of like-kind exchange property from
nonrecognition treatment on the sale or
exchange of a principal residence (sec. 840 of
the Act)....................................... 404
22. Prevention of mismatching of interest and
original issue discount deductions and income
inclusions in transactions with related foreign
persons (sec. 841 of the Act and secs. 163 and
267 of the Code)............................... 404
23. Deposits made to suspend the running of
interest on potential underpayments (sec. 842
of the Act and new sec. 6603 of the Code)...... 408
24. Authorize IRS to enter into installment
agreements that provide for partial payment
(sec. 843 of the Act and sec. 6159 of the Code) 411
25. Affirmation of consolidated return regulation
authority (sec. 844 of the Act and sec. 1502 of
the Code)...................................... 412
26. Expanded disallowance of deduction for interest
on convertible debt (sec. 845 of the Act and
sec. 163 of the Code).......................... 416
27. Reform of tax treatment of certain leasing
arrangements and limitation on deductions
allocable to property used by governments or
other tax-exempt entities (secs. 847 through
849 of the Act and secs. 167 and 168 of the
Code, and new sec. 470 of the Code)............ 418
C. Reduction of Fuel Tax Evasion....................... 426
1. Exemption from certain excise taxes for mobile
machinery vehicles and modification of
definition of offhighway vehicle (secs. 851 and
852 of the Act and secs. 4053, 4072, 4082,
4483, 6421, and 7701 of the Code).............. 426
2. Taxation of aviation-grade kerosene (sec. 853 of
the Act and secs. 4041, 4081, 4082, 4083, 4091,
4092, 4093, 4101, and 6427 of the Code)........ 429
3. Mechanical dye injection and related penalties
(secs. 854, 855, and 856 of the Act and secs.
4082 and 6715 and new sec. 6715A of the Code).. 436
4. Terminate dyed diesel use by intercity buses
(sec. 857 of the Act and secs. 4082 and 6427 of
the Code)...................................... 439
5. Authority to inspect on-site records (sec. 858
of the Act and sec. 4083 of the Code).......... 440
6. Assessable penalty for refusal of entry (sec.
859 of the Act and new sec. 6717 of the Code).. 440
7. Registration of pipeline or vessel operators
required for exemption of bulk transfers to
registered terminals or refineries (sec. 860 of
the Act and sec. 4081 of the Code)............. 441
8. Display of registration and penalties for
failure to display registration and to register
(sec. 861 of the Act and secs. 4101, 7232, 7272
and new secs. 6718 and 6719 of the Code)....... 443
9. Registration of persons within foreign trade
zones (sec. 862 of the Act and sec. 4101 of the
Code).......................................... 444
10. Penalties for failure to report (sec. 863 of
the Act and new sec. 6725 of the Code)......... 444
11. Electronic filing of required information
reports (sec. 864 of the Act and sec. 4010 of
the Code)...................................... 445
12. Taxable fuel refunds for certain ultimate
vendors (sec. 865 of the Act and secs. 6416 and
6427 of the Code).............................. 446
13. Two party exchanges (sec. 866 of the Act and
new sec. 4105 of the Code)..................... 447
14. Modification of the use tax on heavy highway
vehicles (sec. 867 of the Act and secs. 4481,
4483 and 6165 of the Code)..................... 448
15. Dedication of revenue from certain penalties to
the Highway Trust Fund (sec. 868 of the Act and
sec. 9503 of the Code)......................... 449
16. Simplification of tax on tires (sec. 869 of the
Act and sec. 4071 of the Code)................. 449
17. Taxation of transmix and diesel fuel blend
stocks and Treasury study on fuel tax
compliance (secs. 870 and 871 of the Act and
sec. 4083 of the Code)......................... 451
D. Other Revenue Provisions............................ 454
1. Permit private sector debt collection companies
to collect tax debts (sec. 881 of the Act and
new sec. 6306 of the Code)..................... 454
2. Modify charitable contribution rules for
donations of patents and other intellectual
property (sec. 882 of the Act and secs. 170 and
6050L of the Code)............................. 457
3. Require increased reporting for noncash
charitable contributions (sec. 883 of the Act
and sec. 170 of the Code)...................... 461
4. Limit deduction for charitable contributions of
vehicles (sec. 884 of the Act and sec. 170 and
new sec. 6720 of the Code)..................... 463
5. Treatment of nonqualified deferred compensation
plans (sec. 885 of the Act and secs. 6040 and
6051 and new sec. 409A of the Code)............ 467
6. Extend the present-law intangible amortization
provisions to acquisitions of sports franchises
(sec. 886 of the Act and sec. 197 of the Code). 479
7. Increase continuous levy for certain Federal
payments (sec. 887 of the Act and sec. 6331(h)
of the Code)................................... 480
8. Modification of straddle rules (sec. 888 of the
Act and sec. 1092 of the Code)................. 481
9. Add vaccines against Hepatitis A to the list of
taxable vaccines (sec. 889 of the Act and sec.
4132 of the Code).............................. 485
10. Add vaccines against influenza to the list of
taxable vaccines (sec. 890 of the Act and sec.
4132 of the Code).............................. 487
11. Extension of IRS user fees (sec. 891 of the Act
and sec. 7528 of the Code)..................... 488
12. Extension of Customs user fees (sec. 892 of the
Act)........................................... 488
13. Prohibition on nonrecognition of gain through
complete liquidation of holding company (sec.
893 of the Act and sec. 332 of the Code)....... 489
14. Effectively connected income to include certain
foreign source income (sec. 894 of the Act and
sec. 864 of the Code).......................... 490
15. Recapture of overall foreign losses on sale of
controlled foreign corporation stock (sec. 895
of the Act and sec. 904 of the Code)........... 493
16. Recognition of cancellation of indebtedness
income realized on satisfaction of debt with
partnership interest (sec. 896 of the Act and
sec. 108 of the Code).......................... 495
17. Denial of installment sale treatment for all
readily tradable debt (sec. 897 of the Act and
sec. 453 of the Code).......................... 497
18. Modify treatment of transfers to creditors in
divisive reorganizations (sec. 898 of the Act
and secs. 357 and 361 of the Code)............. 497
19. Clarify definition of nonqualified preferred
stock (sec. 899 of the Act and sec. 351(g) of
the Code)...................................... 499
20. Modify definition of controlled group of
corporations (sec. 900 of the Act and sec. 1563
of the Code)................................... 500
21. Establish specific class lives for utility
grading costs (sec. 901 of the Act and sec. 168
of the Code)................................... 502
22. Provide consistent amortization period for
intangibles (sec. 902 of the Act and secs. 195,
248, and 709 of the Code)...................... 503
23. Freeze of provision regarding suspension of
interest where Secretary fails to contact
taxpayer (sec. 903 of the Act and sec. 6404(g)
of the Code)................................... 504
24. Increase in withholding from supplemental wage
payments in excess of $1 million (sec. 904 of
the Act and sec. 13273 of the Revenue
Reconciliation Act of 1993).................... 505
25. Capital gain treatment on sale of stock
acquired from exercise of statutory stock
options to comply with conflict of interest
requirements (sec. 905 of the Act and sec. 421
of the Code)................................... 506
26. Application of basis rules to nonresident
aliens (sec. 906 of the Act and sec. 83 of the
Code and new sec. 72(w) of the Code)........... 508
27. Deduction for personal use of company aircraft
and other entertainment expenses (sec. 907 of
the Act and sec. 274(e) of the Code)........... 512
28. Residence and source rules related to a United
States possession (sec. 908 of the Act and new
sec. 937 of the Code).......................... 514
29. Dispositions of transmission property to
implement Federal Energy Regulatory Commission
restructuring policy (sec. 909 of the Act and
sec. 451 of the Code).......................... 517
30. Expansion of limitation on expensing of certain
passenger automobiles (sec. 910 of the Act and
sec. 179 of the Code).......................... 519
Part Eighteen: The Revenue Provisions of the Ronald W. Reagan
National Defense Authorization Act for Fiscal Year 2005 (Public
Law 108-375)................................................... 522
A. Exclusion from Gross Income of Travel Benefits under
Operation Hero Miles (sec. 585(b) of the Act and
sec. 134 of the Code).............................. 522
Part Nineteen: The Revenue Provisions of the Consolidated
Appropriations Act, 2005 (Public Law 108-447).................. 523
A. Application of the ERISA Anticutback Rules to
Certain Multiemployer Plan Amendments (Division J,
sec. 110 of the Act and sec. 204(g) of ERISA)...... 523
Part Twenty: An Act To Treat Certain Arrangements Maintained by
the YMCA Retirement Fund as Church Plans for Purposes of
Certain Provisions of the Internal Revenue Code of 1986, and
for Other Purposes (Public Law 108-476)........................ 525
A. Certain Arrangements Maintained by the YMCA
Retirement Fund Treated as Church Plans (sec. 1 of
the Act and secs. 401(a), 403(b), and 7702(j) of
the Code).......................................... 525
Part Twenty-One: An Act To Modify the Taxation of Arrow
Components (Public Law 108-493)................................ 529
A. Excise Tax on Arrows (sec. 1 of the Act and sec.
4161 of the Code).................................. 529
Appendix......................................................... 531
INTRODUCTION
This document,\1\ prepared by the staff of the Joint
Committee on Taxation in consultation with the staffs of the
House Committee on Ways and Means and the Senate Committee on
Finance, provides an explanation of tax legislation enacted in
the 108th Congress. The explanation follows the chronological
order of the tax legislation as signed into law.
---------------------------------------------------------------------------
\1\ This document may be cited as follows: Joint Committee on
Taxation, General Explanation of Tax Legislation Enacted in the 108th
Congress (JCS-5-05), May 2005.
---------------------------------------------------------------------------
For each provision, the document includes a description of
present and prior law, explanation of the provision, and
effective date. Present and prior law describes the law in
effect immediately prior to enactment. Prior law indicates the
portion of the law that was changed by the provision. For most
provisions, the reasons for change are also included. In some
instances, provisions included in legislation enacted in the
108th Congress were not reported out of committee before
enactment. As a result, the legislative history of such
provisions does not include the reasons for change normally
included in a committee report. In the case of such provisions,
no reasons for change are included with the explanation of the
provision in this document.
Part One of this document is an explanation of the
provisions of the Jobs and Growth Tax Relief Reconciliation Act
of 2003 (Pub. L. No. 108-27), relating to the acceleration of
certain previously enacted tax reductions, growth incentives
for businesses, reduction in taxes on dividends and capital
gains, and corporate estimated tax payments.
Part Two is an explanation of the provision of Surface
Transportation Extension Act of 2003 (Pub. L. No. 108-88)
relating to the extension of the Highway Trust Fund and Aquatic
Resources Trust Fund expenditure authority.
Part Three is an explanation of provisions relating to
disclosure of return information relating to student loans,
extension of IRS user fees, and extension of custom user fees
of an Act to extend the Temporary Assistance for Needy Families
block grant program and certain tax and trade programs and for
other purposes (Pub. L. No. 108-89).
Part Four is an explanation of the provisions of the
Military Family Tax Relief Act of 2003 (Pub. L. No. 108-121),
relating to improving tax equity for military personnel and
extension of custom user fees.
Part Five is an explanation of the provisions of the
Medicare Prescription Drug, Improvement, and Modernization Act
(Pub. L. No. 108-173) relating to disclosure of return
information for purposes under the Medicare discount card
program, disclosure of return information relating to income-
related reduction in Part B Premium subsidy, health savings
accounts, exclusion from gross income of certain Federal
subsidies for prescription drug plans, and an exception to
information reporting for certain health arrangements.
Part Six is an explanation of the provisions of the Vision
100-Century of Aviation Reauthorization Act (Pub. L. No. 108-
176) relating to the extension of expenditure authority.
Part Seven is an explanation of the provision of the
Servicemembers Civil Relief Act (Pub. L. No. 108-189) relating
to tax collection of servicemembers.
Part Eight is an explanation of the provision of the
Surface Transportation Extension Act of 2004 (Pub. L. No. 108-
202) relating to extension of the Highway Trust Fund and
Aquatic Resources Trust Fund expenditure authority.
Part Nine is an explanation of the revenue provisions of
the Social Security Protection Act of 2004 (Pub. L. No. 108-
203) relating to the treatment of individual work plans under
the Ticket to Work program, FICA and SECA tax exemptions
individuals subject to the laws of a tantalization agreement
partner, and other technical amendments.
Part Ten is an explanation of the provisions of the Pension
Funding Equity Act of 2004 (Pub. L. No. 108-218), relating to
temporary replacement of the 30-year Treasury rate and election
of alternative deficit reduction contribution, multiemployer
plan funding notices, deferral of the charge for a portion of
net experience loss of multiemployer plans, and other
provisions.
Part Eleven is an explanation of the provision of the
Surface Transportation Extension Act of 2004, Part II (Pub. L.
No. 108-224) relating to the extension of the Highway Trust
Fund and Aquatic Resources Trust Fund expenditure authority.
Part Twelve is an explanation of the provision of the
Surface Transportation Extension Act of 2004, Part III (Pub. L.
No. 108-263) relating to the extension of the Highway Trust
Fund and Aquatic Resources Trust Fund expenditure authority.
Part Thirteen is an explanation of the provision of the
Surface Transportation Extension Act of 2004, Part IV (Pub. L.
No. 108-280) relating to the extension of the Highway Trust
Fund and Aquatic Resources Trust Fund expenditure authority.
Part Fourteen is an explanation of the provision of the
Surface Transportation Extension Act of 2004, Part V (Pub. L.
No. 108-310) relating to the extension of the Highway Trust
Fund and Aquatic Resources Trust Fund expenditure authority.
Part Fifteen is an explanation of the provisions of the
Working Families Tax Relief Act of 2004 (Pub. L. No. 108-311),
relating to extension of certain expiring provisions, uniform
definition of child and tax technical corrections.
Part Sixteen is an explanation of the provision to clarify
the tax treatment of bonds and other obligations issued by the
Government of American Samoa (Pub. L. No. 108-326).
Part Seventeen is an explanation of the provisions of the
America Jobs Creation Act of 2004 (Pub. L. No. 108-357),
relating to the repeal of exclusion for extraterritorial
income, business tax incentives, tax relief for agriculture and
small manufacturers, tax reform and simplification for United
States businesses, deduction of State and local sales taxes,
miscellaneous and revenue provisions.
Part Eighteen is an explanation of the revenue provisions
of the Ronald W. Reagan National Defense Authorization Act for
Fiscal Year 2005 (Pub. L. No. 108-375) relating to the
exclusion from gross income of travel benefits under Operation
Hero Miles.
Part Nineteen is an explanation of the revenue provisions
of the Consolidated Appropriations Act, 2005 (Pub. L. No. 108-
447) relating to the application of ERISA anticutback rules to
certain multiemployer plan amendments.
Part Twenty is an explanation of the provisions of the Act
to treat certain arrangements maintained by the YMCA Retirement
Fund as church plans for the purposes of certain provisions of
the Internal Revenue Code of 1986, and for other purposes (Pub.
L. No. 109-476).
Part Twenty-One is an explanation of the provision of the
Act to modify the taxation of arrow components (Pub. L. No.
108-493).
The Appendix provides the estimated budget effects of tax
legislation enacted in the 108th Congress.
The first footnote in each part gives the legislative
history of each of the Acts of the 108th Congress discussed.
PART ONE: JOBS AND GROWTH TAX RELIEF RECONCILIATION ACT OF 2003 (PUBLIC
LAW 108-27) \2\
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\2\ H.R. 2. The House Committee on Ways and Means reported the bill
on May 8, 2003 (H.R. Rep. No. 108-94). The House passed the bill on May
9, 2003. The Senate Committee on Finance reported S. 1054 on May 13,
2003 (S. Prt. No. 108-26). The Senate passed H. R. 2, as amended by the
provisions of S. 1054, on May 15, 2003. The conference report was filed
on May 22, 2003 (H.R. Rep. No. 108-126), and was passed by the House on
May 23, 2003, and the Senate on May 23, 2003. The President signed the
bill on May 28, 2003.
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I. ACCELERATION OF CERTAIN PREVIOUSLY ENACTED TAX REDUCTIONS
A. Accelerate the Increase in the Child Tax Credit (sec. 101 of the Act
and sec. 24 of the Code)
Present and Prior Law
In general
For 2003, an individual may claim a $600 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
descendent of either), or eligible foster child.
Under prior law, the child tax credit was scheduled to
increase to $1,000, phased-in over several years.
Table 1, below, shows the scheduled increases of the child
tax credit as provided under the Economic Growth and Tax Relief
Reconciliation Act of 2001 (``EGTRRA'').
Table 1.--Scheduled Increase of the Child Tax Credit
------------------------------------------------------------------------
Credit
Taxable year amount per
child
------------------------------------------------------------------------
2003-2004.................................................. $600
2005-2008.................................................. $700
2009....................................................... $800
2010 \1\................................................... $1,000
------------------------------------------------------------------------
\1\ The credit reverts to $500 in taxable years beginning after December
31, 2010, under the sunset provision of EGTRRA.
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.\3\ 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
$87,000 of modified adjusted gross income. The phase-out range
for a single individual with two qualifying children is between
$75,000 and $99,000.
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\3\ 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)). Unless otherwise
indicated, all section references are to the Internal Revenue Code.
---------------------------------------------------------------------------
The amount of the tax credit and the phase-out ranges are
not adjusted annually for inflation.
Refundability
For 2003, the child credit is refundable to the extent of
10 percent of the taxpayer's earned income in excess of
$10,500.\4\ The percentage is increased to 15 percent for
taxable years 2005 and thereafter. 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, if that amount is greater than
the refundable credit based on the taxpayer's earned income in
excess of $10,500 (for 2003). The refundable portion of the
child credit does not constitute income and is not treated as
resources for purposes of determining eligibility or the amount
or nature of benefits or assistance under any Federal program
or any State or local program financed with Federal funds. For
taxable years beginning after December 31, 2010, the sunset
provision of EGTRRA applies to the rules allowing refundable
child credits.
---------------------------------------------------------------------------
\4\ The $10,500 amount is indexed for inflation.
---------------------------------------------------------------------------
Alternative minimum tax liability
The child credit is allowed against the individual's
regular income tax and alternative minimum tax. For taxable
years beginning after December 31, 2010, the sunset provision
of EGTRRA applies to the rules allowing the child credit
against the alternative minimum tax.
Reasons for Change
The Jobs and Growth Tax Relief Reconciliation Act of 2003
(``the Act'') accelerated the increase in the child tax credit
in order to provide additional tax relief to families to help
offset the significant costs of raising a child. Further, the
Act provided immediate tax relief to American taxpayers in the
form of the advance payment of the increased amount of the
child credit. The Congress believed that such immediate tax
relief might encourage short-term growth in the economy by
providing individuals with additional cash to spend.
Explanation of Provision
Under the Act, the amount of the child credit is increased
to $1,000 for 2003 and 2004.\5\ After 2004, the child credit
will revert to the levels provided under present and prior law,
as described above. For 2003, the increased amount of the child
credit will be paid in advance beginning in July, 2003, on the
basis of information on each taxpayer's 2002 return filed in
2003. The IRS is not expected to issue advance payment checks
to an individual who did not claim the child credit for 2002.
Such payments will be made in a manner similar to the advance
payment checks issued by the Treasury in 2001 to reflect the
creation of the 10-percent regular income tax rate bracket.\6\
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\5\ The increase in refundability to 15 percent of the taxpayer's
earned income, scheduled for calendar years 2005 and thereafter, is not
accelerated under the provision.
\6\ The size of the child credit for taxable years beginning after
December 31, 2004, was modified by the Working Families Tax Relief Act
of 2004, described in Part Fifteen of this document.
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Effective Date
The provision is effective for taxable years beginning
after December 31, 2002, and before January 1, 2005.
B. Accelerate Marriage Penalty Relief (secs. 102 and 103 of the Act and
secs. 1 and 63 of the Code)
1. Standard deduction marriage penalty relief
Present and Prior 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.\8\ Under prior law for
2003, the basic standard deduction for married couples filing a
joint return was 167 percent of the basic standard deduction
for single filers. (Stated alternatively, under prior law for
2003, the basic standard deduction amount for single filers was
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.
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\7\ Additional standard deductions are allowed with respect to any
individual who is elderly (age 65 or over) or blind.
\8\ For 2003 the basic standard deduction amounts are: (1) $4,750
for unmarried individuals; (2) $7,950 for married individuals filing a
joint return; (3) $7,000 for heads of households; and (4) $3,975 for
married individuals filing separately.
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EGTRRA increased 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.\9\ The increase in the standard deduction for married
taxpayers filing a joint return is scheduled to be phased-in
over five years beginning in 2005 and will be fully phased-in
for 2009 and thereafter. Table 2, below, shows the standard
deduction for married couples filing a joint return as a
percentage of the standard deduction for single individuals.
---------------------------------------------------------------------------
\9\ 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 after the phase-in
period.
Table 2.--Size of the Basic Standard Deduction for Married Couples
Filing Joint Returns
------------------------------------------------------------------------
Standard deduction for
married couples filing
joint returns as
Taxable year percentage of standard
deduction for unmarried
individual returns
------------------------------------------------------------------------
2003-2004..................................... 167
2005.......................................... 174
2006.......................................... 184
2007.......................................... 187
2008.......................................... 190
2009 and 2010 \1\............................. 200
------------------------------------------------------------------------
\1\ The basic standard deduction increases are repealed for taxable
years beginning after December 31, 2010, under the sunset provision of
EGTRRA.
Reasons for Change
The Congress remained 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 Congress believed that
the acceleration of the increase in the standard deduction for
married couples filing a joint return was a responsible
reduction of the marriage tax penalty.
Explanation of Provision
The Act increases the basic standard deduction amount for
joint returns to twice the basic standard deduction amount for
single returns effective for 2003 and 2004. For taxable years
beginning after 2004, the applicable percentages will revert to
those allowed under present and prior law, as described above
in Table 2.\10\
---------------------------------------------------------------------------
\10\ The size of the basic standard deduction for taxable years
beginning after December 31, 2004, was modified by the Working Families
Tax Relief Act of 2004, described in Part Fifteen of this document.
---------------------------------------------------------------------------
Effective Date
The provision is effective for taxable years beginning
after December 31, 2002, and before January 1, 2005.
2. Accelerate the expansion of the 15-percent rate bracket for married
couples filing joint returns
Present and Prior 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.\11\ 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.
---------------------------------------------------------------------------
\11\ Under present law, the rate bracket breakpoint for the 38.6
percent marginal tax rate is the same for single individuals and
married couples filing joint returns.
---------------------------------------------------------------------------
15-percent regular income tax rate bracket
EGTRRA increased 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 a single
individual filing a single return. The increase is phased-in
over four years, beginning in 2005. 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 is 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, 2007.
Table 3, below, shows the size of the 15-percent bracket.
Table 3.--Size of the 15-Percent Rate Bracket for Married Couples Filing
Joint Returns
------------------------------------------------------------------------
End point of 15-percent
rate bracket for married
couples filing joint
Taxable year returns as percentage
rate bracket for
unmarried individuals
------------------------------------------------------------------------
2003-2004..................................... 167
2005.......................................... 180
2006.......................................... 187
2007.......................................... 193
2008 and 2010\1\.............................. 200
------------------------------------------------------------------------
\1\ The increases in the 15-percent rate bracket for married couples
filing a joint return are repealed for taxable years beginning after
December 31, 2010, under the sunset of EGTRRA.
Reasons for Change
The Congress believed that accelerating the expansion of
the 15-percent rate bracket for married couples filing joint
returns, in conjunction with the expansion of the standard
deduction amount for joint filers, would alleviate the effects
of the marriage tax penalty. These provisions significantly
reduced the most widely applicable marriage penalties.
Explanation of Provision
The Act increases of the size of the 15-percent regular
income tax rate bracket for joint returns to twice the width of
the 15-percent regular income tax rate bracket for single
returns for taxable years beginning in 2003 and 2004. For
taxable years beginning after 2004, the applicable percentages
will revert to those allowed under present and prior law, as
described above.\12\
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\12\ The size of the 15-percent regular rate bracket for joint
returns for taxable years beginning after December 31, 2004, was
modified by the Working Families Tax Relief Act of 2004, described in
Part Fifteen of this document.
---------------------------------------------------------------------------
Effective Date
The provision is effective for taxable years beginning
after December 31, 2002, and before January 1, 2005.
C. Accelerate Reductions in Individual Income Tax Rates (secs. 104,
105, and 106 of the Act and secs. 1 and 55 of the Code)
Present and Prior Law
In general
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 2003, the regular income tax rate schedules for
individuals are shown in Table 4, 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 4.--Individual Regular Income Tax Rates for 2003
------------------------------------------------------------------------
But not Then regular income
If taxable income is over: over: tax equals:
------------------------------------------------------------------------
Single Individuals
------------------------------------------------------------------------
$0................................. $6,000 10% of taxable income
$6,000............................. $28,400 $600, plus 15% of the
amount over $6,000
$28,400............................ $68,800 $3,960.00, plus 27%
of the amount over
$28,400
$68,800............................ $143,500 $14,868.00, plus 30%
of the amount over
$68,800
$143,500........................... $311,950 $37,278.00, plus 35%
of the amount over
$143,500
Over $311,950...................... ............ $96,235.50, plus
38.6% of the amount
over $311,950
------------------------------------------------------------------------
Head of Households
------------------------------------------------------------------------
$0................................. $10,000 10% of taxable income
$10,000............................ $38,050 $1,000, plus 15% of
the amount over
$10,000
$38,050............................ $98,250 $5,207.50, plus 27%
of the amount over
$38,050
$98,250............................ $159,100 $21,461.50, plus 30%
of the amount over
$98,250
$159,100........................... $311,950 $39,716.50, plus 35%
of the amount over
$159,100
Over $311,950...................... ............ 93,214, plus 38.6% of
the amount over
$311,950
------------------------------------------------------------------------
Married Individuals Filing Joint Returns
------------------------------------------------------------------------
$0................................. $12,000 10% of taxable income
$12,000............................ $47,450 $1,200, plus 15% of
the amount over
$12,000
$47,450............................ $114,650 $6,517.50, plus 27%
of the amount over
$47,450
$114,650........................... $174,700 $24,661.50, plus 30%
of the amount over
$114,650
$174,700........................... $311,950 $42,676.50, plus 35%
of the amount over
$174,700
Over $311,950...................... ............ $90,714, plus 38.6%
of the amount over
$311,950
------------------------------------------------------------------------
Ten-percent regular income tax rate
Under prior law, the 10-percent rate applied 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. Effective beginning in 2008, the
$6,000 amount will increase to $7,000 and the $12,000 amount
will increase to $14,000.
The taxable income levels for the 10-percent rate bracket
will be adjusted annually for inflation for taxable years
beginning after December 31, 2008. The bracket for single
individuals and married individuals filing separately is one-
half for joint returns (after adjustment of that bracket for
inflation).
The 10-percent rate bracket will expire for taxable years
beginning after December 31, 2010, under the sunset provision
of the Economic Growth and Tax Relief Reconciliation Act of
2001 (``EGTRRA'').
Reduction of other regular income tax rates
Prior to EGTRRA, the regular income tax rates were 15
percent, 28 percent, 31 percent, 36 percent, and 39.6
percent.\13\ EGTRRA added the 10-percent regular income tax
rate, described above, and retained the 15-percent regular
income tax rate. Also, the 15-percent regular income tax
bracket was modified to begin at the end of the 10-percent
regular income tax bracket. EGTRRA also made other changes to
the 15-percent regular income tax bracket.\14\
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\13\ The regular income tax rates will revert to these percentages
for taxable years beginning after December 31, 2010, under the sunset
of EGTRRA.
\14\ See the discussion of the provision regarding marriage penalty
relief in the 15-percent regular income tax bracket, above.
---------------------------------------------------------------------------
Also, under EGTRRA, the 28 percent, 31 percent, 36 percent,
and 39.6 percent rates are phased down over six years to 25
percent, 28 percent, 33 percent, and 35 percent, effective
after June 30, 2001. The taxable income levels for the rates
above the 15-percent rate in all taxable years are the same as
the taxable income levels that apply under the prior-law rates.
Table 5, below, shows the schedule of regular income tax
rate reductions.
Table 5.--Scheduled Regular Income Tax Rate Reductions
------------------------------------------------------------------------
39.6%
28% rate 31% rate 36% rate rate
Taxable year reduced reduced reduced reduced
to: to: to: to:
------------------------------------------------------------------------
2001-2003 \1\............... 27 30 35 38.6
2004-2005................... 26 29 34 37.6
2006-2010 \2\............... 25 28 33 35.0
------------------------------------------------------------------------
\1\ Effective July 1, 2001.
\2\ The reduction in the regular income tax rates are repealed for
taxable years beginning after December 31, 2010, under the sunset
provision of EGTRRA.
Alternative minimum tax exemption amounts
The alternative minimum tax is the amount by which the
tentative minimum tax exceeds the regular income tax. An
individual's tentative minimum tax is the sum of (1) 26 percent
of so much of the taxable excess as does not exceed $175,000
($87,500 in the case of a married individual filing a separate
return) and (2) 28 percent of the remaining taxable excess. The
taxable excess is so much of the alternative minimum taxable
income (``AMTI'') as exceeds the exemption amount. The maximum
tax rates on net capital gain and dividends used in computing
the regular tax are used in computing the tentative minimum
tax. AMTI is the individual's taxable income adjusted to take
account of specified preferences and adjustments.
Under prior law, the exemption amounts were: (1) $49,000
($45,000 in taxable years beginning after 2004) in the case of
married individuals filing a joint return and surviving
spouses; (2) $35,750 ($33,750 in taxable years beginning after
2004) in the case of other unmarried individuals; (3) $24,500
($22,500 in taxable years beginning after 2004) in the case of
married individuals filing a separate return; and (4) $22,500
in the case of an estate or trust. 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. These amounts
are not indexed for inflation.
Reasons for Change
The Congress believed that high marginal individual income
tax rates reduce incentives for taxpayers to work, to save, and
to invest and, thereby, have a negative effect on the long-term
health of the economy. The higher that marginal tax rates are,
the greater is the disincentive for individuals to increase
their work effort. Lower marginal tax rates provide greater
incentives to taxpayers to be entrepreneurial risk takers; the
Congress believed that the higher marginal tax rates of prior-
law discourage success. The Congress believed 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.
In addition, lower marginal tax rates help remove the
barriers that lower-income families face as they try to enter
the middle class. The lower the marginal tax rates for lower-
income families, the greater is the incentive to work. The
expanded 10-percent rate bracket provides an incentive for
these taxpayers to increase their work effort.
Finally, there were signs that the economy was not growing
as fast as desirable. The Congress believed that immediate tax
relief could encourage growth in the economy by providing
individuals with additional tax relief. The Congress recognized
that it was important to act quickly so that taxpayers become
aware of the commitment of the President and the Congress to
enact this tax cut and to adjust income tax withholding tables.
Explanation of Provision
Ten-percent regular income tax rate
The Act accelerates the increase in the taxable income
levels for the 10-percent rate bracket previously scheduled for
2008 to be effective in 2003 and 2004. Specifically, for 2003
and 2004, the Act increases the taxable income level for the
10-percent regular income tax rate brackets for unmarried
individuals from $6,000 to $7,000 and for married individuals
filing jointly from $12,000 to $14,000. The taxable income
levels for the 10-percent regular income tax rate bracket will
be adjusted annually for inflation for taxable years beginning
after December 31, 2003.
For taxable years beginning after December 31, 2004, the
taxable income levels for the 10-percent rate bracket will
revert to the levels allowed under prior law. Therefore, for
2005, 2006, and 2007, the levels will revert to $6,000 for
unmarried individuals and $12,000 for married individuals
filing jointly. In 2008, the taxable income levels for the 10-
percent regular income tax rate brackets will be $7,000 for
unmarried individuals and $14,000 for married individuals
filing jointly. The taxable income levels for the 10-percent
rate bracket will be adjusted annually for inflation for
taxable years beginning after December 31, 2008.\15\
---------------------------------------------------------------------------
\15\ The size of the 10-percent rate bracket for taxable years
beginning after December 31, 2004, was modified by the Working Families
Tax Relief Act of 2004, described in Part Fifteen of this document.
---------------------------------------------------------------------------
Reduction of other regular income tax rates
The Act accelerates the reductions in the regular income
tax rates in excess of the 15-percent regular income tax rate
that were scheduled for 2004 and 2006. Therefore, for 2003-
2010, the regular income tax rates in excess of 15 percent
under the bill are 25 percent, 28 percent, 33 percent, and 35
percent.
Alternative minimum tax exemption amounts
The Act increases the AMT exemption amount for married
taxpayers filing a joint return and surviving spouses to
$58,000, and for unmarried taxpayers to $40,250, for taxable
years beginning in 2003 and 2004.
Effective Date
The provision generally is effective for taxable years
beginning after December 31, 2002. The Congress recognized that
withholding at statutorily mandated rates (such as pursuant to
backup withholding under section 3406) had already occurred.
The Congress intended that taxpayers who have been overwithheld
as a consequence of this obtain a refund of this
overwithholding through the normal process of filing an income
tax return, and not through the payor. In addition, the
Congress anticipated that the Treasury would provide a brief,
reasonable period of transition for payors to implement these
changes in these statutorily mandated withholding rates.
II. GROWTH INCENTIVES FOR BUSINESS
A. Increase and Extension of Bonus Depreciation (sec. 201 of the Act
and sec. 168 of the Code)
Present and Prior Law
In general
A taxpayer is allowed to recover, through annual
depreciation deductions, the cost of certain property used in a
trade or business or for the production of income. The amount
of the depreciation deduction allowed with respect to tangible
property for a taxable year is determined under the modified
accelerated cost recovery system (``MACRS''). Under MACRS,
different types of property generally are assigned applicable
recovery periods and depreciation methods. The recovery periods
applicable to most tangible personal property (generally
tangible property other than residential rental property and
nonresidential real property) range from 3 to 25 years. The
depreciation methods generally applicable to tangible personal
property are the 200-percent and 150-percent declining balance
methods, switching to the straight-line method for the taxable
year in which the depreciation deduction would be maximized.
Section 280F limits the annual depreciation deductions with
respect to passenger automobiles to specified dollar amounts,
indexed for inflation.
Section 167(f)(1) provides that capitalized computer
software costs, other than computer software to which section
197 applies, are recovered ratably over 36 months.
In lieu of depreciation, a taxpayer with a sufficiently
small amount of annual investment generally may elect to deduct
up to $25,000 of the cost of qualifying property placed in
service for the taxable year (sec. 179). In general, qualifying
property is defined as depreciable tangible personal property
that is purchased for use in the active conduct of a trade or
business.
Additional first year depreciation deduction
The Job Creation and Worker Assistance Act of 2002 \16\
(``JCWAA'') allows an additional first-year depreciation
deduction equal to 30 percent of the adjusted basis of
qualified property.\17\ The amount of the additional first-year
depreciation deduction is not affected by a short taxable year.
The additional first-year depreciation deduction is allowed for
both regular tax and alternative minimum tax purposes for the
taxable year in which the property is placed in service.\18\
The basis of the property and the depreciation allowances in
the year of purchase and later years are appropriately adjusted
to reflect the additional first-year depreciation deduction. In
addition, there are no adjustments to the allowable amount of
depreciation for purposes of computing a taxpayer's alternative
minimum taxable income with respect to property to which the
provision applies. A taxpayer is allowed to elect out of the
additional first-year depreciation for any class of property
for any taxable year.
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\16\ Pub. L. No. 107-147, sec. 101 (2002).
\17\ The additional first-year depreciation deduction is subject to
the general rules regarding whether an item is deductible under section
162 or subject to capitalization under section 263 or section 263A.
\18\ However, the additional first-year depreciation deduction is
not allowed for purposes of computing earnings and profits.
---------------------------------------------------------------------------
In order for property to qualify for the additional first-
year depreciation deduction it must meet all of the following
requirements. First, the property must be (1) property to which
MACRS applies with an applicable recovery period of 20 years or
less, (2) water utility property (as defined in section
168(e)(5)), (3) computer software other than computer software
covered by section 197, or (4) qualified leasehold improvement
property (as defined in section 168(k)(3)).\19\ Second, the
original use \20\ of the property must commence with the
taxpayer on or after September 11, 2001.\21\ Third, the
taxpayer must purchase the property within the applicable time
period. Finally, the property must be placed in service before
January 1, 2005. An extension of the placed in service date of
one year (i.e., to January 1, 2006) is provided for certain
property with a recovery period of ten years or longer and
certain transportation property.\22\ Transportation property is
defined as tangible personal property used in the trade or
business of transporting persons or property.
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\19\ A special rule precludes the additional first-year
depreciation deduction for any property that is required to be
depreciated under the alternative depreciation system of MACRS.
\20\ The term ``original use'' means the first use to which the
property is put, whether or not such use corresponds to the use of such
property by the taxpayer.
If in the normal course of its business a taxpayer sells fractional
interests in property to unrelated third parties, then the original use
of such property begins with the first user of each fractional interest
(i.e., each fractional owner is considered the original user of its
proportionate share of the property).
\21\ A special rule applies in the case of certain leased property.
In the case of any property that is originally placed in service by a
person and that is sold to the taxpayer and leased back to such person
by the taxpayer within three months after the date that the property
was placed in service, the property would be treated as originally
placed in service by the taxpayer not earlier than the date that the
property is used under the leaseback.
If property is originally placed in service by a lessor (including
by operation of section 168(k)(2)(D)(i)), such property is sold within
three months after the date that the property was placed in service,
and the user of such property does not change, then the property is
treated as originally placed in service by the taxpayer not earlier
than the date of such sale.
\22\ In order for property to qualify for the extended placed in
service date, the property is required to have a production period
exceeding two years or an estimated production period exceeding one
year and a cost exceeding $1 million.
---------------------------------------------------------------------------
The applicable time period for acquired property is (1)
after September 10, 2001, and before September 11, 2004, but
only if no binding written contract for the acquisition is in
effect before September 11, 2001, or (2) pursuant to a binding
written contract which was entered into after September 10,
2001, and before September 11, 2004.\23\ With respect to
property that is manufactured, constructed, or produced by the
taxpayer for use by the taxpayer, the taxpayer must begin the
manufacture, construction, or production of the property after
September 10, 2001, and before September 11, 2004. Property
that is manufactured, constructed, or produced for the taxpayer
by another person under a contract that is entered into prior
to the manufacture, construction, or production of the property
is considered to be manufactured, constructed, or produced by
the taxpayer. For property eligible for the extended placed in
service date, a special rule limits the amount of costs
eligible for the additional first year depreciation. With
respect to such property, only the portion of the basis that is
properly attributable to the costs incurred before September
11, 2004 (``progress expenditures'') is eligible for the
additional first-year depreciation.\24\
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\23\ Property does not fail to qualify for the additional first-
year depreciation merely because a binding written contract to acquire
a component of the property is in effect prior to September 11, 2001.
\24\ For purposes of determining the amount of eligible progress
expenditures, it is intended that rules similar to sec. 46(d)(3) as in
effect prior to the Tax Reform Act of 1986 shall apply.
---------------------------------------------------------------------------
Property does not qualify for the additional first-year
depreciation deduction when the user of such property (or a
related party) would not have been eligible for the additional
first-year depreciation deduction if the user (or a related
party) were treated as the owner. For example, if a taxpayer
sells to a related party property that was under construction
prior to September 11, 2001, the property does not qualify for
the additional first-year depreciation deduction. Similarly, if
a taxpayer sells to a related party property that was subject
to a binding written contract prior to September 11, 2001, the
property does not qualify for the additional first-year
depreciation deduction. As a further example, if a taxpayer
(the lessee) sells property in a sale-leaseback arrangement,
and the property otherwise would not have qualified for the
additional first-year depreciation deduction if it were owned
by the taxpayer-lessee, then the lessor is not entitled to the
additional first-year depreciation deduction.
The limitation on the amount of depreciation deductions
allowed with respect to certain passenger automobiles (sec.
280F) is increased in the first year by $4,600 for automobiles
that qualify (and do not elect out of the increased first year
deduction). The $4,600 increase is not indexed for inflation.
Reasons for Change
The Congress believed that increasing and extending the
additional first-year depreciation would accelerate purchases
of equipment, promote capital investment, modernization, and
growth, and would help to spur an economic recovery.
Explanation of Provision
The Act provides an additional first-year depreciation
deduction equal to 50 percent of the adjusted basis of
qualified property.\25\ Qualified property is defined in the
same manner as for purposes of the 30-percent additional first-
year depreciation deduction provided by the JCWAA except that
the applicable time period for acquisition (or self
construction) of the property is modified. In addition,
property must be placed in service before January 1, 2005 to
qualify.\26\ Property for which the 50-percent additional first
year depreciation deduction is claimed is not eligible for the
30-percent additional first year depreciation deduction.
---------------------------------------------------------------------------
\25\ A taxpayer is permitted to elect out of the 50-percent
additional first-year depreciation deduction for any class of property
for any taxable year.
\26\ An extension of the placed in service date of one year (i.e.,
January 1, 2006) is provided for certain property with a recovery
period of 10 years or longer and certain transportation property as
defined for purposes of the JCWAA.
---------------------------------------------------------------------------
Under the Act, in order to qualify the property must be
acquired after May 5, 2003, and before January 1, 2005, and no
binding written contract for the acquisition is in effect
before May 6, 2003.\27\ With respect to property that is
manufactured, constructed, or produced by the taxpayer for use
by the taxpayer, the taxpayer must begin the manufacture,
construction, or production of the property after May 5, 2003.
For property eligible for the extended placed in service date
(i.e., certain property with a recovery period of 10 years or
longer and certain transportation property), a special rule
limits the amount of costs eligible for the additional first
year depreciation. With respect to such property, only progress
expenditures properly attributable to the costs incurred before
January 1, 2005, shall be eligible for the additional first
year depreciation.\28\
---------------------------------------------------------------------------
\27\ Property does not fail to qualify for the additional first-
year depreciation merely because a binding written contract to acquire
a component of the property is in effect prior to May 6, 2003. However,
no 50-percent additional first-year depreciation is permitted on any
such component. No inference is intended as to the proper treatment of
components placed in service under the 30 percent additional first-year
depreciation provided by the JCWAA.
\28\ For purposes of determining the amount of eligible progress
expenditures, it is intended that rules similar to sec. 46(d)(3) as in
effect prior to the Tax Reform Act of 1986 are to apply.
---------------------------------------------------------------------------
The Congress wishes to clarify that the adjusted basis of
qualified property acquired by a taxpayer in a like kind
exchange or an involuntary conversion is eligible for the
additional first year depreciation deduction.
The Act also increases the limitation on the amount of
depreciation deductions allowed with respect to certain
passenger automobiles (sec. 280F) in the first year by $7,650
(in lieu of the $4,600 provided under the JCWAA) for
automobiles that qualify (and do not elect out of the increased
first year deduction). The $7,650 increase is not indexed for
inflation.
The Act also extends the placed in service date requirement
for certain property with a recovery period of 10 years or
longer and certain transportation property to property placed
in service prior to January 1, 2006 (instead of January 1,
2005).\29\ In addition, progress expenditures eligible for the
30-percent additional first year depreciation is extended to
include costs incurred prior to January 1, 2005 (instead of
September 11, 2004).
---------------------------------------------------------------------------
\29\ Property that is otherwise eligible for the extended placed-
in-service rules, and that is acquired and placed in service during
2005 pursuant to a written binding contract which was entered into
after May 5, 2003, and before January 1, 2005, is eligible for the 50-
percent additional first-year depreciation deduction. A technical
correction may be necessary so that the statute reflects this intent.
---------------------------------------------------------------------------
Effective Date
The provision applies to taxable years ending after May 5,
2003.
B. Increased Expensing for Small Business (sec. 202 of the Act and sec.
179 of the Code)
Present and Prior Law
In lieu of depreciation, a taxpayer with a sufficiently
small amount of annual investment may elect to deduct up to
$25,000 (for taxable years beginning in 2003 and thereafter) of
the cost of qualifying property placed in service for the
taxable year (sec. 179).\30\ In general, qualifying property is
defined as depreciable tangible personal property that is
purchased for use in the active conduct of a trade or business.
The $25,000 amount is reduced (but not below zero) by the
amount by which the cost of qualifying property placed in
service during the taxable year exceeds $200,000. An election
to expense these items generally is made on the taxpayer's
original return for the taxable year to which the election
relates, and may be revoked only with the consent of the
Commissioner.\31\ In general, taxpayers may not elect to
expense off-the-shelf computer software.\32\
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\30\ Additional section 179 incentives are provided with respect to
a qualified property used by a business in the New York Liberty Zone
(sec. 1400L(f)), an empowerment zone (sec. 1397A), or a renewal
community (sec. 1400J).
\31\ Section 179(c)(2). A taxpayer may make the election on the
original return (whether or not the return is timely), or on an amended
return filed by the due date (including extensions) for filing the
return for the tax year the property was placed in service. If the
taxpayer timely filed an original return without making the election,
the taxpayer may still make the election by filing an amended return
within six months of the due date of the return (excluding extensions).
Treas. Reg. sec. 1.179-5.
\32\ Section 179(d)(1) requires that property be tangible to be
eligible for expensing; in general, computer software is intangible
property.
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The amount eligible to be expensed for a taxable year may
not exceed the taxable income for a taxable year that is
derived from the active conduct of a trade or business
(determined without regard to this provision). Any amount that
is not allowed as a deduction because of the taxable income
limitation may be carried forward to succeeding taxable years
(subject to similar limitations). No general business credit
under section 38 is allowed with respect to any amount for
which a deduction is allowed under section 179.
Reasons for Change
The Congress believed that section 179 expensing provides
two important benefits for small businesses. First, it lowers
the cost of capital for tangible property used in a trade or
business. With a lower cost of capital, the Congress believed
small business will invest in more equipment and employ more
workers. Second, it eliminates depreciation recordkeeping
requirements with respect to expensed property. In order to
increase the value of these benefits and to increase the number
of taxpayers eligible, the Act increases the amount allowed to
be expensed under section 179 and increases the amount of the
phase-out threshold, as well as indexing these amounts.
The Congress also believed that purchased computer software
should be included in the section 179 expensing provision so
that it is not disadvantaged relative to developed software. In
addition, the Congress believed that the process of making and
revoking section 179 elections should be made simpler and more
efficient for taxpayers by eliminating the requirement of the
consent of the Commissioner.
Explanation of Provision \33\
The Act provides that the maximum dollar amount that may be
deducted under section 179 is increased to $100,000 for
property placed in service in taxable years beginning in 2003,
2004, and 2005. In addition, the $200,000 amount is increased
to $400,000 for property placed in service in taxable years
beginning in 2003, 2004, and 2005. The dollar limitations are
indexed annually for inflation for taxable years beginning
after 2003 and before 2006. The provision also includes off-
the-shelf computer software placed in service in a taxable year
beginning in 2003, 2004, or 2005, as qualifying property. With
respect to a taxable year beginning after 2002 and before 2006,
the provision permits taxpayers to make or revoke expensing
elections on amended returns without the consent of the
Commissioner.
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\33\ The provision was subsequently extended in section 201 of the
American Jobs Creation Act of 2004, Pub. L. No. 108-357, described in
Part Seventeen.
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Effective Date
The provision is effective for taxable years beginning
after December 31, 2002.
III. REDUCTION IN TAXES ON DIVIDENDS AND CAPITAL GAINS
A. Reduction in Capital Gains Rates for Individuals; Repeal of Five-
Year Holding Period Requirement (sec. 301 of the Act and sec. 1(h) of
the Code)
Present and Prior Law
In general, gain or loss reflected in the value of an asset
is not recognized for income tax purposes until a taxpayer
disposes of the asset. On the sale or exchange of a capital
asset, any gain generally is included in income. Any net
capital gain of an individual is taxed at maximum rates lower
than the rates applicable to ordinary income. Net capital gain
is the excess of the net long-term capital gain for the taxable
year over the net short-term capital loss for the year. Gain or
loss is treated as long-term if the asset is held for more than
one year.
Capital losses generally are deductible in full against
capital gains. In addition, individual taxpayers may deduct
capital losses against up to $3,000 of ordinary income in each
year. Any remaining unused capital losses may be carried
forward indefinitely to another taxable year.
A capital asset generally means any property except: (1)
inventory, stock in trade, or property held primarily for sale
to customers in the ordinary course of the taxpayer's trade or
business; (2) depreciable or real property used in the
taxpayer's trade or business; (3) specified literary or
artistic property; (4) business accounts or notes receivable;
(5) certain U.S. publications; (6) certain commodity derivative
financial instruments; (7) hedging transactions; and (8)
business supplies. In addition, the net gain from the
disposition of certain property used in the taxpayer's trade or
business is treated as long-term capital gain. Gain from the
disposition of depreciable personal property is not treated as
capital gain to the extent of all previous depreciation
allowances. Gain from the disposition of depreciable real
property is generally not treated as capital gain to the extent
of the depreciation allowances in excess of the allowances that
would have been available under the straight-line method of
depreciation.
Under prior law, the maximum rate of tax on the adjusted
net capital gain of an individual was 20 percent. In addition,
any adjusted net capital gain which otherwise would have been
taxed at a 15-percent rate was taxed at a 10-percent rate.
These rates applied for purposes of both the regular tax and
the alternative minimum tax.
The ``adjusted net capital gain'' of an individual is the
net capital gain reduced (but not below zero) by the sum of the
28-percent rate gain and the unrecaptured section 1250 gain.
The net capital gain is reduced by the amount of gain that the
individual treats as investment income for purposes of
determining the investment interest limitation under section
163(d).
The term ``28-percent rate gain'' means the amount of net
gain attributable to long-term capital gains and losses from
the sale or exchange of collectibles (as defined in section
408(m) without regard to paragraph (3) thereof), an amount of
gain equal to the amount of gain excluded from gross income
under section 1202 (relating to certain small business
stock),\34\ the net short-term capital loss for the taxable
year, and any long-term capital loss carryover to the taxable
year.
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\34\ This results in a maximum effective regular tax rate on
qualified gain from small business stock of 14 percent.
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``Unrecaptured section 1250 gain'' means any long-term
capital gain from the sale or exchange of section 1250 property
(i.e., depreciable real estate) held more than one year to the
extent of the gain that would have been treated as ordinary
income if section 1250 applied to all depreciation, reduced by
the net loss (if any) attributable to the items taken into
account in computing 28-percent rate gain. The amount of
unrecaptured section 1250 gain (before the reduction for the
net loss) attributable to the disposition of property to which
section 1231 applies shall not exceed the net section 1231 gain
for the year.
The unrecaptured section 1250 gain is taxed at a maximum
rate of 25 percent, and the 28-percent rate gain is taxed at a
maximum rate of 28 percent. Any amount of unrecaptured section
1250 gain or 28-percent rate gain otherwise taxed at a 10- or
15-percent rate is taxed at that rate.
Under prior law, any gain from the sale or exchange of
property held more than five years that would otherwise have
been taxed at the 10-percent rate was taxed at an 8-percent
rate. Any gain from the sale or exchange of property held more
than five years and the holding period for which began after
December 31, 2000, which would otherwise have been taxed at a
20-percent rate was taxed at an 18-percent rate.
Reasons for Change
The Congress believed that, by reducing the effective tax
rates on capital gains, American households will respond by
increasing savings. The Congress believed it is important to
encourage risk-taking and believed that a reduction in the
taxation of capital gains will have that effect. The Congress
also believed that a reduction in the taxation of capital gains
will improve the efficiency of the markets, because the
taxation of capital gains upon realization encourages investors
who have accrued past gains to keep their monies ``locked in''
to such investments even when better investment opportunities
present themselves. A reduction in the taxation of capital
gains should reduce this ``lock in'' effect.
The Congress believed it is important that tax policy be
conducive to economic growth. Economic growth cannot occur
without savings, investment, and the willingness of individuals
to take risks. The greater the pool of savings, the greater
will be the monies available for business investment. It is
through such investment that the United States' economy can
increase output and productivity. It is through increases in
productivity that workers earn higher real wages. Hence, a
greater saving rate is necessary for all Americans to benefit
from a higher standard of living.
Explanation of Provision
The Act reduces the 10- and 20-percent rates on the
adjusted net capital gain of an individual to five (zero for
taxable years beginning after 2007) and 15 percent,
respectively. These lower rates apply to both the regular tax
and the alternative minimum tax. The lower rates apply to
assets held more than one year.
Effective Date
The provision applies to taxable years ending on or after
May 6, 2003, and beginning before January 1, 2009.
For taxable years that include May 6, 2003, the lower rates
apply to amounts properly taken into account for the portion of
the year on or after that date. This generally has the effect
of applying the lower rates to capital assets sold or exchanged
(and installment payments received) on or after May 6, 2003. In
the case of gain and loss taken into account by a pass-through
entity, the date taken into account by the entity is the
appropriate date for applying this rule.
B. Dividend Income of Individuals Taxed at Capital Gain Rates (sec. 302
of the Act and sec. 1(h) of the Code)
Present and Prior Law
Under prior law, dividends received by an individual \35\
were included in gross income and taxed as ordinary income at
rates up to 38.6 percent.\36\
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\35\ The rates applicable to individuals also apply to trusts and
estates.
\36\ Section 105 of the Act reduced the maximum rate to 35 percent.
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Under prior law, the rate of tax on the net capital gain of
an individual generally was 20 percent (10 percent \37\ with
respect to income which would otherwise be taxed at the 10- or
15-percent rate).\38\ Net capital gain means net gain from the
sale or exchange of capital assets held for more than one year
in excess of net loss from the sale or exchange of capital
assets held not more than one year.
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\37\ An eight-percent rate applied to property held more than five
years.
\38\ Section 301 of the Act reduced the capital gain rates to five
(zero for taxable years beginning after 2007) and 15 percent,
respectively.
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Reasons for Change
Under prior law, the United States had a ``classical''
system of taxing corporate income. Under this system,
corporations and their shareholders are treated as separate
persons. A tax was imposed on the corporation on its taxable
income, and after-tax earnings distributed to individual
shareholders as dividends are included in the individual's
income and taxed at the individual's tax rate. This system
created the so-called ``double taxation of dividends.''
The Congress noted that economically, the issue was not
that dividends were taxed twice, but rather the magnitude of
the total tax burden on income from different investments. The
Congress believed the prior system, by placing different tax
burdens on different investments, resulted in economic
distortions. The Congress observed that prior law distorted
corporate financial decisions. The Congress observed that
because interest payments on the debt are deductible, prior law
encouraged corporations to finance using debt rather than
equity and created incentives for financial engineering to
achieve interest deductions from financial instruments with
substantial equity characteristics. The Congress believed that
the increase in corporate leverage, while beneficial to each
corporation from a tax perspective, may have placed the economy
at risk of more bankruptcies during an economic downturn. In
addition, the Congress found that prior law encouraged
corporations to retain earnings rather than to distribute them
as taxable dividends. If dividends are discouraged,
shareholders may prefer that corporate management retain and
reinvest earnings rather than pay out dividends, even if the
shareholder might have an alternative use for the funds that
could offer a higher rate of return than that earned on the
retained earnings. This was another source of inefficiency as
the opportunity to earn higher pre-tax returns was by-passed in
favor of lower pre-tax returns.
The Congress believed it is important that tax policy be
conducive to economic growth. Economic growth is impeded by
tax-induced distortions in the capital markets. Mitigating
these distortions will improve the efficiency of the capital
markets. In addition, reducing the aggregate tax burden on
investments made by corporations will lower the cost of capital
needed to finance new investments and lead to increases in
aggregate national investment by the private sector. It is
through such investment that the United States' economy can
increase output and productivity. It is through increases in
productivity that workers earn higher real wages and all
Americans benefit from a higher standard of living.
Explanation of Provision \39\
Under the Act, dividends received by a non-corporate
shareholder from domestic corporations and qualified foreign
corporations are taxed at the same rates that apply to net
capital gain. This treatment applies for purposes of both the
regular tax and the alternative minimum tax. Thus, under the
Act, dividends received by an individual, estate, or trust are
taxed at rates of five (zero for taxable years beginning after
2007) and 15 percent.\40\
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\39\ The provision is described as amended by the technical
corrections enacted by section 402 of the Working Families Relief Act
of 2004. See H.R. Rep. No. 108-696, the Conference Report to accompany
H.R. 1308, pp. 87-88 (Sept. 23, 2004).
\40\ Payments in lieu of dividends are not eligible for the lower
rates. See section 6045(d) relating to statements required to be
furnished by brokers regarding these payments.
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If a shareholder does not hold a share of stock for more
than 60 days during the 121-day period beginning 60 days before
the ex-dividend date (as measured under section 246(c)),\41\
dividends received on the stock are not eligible for the
reduced rates. Also, the reduced rates are not available for
dividends to the extent that the taxpayer is obligated to make
related payments with respect to positions in substantially
similar or related property.
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\41\ In the case of preferred stock, the period is 90 days within a
181-day period beginning 90 days before the ex-dividend date.
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Qualified dividend income includes otherwise qualified
dividends received from a qualified foreign corporation. The
term ``qualified foreign corporation'' includes a foreign
corporation that is eligible for the benefits of a
comprehensive income tax treaty with the United States which
the Treasury Department determines to be satisfactory and which
includes an exchange of information program.\42\ In addition, a
foreign corporation is treated as a qualified foreign
corporation with respect to any dividend paid by the
corporation with respect to stock that is readily tradable on
an established securities market in the United States.\43\
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\42\ IRS Notice 2003-69 (I.R.B. 2003-42, Oct. 20, 2003) provides a
list of treaties satisfying this requirement.
\43\ IRS Notice 2003-71 (I.R.B. 2003-43, Oct. 27, 2003), IRS Notice
2003-79 (I.R.B. 2003-50, December 15, 2003), and IRS Notice 2004-71
(I.R.B. 2004-45, November 8, 2004) provide guidance on when stock of a
foreign corporation is considered readily tradable on an established
securities market in the United States for this purpose.
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Dividends received from a foreign corporation that was a
foreign investment company (as defined in section 1246(b)), a
passive foreign investment company (as defined in section
1297), or a foreign personal holding company (as defined in
section 552) in either the taxable year of the distribution or
the preceding taxable year are not qualified dividends.\44\
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\44\ IRS Notice 2004-70 (I.R.B. 2004-44, Nov. 1, 2004) provides
guidance on dividend treatment for amounts received by shareholders
from foreign corporations subject to anti-deferral regimes.
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Special rules apply in determining a taxpayer's foreign tax
credit limitation under section 904 in the case of qualified
dividend income. For these purposes, rules similar to the rules
of section 904(b)(2)(B) concerning adjustments to the foreign
tax credit limitation to reflect any capital gain rate
differential will apply to any qualified dividend income.
Additionally, it is anticipated that regulations promulgated
under this provision will coordinate the operation of the rules
applicable to qualified dividend income and capital gain.
If an individual, estate, or trust receives an
extraordinary dividend (within the meaning of section 1059(c))
eligible for the reduced rates with respect to any share of
stock, any loss on the sale of the stock is treated as a long-
term capital loss to the extent of the dividend.
A dividend is treated as investment income for purposes of
determining the amount of deductible investment interest only
if the taxpayer elects to treat the dividend as not eligible
for the reduced rates.
The deduction for estate taxes under section 691(c) paid on
any qualified dividend that is income in respect of a decedent
reduces the amount eligible for the lower tax rates.
The amount of dividends qualifying for reduced rates that
may be paid by a regulated investment company (``RIC'') for any
taxable year in which the qualified dividend income received by
the company is less than 95 percent of its gross income (as
specially computed) may not exceed the sum of (i) the qualified
dividend income of the RIC for the taxable year and (ii) the
amount of earnings and profits accumulated in a non-RIC taxable
year that were distributed by the RIC during the taxable year.
The amount of dividends qualifying for reduced rates that
may be paid by a real estate investment trust (``REIT'') for
any taxable year may not exceed the sum of (i) the qualified
dividend income of the REIT for the taxable year, (ii) an
amount equal to the excess of the income subject to the taxes
imposed by section 857(b)(1) and the regulations prescribed
under section 337(d) for the preceding taxable year over the
amount of these taxes for the preceding taxable year, and (iii)
the amount of earnings and profits accumulated in a non-REIT
taxable year that were distributed by the REIT during the
taxable year.
The reduced rates do not apply to dividends received from
an organization that was exempt from tax under section 501 or
was a tax-exempt farmers' cooperative in either the taxable
year of the distribution or the preceding taxable year;
dividends received from a mutual savings bank that received a
deduction under section 591; or deductible dividends paid on
employer securities.
In the case of brokers and dealers who engage in securities
lending transactions, short sales, or other similar
transactions on behalf of their customers in the normal course
of their trade or business, the Congress intended that the IRS
would exercise its authority under section 6724(a) to waive
penalties where dealers and brokers attempt in good faith to
comply with the information reporting requirements under
sections 6042 and 6045, but were unable to reasonably comply
because of the period necessary to conform their information
reporting systems to the retroactive rate reductions on
qualified dividends provided by the Act. In addition, the
Congress expected that individual taxpayers who received
payments in lieu of dividends from these transactions could
treat the payments as dividend income to the extent that the
payments were reported to them as dividend income on their
Forms 1099-DIV received for calendar year 2003, unless they
knew or had reason to know that the payments were in fact
payments in lieu of dividends rather than actual dividends.\45\
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\45\ IRS Notice 2003-67 (I.R.B. 2003-40, Oct. 6, 2003) provides
guidance to brokers and individuals regarding information reporting for
payments in lieu of dividends. IRS Notice 2003-79 (I.R.B 2003-50,
December 15, 2003) and IRS Notice 2004-71 (I.R.B. 2004-45, November 8,
2004) provide guidance to brokers and individuals regarding information
reporting for foreign dividends.
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The tax rate for the accumulated earnings tax (sec. 531)
and the personal holding company tax (sec. 541) is reduced to
15 percent.
Amounts treated as ordinary income on the disposition of
certain preferred stock (sec. 306) are treated as dividends for
purposes of applying the reduced rates.
The collapsible corporation rules (sec. 341) are repealed.
Effective Date
The provision is effective for taxable years beginning
after December 31, 2002. In the case of a RIC, REIT, S
corporation, partnership, estate, trust, or common trust fund,
the provision applies to taxable years ending after December
31, 2002, with respect to dividends received after that date.
The provision does not apply to taxable years beginning
after December 31, 2008.
IV. CORPORATE ESTIMATED TAX PAYMENTS FOR 2003
A. Time for Payment of Corporate Estimated Taxes (sec. 501 of the Act)
Present and Prior Law
In general, corporations are required to make quarterly
estimated tax payments of their income tax liability (sec.
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 Congress believed it was appropriate to modify the
corporate estimated tax requirements.
Explanation of Provision
With respect to corporate estimated tax payments otherwise
due on September 15, 2003, 25 percent is not required to be
paid until October 1, 2003.
Effective Date
The provision is effective on the date of enactment (May
26, 2003)
PART TWO: SURFACE TRANSPORTATION EXTENSION ACT OF 2003 (PUBLIC LAW 108-
88) \46\
A. Extension of Highway Trust Fund and Aquatic Resources Trust Fund
Expenditure Authority (sec. 12 of the Act)
Present and Prior Law
Under prior law, the Internal Revenue Code (sec. 9503)
authorized expenditures (subject to appropriations) to be made
from the Highway Trust Fund through September 30, 2003, for
purposes provided in specified authorizing legislation as in
effect on the date of enactment of the most recent authorizing
Act (the Transportation Equity Act for the 21st Century).
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\46\ H.R. 3087. The House passed the bill on the suspension
calendar on September 24, 2003. The Senate passed the bill by unanimous
consent on September 26, 2003. The President signed the bill on
September 30, 2003.
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Under prior law, expenditures also were authorized from the
Aquatic Resources Trust Fund through September 30, 2003.
Highway Trust Fund spending is limited by anti-deficit
provisions internal to the Highway Trust Fund, the so-called
``Harry Byrd rule.'' The rule requires the Treasury Department
to determine, on a quarterly basis, the amount (if any) by
which unfunded highway authorizations exceed projected net
Highway Trust Fund tax receipts for the 24-month period
beginning at the close of each fiscal year (sec. 9503(d)).
Similar rules apply to unfunded Mass Transit Account
authorizations. If unfunded authorizations exceed projected 24-
month receipts, apportionments to the States for specified
programs funded by the relevant Trust Fund Account are to be
reduced proportionately. Because of the Harry Byrd rule, taxes
dedicated to the Highway Trust Fund typically are scheduled to
expire at least two years after current authorizing Acts.
Explanation of Provision \47\
The Act extends the authority to make expenditures (subject
to appropriations) from the Highway Trust Fund through February
29, 2004. The Act also updates the Highway Trust Fund cross
references to authorizing legislation to include expenditure
purposes in this Act and prior authorizing legislation as in
effect on the date of enactment.
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\47\ The expiration dates described herein were subsequently
extended by the Surface Transportation Extension Act of 2004; the
Surface Transportation Extension Act of 2004, Part II; the Surface
Transportation Extension Act of 2004, Part III; the Surface
Transportation Extension Act of 2004, Part IV; and the Surface
Transportation Extension Act of 2004, Part V, described in Part Eight,
Part Eleven, Part Twelve, Part Thirteen, and Part Fourteen,
respectively.
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Instead of extending the taxes dedicated to the Highway
Trust Fund, the Act creates a temporary rule (through February
29, 2004) for purposes of the anti-deficit provisions of the
Highway Trust Fund. For purposes of determining 24 months of
projected revenues for the anti-deficit provisions, the
Secretary of the Treasury is instructed to treat each expiring
provision relating to appropriations and transfers to the
Highway Trust Fund to have been extended through the end of the
24-month period and to assume that the rate of tax during such
24-month period remains the same as the rate in effect on the
date of enactment of the Act.
The Act extends the authority to make expenditures (subject
to appropriations) from the Aquatics Resources Trust Fund
through February 29, 2004. The Act also updates the Aquatics
Resources Trust Fund cross references to authorizing
legislation to include expenditure purposes as in effect on the
date of enactment of this Act.
Effective Date
The provision is effective on the date of enactment
(September 30, 2003).
PART THREE: TO EXTEND THE TEMPORARY ASSISTANCE FOR NEEDY FAMILIES BLOCK
GRANT PROGRAM, AND CERTAIN TAX AND TRADE PROGRAMS, AND FOR OTHER
PURPOSES (PUBLIC LAW 108-89)\48\
A. Disclosure of Return Information Relating to Student Loans (sec. 201
of the Act and sec. 6103(l) of the Code)
Present and Prior Law
Present and prior law prohibit the disclosure of returns
and return information, except to the extent specifically
authorized by the Code.\49\ An exception is provided for
disclosure to the Department of Education (but not to
contractors thereof) of a taxpayer's filing status, adjusted
gross income and identity information (i.e., name, mailing
address, taxpayer identifying number) to establish an
appropriate repayment amount for an applicable student
loan.\50\ Under prior law, the Department of Education
disclosure authority was scheduled to expire after September
30, 2003.
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\48\ H.R. 3146. The House passed the bill on the suspension
calendar on September 24, 2003. The Senate passed the bill with an
amendment by unanimous consent on September 30, 2003. The House passed
the bill as amended by the Senate by unanimous consent on September 30,
2003. The President signed the bill on October 1, 2003.
\49\ Sec. 6103.
\50\ Sec. 6103(l)(13).
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Explanation of Provision
The Act extends the disclosure authority relating to the
disclosure of return information to carry out income-contingent
repayment of student loans. The disclosure authority does not
apply to any request made after December 31, 2004.\51\
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\51\ The provision predated the enactment of H.R. 1308, Pub. L. No.
108-311 (the ``Working Families Tax Relief Act of 2004''), which
further extended the disclosure authority through December 31, 2005.
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Effective Date
The provision is effective with respect to requests for
disclosures made after September 30, 2003.
B. Extension of IRS User Fees (sec. 202 of the Act and new sec. 7528 of
the Code)
Present and Prior Law
The IRS provides written responses to questions of
individuals, corporations, and organizations relating to their
tax status or the effects of particular transactions for tax
purposes. The IRS generally charges a fee \52\ for requests for
a letter ruling, determination letter, opinion letter, or other
similar ruling or determination. Under prior law,\53\ the
statutory authorization for these user fees was extended
through September 30, 2003.
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\52\ These user fees were originally enacted in section 10511 of
the Revenue Act of 1987 (Pub. L. No. 100-203, December 22, 1987) but
were not originally placed in the Code.
\53\ Pub. L. No. 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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Explanation of Provision
The Act extends the statutory authorization for IRS user
fees through December 31, 2004.\54\ The Act also moves the
statutory authorization for these fees into the Code \55\ and
repeals the off-Code statutory authorization for these fees.
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\54\ Section 891 of the American Jobs Creation Act of 2004 (Pub. L.
No. 108-357, October 22, 2004) further extended the statutory
authorization for these user fees through September 30, 2014.
\55\ Sec. 7528. The Act also moved into the Code the user fee
provision relating to pension plans that was enacted in section 620 of
the Economic Growth and Tax Relief Reconciliation Act of 2001 (Pub. L.
No. 107-16, June 7, 2001).
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Effective Date
The provision is effective for requests made after the date
of enactment (October 1, 2003).
C. Extension of Customs User Fees (sec. 301 of the Act)
Present and Prior Law
Section 13031 of the Consolidated Omnibus Budget
Reconciliation Act of 1985 (COBRA) \56\ authorized the
Secretary of the Treasury to collect certain service fees.
Section 412 of the Homeland Security Act of 2002 \57\
authorized the Secretary of the Treasury to delegate such
authority to the Secretary of Homeland Security. Provided for
under 19 U.S.C. 58c, these fees include: processing fees for
air and sea passengers, commercial trucks, rail cars, private
aircraft and vessels, commercial vessels, dutiable mail
packages, barges and bulk carriers, merchandise, and Customs
broker permits. COBRA was amended on several occasions but most
recently by Pub. L. No. 103-182, which extended authorization
for collection of these fees through September 30, 2003.
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\56\ Pub. L. No. 99-272.
\57\ Pub. L. No. 107-296.
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Explanation of Provision
The Act extends the authorization for the collection of
customs user fees though March 31, 2004.\58\
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\58\ The expiration date was subsequently extended by the Military
Family Tax Relief Act of 2003, and the American Jobs Creation Act of
2004, described in Part Four and Part Seventeen, respectively. Present
law provides authorization for the collection of these fees through
September 30, 2014 (sec. 201; 117 Stat. 1335).
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Effective Date
The provision is effective on the date of enactment
(October 1, 2003).
PART FOUR: MILITARY FAMILY TAX RELIEF ACT OF 2003 (PUBLIC LAW 108-121)
\59\
I. IMPROVING TAX EQUITY FOR MILITARY PERSONNEL
A. Exclusion of Gain on Sale of a Principal Residence by a Member of
the Uniformed Services or the Foreign Service (sec. 101 of the Act and
sec. 121 of the Code)
Present and Prior Law
Under present and prior law, an individual taxpayer may
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. To be eligible for the exclusion, the taxpayer must
have owned and used the residence as a principal residence for
at least two of the five years ending on the sale or exchange.
A taxpayer who fails to meet these requirements by reason of a
change of place of employment, health, or, to the extent
provided under regulations, unforeseen circumstances is able to
exclude an amount equal to the fraction of the $250,000
($500,000 if married filing a joint return) that is equal to
the fraction of the two years that the ownership and use
requirements are met. Under prior law, there were no special
rules relating to members of the uniformed services or the
Foreign Service of the United States.
---------------------------------------------------------------------------
\59\ H.R. 3365. The House passed the bill on the suspension
calendar on October 29, 2003. The Senate passed the bill with an
amendment by unanimous consent on November 3, 2003. The House passed
the bill as amended by the Senate on the suspension calendar on
November 5, 2003. The President signed the bill on November 11, 2003.
---------------------------------------------------------------------------
Reasons for Change \60\
The Congress believed that members of the uniformed
services and the Foreign Service of the United States who would
otherwise qualify for the exclusion of the gain on the sale of
a principal residence should not be deprived the exclusion
because of service to their country. The Congress believed that
it is unfair that members of the uniformed services and the
Foreign Service of the United States are unable to avail
themselves of the exclusion due to relocations required by
service to their country.
---------------------------------------------------------------------------
\60\ See S. 351, the ``Armed Forces Tax Fairness Act of 2003,''
which was reported by the Senate Committee on Finance on February 11,
2003 (S. Rep. No. 108-3) and H.R. 878, the ``Armed Forces Tax Fairness
Act of 2003,'' which was reported by the House Committee on Ways and
Means on March 5, 2003 (H.R. Rep. No. 108-23).
---------------------------------------------------------------------------
Explanation of Provision
Under the Act, an individual may elect to suspend for a
maximum of 10 years the five-year test period for ownership and
use during certain absences due to service in the uniformed
services or the Foreign Service of the United States. The
uniformed services include: (1) the Armed Forces (the Army,
Navy, Air Force, Marine Corps, and Coast Guard); (2) the
commissioned corps of the National Oceanic and Atmospheric
Administration; and (3) the commissioned corps of the Public
Health Service. If the election is made, the five-year period
ending on the date of the sale or exchange of a principal
residence does not include any period up to five years during
which the taxpayer or the taxpayer's spouse is on qualified
official extended duty as a member of the uniformed services or
in the Foreign Service of the United States. For these
purposes, qualified official extended duty is any period of
extended duty while serving at a place of duty at least 150
miles away from the taxpayer's principal residence or under
orders compelling residence in Government furnished quarters.
Extended duty is defined as any period of duty pursuant to a
call or order to such duty for a period in excess of 180 days
or for an indefinite period. The election may be made with
respect to only one property for a suspension period.
Effective Date
The provision is effective for sales or exchanges after May
6, 1997.
B. Exclusion from Gross Income of Certain Death Gratuity Payments (sec.
102 of the Act and sec. 134 of the Code)
Present and Prior Law
Present and prior law provides that qualified military
benefits are not included in gross income. Generally, a
qualified military benefit is any allowance or in-kind benefit
(other than personal use of a vehicle) which: (1) is received
by any member or former member of the uniformed services of the
United States or any dependent of such member by reason of such
member's status or service as a member of such uniformed
services; and (2) was excludable from gross income on September
9, 1986, under any provision of law, regulation, or
administrative practice which was in effect on such date.
Generally, other than certain cost of living adjustments, no
modification or adjustment of any qualified military benefit
after September 9, 1986, is taken into account for purposes of
this exclusion from gross income. Qualified military benefits
include certain death gratuities. The amount of the military
death gratuity benefit has been increased since September 9,
1986, to $6,000 pursuant to Chapter 75 of Title 10 of the
United States Code. Under prior law, the amount of the
exclusion from gross income was not increased to take into
account this change.
Reasons for Change \61\
The Congress believed that the amount of the exclusion for
these death gratuities should be conformed to the levels of
such death gratuities. Further, the Congress believed that the
amount of the exclusion should be automatically adjusted for
future changes in these death gratuities.
---------------------------------------------------------------------------
\61\ See S. 351, the ``Armed Forces Tax Fairness Act of 2003,''
which was reported by the Senate Committee on Finance on February 11,
2003 (S. Rep. No. 108-3) and H.R. 878, the ``Armed Forces Tax Fairness
Act of 2003,'' which was reported by the House Committee on Ways and
Means on March 5, 2003 (H.R. Rep. No. 108-23).
---------------------------------------------------------------------------
Explanation of Provision
The Act extends the exclusion from gross income for
military benefits to any adjustment to the amount of the death
gratuity payable under Chapter 75 of Title 10 of the United
States Code that is pursuant to a provision of law enacted
after September 9, 1986, with respect to the death of certain
members of the Armed services on active duty, inactive duty
training, or engaged in authorized travel.\62\
---------------------------------------------------------------------------
\62\ The Act also increases the death gratuity benefit from $6,000
to $12,000.
---------------------------------------------------------------------------
Effective Date
The provision is effective with respect to deaths occurring
after September 10, 2001.
C. Exclusion for Amounts Received Under Department of Defense
Homeowners Assistance Program (sec. 103 of the Act and sec. 132 of the
Code)
Present and Prior Law
Homeowners Assistance Program payment
The Department of Defense Homeowners Assistance Program
(``HAP'') provides payments to certain employees and members of
the Armed Forces to offset the adverse effects on housing
values that result from a military base realignment or
closure.\63\
---------------------------------------------------------------------------
\63\ The payments are authorized under the provisions of 42 U.S.C.
sec. 3374.
---------------------------------------------------------------------------
In general, under HAP, eligible individuals receive either:
(1) a cash payment as compensation for losses that may be or
have been sustained in a private sale, in an amount not to
exceed the difference between (a) 95 percent of the fair market
value of their property prior to public announcement of
intention to close all or part of the military base or
installation and (b) the fair market value of such property at
the time of the sale; or (2) as the purchase price for their
property, an amount not to exceed 90 percent of the prior fair
market value as determined by the Secretary of Defense, or the
amount of the outstanding mortgages.
Tax treatment
Unless specifically excluded, gross income for Federal
income tax purposes includes all income from whatever source
derived. Amounts received under HAP are received in connection
with the performance of services. Under prior law, these
amounts were includible in gross income as compensation for
services to the extent such payments exceed the fair market
value of the property relinquished in exchange for such
payments. Additionally under prior law, such payments were
wages for Federal Insurance Contributions Act (``FICA'') tax
purposes (including Medicare).
Reasons for Change \64\
The Congress believed that an exclusion from gross income
and FICA taxes was necessary to provide full compensation for
the losses in home values incurred as a result of military base
realignment or closure. The Congress further believed that this
would help to facilitate necessary military base realignment or
closure.
---------------------------------------------------------------------------
\64\ See S. 351, the ``Armed Forces Tax Fairness Act of 2003,''
which was reported by the Senate Committee on Finance on February 11,
2003 (S. Rep. No. 108-3) and H.R. 878, the ``Armed Forces Tax Fairness
Act of 2003,'' which was reported by the House Committee on Ways and
Means on March 5, 2003 (H.R. Rep. No. 108-23).
---------------------------------------------------------------------------
Explanation of Provision
The Act generally exempts from gross income amounts
received under the HAP (as in effect on the date of enactment
of this Act). Amounts received under the program also are not
considered wages for FICA tax purposes (including Medicare).
The excludable amount is limited to the reduction in the fair
market value of property.
Effective Date
The provision is effective for payments made after the date
of enactment (November 11, 2003).
D. Expansion of Combat Zone Filing Rules to Contingency Operations
(sec. 104 of the Act and sec. 7508 of the Code)
Present and Prior Law
General time limits for filing tax returns
Individuals generally must file their Federal income tax
returns by April 15 of the year following the close of a
taxable year. The Secretary may grant reasonable extensions of
time for filing such returns. Treasury regulations provide an
additional automatic two-month extension (until June 15 for
calendar-year individuals) for United States citizens and
residents in military or naval service on duty on April 15 of
the following year (the otherwise applicable due date of the
return) outside the United States. No action is necessary to
apply for this extension, but taxpayers must indicate on their
returns (when filed) that they are claiming this extension.
Unlike most extensions of time to file, this extension applies
to both filing returns and paying the tax due.
Treasury regulations also provide, upon application on the
proper form, an automatic four-month extension (until August 15
for calendar-year individuals) for any individual timely filing
that form and paying the amount of tax estimated to be due.
In general, individuals must make quarterly estimated tax
payments by April 15, June 15, September 15, and January 15 of
the following taxable year. Wage withholding is considered to
be a payment of estimated taxes.
Suspension of time periods
In general, the period of time for performing various acts
under the Code, such as filing tax returns, paying taxes, or
filing a claim for credit or refund of tax, is suspended for
any individual serving in the Armed Forces of the United States
in an area designated as a ``combat zone'' during the period of
combatant activities. An individual who becomes a prisoner of
war is considered to continue in active service and is
therefore also eligible for these suspension of time
provisions. The suspension of time also applies to an
individual serving in support of such Armed Forces in the
combat zone, such as Red Cross personnel, accredited
correspondents, and civilian personnel acting under the
direction of the Armed Forces in support of those Forces. The
designation of a combat zone must be made by the President in
an Executive Order. The President must also designate the
period of combatant activities in the combat zone (the starting
date and the termination date of combat).
The suspension of time encompasses the period of service in
the combat zone during the period of combatant activities in
the zone, as well as (1) any time of continuous qualified
hospitalization resulting from injury received in the combat
zone \65\ or (2) time in missing in action status, plus the
next 180 days.
---------------------------------------------------------------------------
\65\ Two special rules apply to continuous hospitalization inside
the United States. First, the suspension of time provisions based on
continuous hospitalization inside the United States are applicable only
to the hospitalized individual; they are not applicable to the spouse
of such individual. Second, in no event do the suspension of time
provisions based on continuous hospitalization inside the United States
extend beyond five years from the date the individual returns to the
United States. These two special rules do not apply to continuous
hospitalization outside the United States.
---------------------------------------------------------------------------
The suspension of time applies to the following acts:
1. Filing any return of income, estate, or gift tax (except
employment and withholding taxes);
2. Payment of any income, estate, or gift tax (except
employment and withholding taxes);
3. Filing a petition with the Tax Court for redetermination
of a deficiency, or for review of a decision rendered by the
Tax Court;
4. Allowance of a credit or refund of any tax;
5. Filing a claim for credit or refund of any tax;
6. Bringing suit upon any such claim for credit or refund;
7. Assessment of any tax;
8. Giving or making any notice or demand for the payment of
any tax, or with respect to any liability to the United States
in respect of any tax;
9. Collection of the amount of any liability in respect of
any tax;
10. Bringing suit by the United States in respect of any
liability in respect of any tax; and
11. Any other act required or permitted under the internal
revenue laws specified by the Secretary of the Treasury.
Individuals may, if they choose, perform any of these acts
during the period of suspension. Spouses of qualifying
individuals are entitled to the same suspension of time, except
that the spouse is ineligible for this suspension for any
taxable year beginning more than two years after the date of
termination of combatant activities in the combat zone.
Reasons for Change \66\
The Congress believed that military personnel deployed
outside the United States away from their permanent duty
station while participating in a contingency operation should
be entitled to utilize the same suspension of time provisions
as those deployed in a combat zone.
---------------------------------------------------------------------------
\66\ See S. 351, the ``Armed Forces Tax Fairness Act of 2003,''
which was reported by the Senate Committee on Finance on February 11,
2003 (S. Rep. No. 108-3) and H.R. 878, the ``Armed Forces Tax Fairness
Act of 2003,'' which was reported by the House Committee on Ways and
Means on March 5, 2003 (H.R. Rep. No. 108-23).
---------------------------------------------------------------------------
Explanation of Provision
The Act applies the special suspension of time period rules
to persons deployed outside the United States away from the
individual's permanent duty station while participating in an
operation designated by the Secretary of Defense as a
contingency operation or that becomes a contingency operation.
A contingency operation is defined \67\ as a military operation
that is designated by the Secretary of Defense as an operation
in which members of the Armed Forces are or may become involved
in military actions, operations, or hostilities against an
enemy of the United States or against an opposing military
force, or results in the call or order to (or retention of)
active duty of members of the uniformed services during a war
or a national emergency declared by the President or Congress.
---------------------------------------------------------------------------
\67\ The definition is by cross-reference to 10 U.S.C. sec. 101.
---------------------------------------------------------------------------
Effective Date
The provision applies to any period for performing an act
that has not expired before the date of enactment (November 11,
2003).
E. Modification of Membership Requirement for Exemption from Tax for
Certain Veterans' Organizations (sec. 105 of the Act and sec.
501(c)(19) of the Code)
Present and Prior Law
Under present and prior law, a veterans' organization as
described in section 501(c)(19) of the Code generally is exempt
from taxation. The Code defines such an organization as a post
or organization of past or present members of the Armed Forces
of the United States: (1) that is organized in the United
States or any of its possessions; (2) no part of the net
earnings of which inures to the benefit of any private
shareholder or individual; and (3) that meets certain
membership requirements. The membership requirements are that
(1) at least 75 percent of the organization's members are past
or present members of the Armed Forces of the United States,
and, under prior law, that (2) substantially all of the
remaining members are cadets or are spouses, widows, or
widowers of past or present members of the Armed Forces of the
United States or of cadets. Under present and prior law, no
more than 2.5 percent of an organization's total members may
consist of individuals who are not veterans, cadets, or
spouses, widows, or widowers of such individuals.
Contributions to an organization described in section
501(c)(19) may be deductible for Federal income or gift tax
purposes if the organization is a post or organization of war
veterans.
Reasons for Change \68\
As the membership of veterans' organizations changes due to
aging and the deaths of members, veterans' organizations that
currently qualify for tax exemption under section 501(c)(19)
may cease to qualify for exempt status under that section, even
though the membership, apart from changes due to deaths,
remains the same. The Congress believed that a limited
expansion of the membership of veterans' organizations will
enable certain of such organizations to retain exempt status,
which might otherwise be in jeopardy, and will not unduly
expand the membership base beyond persons with a close
connection to members of the Armed Forces or cadets.
---------------------------------------------------------------------------
\68\ See S. 351, the ``Armed Forces Tax Fairness Act of 2003,''
which was reported by the Senate Committee on Finance on February 11,
2003 (S. Rep. No. 108-3) and H.R. 878, the ``Armed Forces Tax Fairness
Act of 2003,'' which was reported by the House Committee on Ways and
Means on March 5, 2003 (H.R. Rep. No. 108-23).
---------------------------------------------------------------------------
Explanation of Provision
The Act permits ancestors or lineal descendants of past or
present members of the Armed Forces of the United States or of
cadets to qualify as members for purposes of the
``substantially all'' test. The Act does not change the
requirement that 75 percent of the organization's members must
be past or present members of the Armed Forces of the United
States or the 2.5 percent rule.
Effective Date
The provision is effective for taxable years beginning
after the date of enactment (November 11, 2003).
F. Clarification of Treatment of Certain Dependent Care Assistance
Programs Provided to Members of the Uniformed Services of the United
States (sec. 106 of the Act and sec. 134 of the Code)
Present and Prior Law
Present and prior law provides that qualified military
benefits are not included in gross income. Generally, a
qualified military benefit is any allowance or in-kind benefit
(other than personal use of a vehicle) which: (1) is received
by any member or former member of the uniformed services of the
United States or any dependent of such member by reason of such
member's status or service as a member of such uniformed
services; and (2) was excludable from gross income on September
9, 1986, under any provision of law, regulation, or
administrative practice which was in effect on such date.
Generally, other than certain cost of living adjustments, no
modification or adjustment of any qualified military benefit
after September 9, 1986, is taken into account for purposes of
this exclusion from gross income. Under prior law, questions
arose as to the scope of the exclusion with respect to the
dependent care credit.
Reasons for Change \69\
The Congress believed that it is important to remove any
uncertainty regarding the tax treatment of dependent care
assistance provided to members of the uniformed services.
---------------------------------------------------------------------------
\69\ See S. 351, the ``Armed Forces Tax Fairness Act of 2003,''
which was reported by the Senate Committee on Finance on February 11,
2003 (S. Rep. No. 108-3) and H.R. 878, the ``Armed Forces Tax Fairness
Act of 2003,'' which was reported by the House Committee on Ways and
Means on March 5, 2003 (H.R. Rep. No. 108-23).
---------------------------------------------------------------------------
Explanation of Provision
The Act clarifies that dependent care assistance provided
under a dependent care assistance program (as in effect on the
date of enactment of this Act) for a member of the uniformed
services by reason of such member's status or service as a
member of the uniformed services is excludable from gross
income as a qualified military benefit subject to the present-
law rules. The uniformed services include: (1) the Armed Forces
(the Army, Navy, Air Force, Marine Corps, and Coast Guard); (2)
the commissioned corps of the National Oceanic and Atmospheric
Administration; and (3) the commissioned corps of the Public
Health Service. Amounts received under the program also are not
considered wages for Federal Insurance Contributions Act tax
purposes (including Medicare).
Effective Date
The provision is effective for taxable years beginning
after December 31, 2002. No inference is intended as to the tax
treatment of such amounts for prior taxable years.
G. Treatment of Service Academy Appointments as Scholarships for
Purposes of Qualified Tuition Programs and Coverdell Education Savings
Accounts (sec. 107 of the Act and secs. 529 and 530 of the Code)
Present and Prior Law
The Code provides tax-exempt status to qualified tuition
programs, meaning programs established and maintained by a
State or agency or instrumentality thereof or by one or more
eligible educational institutions under which a person (1) may
purchase tuition credits or certificates on behalf of a
designated beneficiary which entitle the beneficiary to the
waiver or payment of qualified higher education expenses of the
beneficiary, or (2) in the case of a program established by and
maintained by a State or agency or instrumentality thereof, may
make contributions to an account which is established for the
purpose of meeting the qualified higher education expenses of
the designated beneficiary of the account. Contributions to
qualified tuition programs may be made only in cash. Qualified
tuition programs must have adequate safeguards to prevent
contributions on behalf of a designated beneficiary in excess
of amounts necessary to provide for the qualified higher
education expenses of the beneficiary.
The Code provides tax-exempt status to Coverdell education
savings accounts (``ESAs''), meaning certain trusts or
custodial accounts which are created or organized in the United
States exclusively for the purpose of paying the qualified
education expenses of a designated beneficiary. Contributions
to ESAs may be made only in cash. Annual contributions to ESAs
may not exceed $2,000 per beneficiary (except in cases
involving certain tax-free rollovers) and may not be made after
the designated beneficiary reaches age 18.
Earnings on contributions to an ESA or a qualified tuition
program generally are subject to tax when withdrawn. However,
distributions from an ESA or qualified tuition program are
excludable from the gross income of the distributee to the
extent that the total distribution does not exceed the
qualified education expenses incurred by the beneficiary during
the year the distribution is made.
If the qualified education expenses of the beneficiary for
the year are less than the total amount of the distribution
from an ESA or qualified tuition program, then the qualified
education expenses are deemed to be paid from a pro-rata share
of both the principal and earnings components of the
distribution. In such a case, only a portion of the earnings is
excludable (i.e., the portion of the earnings based on the
ratio that the qualified 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 ESA or a
qualified tuition program that is includible in income is
generally 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 (to the extent it does not exceed the
amount of the scholarship).
Service obligations are required of recipients of
appointments to the United States Military Academy, the United
States Naval Academy, the United States Air Force Academy, the
United States Coast Guard Academy, or the United States
Merchant Marine Academy. Because of these service obligations,
appointments to the Academies are not considered scholarships
for purposes of the waiver of the additional 10 percent tax on
withdrawals from ESAs and qualified tuition programs that are
not used for qualified education purposes.
Reasons for Change \70\
The Congress believed that it was appropriate to treat
appointments to a United States Service Academy in a manner
similar to the treatment of qualified scholarships.
Accordingly, Congress believed that it was appropriate to waive
the additional 10-percent tax on withdrawals from ESAs and
qualified tuition programs that are not used for qualified
education purposes because the designated beneficiary received
an appointment to a United States Service Academy.
---------------------------------------------------------------------------
\70\ See S. 351, the ``Armed Forces Tax Fairness Act of 2003,''
which was reported by the Senate Committee on Finance on February 11,
2003 (S. Rep. No. 108-3) and H.R. 878, the ``Armed Forces Tax Fairness
Act of 2003,'' which was reported by the House Committee on Ways and
Means on March 5, 2003 (H.R. Rep. No. 108-23).
---------------------------------------------------------------------------
The Congress believed that imposing an additional tax on
earnings from educational savings accounts and qualified
tuition plans is inappropriate in the case of individuals who
choose to serve their country as a member of the military and
who, as a part of that service, obtain their education at one
of the Service Academies.
Explanation of Provision
Under the Act, the additional 10-percent tax does not apply
to withdrawals from Coverdell education savings accounts and
qualified tuition programs made on account of the attendance of
the beneficiary at the United States Military Academy, the
United States Naval Academy, the United States Air Force
Academy, the United States Coast Guard Academy, or the United
States Merchant Marine Academy.
The amount of funds that can be withdrawn without the
additional tax is limited to the costs of advanced education as
defined in 10 U.S.C. section 2005(e)(3) (as in effect on the
date of the enactment of the Act) at such Academies.
Effective Date
The provision applies to taxable years beginning after
December 31, 2002.
H. Suspension of Tax-Exempt Status of Terrorist Organizations (sec. 108
of the Act and sec. 501 of the Code)
Present and Prior Law
Under present and prior law, the Internal Revenue Service
generally issues a letter revoking recognition of an
organization's tax-exempt status only after (1) conducting an
examination of the organization, (2) issuing a letter to the
organization proposing revocation, and (3) allowing the
organization to exhaust the administrative appeal rights that
follow the issuance of the proposed revocation letter. In the
case of an organization described in section 501(c)(3), the
revocation letter immediately is subject to judicial review
under the declaratory judgment procedures of section 7428. To
sustain a revocation of tax-exempt status under section 7428,
the IRS must demonstrate that the organization is no longer
entitled to exemption. Under prior law, there was no procedure
for the IRS to suspend the tax-exempt status of an
organization.
To combat terrorism, the Federal government has designated
a number of organizations as terrorist organizations or
supporters of terrorism under the Immigration and Nationality
Act, the International Emergency Economic Powers Act, and the
United Nations Participation Act of 1945.
Reasons for Change \71\
The Congress believed that an organization that has been
designated or otherwise identified by the Federal government as
a terrorist organization pursuant to certain authority should
not be exempt from Federal income tax and that contributions to
such organizations should not be deductible for Federal income
tax purposes. The Congress believed that the Federal
government's designation or identification of an organization
as a terrorist organization is ground for suspension of tax-
exempt status, and that in such cases a separate investigation
of the organization by the Internal Revenue Service is not
necessary. Further, because a terrorist organization may
challenge the Federal government's designation or
identification of the organization under the law authorizing
the designation or identification, recourse to the declaratory
judgment procedures of the Internal Revenue Code to challenge
the suspension of tax-exemption is not appropriate.
---------------------------------------------------------------------------
\71\ See S. 351, the ``Armed Forces Tax Fairness Act of 2003,''
which was reported by the Senate Committee on Finance on February 11,
2003 (S. Rep. No. 108-3) and H.R. 878, the ``Armed Forces Tax Fairness
Act of 2003,'' which was reported by the House Committee on Ways and
Means on March 5, 2003 (H.R. Rep. No. 108-23).
---------------------------------------------------------------------------
Explanation of Provision
The Act suspends the tax-exempt status of an organization
that is exempt from tax under section 501(a) for any period
during which the organization is designated or identified by
U.S. Federal authorities as a terrorist organization or
supporter of terrorism. The Act also makes such an organization
ineligible to apply for tax-exemption under section 501(a). The
period of suspension runs from the date the organization is
first designated or identified (or from the date of enactment
of the bill, whichever is later) to the date when all
designations or identifications with respect to the
organization have been rescinded pursuant to the law or
Executive Order under which the designation or identification
was made.
The Act describes a terrorist organization as an
organization that has been designated or otherwise individually
identified (1) as a terrorist organization or foreign terrorist
organization under the authority of section
212(a)(3)(B)(vi)(II) or section 219 of the Immigration and
Nationality Act; (2) in or pursuant to an Executive Order that
is related to terrorism and issued under the authority of the
International Emergency Economic Powers Act or section 5 of the
United Nations Participation Act for the purpose of imposing on
such organization an economic or other sanction; or (3) in or
pursuant to an Executive Order that refers to the provision and
is issued under the authority of any Federal law if the
organization is designated or otherwise individually identified
in or pursuant to such Executive Order as supporting or
engaging in terrorist activity (as defined in section
212(a)(3)(B) of the Immigration and Nationality Act) or
supporting terrorism (as defined in section 140(d)(2) of the
Foreign Relations Authorization Act, Fiscal Years 1988 and
1989). During the period of suspension, no deduction for any
contribution to a terrorist organization is allowed under the
Code, including under sections 170, 545(b)(2), 556(b)(2),
642(c), 2055, 2106(a)(2), or 2522.
No organization or other person may challenge, under
section 7428 or any other provision of law, in any
administrative or judicial proceeding relating to the Federal
tax liability of such organization or other person, the
suspension of tax-exemption, the ineligibility to apply for
tax-exemption, a designation or identification described above,
the timing of the period of suspension, or a denial of
deduction described above. The suspended organization may
maintain other suits or administrative actions against the
agency or agencies that designated or identified the
organization, for the purpose of challenging such designation
or identification (but not the suspension of tax-exempt status
under this provision).
If the tax-exemption of an organization is suspended and
each designation and identification that has been made with
respect to the organization is determined to be erroneous
pursuant to the law or Executive Order making the designation
or identification, and such erroneous designation results in an
overpayment of income tax for any taxable year with respect to
such organization, a credit or refund (with interest) with
respect to such overpayment shall be made. If the operation of
any law or rule of law (including res judicata) prevents the
credit or refund at any time, the credit or refund may
nevertheless be allowed or made if the claim for such credit or
refund is filed before the close of the one-year period
beginning on the date that the last remaining designation or
identification with respect to the organization is determined
to be erroneous.
The Act directs the IRS to update the listings of tax-
exempt organizations to take account of organizations that have
had their exemption suspended and to publish notice to
taxpayers of the suspension of an organization's tax-exemption
and the fact that contributions to such organization are not
deductible during the period of suspension.
Effective Date
The provision is effective for designations made before,
on, or after the date of enactment (November 11, 2003).
I. Above-the-Line Deduction for Overnight Travel Expenses of National
Guard and Reserve Members (sec. 109 of the Act and sec. 162 of the
Code)
Present and Prior Law
Under prior law, National Guard and Reserve members could
claim itemized deductions for their nonreimbursable expenses
for transportation, meals, and lodging when they must travel
away from home (and stay overnight) to attend National Guard
and Reserve meetings. These overnight travel expenses were
combined with other miscellaneous itemized deductions on
Schedule A of the individual's income tax return and were
deductible only to the extent that the aggregate of these
deductions exceeds two percent of the taxpayer's adjusted gross
income. Under present and prior law, no deduction is generally
permitted for commuting expenses to and from drill meetings.
Reasons for Change \72\
The Congress believed that all National Guard and Reserve
members incurring unreimbursed overnight expenses to attend
National Guard and Reserve meetings should be able to deduct
these expenses from their income, not just those who itemize
their deductions. Accordingly, the Congress provided an above-
the-line deduction for these expenses.
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\72\ See S. 351, the ``Armed Forces Tax Fairness Act of 2003,''
which was reported by the Senate Committee on Finance on February 11,
2003 (S. Rep. No. 108-3) and H.R. 878, the ``Armed Forces Tax Fairness
Act of 2003,'' which was reported by the House Committee on Ways and
Means on March 5, 2003 (H.R. Rep. No. 108-23).
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Explanation of Provision
The Act provides an above-the-line deduction for the
overnight transportation, meals, and lodging expenses of
National Guard and Reserve members who must travel away from
home more than 100 miles (and stay overnight) to attend
National Guard and Reserve meetings. Accordingly, these
individuals incurring these expenses can deduct them from gross
income regardless of whether they itemize their deductions. The
amount of the expenses that may be deducted may not exceed
$1,500 per taxable year and is only available for any period
during which the individual is more than 100 miles from home in
connection with such services.
Effective Date
The provision is effective with respect to amounts paid or
incurred in taxable years beginning after December 31, 2002.
J. Extension of Certain Tax Relief Provisions to Astronauts (sec. 110
of the Act and secs. 101, 692, and 2201 of the Code)
Present and Prior Law
In general
The Victims of Terrorism Tax Relief Act of 2001 (the
``Victims Act'') provided certain income and estate tax relief
to individuals who die from wounds or injury incurred as a
result of the terrorist attacks against the United States on
September 11, 2001, and April 19, 1995 (the bombing of the
Alfred P. Murrah Federal Building in Oklahoma City), or as a
result of illness incurred due to an attack involving anthrax
that occurred on or after September 11, 2001, and before
January 1, 2002.
Income tax relief
The Victims Act extended relief similar to the present-law
treatment of military or civilian employees of the United
States who die as a result of terrorist or military activity
outside the United States to individuals who die as a result of
wounds or injury which were incurred as a result of the
terrorist attacks that occurred on September 11, 2001, or April
19, 1995, and individuals who die as a result of illness
incurred due to an attack involving anthrax that occurs on or
after September 11, 2001, and before January 1, 2002. Under the
Victims Act, such individuals generally are exempt from income
tax for the year of death and for prior taxable years beginning
with the taxable year prior to the taxable year in which the
wounds or injury occurred.\73\ The exemption applies to these
individuals whether killed in an attack (e.g., in the case of
the September 11, 2001, attack in one of the four airplanes or
on the ground) or in rescue or recovery operations.
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\73\ Present law does not provide relief from self-employment tax
liability.
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Present and prior law provides tax relief of at least
$10,000 to each eligible individual regardless of the income
tax liability of the individual for the eligible tax years. If
an eligible individual's income tax for years eligible for the
exclusion under the provision is less than $10,000, the
individual is treated as having made a tax payment for such
individual's last taxable year in an amount equal to the excess
of $10,000 over the amount of tax not imposed under the
provision.
Subject to rules prescribed by the Secretary, the exemption
from tax does not apply to the tax attributable to (1) deferred
compensation which would have been payable after death if the
individual had died other than as a specified terrorist victim,
or (2) amounts payable in the taxable year which would not have
been payable in such taxable year but for an action taken after
September 11, 2001. Thus, for example, the exemption does not
apply to amounts payable from a qualified plan or individual
retirement arrangement to the beneficiary or estate of the
individual. Similarly, amounts payable only as death or
survivor's benefits pursuant to deferred compensation
preexisting arrangements that would have been paid if the death
had occurred for another reason are not covered by the
exemption. In addition, if the individual's employer makes
adjustments to a plan or arrangement to accelerate the vesting
of restricted property or the payment of nonqualified deferred
compensation after the date of the particular attack, the
exemption does not apply to income received as a result of that
action.\74\ Also, if the individual's beneficiary cashed in
savings bonds of the decedent, the exemption does not apply. On
the other hand, the exemption does apply, for example, to a
final paycheck of the individual or dividends on stock held by
the individual when paid to another person or the individual's
estate after the date of death but before the end of the
taxable year of the decedent (determined without regard to the
death). The exemption also applies to payments of an
individual's accrued vacation and accrued sick leave.
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\74\ Such amounts may, however, be excludable from gross income
under the death benefit exclusion provided in section 102 of the
Victims Act.
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The tax relief does not apply to any individual identified
by the Attorney General to have been a participant or
conspirator in any terrorist attack to which the provision
applies, or a representative of such individual.
Exclusion of death benefits
The Victims Act generally provides an exclusion from gross
income for amounts received if such amounts are paid by an
employer (whether in a single sum or otherwise \75\) by reason
of the death of an employee who dies as a result of wounds or
injury which were incurred as a result of the terrorist attacks
that occurred on September 11, 2001, or April 19, 1995, or as a
result of illness incurred due to an attack involving anthrax
that occurred on or after September 11, 2001, and before
January 1, 2002. Subject to rules prescribed by the Secretary,
the exclusion does not apply to amounts that would have been
payable if the individual had died for a reason other than the
attack. The exclusion does apply, however, to death benefits
provided under a qualified plan that satisfy the incidental
benefit rule.
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\75\ Thus, for example, payments made over a period of years could
qualify for the exclusion.
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For purposes of the exclusion, self-employed individuals
are treated as employees. Thus, for example, payments by a
partnership to the surviving spouse of a partner who died as a
result of the September 11, 2001, attacks may be excludable
under the provision.
The tax relief does not apply to any individual identified
by the Attorney General to have been a participant or
conspirator in any terrorist attack to which the provision
applies, or a representative of such individual.
Estate tax relief
Present and prior law provides a reduction in Federal
estate tax for taxable estates of U.S. citizens or residents
who are active members of the U.S. Armed Forces and who are
killed in action while serving in a combat zone (sec. 2201).
This provision also applies to active service members who die
as a result of wounds, disease, or injury suffered while
serving in a combat zone by reason of a hazard to which the
service member was subjected as an incident of such service.
In general, the effect of section 2201 is to replace the
Federal estate tax that would otherwise be imposed with a
Federal estate tax equal to 125 percent of the maximum State
death tax credit determined under section 2011(b). Credits
against the tax, including the unified credit of section 2010
and the State death tax credit of section 2011, then apply to
reduce (or eliminate) the amount of the estate tax payable.
Generally, the reduction in Federal estate taxes under
section 2201 is equal in amount to the ``additional estate
tax.'' The additional estate tax is the difference between the
Federal estate tax imposed by section 2001 and 125 percent of
the maximum State death tax credit determined under section
2011(b) as in effect prior to its repeal by EGTRRA.
The Victims Act generally treats individuals who die from
wounds or injury incurred as a result of the terrorist attacks
that occurred on September 11, 2001, or April 19, 1995, or as a
result of illness incurred due to an attack involving anthrax
that occurred on or after September 11, 2001, and before
January 1, 2002, in the same manner as if they were active
members of the U.S. Armed Forces killed in action while serving
in a combat zone or dying as a result of wounds or injury
suffered while serving in a combat zone for purposes of section
2201. Consequently, the estates of these individuals are
eligible for the reduction in Federal estate tax provided by
section 2201. The tax relief does not apply to any individual
identified by the Attorney General to have been a participant
or conspirator in any terrorist attack to which the provision
applies, or a representative of such individual.
The Victims Act also changed the general operation of
section 2201, as it applies to both the estates of service
members who qualify for special estate tax treatment under
present and prior law and to the estates of individuals who
qualify for the special treatment only under the Act. Under the
Victims Act, the Federal estate tax is determined in the same
manner for all estates that are eligible for Federal estate tax
reduction under section 2201. In addition, the executor of an
estate that is eligible for special estate tax treatment under
section 2201 may elect not to have section 2201 apply to the
estate. Thus, in the event that an estate may receive more
favorable treatment without the application of section 2201 in
the year of death than it would under section 2201, the
executor may elect not to apply the provisions of section 2201,
and the estate tax owed (if any) would be determined pursuant
to the generally applicable rules.
Under the Victims Act, section 2201 no longer reduces
Federal estate tax by the amount of the additional estate tax.
Instead, the Victims Act provides that the Federal estate tax
liability of eligible estates is determined under section 2001
(or section 2101, in the case of decedents who were neither
residents nor citizens of the United States), using a rate
schedule that is equal to 125 percent of the pre-EGTRRA maximum
State death tax credit amount. This rate schedule is used to
compute the tax under section 2001(b) or section 2101(b) (i.e.,
both the tentative tax under section 2001(b)(1) and section
2101(b), and the hypothetical gift tax under section 2001(b)(2)
are computed using this rate schedule). As a result of this
provision, the estate tax is unified with the gift tax for
purposes of section 2201 so that a single graduated (but
reduced) rate schedule applies to transfers made by the
individual at death, based upon the cumulative taxable
transfers made both during lifetime and at death.
In addition, while the Victims Act provides an alternative
reduced rate table for purposes of determining the tax under
section 2001(b) or section 2101(b), the amount of the unified
credit nevertheless is determined as if section 2201 did not
apply, based upon the unified credit as in effect on the date
of death. For example, in the case of victims of the September
11, 2001, terrorist attack, the applicable unified credit
amount under section 2010(c) would be determined by reference
to the actual section 2001(c) rate table.
Reasons for Change \76\
The Congress wished to honor the bravery of individuals
who lost their lives in the space shuttle Columbia disaster.
Further, the Congress believed it appropriate to provide these
tax relief measures to those individuals and their families.
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\76\ See S. 351, the ``Armed Forces Tax Fairness Act of 2003,''
which was reported by the Senate Committee on Finance on February 11,
2003 (S. Rep. No. 108-3) and H.R. 878, the ``Armed Forces Tax Fairness
Act of 2003,'' which was reported by the House Committee on Ways and
Means on March 5, 2003 (H.R. Rep. No. 108-23).
---------------------------------------------------------------------------
Explanation of Provision
The Act extends the exclusion from income tax, the
exclusion for death benefits, and the estate tax relief
available under the Victims of Terrorism Tax Relief Act of 2001
to astronauts who lose their lives on a space mission
(including the individuals who lost their lives in the space
shuttle Columbia disaster).
Effective Date
The provision is generally effective for qualified
individuals whose lives are lost on a space mission after
December 31, 2002.
II. REVENUE PROVISION
A. Extension of Customs User Fees (sec. 201 of the Act)
Present and Prior Law
Section 13031 of the Consolidated Omnibus Budget
Reconciliation Act of 1985 (COBRA) (Pub. L. No. 99-272),
authorized the Secretary of the Treasury to collect certain
service fees. Section 412 of the Homeland Security Act of 2002
(Pub. L. No. 107-296) authorized the Secretary of the Treasury
to delegate such authority to the Secretary of Homeland
Security. Provided for under 19 U.S.C. sec. 58c, these fees
include: processing fees for air and sea passengers, commercial
trucks, rail cars, private aircraft and vessels, commercial
vessels, dutiable mail packages, barges and bulk carriers,
merchandise, and customs broker permits. COBRA was amended on
several occasions but most recently by Pub. L. No. 108-89,
which extended authorization for the collection of these fees
through March 31, 2004.\77\
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\77\ Sec. 201; 117 Stat. 1335.
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Explanation of Provision
The Act extends the authorization for the collection of
customs user fees though March 1, 2005.\78\
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\78\ The expiration date was subsequently extended by the American
Jobs Creation Act of 2004, described in Part Seventeen. Present law
provides authorization for the collection of these fees through
September 30, 2014 (sec. 201; 117 Stat. 1935).
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Effective Date
The provision is effective on the date of enactment
(November 11, 2003).
PART FIVE: MEDICARE PRESCRIPTION DRUG, IMPROVEMENT, AND MODERNIZATION
ACT OF 2003 (PUBLIC LAW 108-173) \79\
A. Disclosure of Return Information for Purposes of Providing
Transitional Assistance Under Medicare Discount Card Program (sec.
105(e) of the Act and sec. 6103(l)(19) of the Code)
Present and Prior Law
The Internal Revenue Code prohibits disclosure of returns
and return information, except to the extent specifically
authorized by the Code (sec. 6103(a)). Unauthorized disclosure
is a felony punishable by a fine not exceeding $5,000 or
imprisonment of not more than five years, or both, together
with the costs of prosecution (sec. 7213). Unauthorized
inspection of such information is a misdemeanor, punishable by
a fine not exceeding $1,000 or imprisonment of not more than
one year, or both, together with the costs of prosecution (sec.
7213A). An action for civil damages also may be brought for
unauthorized disclosure (sec. 7431). No return or return
information may be furnished by the Internal Revenue Service
(``IRS'') to another agency unless the other agency establishes
procedures satisfactory to the IRS for safeguarding the
information it receives (sec. 6103(p)).
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\79\ H.R. 1. The House passed the bill, with the text of H.R. 2596
(a bill relating to Health Savings Accounts) appended thereto, on June
27, 2003. The Senate Committee on Finance reported S. 1 on June 13,
2003. The Senate passed H.R. 1, as amended by the provisions of S. 1,
on July 7, 2003. The conference report was filed on November 21, 2003
(H.R. Rep. No. 108-391). The conference bill passed the House on
November 22, 2003, and the Senate on November 25, 2003. The President
signed the bill on December 8, 2003.
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Explanation of Provision
The Act establishes a new optional Medicare prescription
drug benefit program, effective January 1, 2006. Until the new
permanent program is effective, the Secretary of Health and
Human Services is required to establish a program to endorse
prescription drug discount programs in order to provide access
to prescription drug discounts for discount card-eligible
individuals and to provide for transitional assistance for
eligible individuals enrolled in such endorsed programs.
An individual who wishes to be treated as a ``transitional
assistance eligible individual'' has the option of self-
certifying under penalty of perjury as to the amount of the
individual's income, family size, and prescription drug
coverage (if any). The Secretary of Health and Human Services
is authorized to verify eligibility for individuals seeking to
enroll in an endorsed program and for individuals who provide
self-certification as to the foregoing items. In its
verification process, the Department of Health and Human
Services may obtain and use return information from the IRS.
Specifically, the provision authorizes the IRS to disclose to
employees and contractors of the Department of Health and Human
Services whether adjusted gross income, as modified in
accordance with definitions that will be specified by the
Secretary of Health and Human Services, exceeds amounts that
are 100 and 135 percent of the official poverty line.\80\ The
IRS also is authorized to disclose the applicable year (as
defined below) and whether the return was a joint return. If no
return has been filed for such year, the IRS is authorized to
disclose the fact that no return has been filed for such
taxpayer. ``Applicable year'' means the most recent taxable
year for which information is available in the IRS data
information systems generally for all taxpayers, or if there is
no return filed for such taxpayer for such year, the prior
taxable year. Return information disclosed may only be used for
the purposes of determining eligibility for and administering
the transitional assistance program as established under the
provision. Employees and contractors of the Department of
Health and Human Services are subject to the penalties for
unauthorized disclosure and inspection, as well as the
applicable safeguard requirements.
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\80\ For this purpose, the official poverty line is defined in
section 673(3) of the Community Services Block Grant Act, 42 U.S.C.
sec. 9902(2).
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Effective Date
The provision is effective for disclosures made after the
date of enactment (December 8, 2003).
B. Disclosure of Return Information Relating to Income-Related
Reduction in Part B Premium Subsidy (sec. 811(c) of the Act and sec.
6103(l)(20) of the Code)
Present and Prior Law
The Internal Revenue Code prohibits disclosure of returns
and return information, except to the extent specifically
authorized by the Code (sec. 6103(a)). Unauthorized disclosure
is a felony punishable by a fine not exceeding $5,000 or
imprisonment of not more than five years, or both, together
with the costs of prosecution (sec. 7213). Unauthorized
inspection of such information is a misdemeanor, punishable by
a fine not exceeding $1,000 or imprisonment of not more than
one year, or both, together with the costs of prosecution (sec.
7213A). An action for civil damages also may be brought for
unauthorized disclosure (sec. 7431). No return or return
information may be furnished by the Internal Revenue Service
(``IRS'') to another agency unless the other agency establishes
procedures satisfactory to the IRS for safeguarding the
information it receives (sec. 6103(p)).
Explanation of Provision
To facilitate the income-related reduction in Part B
premium subsidy, the Act authorizes the disclosure of certain
return information to employees and contractors of the Social
Security Administration. Upon written request from the
Commissioner of Social Security, the IRS may disclose certain
items of return information with respect to a taxpayer whose
premium may be subject to a subsidy adjustment.\81\ With
respect to such taxpayers, the IRS may disclose (1) taxpayer
identity information; (2) filing status; (3) adjusted gross
income; (4) the amounts excluded from such taxpayer's gross
income under sections 135 and 911 of the Code (relating to
income from United States Savings bonds used to pay higher
education tuition and fees, and foreign earned income); (5)
tax-exempt interest received or accrued during the taxable year
to the extent such information is available; (6) amounts
excluded from such taxpayer's gross income by sections 931 and
933 of the Code (relating to income from sources within Guam,
American Samoa, the Northern Mariana Islands, or Puerto Rico);
(7) for nonfilers only, such other information relating to the
liability of the taxpayer as the Secretary may prescribe by
regulation, as might indicate that the amount of the premium of
the taxpayer may be subject to adjustment (including estimated
tax payments and income information derived from Form W-2, Form
1099, and similar information returns); and (8) the taxable
year with respect to which the preceding information relates.
Return information disclosed under this authority may be used
by employees and contractors of the Social Security
Administration only for purposes of, and to the extent
necessary in, establishing the appropriate amount of any Part B
premium adjustment. Employees and contractors of the Social
Security Administration are subject to the penalties for
unauthorized disclosure and inspection, as well as the
applicable safeguard requirements.
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\81\ Adjustments are determined pursuant to section 1839(i) of the
Social Security Act (as added by the provision).
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Effective Date
The provision is effective for premium adjustments under
section 1839(i) of the Social Security Act for months beginning
with January 2007.
C. Health Savings Accounts (sec. 1201 of the Act and new sec. 223 of
the Code)
Present and Prior Law
Overview
A number of provisions dealing with the Federal tax
treatment of health expenses and health insurance coverage
exist under present and prior law.
Employer-provided health coverage
In general, employer contributions to an accident or health
plan are excludable from an employee's gross income (and wages
for employment tax purposes).\82\ This exclusion generally
applies to coverage provided to employees (including former
employees) and their spouses, dependents, and survivors.
Benefits paid under employer-provided accident or health plans
are also generally excludable from income to the extent they
are reimbursements for medical care.\83\ If certain
requirements are satisfied, employer-provided accident or
health coverage offered under a cafeteria plan is also
excludable from an employee's gross income and wages.\84\
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\82\ Secs. 106, 3121(a)(2), and 3306(b)(2).
\83\ Sec.105. In the case of a self-insured medical reimbursement
arrangement, the exclusion applies to highly compensated employees only
if certain nondiscrimination rules are satisfied. Sec. 105(h). Medical
care is defined as under section 213(d) and generally includes amounts
paid for qualified long-term care insurance and services.
\84\ Secs. 125, 3121(a)(5)(G), and 3306(b)(5)(G). Long-term care
insurance and services may not be provided through a cafeteria plan.
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Two general employer-provided arrangements can be used to
pay for or reimburse medical expenses of employees on a tax-
favored basis: flexible spending arrangements (``FSAs'') and
health reimbursement arrangements (``HRAs''). While these
arrangements provide similar tax benefits (i.e., the amounts
paid under the arrangements for medical care are excludable
from gross income and wages for employment tax purposes), they
are subject to different rules. A main distinguishing feature
between the two arrangements is that while FSAs are generally
part of a cafeteria plan and contributions to FSAs are made on
a salary reduction basis, HRAs cannot be part of a cafeteria
plan and contributions cannot be made on a salary-reduction
basis.\85\
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\85\ Notice 2002-45, 2002-28 I.R.B. 93 (July 15, 2002); Rev. Rul.
2002-41, 2002-28 I.R.B. 75 (July 15, 2002).
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Amounts paid or accrued by an employer within a taxable
year for a sickness, accident, hospitalization, medical
expense, or similar health plan for its employees are generally
deductible as ordinary and necessary business expenses.\86\
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\86\ Sec. 162.
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Self-employed individuals
The exclusion for employer-provided health coverage does
not apply to self-employed individuals. However, self-employed
individuals (i.e., sole proprietors or partners in a
partnership) \87\ are entitled to deduct 100 percent of the
amount paid for health insurance for themselves and their
spouse and dependents.\88\
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\87\ Self-employed individuals include more than two-percent
shareholders of S corporations who are treated as partners for purposes
of fringe benefits rules pursuant to section 1372.
\88\ Sec. 162(1).
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Itemized deduction for medical expenses
Individuals who itemize deductions may deduct amounts paid
during the taxable year (to the extent not reimbursed by
insurance or otherwise) for medical care of the taxpayer, the
taxpayer's spouse, and dependents, to the extent that the total
of such expenses exceeds 7.5 percent of the taxpayer's adjusted
gross income.\89\
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\89\ Sec. 213. The adjusted gross income percentage is 10 percent
for purposes of the alternative minimum tax. Sec. 56(b)(1)(B).
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Archer medical savings accounts
In general
In general, an Archer medical savings account (``MSA'') is
a tax-exempt trust or custodial account created exclusively for
the benefit of the account holder that is subject to rules
similar to those applicable to individual retirement
arrangements.\90\
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\90\ Sec. 220.
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Within limits, contributions to an Archer MSA are
deductible in determining adjusted gross income if made by an
eligible individual and are excludable from gross income and
wages for employment tax purposes if made by the employer of an
eligible individual. Earnings on amounts in an Archer MSA are
not includible in gross income in the year earned (i.e., inside
buildup is not taxable). Distributions from an Archer MSA for
qualified medical expenses are not includible in gross income.
Distributions not used for qualified medical expenses are
includible in gross income and subject to an additional 15-
percent tax unless the distribution is made after death,
disability, or the individual attains the age of Medicare
eligibility (i.e., age 65).
Qualified medical expenses are generally defined as under
section 213(d), except that qualified medical expenses do not
include expenses for health insurance other than long-term care
insurance, premiums for health coverage during any period of
continuation coverage required by Federal law, and premiums for
health care coverage while an individual is receiving
unemployment compensation under Federal or State law. For
purposes of determining the itemized deduction for medical
expenses, distributions from an Archer MSA for qualified
medical expenses are not treated as expenses paid for medical
care under section 213.
Eligible individuals
Archer MSAs are available only to employees of a small
employer who are covered under an employer-sponsored high
deductible health plan and to self-employed individuals covered
under a high deductible health plan.\91\ An employer is a small
employer if it employed, on average, no more than 50 employees
on business days during either of the two preceding calendar
years. An individual is not eligible for an Archer MSA if he or
she is covered under any other health plan that is not a high
deductible health plan (other than a plan providing certain
limited types of coverage). Individuals entitled to benefits
under Medicare are not eligible individuals. Eligible
individuals do not include individuals who may be claimed as a
dependent on another person's tax return.
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\91\ Self-employed individuals include more than two-percent
shareholders of S corporations who are treated as partners for purposes
of fringe benefit rules pursuant to section 1372.
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Treatment of contributions
Individual contributions to an Archer MSA are deductible
(within limits) in determining adjusted gross income (i.e.,
``above-the-line''). In addition, employer contributions are
excludable from gross income and wages for employment tax
purposes (within the same limits). Contributions to an Archer
MSA may not be made through a cafeteria plan. In the case of an
employee, contributions can be made to an Archer MSA either by
the individual or by the individual's employer, but not by
both.
The maximum annual contribution that can be made to an
Archer MSA for a year is 65 percent of the annual deductible
under the high deductible health plan in the case of self-only
coverage and 75 percent of the annual deductible in the case of
family coverage.
If an employer provides a high deductible health plan
coupled with Archer MSAs for employees and makes employer
contributions to the Archer MSAs, the employer must make
available a comparable contribution on behalf of all employees
with comparable coverage during the same period. Contributions
are considered comparable if they are either of the same amount
or the same percentage of the deductible under the high
deductible health plan. If employer contributions do not
satisfy the comparability rule during a period, then the
employer is subject to an excise tax equal to 35 percent of the
aggregate amount contributed by the employer to Archer MSAs of
the employer for that period.
Definition of high deductible health plan
For 2003, a high deductible health plan is a health plan
with an annual deductible of at least $1,700 and no more than
$2,500 in the case of self-only coverage and at least $3,350
and no more than $5,050 in the case of family coverage. In
addition, the maximum out-of-pocket expenses with respect to
allowed costs must be no more than $3,350 in the case of self-
only coverage and no more than $6,150 in the case of family
coverage (for 2003).\92\ Out-of-pocket expenses include
deductibles, co-payments, and other amounts (other than
premiums) that the individual must pay for covered benefits
under the plan. A plan does not fail to qualify as a high
deductible health plan merely because it does not have a
deductible for preventive care as required under State law. A
plan does not qualify as a high deductible health plan if
substantially all of the coverage under the plan is certain
permitted insurance or is coverage (whether provided through
insurance or otherwise) for accidents, disability, dental care,
vision care, or long-term care.
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\92\ The deductible and out-of-pocket expenses dollar amounts are
indexed for inflation in $50 increments.
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Treatment of death of account holder
Upon death, any balance remaining in the decedent's Archer
MSA is includible in his or her gross estate. If the account
holder's surviving spouse is the named beneficiary of the
Archer MSA, then, after the death of the account holder, the
Archer MSA becomes the Archer MSA of the surviving spouse and
the amount of the Archer MSA balance may be deducted in
computing the decedent's taxable estate, pursuant to the estate
tax marital deduction.\93\ If, upon the account holder's death,
the Archer MSA passes to a named beneficiary other than the
decedent's surviving spouse, the Archer MSA ceases to be an
Archer MSA as of the date of the decedent's death, and the
beneficiary is required to include the fair market value of the
Archer MSA assets as of the date of death in gross income for
the taxable year that includes the date of death. The amount
includible in gross income is reduced by the amount in the
Archer MSA used, within one year after death, to pay qualified
medical expenses incurred prior to the death. If there is no
named beneficiary for the decedent's Archer MSA, the Archer MSA
ceases to be an Archer MSA as of the date of death, and the
fair market value of the assets in the Archer MSA as of such
date is includible in the decedent's gross income for the year
of the death.
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\93\ Sec. 2056.
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Limit on number of MSAs; termination of MSA availability
The number of taxpayers benefiting annually from an Archer
MSA contribution is limited to a threshold level (generally
750,000 taxpayers). The number of Archer MSAs established has
not exceeded the threshold level.
After 2003, no new contributions could be made to Archer
MSAs except by or on behalf of individuals who previously had
Archer MSA contributions and employees who are employed by a
participating employer.\94\
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\94\ Under Pub. L. No. 108-311, new contributions to Archer MSAs
can be made through 2005.
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Explanation of Provision
In general
The Act adds provisions for health savings accounts (HSAs),
effective for taxable years beginning after December 31, 2003.
In general, HSAs provide tax-favored treatment for current
medical expenses as well as the ability to save on a tax-
favored basis for future medical expenses. In general, HSAs are
tax-exempt trusts or custodial accounts created exclusively to
pay for the qualified medical expenses of the account holder
and his or her spouse and dependents that are subject to rules
similar to those applicable to individual retirement
arrangements.\95\
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\95\ The present-law requirement applicable to insurance companies
that certain policy acquisition expenses must be capitalized and
amortized (sec. 848) does not apply in the case of any contract that is
an HSA.
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Within limits, contributions to an HSA made by or on behalf
of an eligible individual are deductible by the individual.
Contributions to an HSA are excludable from income and
employment taxes if made by the employer. Earnings on amounts
in HSAs are not taxable. Distributions from an HSA for
qualified medical expenses are not includible in gross income.
Distributions from an HSA that are not used for qualified
medical expenses are includible in gross income and are subject
to an additional tax of 10 percent, unless the distribution is
made after death, disability, or the individual attains the age
of Medicare eligibility (i.e., age 65).
Eligible individuals
Eligible individuals for HSAs are individuals who are
covered by a high deductible health plan and no other health
plan that is not a high deductible health plan and which
provides coverage for any benefit which is covered under the
high deductible health plan. Individuals entitled to benefits
under Medicare are not eligible to make contributions to an
HSA. Eligible individuals do not include individuals who may be
claimed as a dependent on another person's tax return.
An individual with other coverage in addition to a high
deductible health plan is still eligible for an HSA if such
other coverage is certain permitted insurance or permitted
coverage. Permitted insurance is: (1) insurance if
substantially all of the coverage provided under such insurance
relates to (a) liabilities incurred under worker's compensation
law, (b) tort liabilities, (c) liabilities relating to
ownership or use of property (e.g., auto insurance), or (d)
such other similar liabilities as the Secretary may prescribe
by regulations; (2) insurance for a specified disease or
illness; and (3) insurance that provides a fixed payment for
hospitalization. Permitted coverage is coverage (whether
provided through insurance or otherwise) for accidents,
disability, dental care, vision care, or long-term care.
A high deductible health plan is a health plan that has a
deductible that is at least $1,000 for self-only coverage or
$2,000 for family coverage and that has an out-of-pocket
expense limit that is no more than $5,000 in the case of self-
only coverage and $10,000 in the case of family coverage.\96\
As under present and prior law, out-of-pocket expenses include
deductibles, co-payments, and other amounts (other than
premiums) that the individual must pay for covered benefits
under the plan. A plan is not a high deductible health plan if
substantially all of the coverage is for permitted coverage or
coverage that may be provided by permitted insurance, as
described above.
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\96\ The $1,000 and $5,000 limits are indexed for inflation. The
family coverage limits will always be twice the self-only coverage
limits (as indexed for inflation). In the case of the plan using a
network of providers, the plan does not fail to be a high deductible
health plan (if it would otherwise meet the requirements of a high
deductible health plan) solely because the out-of-pocket expense limit
for services provided outside of the network exceeds the $5,000 and
$10,000 out-of-pocket expense limits. In addition, such plan's
deductible for out-of-network services is not taken into account in
determining the annual contribution limit (i.e., the deductible for
services with the network is used for such purpose).
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A plan does not fail to be a high deductible health plan by
reason of failing to have a deductible for preventive care.
Except as otherwise provided by the Secretary, preventive care
is defined as under section 1871 of the Social Security Act. It
is intended that the Secretary of the Treasury will amend the
definition of preventive care if the definition used under the
Social Security Act is inconsistent with the purposes of the
provision.
Tax treatment of and limits on contributions
Contributions to an HSA by or on behalf of an eligible
individual are deductible (within limits) in determining
adjusted gross income (i.e., ``above-the-line'') of the
individual. Thus, for example, contributions made by an
eligible individual's family members are deductible by the
eligible individual to the extent the contributions would be
deductible if made by the individual.\97\ In addition, employer
contributions to HSAs (including salary reduction contributions
made through a cafeteria plan) are excludable from gross income
and wages for employment tax purposes.\98\ In the case of an
employee, contributions to an HSA may be made by both the
individual and the individual's employer. All contributions are
aggregated for purposes of the maximum annual contribution
limit. Contributions to Archer MSAs reduce the annual
contribution limit for HSAs.
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\97\ Under present law, contributions made on behalf of another
individual are generally treated as gifts. The present-law gift tax
rules apply to contributions made on behalf of another individual.
\98\ Employer contributions to an HSA are excludable from wages for
employment tax purposes if, at the time of payment, it is reasonable to
believe that the employee will be able to exclude such payment from
income.
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The maximum aggregate annual contribution that can be made
to an HSA is the lesser of (1) 100 percent of the annual
deductible under the high deductible health plan, or (2) the
maximum deductible permitted under an Archer MSA high
deductible health plan under present and prior law, as adjusted
for inflation.\99\ For 2004, the amount of the maximum
deductible under an Archer MSA high deductible health plan is
$2,600 in the case of self-only coverage and $5,150 in the case
of family coverage. The annual contribution limits are
increased for individuals who have attained age 55 by the end
of the taxable year. In the case of policyholders and covered
spouses who are age 55 or older, the HSA annual contribution
limit is greater than the otherwise applicable limit by $500 in
2004, $600 in 2005, $700 in 2006, $800 in 2007, $900 in 2008,
and $1,000 in 2009 and thereafter.\100\ Contributions,
including catch-up contributions, cannot be made once an
individual is eligible for Medicare.
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\99\ The annual contribution limit is the sum of the limits
determined separately for each month, based on the individual's status
and health plan coverage as of the first day of the month.
\100\ As in determining the general annual contribution limit, the
increase in the annual contribution limit for individuals who have
attained age 55 is also determined on a monthly basis.
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An excise tax applies to contributions in excess of the
maximum contribution amount for the HSA. The excise tax is
generally equal to six percent of the cumulative amount of
excess contributions that are not distributed from the HSA.
Amounts can be rolled over into an HSA from another HSA or
from an Archer MSA.
If an employer makes contributions to employees' HSAs, the
employer must make available comparable contributions on behalf
of all employees with comparable coverage during the same
period. Contributions are considered comparable if they are
either of the same amount or the same percentage of the
deductible under the plan. The comparability rule is applied
separately to part-time employees (i.e., employees who are
customarily employed for fewer than 30 hours per week).
If employer contributions do not satisfy the comparability
rule during a period, then the employer is subject to an excise
tax equal to 35 percent of the aggregate amount contributed by
the employer to HSAs for that period. The excise tax is
designed as a proxy for the denial of the deduction for
employer contributions. In the case of a failure to comply with
the comparability rule which is due to reasonable cause and not
to willful neglect, the Secretary may waive part or all of the
tax imposed to the extent that the payment of the tax would be
excessive relative to the failure involved. For purposes of the
comparability rule, employers under common control are
aggregated.
Taxation of distributions
Distributions from an HSA for qualified medical expenses of
the individual and his or her spouse or dependents generally
are excludable from gross income. In general, amounts in an HSA
can be used for qualified medical expenses even if the
individual is not currently eligible for contributions to the
HSA.
Qualified medical expenses generally are defined as under
section 213(d) and include expenses for diagnosis, cure,
mitigation, treatment, or prevention of disease, including
prescription drugs, transportation primarily for and essential
to such care, and qualified long-term care expenses of the
account holder and his or her spouse or dependents. Qualified
medical expenses do not include expenses for insurance other
than for (1) long-term care insurance, (2) premiums for health
coverage during any period of continuation coverage required by
Federal law, (3) premiums for health care coverage while an
individual is receiving unemployment compensation under Federal
or State law, or (4) in the case of an account beneficiary who
has attained the age of Medicare eligibility, health insurance
premiums for Medicare, other than premiums for Medigap
policies. Such qualified health insurance premiums include, for
example, Medicare Part A and Part B premiums, Medicare HMO
premiums, and the employee share of premiums for employer-
sponsored health insurance including employer-sponsored retiree
health insurance.
For purposes of determining the itemized deduction for
medical expenses, distributions from an HSA for qualified
medical expenses are not treated as expenses paid for medical
care under section 213.
Distributions from an HSA that are not for qualified
medical expenses are includible in gross income. Distributions
includible in gross income are also subject to an additional
10-percent tax unless made after death, disability, or the
individual attains the age of Medicare eligibility (i.e., age
65).
Tax treatment of HSAs after death
Upon death, any balance remaining in the decedent's HSA is
includible in his or her gross estate.
If the HSA holder's surviving spouse is the named
beneficiary of the HSA, then, after the death of the HSA
holder, the HSA becomes the HSA of the surviving spouse and the
amount of the HSA balance may be deducted in computing the
decedent's taxable estate, pursuant to the estate tax marital
deduction.\101\ The surviving spouse is not required to include
any amount in gross income as a result of the death; the
general rules applicable to the HSA apply to the surviving
spouse's HSA (e.g., the surviving spouse is subject to income
tax only on distributions from the HSA for nonqualified
expenses). The surviving spouse can exclude from gross income
amounts withdrawn from the HSA for expenses incurred by the
decedent prior to death, to the extent they otherwise are
qualified medical expenses.
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\101\ Sec. 2056.
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If, upon death, the HSA passes to a named beneficiary other
than the decedent's surviving spouse, the HSA ceases to be an
HSA as of the date of the decedent's death, and the beneficiary
is required to include the fair market value of HSA assets as
of the date of death in gross income for the taxable year that
includes the date of death. The amount includible in income is
reduced by the amount in the HSA used, within one year after
death, to pay qualified medical expenses incurred by the
decedent prior to the death. As is the case with other HSA
distributions, whether the expenses are qualified medical
expenses is determined as of the time the expenses were
incurred. In computing taxable income, the beneficiary may
claim a deduction for that portion of the Federal estate tax on
the decedent's estate that was attributable to the amount of
the HSA balance.\102\
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\102\ The deduction is calculated in accordance with the present-
law rules relating to income in respect of a decedent set forth in
section 691(c).
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If there is no named beneficiary of the decedent's HSA, the
HSA ceases to be an HSA as of the date of death, and the fair
market value of the assets in the HSA as of such date is
includible in the decedent's gross income for the year of the
death. This rule applies in all cases in which there is no
named beneficiary, even if the surviving spouse ultimately
obtains the right to the HSA assets (e.g., if the surviving
spouse is the sole beneficiary of the decedent's estate).
Reporting requirements
Employer contributions are required to be reported on the
employee's Form W-2. Trustees of HSAs may be required to report
to the Secretary of the Treasury amounts with respect to
contributions, distributions, the return of excess
contributions, and other matters as determined appropriate by
the Secretary. In addition, the Secretary may require providers
of high deductible health plans to make reports to the
Secretary and to account beneficiaries as the Secretary
determines appropriate.
Effective Date
The provision is effective for taxable years beginning
after December 31, 2003.
D. Exclusion from Gross Income of Certain Federal Subsidies for
Prescription Drug Plans (sec. 1202 of the Act and new sec. 139A of the
Code)
Present and Prior Law
Gross income includes all income from whatever source
derived unless a specific exclusion applies.\103\
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\103\ Sec. 61.
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Explanation of Provision
The Act provides that gross income does not include any
special subsidy payment received under section 1860D-22 of the
Social Security Act. The exclusion applies for purposes of both
the regular tax and the alternative minimum tax (including the
adjustment for adjusted current earnings).
The exclusion is not taken into account in determining
whether a deduction is allowable with respect to costs taken
into account in determining the subsidy payment. Accordingly, a
taxpayer could claim a deduction for prescription drug expenses
incurred even though the taxpayer also received an excludible
subsidy related to the same expenses.
Effective Date
The provision is effective for taxable years ending after
the date of enactment (December 8, 2003).
E. Exception to Information Reporting Requirements for Certain Health
Arrangements (sec. 1203 of the Act and sec. 6041 of the Code)
Present and Prior Law
Any person in a trade or business who, in the course of
that trade or business, makes specified payments to another
person totaling $600 or more in a year, must provide an
information report to the IRS (as well as a copy to the
recipient) on the payments.\104\ Reporting is required to be
done on Form 1099. In general, these information reports remind
taxpayers of amounts of income that should be reflected on
their tax returns and assist the IRS in verifying that
taxpayers have correctly reported these amounts.
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\104\ Sec. 6041.
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Treasury regulations specify that fees for professional
services, including the services of physicians, must be
reported.\105\ Treasury regulations also provide a general
exception from these information reporting requirements for
payments made to corporations, except that this exception is
inapplicable if the corporation is ``engaged in providing
medical and health care services.'' \106\
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\105\ Treas. Reg. sec. 1.6041-1(d)(2).
\106\ Treas. Reg. sec. 1.6041-3(p)(1). These regulations also
provide an exception from these information reporting requirements if
the payment is made to a hospital that is tax-exempt or that is owned
and operated by a governmental entity.
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In 2003, the IRS issued a revenue ruling describing when
employer-provided expense reimbursements made through debit or
credit cards or other electronic media are excludible from
gross income.\107\ The ruling stated that ``payments made to
medical service providers through the use of debit, credit, and
stored value cards are reportable by the employer on Form 1099-
MISC under section 6041.'' \108\
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\107\ Rev. Rul. 2003-43, 2003-21 I.R.B. 935 (May 27, 2003).
\108\ Id.
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Reasons for Change \109\
The Congress wished to encourage electronic reimbursement
of medical expenses through the use of debit or store-valued
cards. The Congress believed that the regulatory reporting
requirement discouraged the use of such cards and that such
burden should be removed.
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\109\ See H.R. 2351, the ``Health Savings Account Availability
Act,'' which was reported by the House Committee on Ways and Means on
June 25, 2003 (H.R. Rep. No. 108-177).
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Explanation of Provision
The Act provides an exception from the generally applicable
information reporting provisions for payments for medical care
made under either: (1) a flexible spending arrangement,\110\ or
(2) a health reimbursement arrangement that is treated as
employer-provided coverage.
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\110\ This term is defined in sec. 106(c)(2).
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Effective Date
The provision applies to payments made after December 31,
2002.
PART SIX: VISION 100-CENTURY OF AVIATION REAUTHORIZATION ACT (PUBLIC
LAW 108-176) \111\
A. Extension of Expenditure Authority (secs. 901 and 902 of the Act)
Present and Prior Law
The Airport and Airway Trust Fund (the ``Trust Fund'') was
created in 1970 to finance a major portion of the Federal
expenditures on national aviation programs. Prior to that time,
these expenditures had been financed with General Fund monies.
The statutory provisions relating to the Trust Fund were placed
in the Code in 1982.\112\
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\111\ H.R. 2115. The House Committee on Transportation reported the
bill on June 6, 2003 (H.R. Rep. No. 108-143). The House passed the bill
on June 11, 2003. The Senate Committee on Commerce, Science, and
Transportation reported S. 824 on May 2, 2003 (S. Rep. No. 108-41). The
Senate passed H.R. 2115, as amended by the provisions of S. 824, on
June 12, 2003. The conference report was filed on October 29, 2003
(H.R. Rep. No. 108-334). The conference report passed the House on
October 30, 2003 and the Senate on November 21, 2003. The President
signed the bill on December 12, 2003.
\112\ Sec. 9502.
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Under prior law, the Internal Revenue Code authorized
expenditures to be made from the Trust Fund through September
30, 2003, for purposes provided in specified authorizing
legislation as in effect on the date of enactment of the most
recent authorizing Act (the Wendell H. Ford Aviation Investment
and Reform Act for the 21st Century).
To support the Trust Fund, the Code imposes taxes on both
commercial and noncommercial aviation. Commercial aviation is
the carriage of persons or property by air for compensation
(air transportation ``for hire''). All other air transportation
is defined as non-commercial aviation.\113\
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\113\ Sec. 4041(c)(2). Because these definitions are based on
whether an amount is paid for the transportation, it is possible for
the same aircraft to be used at times in commercial aviation and at
times in non-commercial aviation. This determination is made on a
flight-by-flight basis. For example, a corporate-owned aircraft
transporting employees of the corporation is engaged in non-commercial
aviation (and subject only to fuels excise tax) while the same aircraft
when transporting non-employees is engaged in commercial aviation (and
subject to a mix of ticket and fuels taxes).
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The taxes imposed to finance the aviation trust fund are:
1. ticket taxes imposed on commercial passenger
transportation;
2. a waybill tax imposed on freight transportation; and
3. fuel taxes imposed on gasoline and jet fuel used in
commercial aviation and non-commercial aviation.
Most domestic air passenger transportation is subject to a
two-part ticket tax. First, the Code imposes a tax at the rate
of 7.5 percent of the amount paid for taxable transportation.
Second, the Code imposes a flight segment tax of $3 for each
domestic segment of taxable transportation. Beginning with
calendar year 2003, the domestic flight segment portion of the
ticket tax is adjusted for inflation annually.
Explanation of Provisions
Trust Fund expenditure authority
The Act extends the authority to make expenditures (subject
to appropriations) from the Trust Fund through September 30,
2007. The Act also updates the Trust Fund cross references to
authorizing legislation to include expenditure purposes in this
Act and prior authorizing legislation as in effect on the date
of enactment of the Act.
Domestic flight segment tax
The Act makes a technical correction to the domestic flight
segment portion of the airline ticket tax. Beginning with
calendar year 2003, the domestic flight segment portion of the
airline ticket tax is adjusted for inflation annually. The
technical correction clarifies that, in the case of amounts
paid for transportation before the beginning of the year in
which the transportation is to occur, the rate of tax is the
rate in effect for the calendar year in which the amount is
paid.
Effective Dates
The provision extending expenditure authority is effective
on the date of enactment (December 12, 2003).
The provision relating to the domestic flight segment tax
for flight segments beginning after December 31, 2002, is
effective as if included in the provisions of the Taxpayer
Relief Act of 1997 to which it relates.
PART SEVEN: SERVICEMEMBERS CIVIL RELIEF ACT (PUBLIC LAW 108-189) \114\
A. Servicemembers Civil Relief (sec. 510 of the Act)
Explanation of Provision
Section 510 of the Servicemembers Civil Relief Act reenacts
section 573 of the Soldiers' and Sailors' Civil Relief Act of
1940, with only minor technical changes. First, section 510
requires notice to the IRS or the tax authority of a State or a
political subdivision thereof to be effective. Second, the six
month maximum effective period under the 1940 Act has been
changed to a 180-day period.
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\114\ H.R. 100. The House Committee on Veterans' Affairs reported
the bill on April 30, 2003 (H.R. Rep. No. 108-81). The House passed the
bill on the suspension calendar on May 7, 2003. The Senate Committee on
Veterans' Affairs reported S. 1136 on November 11, 2003 (S. Rep. No.
108-197). The Senate passed H.R. 100, as amended by the provisions of
S. 1136, by unanimous consent on November 21, 2003. The House passed
the bill, as amended by the Senate, by unanimous consent on December
12, 2003. The President signed the bill on December 19, 2003.
PART EIGHT: SURFACE TRANSPORTATION EXTENSION ACT OF 2004 (PUBLIC LAW
108-202) \115\
A. Extension of Highway Trust Fund and Aquatic Resources Trust Fund
Expenditure Authority (sec. 12 of the Act)
Prior Law
Under prior law, the Internal Revenue Code (sec. 9503)
authorized expenditures (subject to appropriations) to be made
from the Highway Trust Fund through February 29, 2004, for
purposes provided in specified authorizing legislation as in
effect on the date of enactment of the most recent authorizing
Act (the Surface Transportation Extension Act of 2003).
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\115\ H.R. 3850. The House passed the bill by unanimous consent on
February 26, 2004. The Senate passed the bill by unanimous consent on
February 27, 2004. The President signed the bill on February 29, 2004.
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Under prior law, expenditures also were authorized from the
Aquatic Resources Trust Fund through February 29, 2004.
Highway Trust Fund spending is limited by anti-deficit
provisions internal to the Highway Trust Fund, the so-called
``Harry Byrd rule''. The rule requires the Treasury Department
to determine, on a quarterly basis, the amount (if any) by
which unfunded highway authorizations exceed projected net
Highway Trust Fund tax receipts for the 24-month period
beginning at the close of each fiscal year (sec. 9503(d)).
Similar rules apply to unfunded Mass Transit Account
authorizations. If unfunded authorizations exceed projected 24-
month receipts, apportionments to the States for specified
programs funded by the relevant Trust Fund Account are to be
reduced proportionately. Because of the Harry Byrd rule, taxes
dedicated to the Highway Trust Fund typically are scheduled to
expire at least two years after current authorizing Acts.
The Surface Transportation Extension Act of 2003, created a
temporary rule (through February 29, 2004) for purposes of the
anti-deficit provisions of the Highway Trust Fund. For purposes
of determining 24 months of projected revenues for the anti-
deficit provisions, the Secretary of the Treasury is instructed
to treat each expiring provision relating to appropriations and
transfers to the Highway Trust Fund to have been extended
through the end of the 24-month period and to assume that the
rate of tax during such 24-month period remains the same as the
rate in effect on the date of enactment of that Act.
Explanation of Provision \116\
The Act extends the authority to make expenditures (subject
to appropriations) from the Highway Trust Fund through April
30, 2004. The Act also updates the Highway Trust Fund cross
references to authorizing legislation to include expenditure
purposes in this Act and prior authorizing legislation as in
effect on the date of enactment.
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\116\ The expiration dates described herein were subsequently
extended by the Surface Transportation Extension Act of 2004, Part II;
the Surface Transportation Extension Act of 2004, Part III; the Surface
Transportation Extension Act of 2004, Part IV; and the Surface
Transportation Extension Act of 2004, Part V, described in Part Eleven,
Part Twelve, Part Thirteen, and Part Fourteen, respectively.
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For purposes of the anti-deficit provisions of the Highway
Trust Fund, the Act extends the temporary rule (through April
30, 2004) created by the Surface Transportation Extension Act
of 2003.
The Act extends the authority to make expenditures (subject
to appropriations) from the Aquatics Resources Trust Fund
through April 30, 2004. The Act also updates the Aquatics
Resources Trust Fund cross references to authorizing
legislation to include expenditure purposes as in effect on the
date of enactment of this Act.
Effective Date
The provision is effective on the date of enactment
(February 29, 2004).
PART NINE: THE SOCIAL SECURITY PROTECTION ACT OF 2004 (PUBLIC LAW 108-
203) \117\
A. Technical Amendment Clarifying Treatment for Certain Purposes of
Individual Work Plans under the Ticket to Work and Self-Sufficiency
Program (sec. 405 of the Act, sec. 1148(g)(1) of the Social Security
Act, and sec. 51 of the Code)
Present and Prior Law
The work opportunity tax credit is a temporary credit
available on an elective basis for employers hiring individuals
from one or more of eight targeted groups.\118\ The credit
generally equals 40 percent (25 percent for employment of 400
hours or less) of qualified first-year wages. Generally,
qualified first-year wages are qualified wages (not in excess
of $6,000) attributable to service rendered by a member of a
targeted group during the one-year period beginning with the
day the individual began work for the employer. Therefore, the
maximum credit per employee is generally $2,400 (40 percent of
the first $6,000 of qualified first-year wages).
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\117\ H.R. 743. The House Committee on Ways and Means reported the
bill on March 24, 2003 (H.R. Rep. No. 108-46). The House passed the
bill on April 2, 2003. The Senate Committee on Finance reported the
bill on October 29, 2003 (S. Rep. No. 108-176). The Senate passed the
bill, as amended, on December 9, 2003. The bill, as amended, passed the
House on February 11, 2004. The President signed the bill on March 2,
2004.
\118\ Section 303 of the Working Class Families Tax Relief Act of
2004, also described in Part Fifteen of this document, provides for the
extension of the work opportunity tax credit for two years, i.e., for
wages paid to qualified individuals who begin work for an employer
after December 31, 2003, and before January 1, 2006.
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For purposes of the credit, the eight targeted groups are:
(1) certain families eligible to receive benefits under the
Temporary Assistance for Needy Families Program; (2) high-risk
youth; (3) qualified ex-felons; (4) vocational rehabilitation
referrals; (5) qualified summer youth employees; (6) qualified
veterans; (7) families receiving food stamps; and (8) persons
receiving certain Supplemental Security Income (SSI) benefits.
For purposes of the credit, the term ``vocational
rehabilitation referral'' means any individual who is certified
by the local designated agency as: (1) having a physical or
mental disability that, for the individual, constitutes or
results in a substantial handicap to employment; and (2) having
been referred to the employer upon completion of (or while
receiving) rehabilitative services pursuant to either an
individualized written plan for employment under a State plan
for vocational rehabilitation services approved under the
Rehabilitation Act of 1973, or a program of vocational
rehabilitation for veterans carried out under applicable
Federal law.
The Ticket to Work and Work Incentives Improvement Act of
1999 established the ``Ticket to Work'' program under the
Social Security Act.\119\ Under this program, a disabled
individual may be employed pursuant to an individual work plan
developed by an approved employment network, which may include
private organizations, rather than pursuant to an
individualized written plan for employment under a State plan
approved under the Rehabilitation Act of 1973.
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\119\ Pub. L. No. 106-170.
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Reasons for Change
The Congress noted that the Ticket to Work program was
designed to increase choice available to beneficiaries when
they select providers of employment services. The Congress
believed that employers hiring individuals with disabilities
should be able to qualify for the work opportunity tax credit,
regardless of whether the employment referral is made by a
public or private service provider. The Congress believed the
eligibility criteria for the work opportunity tax credit should
be updated to conform to the expansion of employment services
and the increase in number and range of vocational
rehabilitation providers as a result of the enactment of the
Ticket to Work Act.
Explanation of Provision
Under the Act, an individual work plan established pursuant
to the Ticket to Work program under the Social Security Act is
treated, for purposes of the work opportunity tax credit, as an
individualized written plan for employment under a State plan
approved under the Rehabilitation Act of 1973.
Effective Date
The provision is effective as if included in the Ticket to
Work and Work Incentives Improvement Act of 1999.
B. Clarification Respecting the FICA and SECA Tax Exemptions for an
Individual Whose Earnings Are Subject to the Laws of a Totalization
Agreement Partner (sec. 415 of the Act and secs. 1401(c), 3101(c), and
3111(c) of the Code)
Present and Prior Law
Under the Federal Insurance Contributions Act (``FICA''),
which is part of the Code, a tax is imposed on the wages paid
by an employer to an employee.\120\ FICA tax consists of two
parts: (1) old age, survivor and disability insurance
(``OASDI''), which correlates to the Social Security program
that provides monthly benefits after retirement, disability, or
death; and (2) Medicare hospital insurance (``HI''). The OASDI
tax rate is 6.2 percent on both the employee and employer (for
a total rate of 12.4 percent). The OASDI tax rate applies to
compensation up to the OASDI wage base ($87,900 for 2004). The
HI tax rate is 1.45 percent on both the employee and the
employer (for a total rate of 2.9 percent). Unlike the OASDI
tax, the HI tax is not limited to a specific amount of
compensation.
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\120\ Code secs. 3101-3128.
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FICA tax generally applies only to employees, not to
individuals engaged in a trade or business. Instead, such
individuals are subject to tax under the Self-Employment
Compensation Act (``SECA'') on their self-employment
income.\121\ Like FICA tax, SECA tax consists of two parts,
OASDI and HI.
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\121\ Code secs. 1401-1403.
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Under the Social Security Act, an individual receives
credit for his or her wages and self-employment income, which
is used to determine eligibility for monthly Social Security
benefits and Medicare coverage.
The United States may enter into agreements (referred to as
``totalization'' agreements) with foreign countries (referred
to as ``totalization agreement partners'') to coordinate
coverage and contributions (or taxes) under the Social Security
program with similar programs of other countries.\122\ These
agreements generally eliminate dual social security coverage
and taxes for the same work and earnings. Wages and self-
employment income are exempt from FICA and SECA to the extent
that, under a totalization agreement with a foreign country,
the wages or self-employment income is subject to taxes or
contributions for similar purposes under the Social Security
system of the foreign country.
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\122\ Sec. 233 of the Social Security Act.
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Reasons for Change
The Congress noted that, under U.S. totalization
agreements, a person's work is generally subject to the Social
Security laws of the country in which the work is performed.
The Congress further noted that, in most cases, the worker
(whether subject to the laws of the United States or the other
country) is compulsorily covered and required to pay
contributions in accordance with the laws of that country; in
some instances, however, work that would be compulsorily
covered in the United States is excluded from compulsory
coverage in the other country (such as Germany). The Congress
was concerned that, in such cases, the IRS had questioned the
exemption from U.S. Social Security tax for workers who elect
not to make contributions to the foreign country's retirement
system. The Congress believed that any question should be
removed regarding the exemption, in a manner consistent with
the general philosophy behind the coverage rules of
totalization agreements.
Explanation of Provision
Under the Act, wages and self-employment income are exempt
from FICA and SECA to the extent that, under a totalization
agreement with a foreign country, the wages or self-employment
income is subject exclusively to the laws applicable to the
Social Security system of the foreign country. As a result, an
individual's earnings are exempt from FICA and SECA in cases in
which the earnings are subject to a foreign country's Social
Security system in accordance with a totalization agreement,
but the foreign country's law does not require compulsory
contributions on those earnings. The Act establishes that such
earnings are exempt from FICA and SECA regardless of whether
the individual elects to make contributions to the foreign
country's Social Security system.
Effective Date
The provision is effective on the date of enactment (March
2, 2004).
C. Technical Amendments
1. Technical correction relating to retirement benefits of ministers
(sec. 422 of the Act and sec. 211(a)(7) of the Social Security
Act)
Present and Prior Law
Under the Self-Employment Compensation Act (``SECA''),
which is part of the Code, an individual engaged in a trade or
business is subject to tax on his or her self-employment
income, which is based on net earnings from self-
employment.\123\ SECA tax consists of two parts: (1) old age,
survivor and disability insurance (``OASDI''), which correlates
to the Social Security program that provides monthly benefits
after retirement, disability, or death; and (2) Medicare
hospital insurance (``HI''). The Code contains definitions of
``self-employment income'' and ``net earnings from self-
employment'' that apply for SECA purposes.
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\123\ Secs. 1401-1403.
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Under the Social Security Act, an individual receives
credit for his or her self-employment income, which is used to
determine insured status, that is, eligibility for monthly
Social Security benefits and Medicare coverage, as well as the
amount of monthly benefits. The Social Security Act contains
definitions of ``self-employment income'' and ``net earnings
from self-employment'' that parallel the Code definitions.
Generally, if a statutory change is made to these definitions,
it is made both in the Code and in the Social Security Act.
The Small Business Job Protection Act of 1996 \124\ amended
the Code to provide that, in the case of a minister or member
of a religious order, net earnings from self-employment does
not include the rental value of a parsonage or parsonage
allowance provided after the individual retires or any other
retirement benefit received from a church plan after the
individual retires. This amendment was effective for years
beginning before, on, or after December 31, 1994.
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\124\ Pub. L. No. 104-188.
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Reasons for Change
The Congress noted that the Small Business Job Protection
Act of 1996 provided that certain retirement benefits received
by ministers and members of religious orders are not subject to
SECA taxes. However, a conforming change was not made to the
Social Security Act to exclude these benefits from being
counted for the purpose of acquiring insured status and
calculating Social Security benefit amounts. The Congress was
concerned that this income was therefore not treated in a
uniform manner. The Congress believed that the Social Security
Act should be conformed to the Code with respect to such
income.
Explanation of Provision
The Act makes a conforming change to the definition of net
earnings from self-employment under the Social Security Act to
exclude the rental value of a parsonage or a parsonage
allowance provided after a minister or member of a religious
order retires or any other retirement benefit received from a
church plan after the individual retires. Thus, these benefits
are not included in earnings for purposes of determining
insured status or the amount of monthly Social Security
benefits.
Effective Date
The provision is effective for years beginning before, on,
or after December 31, 1994.
2. Technical correction relating to domestic employment (sec. 423 of
the Act, sec. 3121(a)(7)(B) and (g)(5) of the Code, and secs.
209(a)(6)(B) and 210(f)(5) of the Social Security Act)
Present and Prior Law
Under the Federal Insurance Contributions Act (``FICA''),
which is part of the Code, a tax is imposed on the wages paid
by an employer to an employee.\125\ FICA tax consists of two
parts: (1) old age, survivor and disability insurance
(``OASDI''), which correlates to the social security program
that provides monthly benefits after retirement, disability, or
death; and (2) Medicare hospital insurance (``HI''). For this
purpose, ``wages'' is defined as all remuneration for
employment, with certain specified exceptions.
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\125\ Secs. 3101-3128.
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This definition of wages provides an exception for cash
remuneration paid by an employer to an employee for
agricultural labor unless the total cash remuneration paid to
the employee in the calendar year is $150 or more. For this
purpose, under prior law, agricultural labor included service
performed on a farm operated for profit if the service was
domestic service in the private home of the employer. In
addition, for years beginning after December 31, 1994, wages
does not include cash remuneration paid to an employee in the
private home of the employer if the total cash remuneration
paid to the employee in the calendar year is less than a
specified amount ($1,400 for 2004).
Under the Social Security Act, an individual receives
credit for his or her wages, which is used to determine insured
status, that is, eligibility for monthly Social Security
benefits and Medicare coverage, as well as the amount of
monthly benefits. The Social Security Act contains a definition
of wages that parallels the Code definitions, including
exceptions for cash remuneration paid for agricultural labor or
domestic service.
Reasons for Change
The Congress recognized that, prior to 1994, domestic
service on a farm was treated as agricultural labor and was
subject to the wage threshold for agricultural labor. The
Congress noted that, according to the Social Security
Administration, in 1994, when Congress amended the law with
respect to domestic employment, the intent was that domestic
employment on a farm would be subject to the wage threshold for
domestic employees instead of the threshold for agricultural
labor. However, the Congress believed that the prior-law
language was unclear, making it appear as if domestic employees
on farms were subject to both thresholds.
Explanation of Provision
Under the Act, domestic service on a farm operated for
profit is treated as domestic service in a private home, rather
than as agricultural labor. As a result, the same wage
threshold applies to cash remuneration for domestic service on
a farm as applies to domestic service in a private home. That
is, cash remuneration paid to an employee for domestic service
on a farm operated for profit is not wages if the total cash
remuneration paid to the employee in the calendar year is less
than a specified amount ($1,400 for 2004).
Effective Date
The provision is effective on the date of enactment (March
2, 2004).
3. Technical correction of outdated references (sec. 424 of the Act,
sec. 3102(a) of the Code, and sec. 211(a)(15) of the Social
Security Act)
Present and Prior Law
Various provisions of the Code and the Social Security Act
contain cross-references to other statutory provisions.
Reasons for Change
The Congress noted that, over the years, provisions in the
Social Security Act, the Code and other related laws have been
deleted, redesignated or amended; however, necessary conforming
changes have not always been made. The Congress further noted
that, consequently, prior law contained some outdated
references.
Explanation of Provision
Under the Act, language referring to a previously repealed
20-day work test for agricultural labor is deleted from the
Code, and a cross-reference in the Social Security Act to a
Code provision is corrected.
Effective Date
The provision is effective on the date of enactment (March
2, 2004).
4. Technical correction respecting self-employment income in community
property States (sec. 425 of the Act, sec. 1402(a)(5) of the
Code, and sec. 211(a)(5) of the Social Security Act)
Present and Prior Law
The Code and the Social Security Act define ``net earnings
from self-employment'' in order to determine self-employment
income, which is subject to tax under the Code and is credited
as earnings under the Social Security Act. Under prior law, the
Code and the Social Security Act provided that, in determining
net earnings from self-employment, if any income derived from a
trade or business (other than a partnership) is community
income under applicable community property laws, all of the
income and deductions attributable to the trade or business are
treated as the income and deductions of the husband unless the
wife exercises substantially all of the management and control
of the trade or business, in which case all of the income and
deductions are treated as income and deductions of the wife.
This rule was held to be unconstitutional, and, as a
result, the same rule for attributing the income and deductions
of a trade or business to a spouse applied to taxpayers in
community property States and in non-community States.\126\
Under this rule, income and deductions of a trade or business
(other than a partnership) are attributed to the spouse
carrying on the trade or business.
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\126\ See Rev. Rul. 82-39, 1982-1 C.B. 119.
---------------------------------------------------------------------------
Reasons for Change
The Congress noted that then-present law was found to be
unconstitutional in several court cases in 1980 and that, since
then, income from a trade or business that is not a partnership
in a community property State has been treated the same as
income from a trade or business that is not a partnership in a
non-community property State, that is, it is taxed and credited
to the spouse who is found to be carrying on the business. The
Congress believed that a change should be made to conform the
provisions in the Social Security Act and the Internal Revenue
Code to current practice in both community property and non-
community property States.
Explanation of Provision
Under the Act, in determining net earnings from self-
employment, if any income derived from a trade or business
(other than a partnership) is community income under applicable
community property laws, the income and deductions attributable
to the trade or business are treated as the income and
deductions of the spouse carrying on the trade or business or,
if the trade or business is jointly operated, treated as the
income and deductions of each spouse on the basis of their
respective distributive shares of the income and deductions.
The Act thus conforms the statutory definition of net earnings
from self-employment with administrative practice.
Effective Date
The provision is effective on the date of enactment (March
2, 2004).
PART TEN: PENSION FUNDING EQUITY ACT OF 2004 (PUBLIC LAW 108-218) \127\
I. PENSION FUNDING
A. Temporary Replacement of 30-Year Treasury Rate and Election of
Alternative Deficit Reduction Contribution (secs. 101 and 102 of the
Act and secs. 404, 412 and 415 of the Code)
Present and Prior Law
In general
The interest rate on 30-year Treasury securities is
generally used for several purposes related to defined benefit
pension plans, specifically: (1) in determining current
liability for purposes of the funding and deduction rules; (2)
in determining unfunded vested benefits for purposes of Pension
Benefit Guaranty Corporation (``PBGC'') variable rate premiums;
and (3) in determining the minimum required value of lump-sum
distributions from a defined benefit pension plan and maximum
lump-sum values for purposes of the limits on benefits payable
under a defined benefit pension plan.
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\127\ H.R. 3108. The House passed the bill on October 8, 2003. The
Senate passed the bill on January 28, 2004. The conference report was
filed on April 1, 2004 (H.R. Rep. No. 108-457). The conference report
passed the House on April 2, 2004, and the Senate on April 8, 2004. The
President signed the bill on April 10, 2004.
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Funding rules
In general
The Internal Revenue Code (the ``Code'') and the Employee
Retirement Income Security Act of 1974 (``ERISA'') impose
minimum funding requirements with respect to defined benefit
pension plans.\128\ Under the funding rules, the amount of
contributions required for a plan year is generally the plan's
normal cost for the year (i.e., the cost of benefits allocated
to the year under the plan's funding method) plus that year's
portion of other liabilities that are amortized over a period
of years, such as benefits resulting from a grant of past
service credit.
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\128\ Code sec. 412; ERISA sec. 302. The Code also imposes limits
on deductible contributions, as discussed below.
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Additional contributions for underfunded plans
Under special funding rules (referred to as the ``deficit
reduction contribution'' rules),\129\ an additional
contribution to a plan is generally required if the plan's
funded current liability percentage is less than 90
percent.\130\ A plan's ``funded current liability percentage''
is the actuarial value of plan assets \131\ as a percentage of
the plan's current liability. In general, a plan's current
liability means all liabilities to employees and their
beneficiaries under the plan.
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\129\ The deficit reduction contribution rules apply to single-
employer plans, other than single-employer plans with no more than 100
participants on any day in the preceding plan year. Single-employer
plans with more than 100 but not more than 150 participants are
generally subject to lower contribution requirements under these rules.
\130\ Under an alternative test, a plan is not subject to the
deficit reduction contribution rules for a plan year if (1) the plan's
funded current liability percentage for the plan year is at least 80
percent, and (2) the plan's funded current liability percentage was at
least 90 percent for each of the two immediately preceding plan years
or each of the second and third immediately preceding plan years.
\131\ The actuarial value of plan assets is the value determined
under an actuarial valuation method that takes into account fair market
value and meets certain other requirements. The use of an actuarial
valuation method allows appreciation or depreciation in the market
value of plan assets to be recognized gradually over several plan
years. Sec. 412(c)(2); Treas. Reg. sec. 1.412(c)(2)-1.
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The amount of the additional contribution required under
the deficit reduction contribution rules is the sum of two
amounts: (1) the excess, if any, of (a) the deficit reduction
contribution (as described below), over (b) the contribution
required under the normal funding rules; and (2) the amount (if
any) required with respect to unpredictable contingent event
benefits.\132\ The amount of the additional contribution cannot
exceed the amount needed to increase the plan's funded current
liability percentage to 100 percent.
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\132\ A plan may provide for unpredictable contingent event
benefits, which are benefits that depend on contingencies that are not
reliably and reasonably predictable, such as facility shutdowns or
reductions in workforce. An additional contribution is generally not
required with respect to unpredictable contingent event benefits unless
the event giving rise to the benefits has occurred.
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The deficit reduction contribution is the sum of (1) the
``unfunded old liability amount,'' (2) the ``unfunded new
liability amount,'' and (3) the expected increase in current
liability due to benefits accruing during the plan year.\133\
The ``unfunded old liability amount'' is the amount needed to
amortize certain unfunded liabilities under 1987 and 1994
transition rules. The ``unfunded new liability amount'' is the
applicable percentage of the plan's unfunded new liability.
Unfunded new liability generally means the unfunded current
liability of the plan (i.e., the amount by which the plan's
current liability exceeds the actuarial value of plan assets),
but determined without regard to certain liabilities (such as
the plan's unfunded old liability and unpredictable contingent
event benefits). The applicable percentage is generally 30
percent, but is reduced if the plan's funded current liability
percentage is greater than 60 percent.
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\133\ If the Secretary of the Treasury prescribes a new mortality
table to be used in determining current liability, as described below,
the deficit reduction contribution may include an additional amount.
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Required interest rate and mortality table
Specific interest rate and mortality assumptions must be
used in determining a plan's current liability for purposes of
the special funding rule. The interest rate used to determine a
plan's current liability is generally required to be within a
permissible range of the weighted average \134\ of the interest
rates on 30-year Treasury securities for the four-year period
ending on the last day before the plan year begins. The
permissible range is generally from 90 percent to 105
percent.\135\ The interest rate used under the plan was
required to be consistent with the assumptions which reflect
the purchase rates which would be used by insurance companies
to satisfy the liabilities under the plan.\136\
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\134\ The weighting used for this purpose is 40 percent, 30
percent, 20 percent and 10 percent, starting with the most recent year
in the four-year period. Notice 88-73, 1988-2 C.B. 383.
\135\ If the Secretary of the Treasury determines that the lowest
permissible interest rate in this range is unreasonably high, the
Secretary may prescribe a lower rate, but not less than 80 percent of
the weighted average of the 30-year Treasury rate.
\136\ Code sec. 412(b)(5)(B)(iii)(II); ERISA sec.
302(b)(5)(B)(iii)(II). Under Notice 90-11, 1990-1 C.B. 319, the
interest rates in the permissible range are deemed to be consistent
with the assumptions reflecting the purchase rates that would be used
by insurance companies to satisfy the liabilities under the plan.
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The Job Creation and Worker Assistance Act of 2002 \137\
temporarily amended the permissible range of the statutory
interest rate used in calculating a plan's current liability
for purposes of applying the additional contribution
requirements, so that the permissible range was from 90 percent
to 120 percent for plan years beginning after December 31,
2001, and before January 1, 2004.
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\137\ Pub. L. No. 107-147.
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Prior law did not provide a special interest rate rule for
plan years beginning after December 31, 2003, and before
January 1, 2006.
The IRS generally publishes the interest rate on 30-year
Treasury securities on a monthly basis. The Department of the
Treasury does not currently issue 30-year Treasury securities.
As of March 2002, the IRS published the average yield on the
30-year Treasury bond maturing in February 2031 as a
substitute.
The Secretary of the Treasury is required to prescribe
mortality tables and to periodically review (at least every
five years) and update such tables to reflect the actuarial
experience of pension plans and projected trends in such
experience.\138\ The Secretary of the Treasury has required the
use of the 1983 Group Annuity Mortality Table.\139\
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\138\ Code sec. 412(l)(7)(C)(ii); ERISA sec. 302(d)(7)(C)(ii).
\139\ Rev. Rul. 95-28, 1995-1 C.B. 74. The IRS and the Treasury
Department have announced that they are undertaking a review of the
applicable mortality table and have requested comments on related
issues, such as how mortality trends should be reflected. Notice 2003-
62, 2003-38 I.R.B. 576; Announcement 2000-7, 2000-1 C.B. 586.
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Full funding limitation
No contributions are required under the minimum funding
rules in excess of the full funding limitation. The full
funding limitation is the excess, if any, of (1) the accrued
liability under the plan (including normal cost), over (2) the
lesser of (a) the market value of plan assets or (b) the
actuarial value of plan assets.\140\ However, the full funding
limitation may not be less than the excess, if any, of 90
percent of the plan's current liability (including the current
liability normal cost) over the actuarial value of plan assets.
In general, current liability is all liabilities to plan
participants and beneficiaries accrued to date, whereas the
accrued liability under the full funding limitation may be
based on projected future benefits, including future salary
increases.
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\140\ For plan years beginning before 2004, the full funding
limitation was generally defined as the excess, if any, of (1) the
lesser of (a) the accrued liability under the plan (including normal
cost) or (b) a percentage (170 percent for 2003) of the plan's current
liability (including the current liability normal cost), over (2) the
lesser of (a) the market value of plan assets or (b) the actuarial
value of plan assets, but in no case less than the excess, if any, of
90 percent of the plan's current liability over the actuarial value of
plan assets. Under the Economic Growth and Tax Relief Reconciliation
Act of 2001 (``EGTRRA''), the full funding limitation based on 170
percent of current liability is repealed for plan years beginning in
2004 and thereafter. The provisions of EGTRRA generally do not apply
for years beginning after December 31, 2010.
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Timing of plan contributions
In general, plan contributions required to satisfy the
funding rules must be made within 8\1/2\ months after the end
of the plan year. If the contribution is made by such due date,
the contribution is treated as if it were made on the last day
of the plan year.
In the case of a plan with a funded current liability
percentage of less than 100 percent for the preceding plan
year, estimated contributions for the current plan year must be
made in quarterly installments during the current plan
year.\141\ The amount of each required installment is 25
percent of the lesser of (1) 90 percent of the amount required
to be contributed for the current plan year or (2) 100 percent
of the amount required to be contributed for the preceding plan
year.\142\
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\141\ Code sec. 412(m); ERISA sec. 302(e).
\142\ In connection with the expanded interest rate range available
for 2002 and 2003, special rules applied in determining current
liability for the preceding plan year for purposes of applying the
quarterly contributions requirements to plan years beginning in 2002
(when the expanded range first applied) and 2004 (when the expanded
range no longer applied). In each of those years (``present year''),
current liability for the preceding year was to be redetermined, using
the permissible range applicable to the present year. This redetermined
current liability was to be used for purposes of the plan's funded
current liability percentage for the preceding year, which could affect
the need to make quarterly contributions, and for purposes of
determining the amount of any quarterly contributions in the present
year, which is based in part on the preceding year.
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Funding waivers
Within limits, the IRS is permitted to waive all or a
portion of the contributions required under the minimum funding
standard for a plan year.\143\ A waiver may be granted if the
employer (or employers) responsible for the contribution could
not make the required contribution without temporary
substantial business hardship and if requiring the contribution
would be adverse to the interests of plan participants in the
aggregate. Generally, no more than three waivers may be granted
within any period of 15 consecutive plan years.
---------------------------------------------------------------------------
\143\ Code sec. 412(d); ERISA sec. 303.
---------------------------------------------------------------------------
If a funding waiver is in effect for a plan, subject to
certain exceptions, no plan amendment may be adopted that
increases the liabilities of the plan by reason of any increase
in benefits, any change in the accrual of benefits, or any
change in the rate at which benefits vest under the plan. In
addition, the IRS is authorized to require security to be
granted as a condition of granting a funding waiver if the sum
of the plan's accumulated funding deficiency and the balance of
any outstanding waived funding deficiencies exceeds $1 million.
Excise tax
An employer is generally subject to an excise tax if it
fails to make minimum required contributions and fails to
obtain a waiver from the IRS.\144\ The excise tax is generally
10 percent of the amount of the funding deficiency. In
addition, a tax of 100 percent may be imposed if the funding
deficiency is not corrected within a certain period.
---------------------------------------------------------------------------
\144\ Code sec. 4971.
---------------------------------------------------------------------------
Deductions for contributions
Employer contributions to qualified retirement plans are
deductible, subject to certain limits. In the case of a defined
benefit pension plan, the employer generally may deduct the
greater of: (1) the amount necessary to satisfy the minimum
funding requirement of the plan for the year; or (2) the amount
of the plan's normal cost for the year plus the amount
necessary to amortize certain unfunded liabilities over ten
years, but limited to the full funding limitation for the
year.\145\ However, the maximum amount of deductible
contributions is generally not less than the plan's unfunded
current liability.\146\
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\145\ Code sec. 404(a)(1).
\146\ Code sec. 404(a)(1)(D). In the case of a plan that terminates
during the year, the maximum deductible amount is generally not less
than the amount needed to make the plan assets sufficient to fund
benefit liabilities as defined for purposes of the PBGC termination
insurance program (sometimes referred to as ``termination liability'').
---------------------------------------------------------------------------
PBGC premiums
Because benefits under a defined benefit pension plan may
be funded over a period of years, plan assets may not be
sufficient to provide the benefits owed under the plan to
employees and their beneficiaries if the plan terminates before
all benefits are paid. The PBGC generally insures the benefits
owed under defined benefit pension plans (up to certain limits)
in the event a plan is terminated with insufficient assets.
Employers pay premiums to the PBGC for this insurance coverage.
PBGC premiums include a flat-rate premium and, in the case
of an underfunded plan, a variable rate premium based on the
amount of unfunded vested benefits.\147\ In determining the
amount of unfunded vested benefits, the interest rate used is
generally 85 percent of the annual yield on 30-year Treasury
securities for the month preceding the month in which the plan
year begins.
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\147\ ERISA sec. 4006.
---------------------------------------------------------------------------
Under the Job Creation and Worker Assistance Act of 2002,
for plan years beginning after December 31, 2001, and before
January 1, 2004, the interest rate used in determining the
amount of unfunded vested benefits for PBGC variable rate
premium purposes was increased to 100 percent of the annual
yield on 30-year Treasury securities for the month preceding
the month in which the plan year begins.
Prior law did not provide a special interest rate rule for
plan years beginning after December 31, 2003, and before
January 1, 2006.
Lump-sum distributions
Accrued benefits under a defined benefit pension plan
generally must be paid in the form of an annuity for the life
of the participant unless the participant consents to a
distribution in another form. Defined benefit pension plans
generally provide that a participant may choose among other
forms of benefit offered under the plan, such as a lump-sum
distribution. These optional forms of benefit generally must be
actuarially equivalent to the life annuity benefit payable to
the participant.
A defined benefit pension plan must specify the actuarial
assumptions that will be used in determining optional forms of
benefit under the plan in a manner that precludes employer
discretion in the assumptions to be used. For example, a plan
may specify that a variable interest rate will be used in
determining actuarial equivalent forms of benefit, but may not
give the employer discretion to choose the interest rate.
Statutory assumptions must be used in determining the
minimum value of certain optional forms of benefit, such as a
lump sum.\148\ That is, the lump sum payable under the plan may
not be less than the amount of the lump sum that is actuarially
equivalent to the life annuity payable to the participant,
determined using the statutory assumptions. The statutory
assumptions consist of an applicable mortality table (as
published by the IRS) and an applicable interest rate.
---------------------------------------------------------------------------
\148\ Code sec. 417(e)(3); ERISA sec. 205(g)(3).
---------------------------------------------------------------------------
The applicable interest rate is the annual interest rate on
30-year Treasury securities, determined as of the time that is
permitted under regulations. The regulations provide various
options for determining the interest rate to be used under the
plan, such as the period for which the interest rate will
remain constant (``stability period'') and the use of
averaging.
Limits on benefits
Annual benefits payable under a defined benefit pension
plan generally may not exceed the lesser of: (1) 100 percent of
average compensation; or (2) $165,000 (for 2004).\149\ The
dollar limit generally applies to a benefit payable in the form
of a straight life annuity beginning no earlier than age 62.
The limit is reduced if benefits are paid before age 62. In
addition, if the benefit is not in the form of a straight life
annuity, the benefit generally is adjusted to an equivalent
straight life annuity. In making these reductions and
adjustments, the interest rate used generally must be not less
than the greater of: (1) five percent; or (2) the interest rate
specified in the plan. However, for purposes of adjusting a
benefit in a form that is subject to the minimum value rules
(including the use of the interest rate on 30-year Treasury
securities), such as a lump-sum benefit, the interest rate used
generally must be not less than the greater of: (1) the
interest rate on 30-year Treasury securities; or (2) the
interest rate specified in the plan. Prior law did not provide
a special interest rate rule for plan years beginning in 2004
and 2005.
---------------------------------------------------------------------------
\149\ Code sec. 415(b).
---------------------------------------------------------------------------
Explanation of Provision
Interest rate for determining current liability and PBGC premiums
Under the Act, the interest rate used for plan years
beginning after December 31, 2003, and before January 1, 2006,
in determining current liability for funding and deduction
purposes and in determining PBGC variable rate premiums is
generally the rate of interest on amounts invested
conservatively in long-term investment-grade corporate
bonds.\150\
---------------------------------------------------------------------------
\150\ The Act also repeals the prior-law rule under which, for
purposes of applying the quarterly contributions requirements to plan
years beginning in 2004, current liability for the preceding year is
redetermined.
---------------------------------------------------------------------------
For purposes of determining a plan's current liability for
plan years beginning after December 31, 2003, and before
January 1, 2006, the interest rate used must be within a
permissible range of the weighted average of the rates of
interest on amounts invested conservatively in long-term
investment-grade corporate bonds during the four-year period
ending on the last day before the plan year begins. The
permissible range for these years is from 90 percent to 100
percent. The interest rate is to be determined by the Secretary
of the Treasury on the basis of two or more indices that are
selected periodically by the Secretary and are in the top three
quality levels available.
The interest rate on long-term corporate bonds is to be
calculated pursuant to a method, prescribed by the Secretary of
the Treasury, which relies on publicly available indices of
high-quality bonds (i.e., the top three quality levels). The
Secretary may use bonds with average maturities of 20 years or
more in determining the rate. The Secretary of Treasury may
prescribe that two thirds of the rate may be based on two or
more indices that are in the top three quality levels, and one
third of such rate may be based on two or more indices that are
in the third quality level. The Secretary has discretion to
determine which publicly available indices to use.
The Secretary is directed to make the permissible range of
the interest rate, as well as the indices and methodology used
to determine the average rate, publicly available. The
methodology used by the Secretary to arrive at a single rate is
to be publicly available (including for a subscription fee or
other charge). The Secretary is to publish the rate on a
monthly basis, along with an updated four-year weighted average
of the rate and an updated permissible range. The Secretary is
to consider and monitor the current marketplace indices to
produce the specified rate to ensure that the indices continue
to be appropriate for this purpose. Through regulations, the
Secretary is to make, as appropriate, prospective changes in
the indices used to determine the rate.
For purposes of determining the four-year weighted average
of interest rates under the temporary provision, the weighting
applicable before the Act continues to apply (i.e., 40 percent,
30 percent, 20 percent and 10 percent, starting with the most
recent year in the four-year period). In addition, consistent
with current IRS guidance, the interest rates in the
permissible range under the temporary provision are deemed to
be consistent with the assumptions reflecting the purchase
rates that would be used by insurance companies to satisfy the
liabilities under the plan. Thus, any interest rate in the
permissible range may be used in determining current liability
while the temporary provision is in effect.
The temporary interest rate generally applies in
determining current liability for purposes of determining the
maximum amount of deductible contributions to a defined benefit
pension plan (regardless of whether the plan is subject to the
deficit reduction contribution requirements). However, an
employer may elect to disregard the temporary interest rate
change for purposes of determining the maximum amount of
deductible contributions (regardless of whether the plan is
subject to the deficit reduction contribution requirements). In
such a case, the interest rate used in determining current
liability for that purpose must be within the permissible range
(90 to 105 percent) of the weighted average of the interest
rates on 30-year Treasury securities for the preceding four-
year period. This is intended solely as a temporary provision
to ensure that, pending long-term reform of the funding and
deduction rules, the deduction limit is neither increased nor
decreased so that employers are not penalized for fully funding
their plans. Because the 30-year Treasury rate is an obsolete
rate, its use must be revisited promptly in the context of
long-term funding and deduction reform. However, the use of the
30-year Treasury rate for the purposes of determining maximum
deduction limits should not be considered precedent for the
determination of other pension plan calculations. Furthermore,
the use of different interest rates for certain pension plan
calculations in the context of this temporary bill should not
be considered precedent for the use of different discount rates
to measure pension plan liabilities.
Under the Act, in determining the amount of unfunded vested
benefits for PBGC variable rate premium purposes for plan years
beginning after December 31, 2003, and before January 1, 2006,
the interest rate used is 85 percent of the annual rate of
interest determined by the Secretary of the Treasury on amounts
invested conservatively in long-term investment-grade corporate
bonds for the month preceding the month in which the plan year
begins (subject to the same requirements applicable to the
determination of the interest rate used in determining current
liability).
Interest rate used to apply benefit limits to lump sums
Under the Act, in the case of plan years beginning in 2004
or 2005, in adjusting a form of benefit that is subject to the
minimum value rules, such as a lump-sum benefit, for purposes
of applying the limits on benefits payable under a defined
benefit pension plan, the interest rate used must be not less
than the greater of: (1) 5.5 percent; or (2) the interest rate
specified in the plan.
Plan amendments
The Act permits certain plan amendments made pursuant to
the interest rate provision of the bill to be retroactively
effective. If certain requirements are met, the plan will be
treated as being operated in accordance with its terms, and the
amendment will not violate the anticutback rules (except as
provided by the Secretary of the Treasury).\151\ In order for
this treatment to apply, the plan amendment must be made on or
before the last day of the first plan year beginning on or
after January 1, 2006. In addition, the amendment must apply
retroactively as of the date on which the interest rate
provision became effective with respect to the plan and the
plan must be operated in compliance with the interest rate
provision until the amendment is made.
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\151\ Code sec. 411(d)(6); ERISA sec. 204(g).
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A plan amendment will not be considered to be pursuant to
the interest rate provision of the bill if it has an effective
date before the effective date of the interest rate provision.
Similarly, relief from the anticutback rules does not apply for
periods prior to the effective date of the interest rate
provision or the plan amendment.
Alternative deficit reduction contribution for certain plans
In general
The Act allows certain employers (``applicable employers'')
to elect a reduced amount of additional required contribution
under the deficit reduction contribution rules (an
``alternative deficit reduction contribution'') with respect to
certain plans for applicable plan years. An applicable plan
year is a plan year beginning after December 27, 2003, and
before December 28, 2005, for which the employer elects a
reduced contribution. If an employer so elects, the amount of
the additional deficit reduction contribution for an applicable
plan year is the greater of: (1) 20 percent of the amount of
the additional contribution that would otherwise be required;
or (2) the additional contribution that would be required if
the deficit reduction contribution for the plan year were
determined as the expected increase in current liability due to
benefits accruing during the plan year.
An election of an alternative deficit reduction
contribution may be made only with respect to a plan that was
not subject to the deficit reduction contribution rules for the
plan year beginning in 2000.\152\ An election may not be made
with respect to more than two plan years. An election is to be
made at such time and in such manner as the Secretary of the
Treasury prescribes. An election does not invalidate any
obligation pursuant to a collective bargaining agreement in
effect on the date of the election to provide benefits, to
change the accrual of benefits, or to change the rate at which
benefits vest under the plan.
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\152\ Whether a plan was subject to the deficit reduction
contribution rules for the plan year beginning in 2000 is determined
without regard to the rule that allows the temporary interest rate
based on amounts invested conservatively in long-term investment-grade
corporate bonds to be used for lookback rule purposes, as discussed
below.
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An applicable employer is an employer that is: (1) a
commercial passenger airline; (2) primarily engaged in the
production or manufacture of a steel mill product, or the
processing of iron ore pellets; or (3) an organization
described in section 501(c)(5) that established the plan for
which an alternative deficit reduction contribution is elected
on June 30, 1955.
Restrictions on amendments
Certain plan amendments may not be adopted during an
applicable plan year (i.e., a plan year for which an
alternative deficit reduction contribution is elected). This
restriction applies to an amendment that increases the
liabilities of the plan by reason of any increase in benefits,
any change in the accrual of benefits, or any change in the
rate at which benefits vest under the plan. The restriction
applies unless: (1) the plan's enrolled actuary certifies (in
such form and manner as prescribed by the Secretary of the
Treasury) that the amendment provides for an increase in annual
contributions that will exceed the increase in annual charges
to the funding standard account attributable to such amendment;
or (2) the amendment is required by a collective bargaining
agreement that is in effect on the date of enactment of the
provision.
If a plan is amended during an applicable plan year in
violation of the provision, an election of an alternative
deficit reduction contribution does not apply to any applicable
plan year ending on after the date on which the amendment is
adopted.
Notice requirement
The Act amends ERISA to provide that, if an employer elects
an alternative deficit reduction contribution for any
applicable plan year, the employer must provide written notice
of the election to participants and beneficiaries and to the
PBGC within 30 days of filing the election. The notice to
participants and beneficiaries must include: (1) the due date
of the alternative deficit reduction contribution; (2) the
amount by which the required contribution to the plan was
reduced as a result of the election; (3) a description of the
benefits under the plan that are eligible for guarantee by the
PBGC; and (4) an explanation of the limitations on the PBGC
guarantee and the circumstances in which the limitations apply,
including the maximum guaranteed monthly benefits that the PBGC
would pay if the plan terminated while underfunded. The notice
to the PBGC must include: (1) the due date of the alternative
deficit reduction contribution; (2) the amount by which the
required contribution to the plan was reduced as a result of
the election; (3) the number of years it will take to restore
the plan to full funding if the employer makes only the
required contributions; and (4) information as to how the
amount by which the plan is underfunded compares with the
capitalization of the employer.
An employer that fails to provide the required notice to a
participant, beneficiary, or the PBGC may (in the discretion of
a court) be liable to the participant, beneficiary, or PBGC in
the amount of up to $100 a day from the date of the failure,
and the court may in its discretion order such other relief as
it deems proper.
Effective date
Interest rate for determining current liability and PBGC premiums
The provision relating to the interest rate used to
determine current liability and PBGC premiums is generally
effective for plan years beginning after December 31, 2003. For
purposes of applying certain rules (``lookback rules'') to plan
years beginning after December 31, 2003, the amendments made by
the provision may be applied as if they had been in effect for
all years beginning before the effective date. For purposes of
the provision, ``lookback rules'' means: (1) the rule under
which a plan is not subject to the additional funding
requirements for a plan year if the plan's funded current
liability percentage was at least 90 percent for each of the
two immediately preceding plan years or each of the second and
third immediately preceding plan years; and (2) the rule under
which quarterly contributions are required for a plan year if
the plan's funded current liability percentage was less than
100 percent for the preceding plan year. The amendments made by
the provision may be applied for purposes of the lookback
rules, regardless of the funded current liability percentage
reported for the plan on the plan's annual reports (i.e., Form
5500) for preceding years.
Interest rate used to apply benefit limits to lump sums
The provision relating to the interest rate used to apply
the benefit limits to certain forms of benefit is generally
effective for plan years beginning after December 31, 2003.
Under a special rule, in the case of a distribution made to a
participant or beneficiary after December 31, 2003, and before
January 1, 2005, in a form of benefit that is subject to the
minimum value rules, such as a lump-sum benefit, and that is
subject to adjustment in applying the limit on benefits payable
under a defined benefit pension plan, the amount payable may
not, solely by reason of the provision, be less than the amount
that would have been payable if the amount payable had been
determined using the applicable interest rate in effect as of
the last day of the last plan year beginning before January 1,
2004.
Alternative deficit reduction contribution for certain plans
The provision relating to alternative deficit reduction
contributions is effective on the date of enactment (April 10,
2004).
B. Multiemployer Plan Funding Notices (sec. 103 of the Act and secs.
101 and 502 of ERISA)
Present and Prior Law
Defined benefit plans are generally required to meet
certain minimum funding rules. These rules are designed to help
ensure that such plans are adequately funded. Both single-
employer plans and multiemployer plans are subject to minimum
funding requirements; however, the requirements for each type
of plan differ in various ways.
Similarly, the Pension Benefit Guaranty Corporation
(``PBGC'') insures certain benefits under both single-employer
and multiemployer defined benefit plans, but the rules relating
to the guarantee vary for each type of plan. In the case of
multiemployer plans, the PBGC guarantees against plan
insolvency. Under its multiemployer program, PBGC provides
financial assistance through loans to plans that are insolvent
(that is, plans that are unable to pay basic PBGC-guaranteed
benefits when due).
Employers maintaining single-employer defined benefit plans
are required to provide certain notices to plan participants
relating to the funding status of the plan. For example, ERISA
requires an employer of a single-employer defined benefit plan
to notify plan participants if the employer fails to make
required contributions (unless a request for a funding waiver
is pending).\153\ In addition, in the case of an underfunded
plan for which variable rate PBGC premiums are required, the
plan administrator generally must notify plan participants of
the plan's funding status and the limits on the PBGC benefit
guarantee if the plan terminates while underfunded.\154\
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\153\ ERISA sec. 101(d).
\154\ ERISA sec. 4011. Multiemployer plans are not required to pay
variable rate premiums.
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Reasons for Change \155\
The Congress believed that participants in multiemployer
plans should be furnished with information about the plan's
funded status and the limitations on the guarantee of benefits
by the PBGC, including the circumstances in which the guarantee
would come into effect. The Congress also believed that such
participants should be provided with information about the
value of the plan's assets and the amount of benefit payments
as well as the rules governing insolvent multiemployer plans.
Requiring administrators of multiemployer plans to provide
participants with annual notices regarding plan funding will
help keep participants in multiemployer plans adequately
informed about their retirement benefits.
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\155\ These reasons for change were included for a substantially
similar provision in S. 2424, the ``National Employee Savings and Trust
Equity Guarantee Act,'' which was reported by the Senate Committee on
Finance on May 14, 2004 (S. Rep. No. 108-266), subsequent to the
enactment of Pub. L. No. 108-218.
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Explanation of Provision
In general
The Act requires the administrator of a defined benefit
plan which is a multiemployer plan to provide an annual funding
notice to: (1) each participant and beneficiary; (2) each labor
organization representing such participants or beneficiaries;
(3) each employer that has an obligation to contribute under
the plan; and (4) the PBGC.
Such a notice must include: (1) identifying information,
including the name of the plan, the address and phone number of
the plan administrator and the plan's principal administrative
officer, each plan sponsor's employer identification number,
and the plan identification number; (2) a statement as to
whether the plan's funded current liability percentage for the
plan year to which the notice relates is at least 100 percent
(and if not, a statement of the percentage); (3) a statement of
the value of the plan's assets, the amount of benefit payments,
and the ratio of the assets to the payments for the plan year
to which the report relates; (4) a summary of the rules
governing insolvent multiemployer plans, including the
limitations on benefit payments and any potential benefit
reductions and suspensions (and the potential effects of such
limitations, reductions, and suspensions on the plan); (5) a
general description of the benefits under the plan which are
eligible to be guaranteed by the PBGC and the limitations of
the guarantee and circumstances in which such limitations
apply; and (6) any additional information which the plan
administrator elects to include to the extent it is not
inconsistent with regulations prescribed by the Secretary of
Labor.
The annual funding notice must be provided no later than
two months after the deadline (including extensions) for filing
the plan's annual report for the plan year to which the notice
relates. The funding notice must be provided in a form and
manner prescribed in regulations by the Secretary of Labor.
Additionally, it must be written so as to be understood by the
average plan participant and may be provided in written,
electronic, or some other appropriate form to the extent that
it is reasonably accessible to persons to whom the notice is
required to be provided.
The Secretary of Labor is directed to issue regulations
(including a model notice) necessary to implement the provision
no later than one year after the date of enactment.
Sanction for failure to provide notice
In the case of a failure to provide the annual
multiemployer plan funding notice, the Secretary of Labor may
assess a civil penalty against a plan administrator of up to
$100 per day for each failure to provide a notice. For this
purpose, each violation with respect to a single participant or
beneficiary is treated as a separate violation.
Effective Date
The provision is effective for plan years beginning after
December 31, 2004.
C. Election for Deferral of Charge for Portion of Net Experience Loss
of Multiemployer Plans (sec. 104 of the Act, sec. 302(b)(7) of ERISA,
and sec. 412(b)(7) of the Code)
Present and Prior Law
General funding requirements
The Code and ERISA impose minimum funding requirements with
respect to defined benefit plans.\156\ Under the minimum
funding rules, the amount of contributions required for a plan
year is generally the plan's normal cost for the year (i.e.,
the cost of benefits allocated to the year under the plan's
funding method) plus that year's portion of other liabilities
that are amortized over a period of years, such as benefits
resulting from a grant of past service credit.\157\ A plan's
normal cost and other liabilities must be determined under an
actuarial cost method permissible under the Code and ERISA.
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\156\ Code sec. 412; ERISA sec. 302.
\157\ Under special funding rules (referred to as the ``deficit
reduction contribution'' rules), an additional contribution may be
required to a single-employer plan if the plan's funded current
liability percentage is less than 90 percent. The deficit reduction
contribution rules do not apply to multiemployer plans.
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Funding standard account
As an administrative aid in the application of the funding
requirements, a defined benefit plan is required to maintain a
special account called a ``funding standard account'' to which
specified charges and credits (including credits for
contributions to the plan), plus interest, are made for each
plan year. If, as of the close of a plan year, the account
reflects credits equal to or in excess of charges, the plan is
generally treated as meeting the minimum funding standard for
the year. Thus, as a general rule, the minimum contribution for
a plan year is determined as the amount by which the charges to
the account would exceed credits to the account if no
contribution were made to the plan. If, as of the close of the
plan year, charges to the funding standard account exceed
credits to the account, then the excess is referred to as an
``accumulated funding deficiency.'' \158\
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\158\ In addition to the funding standard account, a reconciliation
account is sometimes used to balance certain items for purposes of
reporting actuarial information about the plan on the plan's annual
report (Schedule B of Form 5500).
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Experience gains and losses
In determining plan funding under an actuarial cost method,
a plan's actuary generally makes certain assumptions regarding
the future experience of a plan. These assumptions typically
involve rates of interest, mortality, disability, salary
increases, and other factors affecting the value of assets and
liabilities, such as increases or decreases in asset values.
The actuarial assumptions are required to be reasonable and may
be subject to other restrictions. If, on the basis of these
assumptions, the contributions made to the plan result in
actual unfunded liabilities that are less than those
anticipated by the actuary, then the excess is an experience
gain. If the actual unfunded liabilities are greater than those
anticipated, then the difference is an experience loss.
If a plan has a net experience gain, the funding standard
account is credited with the amount needed to amortize the net
experience gain over a certain period. If a plan has a net
experience loss, the funding standard account is charged with
the amount needed to amortize the net experience loss over a
certain period. In the case of a multiemployer plan, the
amortization period for net experience gains and losses is 15
years.
Funding waivers
Within limits, the IRS is permitted to waive all or a
portion of the contributions required under the minimum funding
standard for a plan year.\159\ A waiver may be granted if the
employer (or employers) responsible for the contribution could
not make the required contribution without temporary
substantial business hardship and if requiring the contribution
would be adverse to the interests of plan participants in the
aggregate. In the case of a multiemployer plan, no more than
five waivers may be granted within any period of 15 consecutive
plan years.
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\159\ Sec. 412(d).
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If a funding waiver is in effect for a plan, subject to
certain exceptions, no plan amendment may be adopted that
increases the liabilities of the plan by reason of any increase
in benefits, any change in the accrual of benefits, or any
change in the rate at which benefits vest under the plan.
Excise tax
An employer is generally subject to an excise tax if it
fails to make minimum required contributions and fails to
obtain a waiver from the IRS.\160\ The excise tax is 10 percent
of the amount of the funding deficiency (five percent in the
case of a multiemployer plan). In addition, a tax of 100
percent may be imposed if the funding deficiency is not
corrected within a certain period.
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\160\ Sec. 4971.
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Explanation of Provision
The Act allows the plan sponsor of an eligible
multiemployer plan to elect to defer certain charges to the
funding standard account that would otherwise be made to the
plan's funding standard account for a plan year beginning after
June 30, 2003, and before July 1, 2005. The charges may be
deferred to any plan year selected by the plan sponsor from
either of the two plan years immediately succeeding the plan
year for which the charge would otherwise be made. An election
may be made with respect to up to 80 percent of the charge to
the funding standard account attributable to the amortization
of a net experience loss for the first plan year beginning
after December 31, 2001. An election is to be made at such time
and in such manner as the Secretary of the Treasury prescribes.
For the plan year to which a charge is deferred under the plan
sponsor's election, the funding standard account is required to
be charged with interest at the short-term Federal rate on the
deferred charge for the period of the deferral.
An eligible multiemployer plan is a multiemployer plan: (1)
that, for the first plan year beginning after December 31,
2001, had an actual net investment loss of at least 10 percent
of the average fair market value of plan assets during the plan
year; and (2) with respect to which the plan's enrolled actuary
certifies that (not taking into account the deferral of charges
under the provision and based on the actuarial assumptions used
for the last plan year before date of enactment of the
provision), the plan is projected to have an accumulated
funding deficiency for any plan year beginning after June 30,
2003, and before July 1, 2006. In addition, a plan is not
treated as an eligible multiemployer plan if: (1) for any
taxable year beginning during the ten-year period preceding the
first plan year for which an election is made under the
provision, any employer required to contribute to the plan
failed to timely pay an excise tax imposed on the plan for
failure to make required contributions; (2) for any plan year
beginning after June 30, 1993, and before the first plan year
for which an election is made under the provision, the average
contribution required to be made to the plan by all employers
does not exceed 10 cents per hour, or no employer is required
to make contributions to the plan; or (3) with respect to any
plan year beginning after June 30, 1993, and before the first
plan year for which an election is made under the provision, a
funding waiver or extension of an amortization period was
granted to the plan.
Certain plan amendments may not be adopted during the
period for which a charge is deferred. This restriction applies
to an amendment that increases the liabilities of the plan by
reason of any increase in benefits, any change in the accrual
of benefits, or any change in the rate at which benefits vest
under the plan. The restriction applies unless: (1) the plan's
enrolled actuary certifies (in such form and manner as
prescribed by the Secretary of the Treasury) that the amendment
provides for an increase in annual contributions that will
exceed the increase in annual charges to the funding standard
account attributable to such amendment; or (2) the amendment is
required by a collective bargaining agreement that is in effect
on the date of enactment of the provision. If a plan is amended
in violation of the provision, an election under the provision
does not apply to any plan year ending on or after the date on
which the amendment is adopted.
If a plan sponsor elects to defer charges attributable to a
net experience loss, the plan administrator must provide
written notice of the election within 30 days to participants
and beneficiaries, to each labor organization representing
participants and beneficiaries, to each employer that has an
obligation to contribute under the plan, and to the PBGC. The
notice must include: (1) the amount of the charges to be
deferred under the election and the period of the deferral; and
(2) the maximum guaranteed monthly benefits that the PBGC would
pay if the plan terminated while underfunded. If a plan
administrator fails to comply with the notice requirement, the
Secretary of Labor may assess a civil penalty of not more than
$1,000 a day for each violation.
Effective Date
The provision is effective on the date of enactment (April
10, 2004).
II. OTHER PROVISIONS
A. Two-Year Extension of Transition Rule to Pension Funding
Requirements for Interstate Bus Company (sec. 201 of the Act, and sec.
769(c) of the Retirement Protection Act of 1994 (as added by sec. 1508
of the Taxpayer Relief Act of 1997))
Present and Prior Law
Defined benefit pension plans are required to meet certain
minimum funding rules. In some cases, additional contributions
are required if a single-employer defined benefit pension plan
is underfunded. Additional contributions generally are not
required in the case of a plan with a funded current liability
percentage of at least 90 percent. A plan's funded current
liability percentage is the value of plan assets as a
percentage of current liability. In general, a plan's current
liability means all liabilities to employees and their
beneficiaries under the plan. In the case of a plan with a
funded current liability percentage of less than 100 percent
for the preceding plan year, estimated contributions for the
current plan year must be made in quarterly installments during
the current plan year.
The PBGC insures benefits under most single-employer
defined benefit pension plans in the event the plan is
terminated with insufficient assets to pay for plan benefits.
The PBGC is funded in part by a flat-rate premium per plan
participant, and a variable rate premium based on the amount of
unfunded vested benefits under the plan. A specified interest
rate and a specified mortality table apply in determining
unfunded vested benefits for this purpose.
A special rule modifies the minimum funding requirements in
the case of certain plans. The special rule applies in the case
of plans that (1) were not required to pay a variable rate PBGC
premium for the plan year beginning in 1996, (2) do not, in
plan years beginning after 1995 and before 2009, merge with
another plan (other than a plan sponsored by an employer that
was a member of the controlled group of the employer in 1996),
and (3) are sponsored by a company that is engaged primarily in
interurban or interstate passenger bus service.
The special rule generally treats a plan to which it
applies as having a funded current liability percentage of at
least 90 percent for plan years beginning after 1996 and before
2005 if for such plan year the funded current liability
percentage is at least 85 percent. If the funded current
liability of the plan is less than 85 percent for any plan year
beginning after 1996 and before 2005, the relief from the
minimum funding requirements generally applies only if certain
specified contributions are made.
For plan years beginning after 2004 and before 2010, the
funded current liability percentage generally will be deemed to
be at least 90 percent if the actual funded current liability
percentage is at least at certain specified levels. The relief
from the minimum funding requirements generally applies for a
plan year beginning in 2005, 2006, 2007, or 2008 only if
contributions to the plan for the plan year equal at least the
expected increase in current liability due to benefits accruing
during the plan year.
Under prior law, the special rule did not include a
provision applicable specifically for plan years beginning in
2004 and 2005.
Reasons for Change \161\
The Congress believed that the special funding rules for
plans maintained by certain interstate bus companies were
enacted because the generally applicable funding rules required
greater contributions for such plans than were warranted give
the special characteristics of such plans. In particular, these
plans are closed to new participants and have demonstrated
mortality significantly greater than that predicted under
mortality tables that the plans would otherwise be required to
use for minimum funding purposes. The Congress believed that it
was appropriate to provide an extension of the special minimum
funding rules for these plans for two years.
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\161\ These reasons for change were included for an identical
provision in S. 2424, the ``National Employee Savings and Trust Equity
Guarantee Act,'' which was reported by the Senate Committee on Finance
on May 14, 2004 (S. Rep. No. 108-266), subsequent to the enactment of
Pub. L. No. 108-218.
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Explanation of Provision
The Act temporarily modifies the special funding rules for
plans sponsored by a company engaged primarily in interurban or
interstate passenger bus service by providing that, for plan
years beginning in 2004 and 2005, the funded current liability
percentage of the plan will be treated as at least 90 percent
for purposes of determining the amount of required
contributions (100 percent for purposes of determining whether
quarterly contributions are required). As a result, for these
years, additional contributions and quarterly contributions are
not required with respect to the plan. In addition, for these
years, the mortality table used under the plan is used in
determining the amount of unfunded vested benefits under the
plan for purposes of calculating PBGC variable rate premiums.
Effective Date
The provision effective for plan years beginning after
December 31, 2003.
B. Procedures Applicable to Disputes Involving Pension Plan Withdrawal
Liability (sec. 202 of the Act and sec. 4221 of ERISA)
Present and Prior Law
Under ERISA, when an employer withdraws from a
multiemployer plan, the employer is generally liable for its
share of unfunded vested benefits, determined as of the date of
withdrawal (generally referred to as the ``withdrawal
liability''). Whether and when a withdrawal has occurred and
the amount of the withdrawal liability is determined by the
plan sponsor. The plan sponsor's assessment of withdrawal
liability is presumed correct unless the employer shows by a
preponderance of the evidence that the plan sponsor's
determination of withdrawal liability was unreasonable or
clearly erroneous. A similar standard applies in the event the
amount of the plan's unfunded vested benefits is challenged.
The first payment of withdrawal liability determined by the
plan sponsor is generally due no later than 60 days after
demand, even if the employer contests the determination of
liability. Disputes between an employer and plan sponsor
concerning withdrawal liability are resolved through
arbitration, which can be initiated by either party. Even if
the employer contests the determination, payments of withdrawal
liability must be made by the employer until the arbitrator
issues a final decision with respect to the determination
submitted for arbitration.
For purposes of withdrawal liability, all trades or
businesses under common control are treated as a single
employer. In addition, the plan sponsor may disregard a
transaction in order to assess withdrawal liability if the
sponsor determines that the principal purpose of the
transaction was to avoid or evade withdrawal liability. For
example, if a subsidiary of a parent company is sold and the
subsidiary then withdraws from a multiemployer plan, the plan
sponsor may assess withdrawal liability as if the subsidiary
were still part of the parent company's controlled group if the
sponsor determines that a principal purpose of the sale of the
subsidiary was to evade or avoid withdrawal liability.
Explanation of Provision
Under the Act, a special rule may apply if a transaction is
disregarded by a plan sponsor in determining that a withdrawal
has occurred or that an employer is liable for withdrawal
liability. If the transaction that is disregarded by the plan
sponsor occurred before January 1, 1999, and at least five
years before the date of the withdrawal, then (1) the
determination by the plan sponsor that a principal purpose of
the transaction was to evade or avoid withdrawal liability is
not be presumed to be correct, (2) the plan sponsor, rather
than the employer, has the burden to establish, by a
preponderance of the evidence, the elements of the claim that a
principal purpose of the transaction was to evade or avoid
withdrawal liability, and (3) if an employer contests the plan
sponsor's determination through an arbitration proceeding, or
through a claim brought in a court of competent jurisdiction,
the employer is not obligated to make any withdrawal liability
payments until a final decision in the arbitration proceeding,
or in court, upholds the plan sponsor's determination. The Act
does not modify the burden of establishing other elements of a
claim for withdrawal liability other than whether the purpose
of the transaction was to evade or avoid withdrawal liability.
Effective Date
The provision applies to an employer that receives a
notification of withdrawal liability and demand for payment
under ERISA section 4219(b)(1) after October 31, 2003.
C. Sense of Congress Regarding Defined Benefit Pension System Reform
(sec. 203 of the Act)
Prior Law
No provision.
Explanation of Provision
Under the Act, it is the sense of the Congress that the
Congress must ensure the financial health of the defined
benefit pension system by working to promptly implement: (1) a
permanent replacement for the discount rate used for defined
benefit pension plan calculations; and (2) comprehensive
funding reforms for all defined benefit pension plans aimed at
achieving accurate and sound pension plan funding to enhance
retirement security for workers who rely on defined benefit
pension plan benefits, to reduce the volatility of
contributions, to provide plan sponsors with predictability for
plan contributions, and to ensure adequate disclosures for plan
participants in the case of underfunded plans.
Effective Date
The provision is effective on the date of enactment (April
10, 2004).
D. Extension of Provision Permitting Qualified Transfers of Excess
Pension Assets to Retiree Health Accounts (sec. 204 of the Act, sec.
420 of the Code, and secs. 101, 403, and 408 of ERISA)
Present and Prior Law
Defined benefit plan assets generally may not revert to an
employer prior to termination of the plan and satisfaction of
all plan liabilities. In addition, a reversion may occur only
if the plan so provides. A reversion prior to plan termination
may constitute a prohibited transaction and may result in plan
disqualification. Any assets that revert to the employer upon
plan termination are
includible in the gross income of the employer and subject to
an excise tax. The excise tax rate is 20 percent if the
employer maintains a replacement plan or makes certain benefit
increases in connection with the termination; if not, the
excise tax rate is 50 percent. Upon plan termination, the
accrued benefits of all plan participants are required to be
100-percent vested.
A pension plan may provide medical benefits to retired
employees through a separate account that is part of such plan.
A qualified transfer of excess assets of a defined benefit plan
to such a separate account within the plan may be made in order
to fund retiree health benefits.\162\ A qualified transfer does
not result in plan disqualification, is not a prohibited
transaction, and is not treated as a reversion. Thus,
transferred assets are not includible in the gross income of
the employer and are not subject to the excise tax on
reversions. No more than one qualified transfer may be made in
any taxable year. A qualified transfer can be made only from a
single-employer plan.
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\162\ Sec. 420.
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Excess assets generally means the excess, if any, of the
value of the plan's assets\163\ over the greater of (1) the
accrued liability under the plan (including normal cost) or (2)
125 percent of the plan's current liability.\164\ In addition,
excess assets transferred in a qualified transfer may not
exceed the amount reasonably estimated to be the amount that
the employer will pay out of such account during the taxable
year of the transfer for qualified current retiree health
liabilities. No deduction is allowed to the employer for (1) a
qualified transfer or (2) the payment of qualified current
retiree health liabilities out of transferred funds (and any
income thereon).
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\163\ The value of plan assets for this purpose is the lesser of
fair market value or actuarial value.
\164\ In the case of plan years beginning before January 1, 2004,
excess assets generally means the excess, if any, of the value of the
plan's assets over the greater of (1) the lesser of (a) the accrued
liability under the plan (including normal cost) or (b) 170 percent of
the plan's current liability (for 2003), or (2) 125 percent of the
plan's current liability. The current liability full funding limit was
repealed for years beginning after 2003. Under the general sunset
provision of EGTRRA, the limit is reinstated for years after 2010.
---------------------------------------------------------------------------
Transferred assets (and any income thereon) must be used to
pay qualified current retiree health liabilities for the
taxable year of the transfer. Transferred amounts generally
must benefit pension plan participants, other than key
employees, who are entitled upon retirement to receive retiree
medical benefits through the separate account. Retiree health
benefits of key employees may not be paid out of transferred
assets.
Amounts not used to pay qualified current retiree health
liabilities for the taxable year of the transfer are to be
returned to the general assets of the plan. These amounts are
not includible in the gross income of the employer, but are
treated as an employer reversion and are subject to a 20-
percent excise tax.
In order for the transfer to be qualified, accrued
retirement benefits under the pension plan generally must be
100-percent vested as if the plan terminated immediately before
the transfer (or in the case of a participant who separated in
the one-year period ending on the date of the transfer,
immediately before the separation).
In order for a transfer to be qualified, the employer
generally must maintain retiree health benefits at the same
level for the taxable year of the transfer and the following
four years.
In addition, the ERISA provides that, at least 60 days
before the date of a qualified transfer, the employer must
notify the Secretary of Labor, the Secretary of the Treasury,
employee representatives, and the plan administrator of the
transfer, and the plan administrator must notify each plan
participant and beneficiary of the transfer.\165\
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\165\ ERISA sec. 101(e). ERISA also provides that a qualified
transfer is not a prohibited transaction under ERISA or a prohibited
reversion.
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Under prior law, no qualified transfer could be made after
December 31, 2005.
Reasons for Change \166\
The Congress believed it was appropriate to extend the
ability of employers to transfer assets set aside for pension
benefits to a section 401(h) account for retiree health
benefits as long as the security of employees' pension benefits
is not thereby threatened.
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\166\ The reasons for change were included for an identical
provision in S. 2424, the ``National Employee Savings and Trust Equity
Guarantee Act,'' which was reported by the Senate Committee on Finance
on May 14, 2004 (S. Rep. No. 108-266), subsequent to the enactment of
Pub. L. No. 108-218. See also, H.R. 2896, the ``American Jobs Creation
Act of 2003,'' which was reported by the House Committee on Ways and
Means on November 21, 2003 (H.R. Rep. No. 108-393).
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Explanation of Provision
The Act allows qualified transfers of excess defined
benefit plan assets through December 31, 2013.
Effective Date
The provision is effective on the date of enactment (April
10, 2004).
E. Repeal of Reduction of Deductions for Mutual Life Insurance
Companies (sec. 205 of the Act and sec. 809 of the Code)
Present and Prior Law
In general, a corporation may not deduct amounts
distributed to shareholders with respect to the corporation's
stock. The Deficit Reduction Act of 1984 added a provision to
the rules governing insurance companies that was intended to
remedy the failure of prior law to distinguish between amounts
returned by mutual life insurance companies to policyholders as
customers, and amounts distributed to them as owners of the
mutual company.
Under the provision, section 809, a mutual life insurance
company is required to reduce its deduction for policyholder
dividends by the company's differential earnings amount. If the
company's differential earnings amount exceeds the amount of
its deductible policyholder dividends, the company is required
to reduce its deduction for changes in its reserves by the
excess of its differential earnings amount over the amount of
its deductible policyholder dividends. The differential
earnings amount is the product of the differential earnings
rate and the average equity base of a mutual life insurance
company.
The differential earnings rate is based on the difference
between the average earnings rate of the 50 largest stock life
insurance companies and the earnings rate of all mutual life
insurance companies. The mutual earnings rate applied under the
provision is the rate for the second calendar year preceding
the calendar year in which the taxable year begins. The
differential earnings rate cannot be a negative number.
A company's equity base equals the sum of: (1) its surplus
and capital increased by 50 percent of the amount of any
provision for policyholder dividends payable in the following
taxable year; (2) the amount of its nonadmitted financial
assets; (3) the excess of its statutory reserves over its tax
reserves; and (4) the amount of any mandatory security
valuation reserves, deficiency reserves, and voluntary
reserves. A company's average equity base is the average of the
company's equity base at the end of the taxable year and its
equity base at the end of the preceding taxable year.
A recomputation or ``true-up'' in the succeeding year is
required if the differential earnings amount for the taxable
year either exceeds, or is less than, the recomputed
differential earnings amount. The recomputed differential
earnings amount is calculated taking into account the average
mutual earnings rate for the calendar year (rather than the
second preceding calendar year, as above). The amount of the
true-up for any taxable year is added to, or deducted from, the
mutual company's income for the succeeding taxable year.
For taxable years beginning in 2001, 2002, or 2003, the
differential earnings amount is treated as zero for purposes of
computing both the differential earnings amount and the
recomputed differential earnings amount (true-up).
Explanation of Provision
The Act repeals the rule requiring reduction in certain
deductions of a mutual life insurance company (section 809).
Effective Date
The provision is effective for taxable years beginning
after
December 31, 2004. Thus, for taxable years beginning in 2003,
the differential earnings amount is treated as zero; for
taxable years beginning in 2004, this rule does not apply and
section 809 is in effect (including the true-up applicable with
respect to taxable years beginning in 2004).
F. Modify Qualification Rules for Tax-Exempt Property and Casualty
Insurance Companies (sec. 206 of the Act and secs. 501 and 831 of the
Code)
Present and Prior Law
A property and casualty insurance company generally is
subject to tax on its taxable income (sec. 831(a)). The taxable
income of a property and casualty insurance company is
determined as the sum of its underwriting income and investment
income (as well as gains and other income items), reduced by
allowable deductions (sec. 832).
A property and casualty insurance company is eligible to be
exempt from Federal income tax if its net written premiums or
direct written premiums (whichever is greater) for the taxable
year do not exceed $350,000 (sec. 501(c)(15)).
A property and casualty insurance company may elect to be
taxed only on taxable investment income if its net written
premiums or direct written premiums (whichever is greater) for
the taxable year exceed $350,000, but do not exceed $1.2
million (sec. 831(b)).
For purposes of determining the amount of a company's net
written premiums or direct written premiums under these rules,
premiums received by all members of a controlled group of
corporations of which the company is a part are taken into
account. For this purpose, a more-than-50-percent threshhold
applies under the vote and value requirements with respect to
stock ownership for determining a controlled group, and rules
treating a life insurance company as part of a separate
controlled group or as an excluded member of a group do not
apply (secs. 501(c)(15), 831(b)(2)(B) and 1563).
Reasons for Change \167\
The Congress became aware of abuses in the area of tax-
exempt insurance companies. Considerable media attention has
focused on the inappropriate use of tax-exempt insurance
companies to shelter investment income.\168\ It is believed
that the use of these organizations as vehicles for sheltering
income was never contemplated by Congress. The proliferation of
these organizations as a means to avoid tax on income,
sometimes on large investment portfolios, is inconsistent with
the original narrow scope of the provision, which has been in
the tax law for decades. The Congress believed it is necessary
to limit the availability of tax-exempt status under the
provision so that it cannot be abused as a tax shelter. To that
end, the Act applies a gross receipts test and requires that
premiums received for the taxable year be greater than 50
percent of gross receipts.
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\167\ The reasons for change were included for a substantially
similar provision in S. 2424, the ``National Employee Savings and Trust
Equity Guarantee Act,'' which was reported by the Senate Committee on
Finance on May 14, 2004 (S. Rep. No. 108-266), subsequent to the
enactment of Pub. L. No. 108-218.
\168\ See David Cay Johnston, Insurance Loophole Helps Rich, N.Y.
Times, April 1, 2003; David Cay Johnston, Tiny Insurers Face Scrutiny
as Tax Shields, N.Y. Times, April 4, 2003, at C1; Janet Novack, Are You
a Chump?, Forbes, March 5, 2001.
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The Act correspondingly expands the availability of the
present-law election of a property and casualty insurer to be
taxed only on taxable investment income to companies with
premiums below $350,000. This provision of present law provides
a relatively simple tax calculation for small property and
casualty insurers, and because the election results in the
taxation of investment income, the Congress does not believe
that it is abused to avoid tax on investment income. Thus, the
bill provides that a company whose net written premiums (or if
greater, direct written premiums) do not exceed $1.2 million
(without regard to the $350,000 threshhold of present law) is
eligible for the simplification benefit of this election.
Explanation of Provision
The Act modifies the requirements for a property and
casualty insurance company to be eligible for tax-exempt
status, and to elect to be taxed only on taxable investment
income.
Under the Act, a property and casualty insurance company is
eligible to be exempt from Federal income tax if (a) its gross
receipts for the taxable year do not exceed $600,000, and (b)
the premiums received for the taxable year are greater than 50
percent of its gross receipts. For purposes of determining
these amounts, amounts received by all members of a controlled
group of corporations of which the company is a part are taken
into account. The Act expands the present-law controlled group
rule so that it also takes into account foreign and tax-exempt
corporations.
A company that does not meet the definition of an insurance
company is not eligible to be exempt from Federal income tax
under the Act. For this purpose, the term ``insurance company''
means any company, more than half of the business of which
during the taxable year is the issuing of insurance or annuity
contracts or the reinsuring of risks underwritten by insurance
companies (sec. 816(a) and new sec. 831(c)). A company whose
investment activities outweigh its insurance activities is not
considered to be an insurance company for this purpose.\169\ It
is intended that IRS enforcement activities address the misuse
of present-law section 501(c)(15).
---------------------------------------------------------------------------
\169\ See, e.g., Inter-American Life Insurance Co. v. Comm'r, 56
T.C. 497, aff'd per curiam, 469 F.2d 697 (9th Cir. 1972).
---------------------------------------------------------------------------
The Act also provides that a property and casualty
insurance company may elect to be taxed only on taxable
investment income if its net written premiums or direct written
premiums (whichever is greater) do not exceed $1.2 million
(without regard to whether such premiums exceed $350,000) (sec.
831(b)). For purposes of determining the amount of a company's
net written premiums or direct written premiums under this
rule, premiums received by all members of a controlled group of
corporations (as defined in section 831(b)) of which the
company is a part are taken into account.
It is intended that regulations or other Treasury guidance
provide for anti-abuse rules so as to prevent improper use of
the provision, including, for example, by attempts to
characterize as premiums any income that is other than premium
income.
Under the Act, an additional special rule provides that a
mutual property and casualty insurance company is eligible to
be exempt from Federal income tax under the provision if (a)
its gross receipts for the taxable year do not exceed $150,000,
and (b) the premiums received for the taxable year are greater
than 35 percent of its gross receipts, provided certain
requirements are met. The requirements are that no employee of
the company or member of the employee's family is an employee
of another company that is exempt from tax under section
501(c)(15) (or that would be exempt but for this rule). The
limitation to mutual companies and the limitation on employees
are intended to address the conferees' concern about the
inappropriate use of tax-exempt insurance companies to shelter
investment income, including in the case of companies with
gross receipts under $150,000. For example, it is intended that
the provision not permit the use of small companies with common
owners or employees to shelter investment income for the
benefit of such owners or employees.
Effective Date
The provision generally is effective for taxable years
beginning after December 31, 2003.
Under the provision, a special transition rule applies with
respect to certain companies. This transition rule applies in
the case of a company that, (1) for its taxable year that
includes April 1, 2004, meets the requirements of present-law
section 501(c)(15)(A) (as in effect for the taxable year
beginning before January 1, 2004), and (2) on April 1, 2004, is
in a receivership, liquidation or similar proceeding under the
supervision of a State court. Under the transition rule, in the
case of such a company, the general rule of the provision
applies to taxable years beginning after the earlier of (1) the
date the proceeding ends, or (2) December 31, 2007.
For such a company, the limitations on the carryover of net
operating losses to or from years in which the company was not
subject to tax (including section 831(b)(3)) continue to apply.
A company that is not otherwise eligible for tax-exempt status
under present-law section 501(c)(15) (e.g., a company that is
or becomes a life insurance company, or a company with net (or,
if greater, direct) written premiums exceeding $350,000 for the
taxable year) is not eligible for the transition rule.
G. Definition of Insurance Company for Property and Insurance Company
Tax Rules (sec. 206 of the Act and sec. 831 of the Code)
Present and Prior Law
Specific rules are provided for taxation of the life
insurance company taxable income of a life insurance company
(sec. 801), and for taxation of the taxable income of an
insurance company other than a life insurance company (sec.
831) (generally referred to as a property and casualty
insurance company). For Federal income tax purposes, a life
insurance company means an insurance company that is engaged in
the business of issuing life insurance and annuity contracts,
or noncancellable health and accident insurance contracts, and
that meets a 50-percent test with respect to its reserves (sec.
816(a)). This statutory provision applicable to life insurance
companies explicitly defines the term ``insurance company'' to
mean any company, more than half of the business of which
during the taxable year is the issuing of insurance or annuity
contracts or the reinsuring of risks underwritten by insurance
companies (sec. 816(a)).
The life insurance company statutory definition of an
insurance company does not explicitly apply to property and
casualty insurance companies, although a long-standing Treasury
regulation \170\ that is applied to property and casualty
companies provides a somewhat similar definition of an
``insurance company'' based on the company's ``primary and
predominant business activity.'' \171\
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\170\ The Treasury regulation provides that ``the term `insurance
company' means a company whose primary and predominant business
activity during the taxable year is the issuing of insurance or annuity
contracts or the reinsuring of risks underwritten by insurance
companies. Thus, though its name, charter powers, and subjection to
State insurance laws are significant in determining the business which
a company is authorized and intends to carry on, it is the character of
the business actually done in the taxable year which determines whether
a company is taxable as an insurance company under the Internal Revenue
Code.'' Treas. Reg. sec. 1.801-3(a)(1).
\171\ Court cases involving a determination of whether a company is
an insurance company for Federal tax purposes have examined all of the
business and other activities of the company. In considering whether a
company is an insurance company for such purposes, courts have
considered, among other factors, the amount and source of income
received by the company from its different activities. See Bowers v.
Lawyers Mortgage Co., 285 U.S. 182 (1932); United States v. Home Title
Insurance Co., 285 U.S. 191 (1932). See also Inter-American Life
Insurance Co. v. Comm'r, 56 T.C. 497, aff'd per curiam, 469 F.2d 697
(9th Cir. 1972), in which the court concluded that the company was not
an insurance company: ``The . . . financial data clearly indicates that
petitioner's primary and predominant source of income was from its
investments and not from issuing insurance contracts or reinsuring
risks underwritten by insurance companies. During each of the years in
issue, petitioner's investment income far exceeded its premiums and the
amounts of earned premiums were de minimis during those years. It is
equally as clear that petitioner's primary and predominant efforts were
not expended in issuing insurance contracts or in reinsurance. Of the
relatively few policies directly written by petitioner, nearly all were
issued to [family members]. Also, Investment Life, in which [family
members] each owned a substantial stock interest, was the source of
nearly all of the policies reinsured by petitioner. These facts,
coupled with the fact that petitioner did not maintain an active sales
staff soliciting or selling insurance policies . . ., indicate a lack
of concentrated effort on petitioner's behalf toward its chartered
purpose of engaging in the insurance business. . . . For the above
reasons, we hold that during the years in issue, petitioner was not `an
insurance company . . . engaged in the business of issuing life
insurance' and hence, that petitioner was not a life insurance company
within the meaning of section 801.'' 56 T.C. 497, 507-508.
---------------------------------------------------------------------------
When enacting the statutory definition of a life insurance
company in 1984, Congress stated, ``[b]y requiring [that] more
than half rather than the `primary and predominant business
activity' be insurance activity, the bill adopts a stricter and
more precise standard for a company to be taxed as a life
insurance company than does the general regulatory definition
of an insurance company applicable for both life and nonlife
insurance companies . . . Whether more than half of the
business activity is related to the issuing of insurance or
annuity contracts will depend on the facts and circumstances
and factors to be considered will include the relative
distribution of the number of employees assigned to, the amount
of space allocated to, and the net income derived from, the
various business activities.'' \172\
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\172\ H.R. Rep. No. 98-432, part 2, at 1402-1403 (1984); S. Prt.
No. 98-169, vol. I, at 525-526 (1984); see also H.R. Rep. No. 98-861 at
1043-1044 (1985) (Conference Report).
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Reasons for Change \173\
---------------------------------------------------------------------------
\173\ The reasons for change were included for an identical
provision in S. 2424, the ``National Employee Savings and Trust Equity
Guarantee Act,'' which was reported by the Senate Committee on Finance
on May 14, 2004 (S. Rep. No. 108-266), subsequent to the enactment of
Pub. L. No. 108-218.
---------------------------------------------------------------------------
The Congress believed that the law will be made clearer and
more exact and tax administration will be improved by
conforming the definition of an insurance company for purposes
of the property and casualty insurance tax rules to the
existing statutory definition of an insurance company under the
life insurance company tax rules. Further, the Congress
expected that IRS enforcement activities to prevent abuse of
the provision relating to tax-exempt insurance companies will
be simplified and improved by this provision of the Act.
Explanation of Provision
The Act provides that, for purposes of determining whether
a company is a property and casualty insurance company, the
term ``insurance company'' is defined to mean any company, more
than half of the business of which during the taxable year is
the issuing of insurance or annuity contracts or the reinsuring
of risks underwritten by insurance companies. Thus, the Act
conforms the definition of an insurance company for purposes of
the rules taxing property and casualty insurance companies to
the rules taxing life insurance companies, so that the
definition is uniform. The Act adopts a stricter and more
precise standard than the ``primary and predominant business
activity'' test contained in Treasury Regulations. A company
whose investment activities outweigh its insurance activities
is not considered to be an insurance company under the
Act.\174\ It is not intended that a company whose sole activity
is the run-off of risks under the company's insurance contracts
be treated as a company other than an insurance company, even
if the company has little or no premium income.
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\174\ See Inter-American Life Insurance Co. v. Comm'r, supra.
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Effective Date
The provision applies to taxable years beginning after
December 31, 2003.
PART ELEVEN: SURFACE TRANSPORTATION EXTENSION ACT OF 2004, PART II
(PUBLIC LAW 108-224) \175\
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\175\ H.R. 4219. The House passed the bill on the suspension
calendar on April 28, 2004. The Senate passed the bill by unanimous
consent on April 29, 2004. The President signed the bill on April 30,
2004.
---------------------------------------------------------------------------
A. Extension of Highway Trust Fund and Aquatic Resources Trust Fund
Expenditure Authority (sec. 10 of the Act)
Prior Law
Under prior law, the Internal Revenue Code (sec. 9503)
authorized expenditures (subject to appropriations) to be made
from the Highway Trust Fund through April 30, 2004, for
purposes provided in specified authorizing legislation as in
effect on the date of enactment of the most recent authorizing
Act (the Surface Transportation Extension Act of 2004).
Under prior law, expenditures also were authorized from the
Aquatic Resources Trust Fund through April 30, 2004.
Highway Trust Fund spending is limited by anti-deficit
provisions internal to the Highway Trust Fund, the so-called
``Harry Byrd rule''. The rule requires the Treasury Department
to determine, on a quarterly basis, the amount (if any) by
which unfunded highway authorizations exceed projected net
Highway Trust Fund tax receipts for the 24-month period
beginning at the close of each fiscal year (sec. 9503(d)).
Similar rules apply to unfunded Mass Transit Account
authorizations. If unfunded authorizations exceed projected 24-
month receipts, apportionments to the States for specified
programs funded by the relevant Trust Fund Account are to be
reduced proportionately. Because of the Harry Byrd rule, taxes
dedicated to the Highway Trust Fund typically are scheduled to
expire at least two years after current authorizing Acts.
The Surface Transportation Extension Act of 2003, created a
temporary rule (through February 29, 2004) for purposes of the
anti-deficit provisions of the Highway Trust Fund. For purposes
of determining 24 months of projected revenues for the anti-
deficit provisions, the Secretary of the Treasury is instructed
to treat each expiring provision relating to appropriations and
transfers to the Highway Trust Fund to have been extended
through the end of the 24-month period and to assume that the
rate of tax during such 24-month period remains the same as the
rate in effect on the date of enactment of that Act. The
Surface Transportation Extension Act of 2004 extended this rule
through April 30, 2004.
Explanation of Provision \176\
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\176\ The expiration dates described herein were subsequently
extended by the Surface Transportation Extension Act of 2004, Part III;
the Surface Transportation Extension Act of 2004, Part IV; and the
Surface Transportation Extension Act of 2004, Part V, described in Part
Twelve, Part Thirteen, and Part Fourteen, respectively.
---------------------------------------------------------------------------
The Act extends the authority to make expenditures (subject
to appropriations) from the Highway Trust Fund through June 30,
2004. The Act also updates the Highway Trust Fund cross
references to authorizing legislation to include expenditure
purposes in this Act and prior authorizing legislation as in
effect on the date of enactment. For purposes of the anti-
deficit provisions of the Highway Trust Fund, the Act extends
the temporary rule through June 30, 2004.
The Act extends the authority to make expenditures (subject
to appropriations) from the Aquatics Resources Trust Fund
through June 30, 2004. The Act also updates the Aquatics
Resources Trust Fund cross references to authorizing
legislation to include expenditure purposes as in effect on the
date of enactment of this Act.
Effective Date
The provision is effective on the date of enactment (April
30, 2004).
PART TWELVE: SURFACE TRANSPORTATION EXTENSION ACT OF 2004, PART III
(PUBLIC LAW 108-263) \177\
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\177\ H.R. 4635. The House passed the bill on the suspension
calendar on June 23, 2004. The Senate passed the bill by unanimous
consent on June 23, 2004. The President signed the bill on June 30,
2004.
---------------------------------------------------------------------------
A. Extension of Highway Trust Fund and Aquatic Resources Trust Fund
Expenditure Authority (sec. 10 of the Act)
Prior Law
Under prior law, the Internal Revenue Code (sec. 9503)
authorized expenditures (subject to appropriations) to be made
from the Highway Trust Fund through June 30, 2004, for purposes
provided in specified authorizing legislation as in effect on
the date of enactment of the most recent authorizing Act (the
Surface Transportation Extension Act of 2004, Part II).
Under prior law, expenditures also were authorized from the
Aquatic Resources Trust Fund through June 30, 2004.
Highway Trust Fund spending is limited by anti-deficit
provisions internal to the Highway Trust Fund, the so-called
``Harry Byrd rule''. The rule requires the Treasury Department
to determine, on a quarterly basis, the amount (if any) by
which unfunded highway authorizations exceed projected net
Highway Trust Fund tax receipts for the 24-month period
beginning at the close of each fiscal year (sec. 9503(d)).
Similar rules apply to unfunded Mass Transit Account
authorizations. If unfunded authorizations exceed projected 24-
month receipts, apportionments to the States for specified
programs funded by the relevant Trust Fund Account are to be
reduced proportionately. Because of the Harry Byrd rule, taxes
dedicated to the Highway Trust Fund typically are scheduled to
expire at least two years after current authorizing Acts.
The Surface Transportation Extension Act of 2003, created a
temporary rule (through February 29, 2004) for purposes of the
anti-deficit provisions of the Highway Trust Fund. For purposes
of determining 24 months of projected revenues for the anti-
deficit provisions, the Secretary of the Treasury is instructed
to treat each expiring provision relating to appropriations and
transfers to the Highway Trust Fund to have been extended
through the end of the 24-month period and to assume that the
rate of tax during such 24-month period remains the same as the
rate in effect on the date of enactment of that Act. The
Surface Transportation Extension Act of 2004 extended this rule
through April 30, 2004. The Surface Transportation Extension
Act of 2004, Part II, extended this rule through June 30, 2004.
Explanation of Provision \178\
---------------------------------------------------------------------------
\178\ The expiration dates described herein were subsequently
extended by the Surface Transportation Extension Act of 2004, Part IV;
and the Surface Transportation Extension Act of 2004, Part V, described
in Part Thirteen, and Part Fourteen, respectively.
---------------------------------------------------------------------------
The Act extends the authority to make expenditures (subject
to appropriations) from the Highway Trust Fund through July 31,
2004. The Act also updates the Highway Trust Fund cross
references to authorizing legislation to include expenditure
purposes in this Act and prior authorizing legislation as in
effect on the date of enactment.
For purposes of the anti-deficit provisions of the Highway
Trust Fund, the Act extends the temporary rule through July 31,
2004.
The Act extends the authority to make expenditures (subject
to appropriations) from the Aquatics Resources Trust Fund
through July 31, 2004. The Act also updates the Aquatics
Resources Trust Fund cross references to authorizing
legislation to include expenditure purposes as in effect on the
date of enactment of this Act.
Effective Date
The provision is effective on the date of enactment (June
30, 2004).
PART THIRTEEN: SURFACE TRANSPORTATION EXTENSION ACT OF 2004, PART IV
(PUBLIC LAW 108-280) \179\
---------------------------------------------------------------------------
\179\ H.R. 4916. The House passed the bill by unanimous consent on
July 22, 2004. The Senate passed the bill without amendment by
unanimous consent on July 22, 2004. The President signed the bill on
July 30, 2004.
---------------------------------------------------------------------------
A. Extension of Highway Trust Fund and Aquatic Resources Trust Fund
Expenditure Authority (sec. 10 of the Act)
Prior Law
Under prior law, the Internal Revenue Code (sec. 9503)
authorized expenditures (subject to appropriations) to be made
from the Highway Trust Fund through July 31, 2004, for purposes
provided in specified authorizing legislation as in effect on
the date of enactment of the most recent authorizing Act (the
Surface Transportation Extension Act of 2004, Part III).
Under prior law, expenditures also were authorized from the
Aquatic Resources Trust Fund through July 31, 2004.
Highway Trust Fund spending is limited by anti-deficit
provisions internal to the Highway Trust Fund, the so-called
``Harry Byrd rule''. The rule requires the Treasury Department
to determine, on a quarterly basis, the amount (if any) by
which unfunded highway authorizations exceed projected net
Highway Trust Fund tax receipts for the 24-month period
beginning at the close of each fiscal year (sec. 9503(d)).
Similar rules apply to unfunded Mass Transit Account
authorizations. If unfunded authorizations exceed projected 24-
month receipts, apportionments to the States for specified
programs funded by the relevant Trust Fund Account are to be
reduced proportionately. Because of the Harry Byrd rule, taxes
dedicated to the Highway Trust Fund typically are scheduled to
expire at least two years after current authorizing Acts.
The Surface Transportation Extension Act of 2003, created a
temporary rule (through February 29, 2004) for purposes of the
anti-deficit provisions of the Highway Trust Fund. For purposes
of determining 24 months of projected revenues for the anti-
deficit provisions, the Secretary of the Treasury is instructed
to treat each expiring provision relating to appropriations and
transfers to the Highway Trust Fund to have been extended
through the end of the 24-month period and to assume that the
rate of tax during such 24-month period remains the same as the
rate in effect on the date of enactment of that Act. The
Surface Transportation Extension Act of 2004 extended this rule
through April 30, 2004. The Surface Transportation Extension
Act of 2004, Part II, extended this rule through June 30, 2004.
The Surface Transportation Extension Act of 2004, Part III,
extended this rule through July 31, 2004.
Explanation of Provision \180\
---------------------------------------------------------------------------
\180\ The expiration dates described herein were subsequently
extended by the Surface Transportation Extension Act of 2004, Part V,
described in Part Fourteen.
---------------------------------------------------------------------------
The Act extends the authority to make expenditures (subject
to appropriations) from the Highway Trust Fund through
September 30, 2004. Core highway programs are authorized
through September 24, 2004. The term ``core highway program''
means any program (other than any program carried out by the
National Highway Traffic Safety Administration and any program
carried out by the Federal Motor Carrier Administration) funded
by the Highway Trust fund (other than the Mass Transit
Account). The Act also updates the Highway Trust Fund cross
references to authorizing legislation to include expenditure
purposes in this Act and prior authorizing legislation as in
effect on the date of enactment.
For purposes of the anti-deficit provisions of the Highway
Trust Fund, the Act extends the temporary rule through
September 30, 2004.
The Act extends the authority to make expenditures (subject
to appropriations) from the Aquatics Resources Trust Fund
through September 30, 2004. The Act also updates the Aquatics
Resources Trust Fund cross references to authorizing
legislation to include expenditure purposes as in effect on the
date of enactment of this Act.
Effective Date
The provision is effective on the date of enactment (July
30, 2004).
PART FOURTEEN: SURFACE TRANSPORTATION EXTENSION ACT OF 2004, PART V
(PUBLIC LAW 108-310) \181\
---------------------------------------------------------------------------
\181\ H.R. 5183. The House passed the bill on September 30, 2004.
The Senate passed the bill without amendment by unanimous consent on
September 30, 2004. The President signed the bill on September 30,
2004.
---------------------------------------------------------------------------
A. Extension of Highway Trust Fund and Aquatic Resources Trust Fund
Expenditure Authority (sec. 13 of the Act)
Present and Prior Law
Expenditure authority
Under prior law, the Internal Revenue Code (sec. 9503)
authorized expenditures (subject to appropriations) to be made
from the Highway Trust Fund generally through September 30,
2004, for purposes provided in specified authorizing
legislation as in effect on the date of enactment of the most
recent authorizing Act (the Surface Transportation Extension
Act of 2004, Part IV).\182\
---------------------------------------------------------------------------
\182\ Core highway programs were authorized through September 24,
2004. The term ``core highway program'' means any program (other than
any program carried out by the National Highway Traffic Safety
Administration and any program carried out by the Federal Motor Carrier
Administration) funded by the Highway Trust fund (other than the Mass
Transit Account).
---------------------------------------------------------------------------
Under prior law, expenditures also were authorized from the
Aquatic Resources Trust Fund through September 30, 2004.
Highway Trust Fund spending is limited by anti-deficit
provisions internal to the Highway Trust Fund, the so-called
``Harry Byrd rule''. The rule requires the Treasury Department
to determine, on a quarterly basis, the amount (if any) by
which unfunded highway authorizations exceed projected net
Highway Trust Fund tax receipts for the 24-month period
beginning at the close of each fiscal year (sec. 9503(d)).
Similar rules apply to unfunded Mass Transit Account
authorizations. If unfunded authorizations exceed projected 24-
month receipts, apportionments to the States for specified
programs funded by the relevant Trust Fund Account are to be
reduced proportionately. Because of the Harry Byrd rule, taxes
dedicated to the Highway Trust Fund typically are scheduled to
expire at least two years after current authorizing Acts.
The Surface Transportation Extension Act of 2003, created a
temporary rule (through February 29, 2004) for purposes of the
anti-deficit provisions of the Highway Trust Fund. For purposes
of determining 24 months of projected revenues for the anti-
deficit provisions, the Secretary of the Treasury is instructed
to treat each expiring provision relating to appropriations and
transfers to the Highway Trust Fund to have been extended
through the end of the 24-month period and to assume that the
rate of tax during such 24-month period remains the same as the
rate in effect on the date of enactment of that Act. The
Surface Transportation Extension Act of 2004 extended this rule
through April 30, 2004. The Surface Transportation Extension
Act of 2004, Part II, extended this rule through June 30, 2004.
The Surface Transportation Extension Act of 2004, Part III,
extended this rule through July 31, 2004. The Surface
Transportation Extension Act of 2004, Part IV, extended this
rule through September 30, 2004.
Alcohol fuel taxes
In general, 18.3 cents per gallon of the gasoline excise
tax is deposited in the Highway Trust Fund and 0.1 cent per
gallon is deposited in the Leaking Underground Storage Tank
Trust Fund (the ``LUST'' rate). Under prior law, in the case of
gasohol with respect to which a reduced excise tax is
paid,\183\ 2.5 cents per gallon of the reduced tax was retained
in the General Fund. The balance of the reduced rate (less the
LUST rate) was deposited in the Highway Trust Fund. Also under
prior law, of the reduced tax rate on gasoline to be blended
into an alcohol fuel, 2.8 cents per gallon of the reduced tax
was retained in the General Fund. The balance of the reduced
rate (less the LUST rate) was deposited in the Highway Trust
Fund.
---------------------------------------------------------------------------
\183\ For example, under prior law, a 10 percent ethanol/gasoline
blend was taxed at 13.2 cents per gallon. Gasoline for use in producing
gasohol consisting of 10 percent ethanol was taxed at 14.666 cents per
gallon.
---------------------------------------------------------------------------
Explanation of Provision
Expenditure authority
The Act extends the authority to make expenditures (subject
to appropriations) from the Highway Trust Fund through May 31,
2005. The Act also updates the Highway Trust Fund cross
references to authorizing legislation to include expenditure
purposes in this Act and prior authorizing legislation as in
effect on the date of enactment.
For purposes of the anti-deficit provisions of the Highway
Trust Fund, the Act extends the temporary rule through May 31,
2005.
The Act extends the authority to make expenditures (subject
to appropriations) from the Aquatics Resources Trust Fund
through May 31, 2005. The Act also updates the Aquatics
Resources Trust Fund cross references to authorizing
legislation to include expenditure purposes as in effect on the
date of enactment of this Act.
All alcohol fuel taxes transferred to Highway Trust Fund for FY 2004
For the period beginning October 1, 2003, through September
30, 2004, the Act authorizes the transfer to the Highway Trust
Fund of the 2.5 and 2.8 cents per gallon of tax imposed on
alcohol fuels that had been retained by the General Fund.
Effective Date
The provisions relating to expenditure authority are
effective on the date of enactment (September 30, 2004). The
provision relating to the transfer of alcohol fuel taxes to the
Highway Trust Fund is effective for taxes imposed after
September 30, 2003.
PART FIFTEEN: WORKING FAMILIES TAX RELIEF ACT OF 2004 (PUBLIC LAW 108-
311) \184\
I. EXTENSION OF CERTAIN EXPIRING PROVISIONS
A. Extension of the Child Tax Credit, Acceleration of Refundability of
the Child Tax Credit and Treatment of Combat Pay as Earned Income for
Purposes of the Child Tax Credit and Earned Income Credit (secs. 101-
104 of the Act and sec. 24 and 32 of the Code)
Present and Prior Law
In general
For 2004, an individual may claim a $1,000 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
descendent of either), or eligible foster child.
---------------------------------------------------------------------------
\184\ H.R. 1308. The House passed the bill on the suspension
calendar on March 19, 2003. The Senate passed the bill, as amended, on
June 5, 2003. The House passed the bill with a further amendment on
June 12, 2003. The conference report was filed on September 23, 2004
(H.R. Rep. No. 108-696). The conference report passed the House on
September 23, 2004, and passed the Senate on September 23, 2004. The
President signed the bill on October 4, 2004.
---------------------------------------------------------------------------
The child tax credit is scheduled to revert to $700 in
2005, and then, over several years, increase to $1,000.
Table 6, below, shows the scheduled amount of the child tax
credit.
Table 6.--Scheduled Amount of the Child Tax Credit
------------------------------------------------------------------------
Credit
Taxable year amount per
child
------------------------------------------------------------------------
2003-2004.................................................. $1,000
2005-2008.................................................. 700
2009....................................................... 800
2010 \1\................................................... 1,000
------------------------------------------------------------------------
\1\ The credit reverts to $500 in taxable years beginning after December
31, 2010, under the sunset provision of EGTRRA (the ``Economic Growth
and Tax Relief Reconciliation Act of 2001,'' Pub. L. No. 107-16).
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.\185\ 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
$95,000 of modified adjusted gross income. The phase-out range
for a single individual with two qualifying children is between
$75,000 and $115,000.
---------------------------------------------------------------------------
\185\ 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 amount of the tax credit and the phase-out ranges are
not adjusted annually for inflation.
Refundability
For 2004, the child credit is refundable to the extent of
10 percent of the taxpayer's taxable earned income (which is
taken into account in determining taxable income) in excess of
$10,750.\186\ The percentage is increased to 15 percent for
taxable years 2005 and thereafter. 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, if that amount is greater than
the refundable credit based on the taxpayer's taxable earned
income in excess of $10,750 (for 2004). The refundable portion
of the child credit does not constitute income and is not
treated as resources for purposes of determining eligibility or
the amount or nature of benefits or assistance under any
Federal program or any State or local program financed with
Federal funds. For taxable years beginning after December 31,
2010, the sunset provision of EGTRRA applies to the 15-percent
rule for allowing refundable child credits.
---------------------------------------------------------------------------
\186\ The $10,750 amount is indexed for inflation.
---------------------------------------------------------------------------
Alternative minimum tax liability
The child credit is allowed against the individual's
regular income tax and alternative minimum tax. For taxable
years beginning after December 31, 2010, the sunset provision
of EGTRRA applies to the rules allowing the child credit
against the alternative minimum tax.
Explanation of Provision
In general
The Act increases the child credit to $1,000 for taxable
years 2005-2009. Therefore, the maximum child tax credit is
$1,000 per child for taxable years 2005-2010. All modifications
to the child credit under the Act are subject to the sunset
provision of EGTRRA.\187\
---------------------------------------------------------------------------
\187\ The credit reverts to $500 in taxable years beginning after
December 31, 2010, under the sunset provision of EGTRRA.
---------------------------------------------------------------------------
Refundability
The Act accelerates to 2004 the increase in refundability
of the child credit to 15 percent of the taxpayer's earned
income in excess of $10,750 (with indexing).
Combat pay treated as earned income
The Act provides that combat pay that is otherwise excluded
from gross income under section 112 is treated as earned income
which is taken into account in computing taxable income for
purposes of calculating the refundable portion of the child
credit.
The Act provides that any taxpayer may elect to treat
combat pay that is otherwise excluded from gross income under
section 112 as earned income for purposes of the earned income
credit. This election is available with respect to any taxable
year ending after the date of enactment and before January 1,
2006.
Effective Dates
The provision generally applies to taxable years beginning
after December 31, 2004. The provision relating to the
acceleration of the refundability of the child credit applies
to taxable years beginning after December 31, 2003. The
provision relating to the treatment of combat pay as earned
income for purposes of the child credit is effective for
taxable years beginning after December 31, 2003. The earned
income credit election is effective for taxable years ending
after the date of enactment (October 4, 2004) and before
January 1, 2006.
B. Extend Marriage Penalty Relief (sec. 101 of the Act and secs. 1 and
63 of the Code)
1. Standard deduction marriage penalty relief (sec. 63 of the Code)
Present and Prior 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),\188\ 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.\189\ In general, two
unmarried individuals have standard deductions whose sum
exceeds the standard deduction for a married couple filing a
joint return. EGTRRA increased the basic standard deduction for
a married couple filing a joint return, providing for a phase-
in of the increase until the basic standard deduction for a
married couple filing a joint return equaled twice the basic
standard deduction for an unmarried individual filing a single
return by 2009.\190\ The Jobs and Growth Tax Relief
Reconciliation Act of 2003 (``JGTRRA'') accelerated the phase-
in, providing that the basic standard deduction for a married
couple filing a joint return equaled twice the basic standard
deduction for an unmarried individual filing a single return
for 2003 and 2004, reverting to the phase-in schedule provided
by EGTRAA for 2005-2009.
---------------------------------------------------------------------------
\188\ Additional standard deductions are allowed with respect to
any individual who is elderly (age 65 or over) or blind.
\189\ For 2004 the basic standard deduction amounts are: (1) $4,850
for unmarried individuals; (2) $9,700 for married individuals filing a
joint return; (3) $7,150 for heads of households; and (4) $4,850 for
married individuals filing separately.
\190\ 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 after the phase-in
period.
---------------------------------------------------------------------------
Table 7, below, shows the standard deduction for married
couples filing a joint return as a percentage of the standard
deduction for single individuals.
Table 7.--Amount of the Basic Standard Deduction for Married Couples
Filing Joint Returns
------------------------------------------------------------------------
Standard deduction for
married couples filing
joint returns as
Taxable year percentage of standard
deduction for unmarried
individual returns
------------------------------------------------------------------------
2003-2004..................................... 200
2005.......................................... 174
2006.......................................... 184
2007.......................................... 187
2008.......................................... 190
2009 and 2010 \1\............................. 200
------------------------------------------------------------------------
\1\ The basic standard deduction increases are repealed for taxable
years beginning after December 31, 2010, under the sunset provision of
EGTRRA.
Explanation of Provision
The Act increases the basic standard deduction amount for
joint returns to twice the basic standard deduction amount for
single returns effective for 2005-2008. Therefore, the basic
standard deduction for joint returns is twice the basic
standard deduction for single returns for taxable years 2005-
2010. All modifications to the basic standard deduction under
the Act are subject to the sunset provision of EGTRRA.
Effective Date
The provision is effective for taxable years beginning
after December 31, 2004.
2. Increase the size of the 15-percent rate bracket for married couples
filing joint returns (sec. 1 of the Code)
Present and Prior 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.\191\ 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.
---------------------------------------------------------------------------
\191\ Under present law, the rate bracket breakpoint for the 35-
percent marginal tax rate is the same for single individuals and
married couples filing joint returns.
---------------------------------------------------------------------------
15-percent regular income tax rate bracket
EGTRRA increased 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 a single
individual filing a single return, phasing in the increase over
four years, beginning in 2005. JGTRRA accelerated these
increases, making the size of the 15-percent regular income tax
rate bracket for a married couple filing a joint return equal
to twice the size of the corresponding rate bracket for a
single individual filing a single return for taxable years
beginning in 2003 and 2004. For taxable years beginning after
2004, the applicable percentages will revert to those provided
by EGTRRA. Table 8, below, shows the size of the 15-percent
bracket.
Table 8.--Size of the 15-Percent Rate Bracket for Married Couples Filing
Joint Returns
------------------------------------------------------------------------
End point of 15-percent
rate bracket for married
couples filing joint
Taxable year returns as percentage of
end point of 15-percent
rate bracket for
unmarried individual
------------------------------------------------------------------------
2003-2004..................................... 200
2005.......................................... 180
2006.......................................... 187
2007.......................................... 193
2008 and 2010 \1\............................. 200
------------------------------------------------------------------------
\1\ The increases in the 15-percent rate bracket for married couples
filing a joint return are repealed for taxable years beginning after
December 31, 2010, under the sunset provision of EGTRRA.
Explanation of Provision
The Act increases the size of the 15-percent rate bracket
for joint returns to twice the size of the corresponding rate
bracket for single returns effective for 2005-2007. Therefore,
the size of the 15-percent rate bracket for joint returns is
twice the size of the corresponding rate bracket for single
returns for taxable years 2005-2010. The modification to the
15-percent rate bracket under the Act is subject to the sunset
provision of EGTRRA.
Effective Date
The provision is effective for taxable years beginning
after December 31, 2004.
C. Extend Size of 10-Percent Rate Bracket for Individuals (sec. 103 of
the Act and sec. 1 of the Code)
Present and Prior Law
In general
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.
Ten-percent regular income tax rate
EGTRRA created a new 10-percent rate that applied 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, and provided a scheduled
increase effective beginning in 2008 under which the $6,000
amount would increase to $7,000 and the $12,000 amount would
increase to $14,000, with such amounts adjusted annually for
inflation for taxable years beginning after December 31, 2008.
JGTRRA accelerated the scheduled increases to 2003 and 2004
(with indexing). For 2004, the size of the 10-percent bracket
for single individuals is $7,150 ($14,300 for married
individuals filing a joint return). For 2005-2010, the size of
the 10-percent bracket reverts to the levels provided under
EGTRRA. Thus the amounts drop to $6,000 for single individuals,
$10,000 for heads of households and $12,000 for married
individuals filing a joint return) for 2005-2007. In 2008, the
amounts will increase to $7,000 ($14,000 for married
individuals filing a joint return). These amounts ($7,000 for
single individuals, $10,000 for heads of households and $14,000
for married individuals) are adjusted annually for inflation
for taxable years beginning after December 31, 2008. The 10-
percent rate bracket will expire for taxable years beginning
after December 31, 2010, under the sunset provision of EGTRRA.
Explanation of Provision
The Act extends the size of the 10-percent rate bracket
through 2010. Specifically, the size of the 10-percent rate
bracket for 2005 through 2010 is set at the 2003 level ($7,000
for single individuals, $10,000 for heads of households and
$14,000 for married individuals) with annual indexing from
2003. The modifications to the 10-percent rate bracket under
the Act are subject to the sunset provision of EGTRRA.
Effective Date
The provision is effective for taxable years beginning
after December 31, 2004.
D. Extend Alternative Minimum Tax Exemption for Individuals (sec. 104
of the Act and sec. 55 of the Code)
Present and Prior Law
The alternative minimum tax is the amount by which the
tentative minimum tax exceeds the regular income tax. An
individual's tentative minimum tax is the sum of (1) 26 percent
of so much of the taxable excess as does not exceed $175,000
($87,500 in the case of a married individual filing a separate
return) and (2) 28 percent of the remaining taxable excess. The
taxable excess is so much of the alternative minimum taxable
income (``AMTI'') as exceeds the exemption amount. The maximum
tax rates on net capital gain and dividends used in computing
the regular tax are used in computing the tentative minimum
tax. AMTI is the individual's taxable income adjusted to take
account of specified preferences and adjustments.
Under prior law, the exemption amounts were: (1) $45,000
($58,000 for taxable years beginning before 2005) in the case
of married individuals filing a joint return and surviving
spouses; (2) $33,750 ($40,250 for taxable years beginning
before 2005) in the case of other unmarried individuals; (3)
$22,500 ($29,000 for taxable years beginning before 2005) in
the case of married individuals filing a separate return; and
(4) $22,500 in the case of an estate or trust. 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, an estate, or a trust. These amounts
are not indexed for inflation.
Explanation of Provision
The Act extends the increased AMT exemption amounts to
taxable years beginning in 2005.
Effective Date
The provision applies to taxable years beginning after
December 31, 2004.
II. UNIFORM DEFINITION OF CHILD
A. Establish Uniform Definition of a Qualifying Child (secs. 201-208 of
the Act and secs. 2, 21, 24, 32, 151, and 152 of the Code)
Present and Prior Law
In general
Present and prior law contains five commonly used
provisions that provide benefits to taxpayers with children:
(1) the dependency exemption; (2) the child credit; (3) the
earned income credit; (4) the dependent care credit; and (5)
head of household filing status. Under prior law, each
provision had separate criteria for determining whether the
taxpayer qualified for the applicable tax benefit with respect
to a particular child. The separate criteria included factors
such as the relationship (if any) the child must bear to the
taxpayer, the age of the child, and whether the child must live
with the taxpayer. Thus, with respect to the same individual, a
taxpayer was required to determine eligibility for each benefit
separately, and an individual who qualified a taxpayer for one
provision did not automatically qualify the taxpayer for
another provision.
Dependency exemption \192\
In general
Under present and prior law, taxpayers are entitled to a
personal exemption deduction for the taxpayer, his or her
spouse, and each dependent. The deduction for personal
exemptions is phased out for taxpayers with incomes above
certain thresholds.\193\
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\192\ Secs. 151 and 152. Under the prior-law statutory structure,
section 151 provided for the deduction for personal exemptions with
respect to ``dependents.'' The term ``dependent'' was defined in
section 152. Most of the requirements regarding dependents were
contained in section 152; section 151 contained additional requirements
that had to be satisfied in order to obtain a dependency exemption with
respect to a dependent (as so defined). In particular, section 151
contained the gross income test, the rules relating to married
dependents filing a joint return, and the requirement for a taxpayer
identification number. The other rules discussed here also were
contained in section 151.
\193\ Sec. 151(d)(3).
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Under prior law, in general, a taxpayer was entitled to a
dependency exemption for an individual if the individual: (1)
satisfied a relationship test or was a member of the taxpayer's
household for the entire taxable year; (2) satisfied a support
test; (3) satisfied a gross income test or was a child of the
taxpayer under a certain age; (4) was a citizen or resident of
the U.S. or resident of Canada or Mexico;\194\ and (5) did not
file a joint return with his or her spouse for the year.\195\
In addition, under present and prior law, the taxpayer
identification number of the individual must be included on the
taxpayer's return.
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\194\ Under present and prior law, a legally adopted child who does
not satisfy the residency or citizenship requirement may nevertheless
qualify as a dependent (provided other applicable requirements are met)
if (1) the child's principal place of abode is the taxpayer's home and
(2) the taxpayer is a citizen or national of the United States. Sec.
152(b)(3).
\195\ This restriction did not apply if the return was filed solely
to obtain a refund and no tax liability would exist for either spouse
if they filed separate returns. Rev. Rul. 54-567, 1954-2 C.B. 108.
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Relationship or member of household test
Relationship test.--Under prior law, the relationship test
was satisfied if an individual was the taxpayer's (1) son or
daughter or a descendant of either (e.g., grandchild or great-
grandchild); (2) stepson or stepdaughter; (3) brother or sister
(including half brother, half sister, stepbrother, or
stepsister); (4) parent, grandparent, or other direct ancestor
(but not foster parent); (5) stepfather or stepmother; (6)
brother or sister of the taxpayer's father or mother; (7) son
or daughter of the taxpayer's brother or sister; or (8) the
taxpayer's father-in-law, mother-in-law, son-in-law, daughter-
in-law, brother-in-law, or sister-in-law.
Under prior law, an adopted child (or a child who was a
member of the taxpayer's household and who had been placed with
the taxpayer for adoption) was treated as a child of the
taxpayer. Under prior law, a foster child was treated as a
child of the taxpayer if the foster child was a member of the
taxpayer's household for the entire taxable year.
Member of household test.--Under prior law, if the
relationship test was not satisfied, then the individual may
have been considered the dependent of the taxpayer if the
individual was a member of the taxpayer's household for the
entire year. Thus, a taxpayer may have been eligible to claim a
dependency exemption with respect to an unrelated child who
lived with the taxpayer for the entire year.
Under present and prior law, for the member of household
test to be satisfied, the taxpayer must both maintain the
household and occupy the household with the individual.\196\ A
taxpayer or other individual does not fail to be considered a
member of a household because of ``temporary'' absences due to
special circumstances, including absences due to illness,
education, business, vacation, and military service.\197\
Similarly, an individual does not fail to be considered a
member of the taxpayer's household due to a custody agreement
under which the individual is absent for less than six
months.\198\ Indefinite absences that last for more than the
taxable year may be considered ``temporary.'' For example, the
IRS has ruled that an elderly woman who was indefinitely
confined to a nursing home was temporarily absent from a
taxpayer's household. Under the facts of the ruling, the woman
had been an occupant of the household before being confined to
a nursing home, the confinement had extended for several years,
and it was possible that the woman would die before becoming
well enough to return to the taxpayer's household. There was no
intent on the part of the taxpayer or the woman to change her
principal place of abode.\199\
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\196\ Treas. Reg. sec. 1.152-1(b).
\197\ Id.
\198\ Id.
\199\ Rev. Rul. 66-28, 1966-1 C.B. 31.
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Support test
In general.--Under present and prior law, the support test
is satisfied if the taxpayer provides over one half of the
support of the individual for the taxable year. To determine
whether a taxpayer has provided more than one half of an
individual's support, the amount the taxpayer contributed to
the individual's support is compared with the entire amount of
support the individual received from all sources, including the
individual's own funds.\200\ Governmental payments and
subsidies (e.g., Temporary Assistance to Needy Families, food
stamps, and housing) generally are treated as support provided
by a third party. Expenses that are not directly related to any
one member of a household, such as the cost of food for the
household, must be divided among the members of the household.
If any person furnishes support in kind (e.g., in the form of
housing), then the fair market value of that support must be
determined.
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\200\ Under present and prior law, in the case of a son, daughter,
stepson, or stepdaughter of the taxpayer who is a full-time student,
scholarships are not taken into account for the support test. Sec.
152(d) (prior to amendment by the Act).
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Multiple support agreements.--In some cases, no one
taxpayer provides more than one half of the support of an
individual. Instead, two or more taxpayers, each of whom would
be able to claim a dependency exemption but for the support
test, together provide more than one half of the individual's
support. If this occurs, under prior law (and in cases under
present law where support remains relevant) the taxpayers may
agree to designate that one of the taxpayers who individually
provides more than 10 percent of the individual's support can
claim a dependency exemption for the child. Each of the others
must sign a written statement agreeing not to claim the
exemption for that year. The statements must be filed with the
income tax return of the taxpayer who claims the exemption.
Special rules for divorced or legally separated parents.--
Under present and prior law, special rules apply in the case of
a child of divorced or legally separated parents (or parents
who live apart at all times during the last six months of the
year) who provide over one half the child's support during the
calendar year.\201\ If such a child is in the custody of one or
both of the parents for more than one half of the year, then
the parent having custody for the greater portion of the year
is deemed to satisfy the support test; however, the custodial
parent may release the dependency exemption to the noncustodial
parent by filing a written declaration with the IRS.\202\
Special support rules also apply in the case of certain pre-
1985 agreements between divorced or legally separated parents.
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\201\ For purposes of this rule, a ``child'' means a son, daughter,
stepson, or stepdaughter (including an adopted child or foster child,
or child placed with the taxpayer for adoption). Sec. 152(e)(1)(A)
(prior to amendment by the Act).
\202\ Sec. 152(e)(4) (prior to amendment by the Act).
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Gross income test
In general, under prior law (and in certain cases under
present law), an individual may not be claimed as a dependent
of a taxpayer if the individual has gross income that is at
least equal to the personal exemption amount for the taxable
year.\203\ Under prior law, if the individual was the child of
the taxpayer and under age 19 (or under age 24, if a full-time
student), the gross income test did not apply.\204\ For
purposes of this prior-law rule, a ``child'' means a son,
daughter, stepson, or stepdaughter (including an adopted child
of the taxpayer, a foster child who resides with the taxpayer
for the entire year, or a child placed with the taxpayer for
adoption by an authorized adoption agency).
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\203\ Certain income from sheltered workshops is not taken into
account in determining the gross income of permanently and totally
disabled individuals. Sec. 151(c)(5) (prior to amendment by the Act).
\204\ Sec. 151(c). The IRS has issued guidance stating that for
purposes of the dependency exemption, an individual attains a specified
age on the anniversary of the date that the child was born (e.g., a
child born on January 1, 1987, attains the age of 17 on January 1,
2004). Rev. Rul. 2003-72, 2003-33 I.R.B. 346.
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Earned income credit \205\
In general
In general, the earned income credit is a refundable credit
for low-income workers. The amount of the credit depends on the
earned income of the taxpayer and whether the taxpayer has one,
more than one, or no ``qualifying children.'' Under present and
prior law, in order to be a qualifying child for the earned
income credit, an individual must satisfy a relationship test,
a residency test, and an age test. In addition, the name, age,
and taxpayer identification number of the qualifying child must
be included on the return.
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\205\ Sec. 32.
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Relationship test
Under prior law, an individual satisfied the relationship
test under the earned income credit if the individual was the
taxpayer's: (1) son, daughter, stepson, or stepdaughter, or a
descendant of any such individual;\206\ (2) brother, sister,
stepbrother, or stepsister, or a descendant of any such
individual, who the taxpayer cared for as the taxpayer's own
child; or (3) eligible foster child. An eligible foster child
was an individual (1) who was placed with the taxpayer by an
authorized placement agency, and (2) who the taxpayer cared for
as her or his own child. Under present and prior law, 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 or would
be entitled to the exemption if the taxpayer had not waived the
exemption to the noncustodial parent.\207\
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\206\ 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).
\207\ Sec. 32(c)(3)(B).
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Residency test
Under present and prior law, the residency test is
satisfied if the individual has the same principal place of
abode as the taxpayer for more than one half of the taxable
year. The residence must be in the United States.\208\
Temporary absences due to special circumstances, including
absences due to illness, education, business, vacation, and
military service are not treated as absences for purposes of
determining whether the residency test is satisfied.\209\ Under
the earned income credit, there is no requirement that the
taxpayer maintain the household in which the taxpayer and the
qualifying individual reside.
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\208\ The principal place of abode of a member of the Armed
Services is treated as in the United States during any period during
which the individual is stationed outside the United States on active
duty. Sec. 32(c)(4).
\209\ IRS Publication 596, Earned Income Credit (EIC), at 14. H.R.
Rep. No. 101-964 (October 27, 1990), at 1037.
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Age test
Under present and prior law, in general, the age test is
satisfied if the individual has not attained age 19 as of the
close of the calendar year.\210\ In the case of a full-time
student, the age test is satisfied if the individual has not
attained age 24 as of the close of the calendar year. In the
case of an individual who is permanently and totally disabled,
no age limit applies.
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\210\ The IRS has issued guidance stating that for purposes of the
earned income credit, an individual attains a specified age on the
anniversary of the date that the child was born (e.g., a child born on
January 1, 1987, attains the age of 17 on January 1, 2004). Rev. Rul.
2003-72, 2003-33 I.R.B. 346.
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Child credit \211\
Taxpayers with incomes below certain amounts are eligible
for a child credit for each qualifying child of the taxpayer.
The amount of the child credit is up to $1,000, in the case of
taxable years beginning before 2011, and then declines to $500
in taxable year 2011.\212\ Under prior law, for purposes of
this credit, a qualifying child was an individual: (1) with
respect to whom the taxpayer was entitled to a dependency
exemption for the year; (2) who satisfied the same relationship
test applicable to the earned income credit; and (3) who had
not attained age 17 as of the close of the calendar year.\213\
In addition, under present and prior law, the child must be a
citizen or resident of the United States.\214\ A portion of the
child credit is refundable under certain circumstances.\215\
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\211\ Sec. 24.
\212\ EGTRRA, Pub. L. No. 107-16, sec. 901(a) (2001). Prior to
enactment of the Act, the maximum credit was $700 for taxable years
2005-2008, and $800 for taxable years beginning in 2009.
\213\ The IRS has issued guidance stating that for purposes of the
child credit, an individual attains a specified age on the anniversary
of the date that the child was born (e.g., a child born on January 1,
1987, attains the age of 17 on January 1, 2004). Rev. Rul. 2003-72,
2003-33 I.R.B. 346.
\214\ Under present and prior law, the child credit does not apply
with respect to a child who is a resident of Canada or Mexico and is
not a U.S. citizen, even if a dependency exemption is available with
respect to the child. Sec. 24(c)(2). The child credit is, however,
available with respect to a child dependent who is not a resident or
citizen of the United States if: (1) the child has been legally adopted
by the taxpayer; (2) the child's principal place of abode is the
taxpayer's home; and (3) the taxpayer is a U.S. citizen or national.
See sec. 24(c)(2) and sec. 152(b)(3).
\215\ Sec. 24(d).
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Dependent care credit \216\
Under prior law, the dependent care credit could be claimed
by a taxpayer who maintained a household that included one or
more qualifying individuals and who had employment-related
expenses. Under prior law, a qualifying individual included (1)
a dependent of the taxpayer under age 13 for whom the taxpayer
was entitled to a dependency exemption,\217\ (2) a dependent of
the taxpayer who was physically or mentally incapable of caring
for himself or herself,\218\ or (3) the spouse of the taxpayer,
if the spouse was physically or mentally incapable of caring
for himself or herself. In addition, under present and prior
law, a taxpayer identification number for the qualifying
individual must be included on the return.
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\216\ Sec. 21.
\217\ The IRS has issued guidance stating that for purposes of the
dependent care credit, an individual attains a specified age on the
anniversary of the date that the child was born (e.g., a child born on
January 1, 1987, attains the age of 17 on January 1, 2004). Rev. Rul.
2003-72, 2003-33 I.R.B. 346.
\218\ Although such an individual must have been a dependent of the
taxpayer as defined in section 152, it was not required that the
taxpayer be entitled to a dependency exemption with respect to the
individual under section 151. Thus, such an individual may have been a
qualifying individual for purposes of the dependent care credit, even
though the taxpayer was not entitled to a dependency exemption because
the individual did not meet the gross income test.
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Under prior law, a taxpayer was considered to maintain a
household for a period if over one half the cost of maintaining
the household for the period was furnished by the taxpayer (or,
if married, the taxpayer and his or her spouse). Costs of
maintaining the household included expenses such as rent,
mortgage interest (but not principal), real estate taxes,
insurance on the home, repairs (but not home improvements),
utilities, and food eaten in the home.
Under present and prior law, a special rule applies in the
case of a child who is under age 13 or is physically or
mentally incapable of caring for himself or herself if the
custodial parent has waived his or her dependency exemption to
the noncustodial parent.\219\ For the dependent care credit,
such a child is treated as a qualifying individual with respect
to the custodial parent, not the parent entitled to claim the
dependency exemption.
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\219\ Sec. 21(e)(5).
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Head of household filing status \220\
Under prior law, a taxpayer could claim head of household
filing status if the taxpayer was unmarried (and not a
surviving spouse) and paid more than one half of the cost of
maintaining as his or her home a household which was the
principal place of abode for more than one half of the year of
(1) an unmarried son, daughter, stepson or stepdaughter of the
taxpayer or an unmarried descendant of the taxpayer's son or
daughter, (2) an individual described in (1) who is married, if
the taxpayer may claim a dependency exemption with respect to
the individual (or could claim the exemption if the taxpayer
had not waived the exemption to the noncustodial parent), or
(3) a relative with respect to whom the taxpayer may claim a
dependency exemption.\221\ Under present and prior law, if
certain other requirements are satisfied, head of household
filing status also may be claimed if the taxpayer is entitled
to a dependency exemption with respect to one of the taxpayer's
parents.
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\220\ Sec. 2(b).
\221\ Sec. 2(b)(1)(A)(ii), as qualified by sec. 2(b)(3)(B). An
individual for whom the taxpayer is entitled to claim a dependency
exemption by reason of a multiple support agreement does not qualify
the taxpayer for head of household filing status.
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Reasons for Change \222\
Prior law contained five commonly used provisions that
provided benefits to taxpayers with children: (1) the
dependency exemption; (2) the child credit; (3) the earned
income credit; (4) the dependent care credit; and (5) head of
household filing status. Each provision had separate criteria
for determining whether the taxpayer qualified for the
applicable tax benefit with respect to a particular child. The
separate criteria included factors such as the relationship (if
any) the child must bear to the taxpayer, the age of the child,
and whether the child must live with the taxpayer. Thus, a
taxpayer was required to apply different definitions to the
same individual when determining eligibility for these
provisions, and an individual who qualified a taxpayer for one
provision did not automatically qualify the taxpayer for
another provision. The use of different tests to determine
whether a taxpayer may claim one or more of these tax benefits
with respect to a child caused complexity for taxpayers and the
IRS. The different tests relating to qualifying children were a
source of errors for taxpayers both because the rules for each
provision were different and because of the complexity of
particular rules. The variety of rules caused taxpayers
inadvertently to claim tax benefits for which they did not
qualify, as well as to fail to claim tax benefits for which
they did qualify. Adopting a uniform definition of qualifying
child for five commonly used provisions (the dependency
exemption, the child credit, the earned income credit, the
dependent care credit, and head of household filing status)
achieves simplification by making it easier for taxpayers to
determine whether they qualify for the various tax benefits
relating to children, reduces inadvertent taxpayer errors
arising from confusion due to differing rules, and makes the
applicable provisions easier for the IRS to administer.
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\222\ See S. 882, the ``Tax Administration Good Government Act,''
which was reported by the Senate Committee on Finance on May 4, 2004
(S. Rep. No. 108-257).
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Explanation of Provision
In general
In general
The Act establishes a uniform definition of qualifying
child for purposes of the dependency exemption, the child
credit, the earned income credit, the dependent care credit,
and head of household filing status. A taxpayer generally may
claim an individual who does not meet the uniform definition of
qualifying child (with respect to any taxpayer) as a dependent
if the present-law dependency requirements are satisfied. The
Act generally does not modify other parameters of each tax
benefit (e.g., the earned income requirements of the earned
income credit) or the rules for determining whether individuals
other than children of the taxpayer qualify for each tax
benefit.
Under the uniform definition, in general, a child is a
qualifying child of a taxpayer if the child satisfies each of
three tests: (1) the child has the same principal place of
abode as the taxpayer for more than one half the taxable year;
(2) the child has a specified relationship to the taxpayer; and
(3) the child has not yet attained a specified age. A tie-
breaking rule applies if more than one taxpayer claims a child
as a qualifying child.
Under the Act, the present-law support and gross income
tests for determining whether an individual is a dependent
generally do not apply to a child who meets the requirements of
the uniform definition of qualifying child.
Residency test
Under the uniform definition's residency test, a child must
have the same principal place of abode as the taxpayer for more
than one half of the taxable year. It is intended that, as is
the case under present law, temporary absences due to special
circumstances, including absences due to illness, education,
business, vacation, or military service, are not treated as
absences.
Relationship test
In order to be a qualifying child under the Act, the child
must be the taxpayer's son, daughter, stepson, stepdaughter,
brother, sister, stepbrother, stepsister, or a descendant of
any such individual. The Act modifies the definition of adopted
child, for purposes of determining whether an adopted child is
treated as a child by blood, to mean an individual who is
legally adopted by the taxpayer, or an individual who is
lawfully placed with the taxpayer for legal adoption by the
taxpayer. A foster child who is placed with the taxpayer by an
authorized placement agency or by judgment, decree, or other
order of any court of competent jurisdiction is treated as the
taxpayer's child.\223\
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\223\ The Act eliminates the present-law rule requiring that if a
child is the taxpayer's sibling or stepsibling or a descendant of any
such individual, the taxpayer must care for the child as if the child
were his or her own child.
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Age test
Under the Act, the age test varies depending upon the tax
benefit involved. In general, a child must be under age 19 (or
under age 24 in the case of a full-time student) in order to be
a qualifying child.\224\ In general, no age limit applies with
respect to individuals who are totally and permanently disabled
within the meaning of section 22(e)(3) at any time during the
calendar year. The Act retains the present-law requirements
that a child must be under age 13 (if he or she is not
disabled) for purposes of the dependent care credit, and under
age 17 (whether or not disabled) for purposes of the child
credit.
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\224\ The Act retains the present-law definition of full-time
student set forth in section 151(c)(4).
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Children who support themselves
Under the Act, a child who provides over one half of his or
her own support generally is not considered a qualifying child
of another taxpayer. The Act retains the present-law rule,
however, that a child who provides over one half of his or her
own support may constitute a qualifying child of another
taxpayer for purposes of the earned income credit.
Tie-breaking rules
If a child would be a qualifying child with respect to more
than one individual (e.g., a child lives with his or her mother
and grandmother in the same residence) and more than one person
claims a benefit with respect to that child, then the following
``tie-breaking'' rules apply. First, if only one of the
individuals claiming the child as a qualifying child is the
child's parent, the child is deemed the qualifying child of the
parent. Second, if both parents claim the child and the parents
do not file a joint return, then the child is deemed a
qualifying child first with respect to the parent with whom the
child resides for the longest period of time, and second with
respect to the parent with the highest adjusted gross income.
Third, if the child's parents do not claim the child, then the
child is deemed a qualifying child with respect to the claimant
with the highest adjusted gross income.
Interaction with present-law rules
Taxpayers generally may claim an individual who does not
meet the uniform definition of qualifying child with respect to
any taxpayer as a dependent if the present-law dependency
requirements (including the gross income and support tests) are
satisfied.\225\ Thus, for example, as under present law, a
taxpayer may claim a parent as a dependent if the taxpayer
provides more than one half of the support of the parent and
the parent's gross income is less than the exemption amount. As
another example, under the Act a grandparent may claim a
dependency exemption with respect to a grandson who does not
reside with any taxpayer for over one half the year, if the
grandparent provides more than one half of the support of the
grandson and the grandson's gross income is less than the
exemption amount.
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\225\ Individuals who satisfy the present-law dependency tests and
who are not qualifying children are referred to as ``qualifying
relatives'' under the Act.
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Citizenship and residency
Children who are U.S. citizens living abroad or non-U.S.
citizens living in Canada or Mexico may qualify as a qualifying
child, as is the case under the present-law dependency tests. A
legally adopted child who does not satisfy the residency or
citizenship requirement may nevertheless qualify as a
qualifying child (provided other applicable requirements are
met) if (1) the child's principal place of abode is the
taxpayer's home and (2) the taxpayer is a citizen or national
of the United States.
Children of divorced or legally separated parents
The Act retains the present-law rule that allows a
custodial parent to release the claim to a dependency exemption
(and, therefore, the child credit) to a noncustodial
parent.\226\ Thus, under the Act, custodial waivers that are in
place and effective on the date of enactment will continue to
be effective after the date of enactment if they continue to
satisfy the waiver rule. In addition, the Act retains the
custodial waiver rule for purposes of the dependency exemption
(and, therefore, the child credit) for decrees of divorce or
separate maintenance or written separation agreements that
become effective after the date of enactment. Under the Act, as
under present law, the custodial waiver rules do not affect
eligibility with respect to children of divorced or legally
separated parents for purposes of the earned income credit, the
dependent care credit, and head of household filing status.
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\226\ A technical correction may be necessary so that the statute
reflects this intent.
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While retaining the substantive effect of the present-law
waiver provisions, the Act modifies the mechanical structure of
the rules. Under present law, a waiver may be made with respect
to the dependency exemption. The waiver then automatically
carries over to the child credit, because in order to claim the
child credit, the taxpayer must be allowed the dependency
exemption with respect to the child. Thus, if the dependency
exemption is waived, the child credit applies to the taxpayer
who is allowed the dependency exemption under the waiver.
The Act obtains the same result, but through a slightly
modified statutory structure. Under the Act, if a waiver is
made, the waiver applies for purposes of determining whether a
child meets the definition of a qualifying child or a
qualifying relative under section 152(c) or 152(d) as amended
by the provision. While the definition of qualifying child is
generally uniform, for purposes of the earned income credit,
head of household status, and the dependent care credit, the
definition of qualifying child is made without regard to the
waiver provision.\227\ Thus, as under present law, a waiver
that applies for the dependency exemption will also apply for
the child credit, and the waiver will not apply for purposes of
the other provisions.
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\227\ See secs. 2(b)(1)(A)(i) and 32(c)(3)(A) as amended by the
Act, and sec. 21(e)(5).
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Other provisions
The Act retains the applicable present-law requirements
that a taxpayer identification number for a child be provided
on the taxpayer's return. For purposes of the earned income
credit, a qualifying child is required to have a social
security number that is valid for employment in the United
States (that is, the child must be a U.S. citizen, permanent
resident, or have a certain type of temporary visa).
Effect on particular tax benefits
Dependency exemption
For purposes of the dependency exemption, the Act defines a
dependent as a qualifying child or a qualifying relative. The
qualifying child test eliminates the support test (other than
in the case of a child who provides more than one half of his
or her own support), and replaces it with the residency
requirement described above. Further, the present-law gross
income test does not apply to a qualifying child. The rules
relating to multiple support agreements do not apply with
respect to qualifying children because the support test does
not apply to them. Special tie-breaking rules (described above)
apply if more than one taxpayer claims a qualifying child under
the Act. These tie-breaking rules do not apply if a child
constitutes a qualifying child with respect to multiple
taxpayers, but only one eligible taxpayer actually claims the
qualifying child.
The Act generally permits taxpayers to continue to apply
the present-law dependency exemption rules to claim a
dependency exemption for a qualifying relative who does not
satisfy the qualifying child definition. In such cases, the
present-law gross income and support tests, including the
special rules for multiple support agreements, the special
rules relating to income of handicapped dependents, and the
special support test in case of students, continue to apply for
purposes of the dependency exemption.
As is the case under present law, a child who provides over
half of his or her own support is not considered a dependent of
another taxpayer under the Act. Further, an individual shall
not be treated as a dependent of any taxpayer if such
individual has filed a joint return with the individual's
spouse for the taxable year.
Earned income credit
In general, the Act adopts a definition of qualifying child
that is similar to the present-law definition under the earned
income credit. The present-law requirement that a foster child
and certain other children be cared for as the taxpayer's own
child is eliminated. The present-law tie-breaker rule
applicable to the earned income credit is used for purposes of
the uniform definition of qualifying child. The Act retains the
present-law requirement that the taxpayer's principal place of
abode must be in the United States.
Child credit
The present-law child credit generally uses the same
relationships to define an eligible child as the uniform
definition. The present-law requirement that a foster child and
certain other children be cared for as the taxpayer's own child
is eliminated. The age limitation under the Act retains the
present-law requirement that the child must be under age 17,
regardless of whether the child is disabled.
Dependent care credit
The present-law requirement that a taxpayer maintain a
household in order to claim the dependent care credit is
eliminated. Thus, if other applicable requirements are
satisfied, a taxpayer may claim the dependent care credit with
respect to a child who lives with the taxpayer for more than
one half the year, even if the taxpayer does not provide more
than one half of the cost of maintaining the household.
The rules for determining eligibility for the credit with
respect to an individual who is physically or mentally
incapable of caring for himself or herself are amended to
include a requirement that the taxpayer and the dependent have
the same principal place of abode for more than one half the
taxable year.
Head of household filing status
Under the Act, a taxpayer is eligible for head of household
filing status only with respect to a qualifying child or an
individual for whom the taxpayer is entitled to a dependency
exemption. Under the Act, a taxpayer may claim head of
household filing status if the taxpayer is unmarried (and not a
surviving spouse) and pays more than one half of the cost of
maintaining as his or her home a household which is the
principal place of abode for more than one half the year of (1)
a qualifying child, or (2) an individual for whom the taxpayer
may claim a dependency exemption. As under present law, a
taxpayer may claim head of household status with respect to a
parent for whom the taxpayer may claim a dependency exemption
and who does not live with the taxpayer, if certain
requirements are satisfied.
Technical and conforming amendments
The Act makes a number of technical and conforming
amendments regarding the change in the definition of dependent
for other purposes of the Code. The conforming amendments
provide that an individual may qualify as a dependent for
certain purposes (e.g., sec. 105, sec. 125, and sec. 213)
without regard to whether the individual has gross income that
exceeds an otherwise applicable gross income limitation or is
married and files a joint return. In addition, an individual
who is treated as a dependent under the conforming amendment
provisions generally is not subject to the general rule that a
dependent of a taxpayer shall be treated as having no
dependents for the taxable year of such individual beginning in
such calendar year.\228\
---------------------------------------------------------------------------
\228\ A technical correction may be necessary so that the statute
reflects this intent with respect to certain other provisions of the
Code, such as with respect to health savings accounts (sec.
223(d)(2)(A)), and the dependent care credit and dependent care
assistance programs (sec. 21(b)(1)(B)).
---------------------------------------------------------------------------
Effective Date
The provision is effective for taxable years beginning
after December 31, 2004.
III. EXTENSIONS OF CERTAIN EXPIRING PROVISIONS
A. Extension of the Research Credit (sec. 301 of the Act and sec. 41 of
the Code)
Present and Prior Law
Section 41 provided a research tax credited equal to 20
percent of the amount by which a taxpayer's qualified research
expenses for a taxable year exceeded its base amount for that
year. Taxpayers were permitted to elect an alternative
incremental research credit regime in which the taxpayer was
assigned a three-tiered fixed-base percentage and the credit
rate likewise was reduced. Under the alternative credit regime,
a credit rate of 2.65 percent applied to the extent that a
taxpayer's current-year research expenses exceed a base amount
computed by using a fixed-base percentage of one percent but do
not exceed a base amount computed by using a fixed-base
percentage of 1.5 percent. A credit rate of 3.2 percent applied
to the extent that a taxpayer's current-year research expenses
exceeded a base amount computed by using a fixed-base
percentage of 1.5 percent but did not exceed a base amount
computed by using a fixed-base percentage of two percent. A
credit rate of 3.75 percent applied to the extent that a
taxpayer's current-year research expenses exceeded a base
amount computed by using a fixed-base percentage of two
percent.
A 20-percent research tax credit also applied to the excess
of (1) 100 percent of corporate cash expenses (including grants
or contributions) paid for basic research conducted by
universities (and certain nonprofit scientific research
organizations) over (2) the sum of (a) the greater of two
minimum basic research floors plus (b) an amount reflecting any
decrease in nonresearch giving to universities by the
corporation as compared to such giving during a fixed-base
period, as adjusted for inflation.
The research tax credit expired and generally does not
apply to amounts paid or incurred after June 30, 2004.
Reasons for Change \229\
The Congress acknowledged that research is important to the
economy. Research is the basis of new products, new services,
new industries, and new jobs for the domestic economy.
Therefore the Congress believed it was appropriate to extend
the prior-law research credit.
---------------------------------------------------------------------------
\229\ See H.R. 4520, the ``American Jobs Creation Act of 2004'',
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act extends the prior-law research credit to qualified
amounts paid or incurred before January 1, 2006.
Effective Date
The provision is effective for amounts paid or incurred
after June 30, 2004.
B. Extension of Parity in the Application of Certain Limits to Mental
Health Benefits (sec. 302 of the Act, sec. 9812 of the Code, sec. 712
of ERISA, and section 2705 of the PHSA)
Present and Prior Law
The Mental Health Parity Act of 1996 amended the Employee
Retirement Income Security Act of 1974 (``ERISA'') and the
Public Health Service Act (``PHSA'') to provide that group
health plans that provide both medical and surgical benefits
and mental health benefits cannot impose aggregate lifetime or
annual dollar limits on mental health benefits that are not
imposed on substantially all medical and surgical benefits. The
provisions of the Mental Health Parity Act were initially
effective with respect to plan years beginning on or after
January 1, 1998, for a temporary period. Since enactment, the
mental health parity requirements in ERISA and the PHSA have
been extended on more than one occasion and currently are
scheduled to expire with respect to benefits for services
furnished on or after December 31, 2004.
The Taxpayer Relief Act of 1997 added to the Code the
requirements imposed under the Mental Health Parity Act, and
imposed an excise tax on group health plans that fail to meet
the requirements. The excise tax is equal to $100 per day
during the period of noncompliance and is generally imposed on
the employer sponsoring the plan if the plan fails to meet the
requirements. The maximum tax that can be imposed during a
taxable year cannot exceed the lesser of 10 percent of the
employer's group health plan expenses for the prior year or
$500,000. No tax is imposed if the Secretary determines that
the employer did not know, and exercising reasonable diligence
would not have known, that the failure existed.
The Code provisions were initially effective with respect
to plan years beginning on or after January 1, 1998, for a
temporary period.\230\ The Code provisions have been extended
on a number of occasions, and, under prior law, expired with
respect to benefits for services furnished after December 31,
2003.
---------------------------------------------------------------------------
\230\ The excise tax does not apply to benefits for services
furnished on or after September 30, 2001, and before January 10, 2002.
---------------------------------------------------------------------------
Reasons for Change \231\
The Congress recognized that the Code provisions relating
to mental health parity are important to carrying out the
purposes of the Mental Health Parity Act. Thus, the Congress
believed that extending the Code provisions relating to mental
health parity was warranted.
---------------------------------------------------------------------------
\231\ See H.R. 4520, the American Jobs Creation Act of 2004, which
was reported by the House Committee on Ways and Means on June 16, 2004
(H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act extends the ERISA and PHSA provisions relating to
mental health parity to benefits for services furnished before
January 1, 2006. The Act also extends the Code provisions
relating to mental health parity to benefits for services
furnished on or after the date of enactment and before January
1, 2006. Thus, the excise tax on failures to meet the
requirements imposed by the Code provisions does not apply
after December 31, 2003, and before the date of enactment.
Effective Date
The provision is effective on the date of enactment
(October 4, 2004).
C. Extension of the Work Opportunity Tax Credit (sec. 303 of the Act
and sec. 51 of the Code)
Present and Prior Law
Work opportunity tax credit
Targeted groups eligible for the credit
The work opportunity tax credit is available on an elective
basis for employers hiring individuals from one or more of
eight targeted groups. The eight targeted groups are: (1)
certain families eligible to receive benefits under the
Temporary Assistance for Needy Families Program; (2) high-risk
youth; (3) qualified ex-felons; (4) vocational rehabilitation
referrals; (5) qualified summer youth employees; (6) qualified
veterans; (7) families receiving food stamps; and (8) persons
receiving certain Supplemental Security Income (SSI) benefits.
A qualified ex-felon is an individual certified as: (1)
haven been convicted of a felony under State or Federal law;
(2) being a member of an economically disadvantaged family; and
(3) having a hiring date within one year of release from prison
or conviction.
Qualified wages
Generally, qualified wages are defined as cash wages paid
by the employer to a member of a targeted group. The employer's
deduction for wages is reduced by the amount of the credit.
Calculation of the credit
The credit equals 40 percent (25 percent for employment of
400 hours or less) of qualified first-year wages. Generally,
qualified first-year wages are qualified wages (not in excess
of $6,000) attributable to service rendered by a member of a
targeted group during the one-year period beginning with the
day the individual began work for the employer. Therefore, the
maximum credit per employee is $2,400 (40 percent of the first
$6,000 of qualified first-year wages). With respect to
qualified summer youth employees, the maximum credit is $1,200
(40 percent of the first $3,000 of qualified first-year wages).
Minimum employment period
No credit is allowed for qualified wages paid to employees
who work less than 120 hours in the first year of employment.
Coordination of the work opportunity tax credit and the welfare-to-work
tax credit
An employer cannot claim the work opportunity tax credit
with respect to wages of any employee on which the employer
claims the welfare-to-work tax credit.
Other rules
The work opportunity tax credit is not allowed for wages
paid to a relative or dependent of the taxpayer. Similarly
wages paid to replacement workers during a strike or lockout
are not eligible for the work opportunity tax credit. Wages
paid to any employee during any period for which the employer
received on-the-job training program payments with respect to
that employee are not eligible for the work opportunity tax
credit. The work opportunity tax credit generally is not
allowed for wages paid to individuals who had previously been
employed by the employer. In addition, many other technical
rules apply.
Expiration date
Under prior law, the credit is effective for wages paid or
incurred to a qualified individual who begins work for an
employer before January 1, 2004.
Reasons for Change \232\
---------------------------------------------------------------------------
\232\ See H.R. 4520, the ``American Jobs Creation Act of 2004'',
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
The Congress believed that a temporary extension of this
credit will allow the Congress and the Treasury and Labor
Departments to continue to examine the effectiveness of the
credit in expanding employment opportunities among the eight
targeted groups.
Explanation of Provision
The Act extends the work opportunity tax credit for two
years (through December 31, 2005).
Effective Date
The extension of the work opportunity tax credit is
effective for wages paid or incurred for individuals beginning
work after December 31, 2003.
D. Extension of the Welfare-to-Work Tax Credit (sec. 303 of the Act and
sec. 51A of the Code)
Present and Prior Law
Welfare-to-work tax credit
Targeted group eligible for the credit
The welfare-to-work tax credit is available on an elective
basis to employers of qualified long-term family assistance
recipients. Qualified long-term family assistance recipients
are: (1) members of a family that has received family
assistance for at least 18 consecutive months ending on the
hiring date; (2) members of a family that has received such
family assistance for a total of at least 18 months (whether or
not consecutive) after August 5, 1997 (the date of enactment of
the welfare-to-work tax credit) if they are hired within 2
years after the date that the 18-month total is reached; and
(3) members of a family who are no longer eligible for family
assistance because of either Federal or State time limits, if
they are hired within 2 years after the Federal or State time
limits made the family ineligible for family assistance.
Qualified wages
Qualified wages for purposes of the welfare-to-work tax
credit are defined more broadly than for purposes of the work
opportunity tax credit. Unlike the definition of wages for the
work opportunity tax credit which includes simply cash wages,
the definition of wages for the welfare-to-work tax credit
includes cash wages paid to an employee plus amounts paid by
the employer for: (1) educational assistance excludable under a
section 127 program (or that would be excludable but for the
expiration of sec. 127); (2) health plan coverage for the
employee, but not more than the applicable premium defined
under section 4980B(f)(4); and (3) dependent care assistance
excludable under section 129. The employer's deduction for
wages is reduced by the amount of the credit.
Calculation of the credit
The welfare-to-work tax credit is available on an elective
basis to employers of qualified long-term family assistance
recipients during the first two years of employment. The
maximum credit is 35 percent of the first $10,000 of qualified
first-year wages and 50 percent of the first $10,000 of
qualified second-year wages. Qualified first-year wages are
defined as qualified wages (not in excess of $10,000)
attributable to service rendered by a member of the targeted
group during the one-year period beginning with the day the
individual began work for the employer. Qualified second-year
wages are defined as qualified wages (not in excess of $10,000)
attributable to service rendered by a member of the targeted
group during the one-year period beginning immediately after
the first year of that individual's employment for the
employer. The maximum credit is $8,500 per qualified employee.
Minimum employment period
No credit is allowed for qualified wages paid to a member
of the targeted group who does not work at least 400 hours or
180 days in the first year of employment.
Coordination of the work opportunity tax credit and the welfare-to-work
tax credit
An employer cannot claim the work opportunity tax credit
with respect to wages of any employee on which the employer
claims the welfare-to-work tax credit.
Other rules
The welfare-to-work tax credit incorporates directly or by
reference many of these other rules contained on the work
opportunity tax credit.
Expiration date
Under prior law, the welfare to work credit is effective
for wages paid or incurred to a qualified individual who begins
work for an employer before January 1, 2004.
Reasons for Change \233\
The Congress believed that the welfare-to-work credit
should be temporarily extended to provide the Congress and
Treasury and Labor Departments a better opportunity to continue
to assess the operation and effectiveness of the credit in
meeting its goals. These goals are: (1) to provide an incentive
to hire long-term welfare recipients; (2) to promote the
transition from welfare to work by increasing access to
employment for these individuals; and (3) to encourage
employers to provide these individuals with training, health
coverage, dependent care and ultimately better job attachment.
---------------------------------------------------------------------------
\233\ See H.R. 4520, the ``American Jobs Creation Act of 2004'',
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act extends the welfare-to-work tax credit for two
years (through December 31, 2005).
Effective Date
The extension of the welfare-to-work tax credit is
effective for wages paid or incurred for individuals beginning
work after December 31, 2003.
E. Qualified Zone Academy Bonds (sec. 304 of the Act and sec. 1397E of
the Code)
Present and Prior Law
Generally, ``qualified zone academy bonds'' are bonds
issued by a State or local government, provided that at least
95 percent of the proceeds are used for one or more qualified
purposes with respect to a ``qualified zone academy'' and
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.
Qualified purposes with respect to any qualified zone academy
are (1) rehabilitating or repairing the public school facility
in which the academy is established, (2) providing equipment
for use at such academy, (3) developing course materials for
education at such academy, and (4) training teachers and other
school personnel. A total of $400 million of qualified zone
academy bonds was authorized to be issued annually in calendar
years 1998 through December 31, 2003.
Reasons for Change \234\
The Congress believed that extension of authority to issue
qualified zone academy bonds was appropriate in light of the
educational needs that exist today.
---------------------------------------------------------------------------
\234\ See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act extends the authority to issue qualified zone
academy bonds through 2005.
Effective Date
The provision is effective for obligations issued after
December 31, 2003.
F. Extension of Cover Over of Excise Tax on Distilled Spirits to Puerto
Rico and Virgin Islands (sec. 305 of the Act and sec. 7652 of the Code)
Present and Prior Law
A $13.50 per proof gallon (a proof gallon is a liquid
gallon consisting of 50 percent alcohol) excise tax is imposed
on distilled spirits produced in or imported into the United
States.
The Code provides for cover over (payment) to Puerto Rico
and the Virgin Islands of the excise tax imposed on rum
imported into the United States, without regard to the country
of origin. The amount of the cover over is generally limited
under section 7652(f) to $10.50 per proof gallon. However, the
limitation is increased to $13.25 per proof gallon during the
period July 1, 1999 through December 31, 2003.
Thus, tax amounts attributable to rum produced in Puerto
Rico are covered over to Puerto Rico. Tax amounts attributable
to rum produced in the Virgin Islands are covered over to the
Virgin Islands. Tax amounts attributable to rum produced in
neither Puerto Rico nor the Virgin Islands are divided and
covered over to the two possessions under a formula. All of the
amounts covered over are subject to the limitation.
Reasons For Change \235\
The Congress believed that the needs of Puerto Rico and the
Virgin Islands justified the extension of the cover over amount
of $13.25 per proof gallon through December 31, 2005.
---------------------------------------------------------------------------
\235\ See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act temporarily suspends the $10.50 per proof gallon
limitation on the amount of excise taxes on rum covered over to
Puerto Rico and the Virgin Islands. Under the Act, the cover
over amount of $13.25 per proof gallon is extended for rum
brought into the United States after December 31, 2003 and
before January 1, 2006. After December 31, 2005, the cover over
amount reverts to $10.50 per proof gallon.
Effective Date
The provision is effective for articles brought into the
United States after December 31, 2003.
G. Charitable Contributions of Computer Technology and Equipment Used
for Educational Purposes (sec. 306 of the Act and sec. 170 of the Code)
Present and Prior Law
A deduction by a corporation for charitable contributions
of computer technology and equipment generally is limited to
the corporation's basis in the property. However, certain
corporations may claim a deduction in excess of basis for a
qualified computer contribution. Under prior law, such enhanced
deduction expired for contributions made during any taxable
year beginning after December 31, 2003.
Reasons for Change \236\
The Congress believed that educational organizations and
public libraries continue to have a need for computer equipment
and that it was appropriate to extend the enhanced deduction
for contributions of such equipment to such institutions.
---------------------------------------------------------------------------
\236\ See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act extends the enhanced deduction for qualified
computer contributions to contributions made during any taxable
year beginning before January 1, 2006.
Effective Date
The provision is effective for taxable years beginning
after December 31, 2003.
H. Certain Expenses of Elementary and Secondary School Teachers (sec.
307 of the Act and sec. 62 of the Code)
Present and Prior Law
In general, ordinary and necessary business expenses are
deductible (sec. 162). However, in general, unreimbursed
employee business expenses are deductible only as an itemized
deduction and only to the extent that the individual's total
miscellaneous deductions (including employee business expenses)
exceed two percent of adjusted gross income. An individual's
otherwise allowable itemized deductions may be further limited
by the overall limitation on itemized deductions, which reduces
itemized deductions for taxpayers with adjusted gross income in
excess of a threshold amount. In addition, miscellaneous
itemized deductions are not allowable under the alternative
minimum tax.
Certain expenses of eligible educators are allowed an
above-the-line deduction. Specifically, for taxable years
beginning in 2002 and 2003, an above-the-line deduction is
allowed for up to $250 annually of expenses paid or incurred by
an eligible educator for books, supplies (other than
nonathletic supplies for courses of instruction in health or
physical education), computer equipment (including related
software and services) and other equipment, and supplementary
materials used by the eligible educator in the classroom. To be
eligible for this deduction, the expenses must be otherwise
deductible under 162 as a trade or business expense. A
deduction is allowed only to the extent the amount of expenses
exceeds the amount excludable from income under section 135
(relating to education savings bonds), 529(c)(1) (relating to
qualified tuition programs), and section 530(d)(2) (relating to
Coverdell education savings accounts).
An eligible educator is a kindergarten through grade 12
teacher, instructor, counselor, principal, or aide in a school
for at least 900 hours during a school year. A school means any
school which provides elementary education or secondary
education, as determined under State law.
Under prior law, the above-the-line deduction for eligible
educators was not allowed for taxable years beginning after
December 31, 2003.
Reasons for Change
The Congress recognized that elementary and secondary
educations often incur substantial unreimbursed expenses in the
course of their teacher duties, and believed that an extension
of the deduction for such expenses was warranted to continue to
provide tax relief to educators who incur such expenses on
behalf of their students.\237\
---------------------------------------------------------------------------
\237\ See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act extends the above-the-line deduction for two years,
i.e., for taxable years beginning in 2004 and 2005.
Effective Date
The provision is effective for taxable years beginning in
2004 and 2005.
I. Expensing of Environmental Remediation Costs (sec. 308 of the Act
and sec. 198 of the Code)
Present and Law
Taxpayers can elect to treat certain environmental
remediation expenditures that would otherwise be chargeable to
capital account as deductible in the year paid or incurred
(sec. 198). The deduction applies for both regular and
alternative minimum tax purposes. The expenditure must be
incurred in connection with the abatement or control of
hazardous substances at a qualified contaminated site.
A ``qualified contaminated site'' generally is any property
that (1) is held for use in a trade or business, for the
production of income, or as inventory and (2) is at a site on
which there has been a release (or threat of release) or
disposal of certain hazardous substances as certified by the
appropriate State environmental agency (so called
``brownfields''). However, sites that are identified on the
national priorities list under the Comprehensive Environmental
Response, Compensation, and Liability Act of 1980 cannot
qualify as targeted areas.
Under prior law, eligible expenditures were those paid or
incurred before January 1, 2004.
Reasons for Change \238\
The Congress observed that by lowering the net capital cost
of a development project the expensing of brownfields
remediation costs promotes the goal of environmental
remediation and promotes new investment and employment
opportunities. In addition, the Congress believed that the
increased investment in the qualifying areas has spillover
effects that are beneficial to the neighboring communities.
Therefore, the Congress believed it was appropriate to extend
the present-law provision permitting the expensing of
environmental remediation costs.
---------------------------------------------------------------------------
\238\ See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act extends the prior law expensing provision for two
years (through December 31, 2005).
Effective Date
Effective for expenses paid or incurred after December 31,
2003.
J. New York Liberty Zone Provisions (sec. 309 of the Act and sec. 1400L
of the Code)
Present and Prior Law
An aggregate of $8 billion in tax-exempt private activity
bonds is authorized for the purpose of financing the
construction and repair of infrastructure in New York City
(``Liberty Zone bonds''). The bonds must be issued before
January 1, 2005.
Certain bonds used to fund facilities located in New York
City are permitted one additional advance refunding before
January 1, 2005 (``advance refunding bonds''). In addition to
satisfying other requirements, the bond refunded must be (1) a
State or local bond that is a general obligation of New York
City, (2) a State or local bond issued by the New York
Municipal Water Finance Authority or Metropolitan
Transportation Authority of the City of New York, or (3) a
qualified 501(c)(3) bond which is a qualified hospital bond
issued by or on behalf of the State of New York or the City of
New York. The maximum amount of advance refunding bonds is $9
billion.
Reasons for Change \239\
The Congress was committed to aiding the City of New York's
economic recovery from the terrorist attacks of September 11,
2001. Therefore, the Congress believed that an extension of the
authority to issue New York Liberty Bonds was appropriate.
---------------------------------------------------------------------------
\239\ See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provisions
The Act extends authority to issue Liberty Zone bonds
through December 31, 2009. The Act also extends the additional
advance refunding authority through December 31, 2005. In
addition, the Act provides that bonds of the Municipal
Assistance Corporation are eligible for advance refunding.
The purpose in extending the New York Liberty Bond program
through December 31, 2009, is to facilitate the full
designation of New York Liberty Bond authority. Congress could
consider a further extension of the New York Liberty Bond
program beyond 2009 if circumstances justify such an extension.
Effective Date
The Liberty Zone bonds and general additional advance
refunding provisions are effective on the date of enactment
(October 4, 2004). The provision relating to the advance
refunding of bonds of the Municipal Assistance Corporation is
effective as if included in the amendments made by section 301
of the Job Creation and Worker Assistance Act of 2002.
K. Tax Incentives for Investment in the District of Columbia (sec. 310
of the Act and secs. 1400, 1400A, 1400B, 1400C, and 1400F of the Code)
Present and Prior Law
Certain economically depressed census tracts within the
District of Columbia were designated as the District of
Columbia Enterprise Zone (the ``D.C. Zone'') within which
businesses and individual residents are eligible for special
tax incentives. Under prior law, the designation expired on
December 31, 2003.
First-time homebuyers of a principal residence in the
District of Columbia were eligible for a nonrefundable tax
credit of up to $5,000 of the amount of the purchase price.
Under prior law, the credit expired for property purchased
after December 31, 2003.
Reasons for Change \240\
Congress believed that the incentives should temporarily
be extended to provide the Congress and the Treasury Department
a better opportunity to continue to assess the overall
operation and effectiveness of the tax incentives to revitalize
the D.C. Zone and to promote homeownership therein.
---------------------------------------------------------------------------
\240\ See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act extends the D.C. Zone designation and related tax
incentives for two years (through December 31, 2005). The
provision extends the first-time homebuyer credit for two years
(through December 31, 2005).
Effective Date
The extension of the D.C. Zone designation and related tax
incentives is generally effective on January 1, 2004, except
that the provision relating to tax-exempt financing incentives
applies to obligations issued after the date of enactment
(October 4, 2004).
L. Combined Employment Tax Reporting (sec. 311 of the Act and sec.
6103(d)(5) of the Code)
Present and Prior Law
Traditionally, Federal tax forms are filed with the Federal
government and State tax forms are filed with individual
States. This necessitates duplication of items common to both
returns.
The Taxpayer Relief Act of 1997 permitted implementation of
a limited demonstration project to assess the feasibility and
desirability of expanding combined Federal and State reporting.
First, it was limited to the sharing of information between the
State of Montana and the IRS. Second, it was limited to
employment tax reporting. Third, it was limited to disclosure
of the name, address, TIN, and signature of the taxpayer, which
is information common to both the Montana and Federal portions
of the combined form. Fourth, it was limited to a period of
five years (expiring August 5, 2002).
Reasons for Change \241\
The Congress believed that authorizing and expanding this
project for a year will provide the Congress with information
to assess the usefulness of the program and whether further
expansions are warranted.
---------------------------------------------------------------------------
\241\See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act provides authority through December 31, 2005, for
any State to participate in a combined Federal and State
employment tax reporting program, provided that the program has
been approved by the Secretary. The Secretary may disclose the
name, address, TIN and signature of the taxpayer to any agency,
body, or commission of a State for purposes of carrying out the
approved program with such agency, body, or commission.
Effective Date
The provision is effective on the date of enactment
(October 4, 2004).
M. Nonrefundable Personal Credits Allowed Against the Alternative
Minimum Tax (sec. 312 of the Act and sec. 26 of the Code)
Present and Prior Law
Present and prior law provides for certain nonrefundable
personal tax credits (i.e., the dependent care credit, the
credit for the elderly and disabled, the adoption credit, the
child tax credit,\242\ the credit for interest on certain home
mortgages, the HOPE Scholarship and Lifetime Learning credits,
the credit for savers, and the D.C. first-time homebuyer
credit).
---------------------------------------------------------------------------
\242\ A portion of the child credit may be refundable.
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For taxable years beginning in 2003, all the nonrefundable
personal credits were allowed to the extent of the full amount
of the individual's regular tax and alternative minimum tax.
For taxable years beginning after 2003, the credits (other
than the adoption credit, child credit and credit for savers)
were allowed only to the extent that the individual's regular
income tax liability exceeds the individual's tentative minimum
tax, determined without regard to the minimum tax foreign tax
credit. The adoption credit, child credit, and IRA credit are
allowed to the full extent of the individual's regular tax and
alternative minimum tax.
Reasons for Change \243\
The Congress believed that the nonrefundable personal
credits should be useable without limitation by reason of the
alternative minimum tax. This provision will result in
significant simplification.
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\243\ See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act extends the provision allowing the nonrefundable
personal credits to the full extent of the regular tax and the
alternative minimum tax for taxable years beginning in 2004 and
2005.
Effective Date
The provision applies to taxable years beginning after
December 31, 2003.
N. Extension of Credit for Electricity Produced from Certain Renewable
Resources (sec. 313 of the Act and sec. 45 of the Code)
Present and Prior Law
An income tax credit is allowed for the production of
electricity from either qualified wind energy, qualified
``closed-loop'' biomass, or qualified poultry waste facilities.
The amount of the credit is 1.8 cents per kilowatt hour for
2004. The credit amount is indexed for inflation.
The credit applies to electricity produced by a wind energy
facility placed in service after December 31, 1993, and before
January 1, 2004, to electricity produced by a closed-loop
biomass facility placed in service after December 31, 1992, and
before January 1, 2004, and to a poultry waste facility placed
in service after December 31, 1999, and before January 1, 2004.
The credit is allowable for production during the 10-year
period after a facility is originally placed in service.
Reasons for Change \244\
The Congress recognized that the section 45 production
credit has fostered additional electricity generation capacity
in the form of non-polluting wind power. The Congress believed
it was important to continue this tax credit by extending the
placed in service date for such facilities to bring more wind
energy to the U. S. electric grid. The Congress further
believed that, to encourage entrepreneurial exploration of
alternative sources for electricity generation, it was
appropriate to extend the present-law provision relating to
facilities that use closed-loop biomass as an energy source, to
give those potential fuel sources an opportunity in the market
place.
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\244\ While there were no committee reports for H.R. 1308, H.R.
4520 which was reported by the House Committee on Ways and Means on
June 16, 2004 (H.R. Rep. No. 108-54) and passed the House of
Representatives on June 17, 2004, contained a nearly identical
provision. H.R. 4520 as passed by the House did not extend that part of
present law relating to poultry waste facilities.
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Explanation of Provision
The Act extends the placed in service date for wind energy
facilities, ``closed-loop'' biomass facilities, and poultry
waste facilities to include facilities placed in service prior
to January 1, 2006.\245\
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\245\ Sec. 45 was subsequently modified to include additional
qualifying facilities by the American Jobs Creation Act of 2004,
described in Part Seventeen.
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Effective Date
Effective for facilities placed in service after December
31, 2003.
O. Suspension of 100-Percent-of-Net-Income Limitation on Percentage
Depletion for Oil and Gas from Marginal Wells (sec. 314 of the Act and
sec. 613A of the Code)
Present and Prior Law
Percentage depletion method for oil and gas properties
applies to independent producers and royalty owners. Generally,
under the percentage depletion method, 15 percent of the
taxpayer's gross income from an oil- or gas-producing property
is allowed as a deduction in each taxable year. The amount
deducted generally may not exceed 100 percent of the net income
from the property in any year (the ``net-income limitation'').
Under prior law, the 100-percent net-income limitation for
marginal wells was suspended for taxable years beginning after
December 31, 1997, and before January 1, 2004.
Reasons for Change \246\
Domestic production from marginal wells is an appropriate
part of establishing national energy security and reducing
dependence on foreign oil. The Congress believed the suspension
of the 100-percent net-income limitation for marginal wells
should be extended to encourage continued operation of such
wells.
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\246\ See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
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Explanation of Provision
The Act extends the suspension of the net-income limitation
for marginal wells for taxable years beginning before January
1, 2006.
Effective Date
The provision is effective for taxable years beginning
after December 31, 2003.
P. Indian Employment Tax Credit (sec. 315 of the Act and sec. 45A of
the Code)
Present and Prior Law
In general, a credit against income tax liability is
allowed to employers for the first $20,000 of qualified wages
and qualified employee health insurance costs paid or incurred
by the employer with respect to certain employees (sec. 45A).
The credit is equal to 20 percent of the excess of eligible
employee qualified wages and health insurance costs during the
current year over the amount of such wages and costs incurred
by the employer during 1993. The credit is an incremental
credit, such that an employer's current-year qualified wages
and qualified employee health insurance costs (up to $20,000
per employee) are eligible for the credit only to the extent
that the sum of such costs exceeds the sum of comparable costs
paid during 1993. No deduction is allowed for the portion of
the wages equal to the amount of the credit.
Under prior law, the wage credit was available for wages
paid or incurred on or after January 1, 1994, in taxable years
that begin before January 1, 2005.
Reasons for Change \247\
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\247\ See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
The Congress believed that extending the wage credit tax
incentive will expand employment opportunities for members of
Indian tribes.
Explanation of Provision
The Act extends the Indian employment credit incentive for
one year (to taxable years beginning before January 1, 2006).
Effective Date
The provision is effective on the date of enactment
(October 4, 2004).
Q. Accelerated Depreciation for Business Property on Indian
Reservations (sec. 316 of the Act and sec. 168(j) of the Code)
Present and Prior Law
With respect to certain property used in connection with
the conduct of a trade or business within an Indian
reservation, depreciation deductions under section 168(j) will
be determined using the following recovery periods:
3-year property......................................... 2 years
5-year property......................................... 3 years
7-year property......................................... 4 years
10-year property........................................ 6 years
15-year property........................................ 9 years
20-year property........................................ 12 years
Nonresidential real property............................ 22 years
``Qualified Indian reservation property'' eligible for
accelerated depreciation includes property which is (1) used by
the taxpayer predominantly in the active conduct of a trade or
business within an Indian reservation, (2) not used or located
outside the reservation on a regular basis, (3) not acquired
(directly or indirectly) by the taxpayer from a person who is
related to the taxpayer (within the meaning of section
465(b)(3)(C)), and (4) described in the recovery-period table
above. In addition, property is not ``qualified Indian
reservation property'' if it is placed in service for purposes
of conducting gaming activities. Certain ``qualified
infrastructure property'' may be eligible for the accelerated
depreciation even if located outside an Indian reservation,
provided that the purpose of such property is to connect with
qualified infrastructure property located within the
reservation (e.g., roads, power lines, water systems, railroad
spurs, and communications facilities).
The depreciation deduction allowed for regular tax purposes
is also allowed for purposes of the alternative minimum tax.
Under prior law, the accelerated depreciation for Indian
reservations was available with respect to property placed in
service on or after January 1, 1994, and before January 1,
2005.
Reasons for Change \248\
The Congress believed that extending the depreciation
incentive will encourage economic development within Indian
reservations and expand employment opportunities on such
reservations.
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\248\ See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act extends eligibility for the special depreciation
periods to property placed in service before January 1, 2006.
Effective Date
The provision is effective on the date of enactment
(October 4, 2004).
R. Disclosure of Return Information Relating to Student Loans (sec. 317
of the Act and sec. 6103(l)(13) of the Code)
Present and Prior Law
Present and prior law prohibit the disclosure of returns
and return information, except to the extent specifically
authorized by the Code.\249\ An exception to the general rule
prohibiting disclosure is provided for disclosure to the
Department of Education (but not to contractors thereof) of a
taxpayer's filing status, adjusted gross income and identity
information (i.e. name, mailing address, taxpayer identifying
number) to establish an appropriate repayment amount for an
applicable student loan. Under prior law, the Department of
Education disclosure authority was scheduled to expire after
December 31, 2004.\250\
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\249\ Sec. 6103.
\250\ Pub. L. No. 108-89 (2003).
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Reasons for Change \251\
The Congress believed that the Department of Education
should be provided with access to tax return information to
assist it in carrying out the income-contingent repayment
program. Thus, the Congress believed that it is appropriate to
provide a further extension of this disclosure authority.
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\251\ See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act extends the disclosure authority relating to the
disclosure of return information to carry out income-contingent
repayment of student loans for an additional year. The
disclosure authority does not apply to any request made after
December 31, 2005.
Effective Date
The provision is effective on the date of enactment
(October 4, 2004).
S. Credit for Qualified Electric Vehicles (sec. 318 of the Act and sec.
30 of the Code)
Present and Prior Law
A 10-percent tax credit is provided for the cost of a
qualified electric vehicle, up to a maximum credit of $4,000. A
qualified electric vehicle generally is a motor vehicle that is
powered primarily by an electric motor drawing current from
rechargeable batteries, fuel cells, or other portable sources
of electrical current. The full amount of the credit is
available for purchases prior to 2004. Under prior law, the
credit phases down in the years 2004 through 2006, and is
unavailable for purchases after December 31, 2006. Under the
phase down, the credit for 2004 is 75 percent of the otherwise
allowable credit.
Reasons for Change \252\
The Congress believed it was necessary to continue to
provide the full benefit of the tax subsidy to the purchase of
these innovative vehicles to enable such vehicles to
demonstrate their road-worthiness to the consumer. However, in
the future, the Congress expects such vehicles to compete in
the market without subsidy.
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\252\ See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act repeals the phase down of the allowable tax credit
for electric vehicles in 2004 and 2005. Thus, a taxpayer who
purchases a qualifying vehicle may claim 100 percent of the
otherwise allowable credit for vehicles purchased in 2004 and
2005. For vehicles purchased in 2006 the credit remains at 25
percent of the otherwise allowable amount as under present law.
Effective Date
The provision is effective for vehicles placed in service
after December 31, 2003.
T. Deduction for Qualified Clean-Fuel Vehicle Property (sec. 319 of the
Act and sec. 179A of the Code)
Present and Prior Law
Certain costs of qualified clean-fuel vehicle may be
expensed and deducted when such property is placed in service.
Qualified clean-fuel vehicle property includes motor vehicles
that use certain clean-burning fuels (natural gas, liquefied
natural gas, liquefied petroleum gas, hydrogen, electricity and
any other fuel at least 85 percent of which is methanol,
ethanol, any other alcohol or ether). The Secretary has
determined that certain hybrid (gas-electric) vehicles are
qualified clean-fuel vehicles.
The maximum amount of the deduction is $50,000 for a truck
or van with a gross vehicle weight over 26,000 pounds or a bus
with a seating capacity of at least 20 adults; $5,000 in the
case of a truck or van with a gross vehicle weight between
10,000 and 26,000 pounds; and $2,000 in the case of any other
motor vehicle. Under prior law, the deduction phases down in
the years 2004 through 2006, and is unavailable for purchases
after December 31, 2006. Under the phase down, the deduction
permitted for 2004 is 75 percent of the otherwise allowable
amount.
Reasons for Change \253\
The Congress believed it was necessary to continue to
provide the full benefit of the tax subsidy to the purchase of
these innovative vehicles to enable such vehicles to
demonstrate their road-worthiness to the consumer. However, in
the future, the Congress expects such vehicles to compete in
the market without subsidy.
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\253\ See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act repeals the phase down of the allowable deduction
for clean-fuel vehicles in 2004 and 2005. Thus, a taxpayer who
purchases a qualifying vehicle may claim 100 percent of the
otherwise allowable deduction for vehicles purchased in 2004
and 2005. For vehicles purchased in 2006 the deduction remains
at 25 percent of the otherwise allowable amount as under
present law.
Effective Date
The provision is effective for vehicles placed in service
after December 31, 2003.
U. Disclosures Relating to Terrorist Activities (sec. 320 of the Act
and sec. 6103(i)(3) and (i)(7) of the Code)
Present and Prior Law
Present and prior law prohibit the disclosure of returns
and return information except to the extent specifically
authorized by the Code. In connection with terrorist
activities, the Code permits the IRS to disclose return
information, other than taxpayer return information,\254\ to
officers and employees of any Federal law enforcement agency
upon a written request.\255\ The Code requires the request to
be made by the head of the Federal law enforcement agency (or
his delegate) involved in the response to or investigation of
terrorist incidents, threats, or activities, and set forth the
specific reason or reasons why such disclosure may be relevant
to a terrorist incident, threat, or activity. Disclosure of the
information is permitted to officers and employees of the
Federal law enforcement agency who are personally and directly
involved in the response to or investigation of terrorist
incidents, threats, or activities. The information is to be
used by such officers and employees solely for such response or
investigation.
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\254\ Sec. 6103(b)(3).
\255\ Sec. 6103(i)(7)(A).
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The Code permits the head of the Federal law enforcement
agency to redisclose the information received under such
authority to officers and employees of any State or local law
enforcement agency personally and directly engaged in the
response to or investigation of the terrorist incident, threat,
or activity.\256\ The State or local law enforcement agency is
required to be part of an investigative or response team with
the Federal law enforcement agency for these disclosures to be
made.
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\256\ Sec. 6103(i)(7)(A)(ii).
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Return information includes a taxpayer's identity.\257\ If
a taxpayer's identity is taken from a return or other
information filed with or furnished to the IRS by or on behalf
of the taxpayer, it is taxpayer return information. Under prior
law, since taxpayer return information was not covered by the
disclosure authorization for Federal law enforcement agencies,
taxpayer identity information submitted by or on behalf of the
taxpayer could not be disclosed pursuant to that authority and
thus could not be associated with other information being
provided to such agencies.
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\257\ Sec. 6103(b)(2)(A).
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The Code also allows the IRS to disclose return information
(other than taxpayer return information) upon the written
request of an officer or employee of the Department of Justice
or Treasury who is appointed by the President with the advice
and consent of the Senate, or who is the Director of the U.S.
Secret Service, if such individual is responsible for the
collection and analysis of intelligence and counterintelligence
concerning any terrorist incident, threat, or activity.\258\ A
taxpayer's identity for this purpose is not considered taxpayer
return information. Such written request is required to set
forth the specific reason or reasons why such disclosure may be
relevant to a terrorist incident, threat, or activity.
Disclosures under this authority are permitted to be made to
those officers and employees of the Department of Justice,
Department of the Treasury, and Federal intelligence agencies
who are personally and directly engaged in the collection or
analysis of intelligence and counterintelligence information or
investigation concerning any terrorist incident, threat, or
activity. Such disclosures are permitted solely for the use of
such officers and employees in such investigation, collection,
or analysis.
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\258\ Sec. 6103(i)(7)(B).
---------------------------------------------------------------------------
The IRS, on its own initiative, is permitted to disclose in
writing return information (other than taxpayer return
information) that may be related to a terrorist incident,
threat, or activity to the extent necessary to apprise the head
of the appropriate investigating Federal law enforcement
agency.\259\ A taxpayer's identity for this purpose is not
considered taxpayer return information. The head of the agency
is permitted to redisclose such information to officers and
employees of such agency to the extent necessary to investigate
or respond to the terrorist incident, threat, or activity.
---------------------------------------------------------------------------
\259\ Sec. 6103(i)(3)(C).
---------------------------------------------------------------------------
Except for the limited exceptions noted above relating to a
taxpayer's identity, if taxpayer return information is to be
disclosed, the disclosure is required to be made pursuant to
the ex parte order of a Federal district court judge or
magistrate.
Under prior law, no disclosures could be made under any of
the above provisions after December 31, 2003.
Reasons for Change \260\
The Congress believed that a renewal of this disclosure
authority will provide additional time to evaluate the
effectiveness of the provision and whether any modifications
need to be implemented to enhance the provision.
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\260\ See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act extends the disclosure authority relating to
terrorist activities. Under the Act, no disclosures can be made
after December 31, 2005.
The Act also makes a technical change to clarify that a
taxpayer's identity is not treated as taxpayer return
information for purposes of disclosures to law enforcement
agencies regarding terrorist activities.
Effective Dates
The provision extending authority is effective for
disclosures made on or after the date of enactment (October 4,
2004). The technical change is effective as if included in
section 201 of the Victims of Terrorism Tax Relief Act of 2001.
V. Extension of Joint Review of Strategic Plans and Budget for the
Internal Revenue Service (sec. 321 of the Act and secs. 8021 and 8022
of the Code)
Prior Law
The Code required the Joint Committee on Taxation to
conduct a joint review \261\ of the strategic plans and budget
of the IRS from 1999 through 2003.\262\ The Code also required
the Joint Committee to provide an annual report \263\ from 1999
through 2003 with respect to:
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\261\ The joint review was required to include two members of the
majority and one member of the minority of the Senate Committees on
Finance, Appropriations, and Governmental Affairs, and of the House
Committees on Ways and Means, Appropriations, and Government Reform and
Oversight.
\262\ Sec. 8021(f).
\263\ Sec. 8022(3)(C).
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Strategic and business plans for the IRS;
Progress of the IRS in meeting its
objectives;
The budget for the IRS and whether it
supports its objectives;
Progress of the IRS in improving taxpayer
service and compliance;
Progress of the IRS on technology
modernization; and
The annual filing season.
Reasons for Change \264\
The Congress believed that a joint review of the IRS should
be held for one additional year and that the report provided by
the Joint Committee on Taxation should be tailored to the
specific issues addressed in the joint review.
---------------------------------------------------------------------------
\264\ See H.R. 4520, the ``American Jobs Creation Act of 2004,''
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
Explanation of Provision
The Act requires that the Joint Committee conduct a joint
review before June 1, 2005. The Act also requires that the
Joint Committee provide an annual report with respect to such
joint review, and specifies that the content of the annual
report is the matters addressed in the joint review.\265\
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\265\ Accordingly, the provision deletes the specific list of
matters required to be covered in the annual report.
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Effective Date
The provision is effective on the date of enactment
(October 4, 2004).
W. Extension of Archer Medical Savings Accounts (``MSAs'') (sec. 322 of
the Act and sec. 220 of the Code)
Present and Prior Law
In general
Within limits, contributions to an Archer MSA are
deductible in determining adjusted gross income if made by an
eligible individual and are excludable from gross income and
wages for employment tax purposes if made by the employer of an
eligible individual. Earnings on amounts in an Archer MSA are
not currently taxable. Distributions from an Archer MSA for
medical expenses are not includible in gross income.
Distributions not used for medical expenses are includible in
gross income. In addition, distributions not used for medical
expenses are subject to an additional 15-percent tax unless the
distribution is made after age 65, death, or disability.
Eligible individuals
Archer MSAs are available to employees covered under an
employer-sponsored high deductible plan of a small employer and
self-employed individuals covered under a high deductible
health plan.\266\ An employer is a small employer if it
employed, on average, no more than 50 employees on business
days during either the preceding or the second preceding year.
An individual is not eligible for an Archer MSA if he or she is
covered under any other health plan in addition to the high
deductible plan.
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\266\ Self-employed individuals include more than two-percent
shareholders of S corporations who are treated as partners for purposes
of fringe benefit rules pursuant to section 1372.
---------------------------------------------------------------------------
Tax treatment of and limits on contributions
Individual contributions to an Archer MSA are deductible
(within limits) in determining adjusted gross income (i.e.,
``above-the-line''). In addition, employer contributions are
excludable from gross income and wages for employment tax
purposes (within the same limits). Contributions to an Archer
MSA may not be made through a cafeteria plan. In the case of an
employee, contributions can be made to an Archer MSA either by
the individual or by the individual's employer.
The maximum annual contribution that can be made to an
Archer MSA for a year is 65 percent of the deductible under the
high deductible plan in the case of individual coverage and 75
percent of the deductible in the case of family coverage.
Definition of high deductible plan
For 2004, a high deductible plan is a health plan with an
annual deductible of at least $1,700 and no more than $2,600 in
the case of individual coverage and at least $3,450 and no more
than $5,150 in the case of family coverage. In addition, the
maximum out-of-pocket expenses with respect to allowed costs
(including the deductible) must be no more than $3,450 in the
case of individual coverage and no more than $6,300 in the case
of family coverage (for 2004).\267\ A plan does not fail to
qualify as a high deductible plan merely because it does not
have a deductible for preventive care as required by State law.
A plan does not qualify as a high deductible health plan if
substantially all of the coverage under the plan is for
permitted coverage (as described above). In the case of a self-
insured plan, the plan must in fact be insurance (e.g., there
must be appropriate risk shifting) and not merely a
reimbursement arrangement.
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\267\ These amounts are indexed for inflation, rounded to the
nearest $50.
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Cap on taxpayers utilizing Archer MSAs and expiration of pilot program
The number of taxpayers benefiting annually from an Archer
MSA contribution is limited to a threshold level (generally
750,000 taxpayers). The number of Archer MSAs established has
not exceeded the threshold level.
Under prior law, after 2003, no new contributions could be
made to Archer MSAs except by or on behalf of individuals who
previously had Archer MSA contributions and employees who are
employed by a participating employer.
Trustees of Archer MSAs are generally required to make
reports to the Treasury by August 1 regarding Archer MSAs
established by July 1 of that year. If any year is a cut-off
year, the Secretary is required to make and publish such
determination by October 1 of such year.
Reasons for Change \268\
The Congress believed that individuals should be encouraged
to save for future medical care expenses and that individuals
should be allowed to save for such expenses on a tax-favored
basis. The Congress believed that consumers who spend their own
savings on health care will make cost-conscious decisions, thus
reducing the rising cost of health care. The Congress believed
that Archer MSAs have been an important tool in allowing
certain individuals to save for future medical expenses on a
tax-favored basis.
---------------------------------------------------------------------------
\268\ See H.R. 4520, the ``American Jobs Creation Act of 2004'',
which was reported by the House Committee on Ways and Means on June 16,
2004 (H.R. Rep. No. 108-548).
---------------------------------------------------------------------------
The Congress was aware that recently enacted health savings
accounts offer more advantageous tax treatment than Archer MSAs
and that amounts can be rolled over into a health savings
account from an Archer MSA on a tax-free basis. Still, the
Congress believed that individuals should be allowed the choice
to continue the use of Archer MSAs. Thus, the Congress believed
that it was appropriate to extend Archer MSAs.
Explanation of Provision
The Act extends Archer MSAs through December 31, 2005. The
Act also provides that the reports required by MSA trustees for
2004 are treated as timely if made within 90 days after the
date of enactment. In addition, the determination of whether
2004 is a cut-off year and the publication of such
determination is to be made within 120 days of the date of
enactment. If 2004 is a cut-off year, the cut-off date will be
the last day of such 120-day period.
Effective Date
The provision is generally effective on January 1, 2004.
The provisions relating to reports and the determination by the
Secretary are effective on the date of enactment (October 4,
2004).
IV. TAX TECHNICAL CORRECTIONS
(secs. 401-408 of the Act)
Present and Prior Law
Certain recently enacted tax legislation needs technical,
conforming, and clerical amendments in order properly to carry
out the intention of the Congress.\269\
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\269\ Tax technical corrections legislation, the ``Tax Technical
Corrections Act of 2003,'' was introduced in the House of
Representatives (H.R. 3654) on December 8, 2003, and in the Senate (S.
1984) on December 9, 2003.
---------------------------------------------------------------------------
Explanation of Provisions
The Act includes technical corrections to recently enacted
tax legislation. Except as otherwise provided, the amendments
made by the technical corrections contained in the Act take
effect as if included in the original legislation to which each
amendment relates. The following is a description of the
provisions contained in the technical corrections title:
Amendments Related to the Medicare Prescription Drug, Improvement, and
Modernization Act of 2003
Additional tax relating to health savings accounts.--Code
section 26(b) provides that ``regular tax liability'' does not
include certain ``additional taxes'' and similar amounts. Under
prior law, regular tax liability did not include the additional
tax on Archer MSA distributions not used for qualified medical
expenses (sec. 220(f)(4)). The provision adds to the list of
such amounts the additional tax on distributions not used for
qualified medical expenses (sec. 223(f)(4)) under the rules
relating to health savings accounts.
Health coverage tax credit.--Code section 35(g)(3) provides
that any amount distributed from an Archer MSA will not be
taken into account for purposes of determining the amount of
health coverage tax credit (``HCTC'') an individual is eligible
to receive. Under the provision, section 35(g)(3) is amended to
provide that amounts distributed from health savings accounts
are not to be taken into account for purposes of determining
the amount of HCTC an individual is entitled to receive.
Amendments Related to the Jobs and Growth Tax Relief Reconciliation Act
of 2003
Dividends taxed at capital gain rates.--Section 302 of the
Jobs and Growth Tax Relief Reconciliation Act of 2003
(``JGTRRA'') generally provides that qualified dividend income
of taxpayers other than corporations is taxed at the same tax
rates as the net capital gain. The provision makes the
following amendments to the provisions adopted by that section:
\270\
The provision clarifies that the determination of net
capital gain, for purposes of determining the amount taxed at
the 25-percent rate (section 1(h)(1)(D)(i)), is made without
regard to qualified dividend income.
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\270\ IR-2004-22 (February 19, 2004) announced that the IRS agreed
to make the technical correction provisions relating to dividends
contained in the Technical Corrections Act of 2003, as introduced,
available to taxpayers in advance of their passage.
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The deduction for estate taxes paid on gain that is income
in respect of a decedent reduces the amount of gain otherwise
taken into account in computing the amount eligible for the
lower tax rates on net capital gain (sec. 691(c)(4)). Since it
is not entirely clear whether this provision also applies to
qualified dividends eligible for the lower tax rates on net
capital gain, the provision clarifies that the provision does
so apply.
The provision clarifies that the extraordinary dividend
rule applies to trusts and estates as well as individuals.
The provision rewrites portions of the provisions relating
to the treatment of dividends received from a regulated
investment company (``RIC'') or a real estate investment trust
(``REIT'') to set forth the rules directly rather than be
reference to rules applicable to dividends received by
corporate shareholders.
The provision provides that all distributions by a RIC or
REIT of the earnings and profits from C corporation years can
be treated as qualifying dividends eligible for the lower rate.
The provision extends the 60-day period for notifying
shareholders of the amount of the qualified dividend income
distributed by a RIC or REIT for taxable years ending on or
before November 30, 2003, to the date the 1099-DIV for 2003 is
required.
The provision provides that, in the case of partnerships, S
corporations, common trust funds, trusts, and estates, section
302 of JGTRRA applies to taxable years ending after December
31, 2002, except that dividends received by the entity prior to
January 1, 2003, are not treated as qualified dividend income.
JGTRRA provided a similar rule in the case of RICs and REITs.
Satisfaction of certain holding period requirements if
stock is acquired on the day before ex-dividend date.--Under
several similar holding period requirements relating to the tax
consequences of receiving dividends, a taxpayer who acquires
stock the day before the ex-dividend date cannot satisfy these
holding period requirements with respect to the dividend. The
provision modifies the stock holding period requirements to
permit taxpayers to satisfy the requirements when they acquire
stock on the day before the ex-dividend date of the stock.
Specifically, the provision modifies the holding period
requirement for the dividends-received deduction under section
246(c) (as modified by section 1015 of the Taxpayer Relief Act
of 1997) by changing from 90 days to 91 days (and from 180 days
to 181 days in the case of certain dividends on preferred
stock) the period within which a taxpayer may satisfy the
requirement. In addition, the provision modifies the holding
period requirement for foreign tax credits with respect to
dividends under section 901(k) (enacted in section 1053 of the
Taxpayer Relief Act of 1997) by changing from 30 days to 31
days (and from 90 days to 91 days in the case of certain
dividends on preferred stock) the period within which a
taxpayer may satisfy the requirement. The provision modifies
the holding period requirement for dividends to be taxed at the
tax rates applicable to net capital gain under section 1(h)(11)
(enacted in section 302 of JGTRRA) by changing from 120 days to
121 days (and from 180 days to 181 days in the case of certain
dividends on preferred stock) the period within which a
taxpayer may satisfy the requirement.
Amendments Related to the Job Creation and Worker Assistance Act of
2002
Bonus depreciation.--Section 101 of the Job Creation and
Worker Assistance Act of 2002 (``JCWA'') provides generally for
30-percent additional first-year depreciation for qualifying
property. Qualifying property is defined to include certain
property subject to the capitalization rules of section 263A by
reason of having an estimated production period exceeding 2
years or an estimated production period exceeding 1 year and a
cost exceeding $1 million (secs. 168(k)(2)(B)(i)(III) and
263A(f)(1)(B)(ii) or (iii)). An unintended interpretation of
this rule could preclude property from qualifying for bonus
depreciation if it meets this description but is subject to the
capitalization rules of section 263A by reason of section
263A(f)(1)(B)(i) (having a long useful life). The provision
clarifies that qualifying property includes such property that
is subject to the capitalization rules of section 263A and is
described in the provisions requiring an estimated production
period exceeding 2 years or an estimated production period
exceeding 1 year and a cost exceeding $1 million.
Section 101 of JCWA provides a binding contract rule in
determining property that qualifies for it. The requirements
that must be satisfied in order for property to qualify include
that (1) the original use of the property must commence with
the taxpayer on or after September 11, 2001, (2) the taxpayer
must acquire the property after September 10, 2001, and before
September 11, 2004, and (3) no binding written contract for the
acquisition of the property is in effect before September 11,
2001 (or, in the case of self-constructed property,
manufacture, construction, or production of the property does
not begin before September 11, 2001). In addition, JCWA
provides a special rule in the case of certain leased property.
In the case of any property that is originally placed in
service by a person and that is sold to the taxpayer and leased
back to such person by the taxpayer within three months after
the date that the property was placed in service, the property
is treated as originally placed in service by the taxpayer not
earlier than the date that the property is used under the
leaseback. JCWA did not specifically address the syndication of
a lease by the lessor.
The provision clarifies that property qualifying for
additional first-year depreciation does not include any
property if the user or a related party to the user or owner of
such property had a written binding contract in effect for the
acquisition of the property at any time on or before September
10, 2001 (or, in the case of self-constructed property, the
manufacture, construction, or production of the property began
on or before September 10, 2001). For example, if a taxpayer
sells to a related party property that was under construction
on or prior to September 10, 2001, the property does not
qualify for the additional first-year depreciation deduction.
Similarly, if a taxpayer sells to a related party property that
was subject to a binding written contract on or prior to
September 10, 2001, the property does not qualify for the
additional first-year depreciation deduction. As a further
example, if a taxpayer sells property and leases the property
back in a sale-leaseback arrangement, and the lessee had a
binding written contract in effect for the acquisition of such
property on or prior to September 10, 2001, then the lessor is
not entitled to the additional first-year depreciation
deduction.
In addition, the provision provides that if property is
originally placed in service by a lessor (including by
operation of section Code 168(k)(2)(D)(i)), such property is
sold within three months after the date that the property was
placed in service, and the user of such property does not
change, then the property is treated as originally placed in
service by the taxpayer not earlier than the date of such sale.
Five-year carryback of net operating losses (``NOLs'').--
Section 102 of JCWA temporarily extends the NOL carryback
period to five years (from two years, or three years in certain
cases) for NOLs arising in taxable years ending in 2001 and
2002. The JCWA was enacted in March 2002, after some taxpayers
had filed returns for 2001.
The provision (1) clarifies that only the NOLs arising in
taxable years ending in 2001 and 2002 qualify for the 5-year
period, and (2) provides that any election to forego any
carrybacks of NOLs arising in 2001 or 2002 can be revoked prior
to November 1, 2002. The provision also allows taxpayers until
November 1, 2002, to use the tentative carryback adjustment
procedures of section 6411 for NOLs arising in 2001 and 2002
(without regard to the 12-month limitation in section 6411). In
addition, the provision clarifies that an election to disregard
the 5-year carryback for certain NOLs is treated as timely made
if made before November 1, 2002 (notwithstanding that section
172(j) requires the election to be made by the due date
(including extensions) for filing the taxpayer's return for the
year of the loss).\271\
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\271\ The corrections are consistent with the guidance issued by
the IRS (Rev. Proc. 2002-40, 2002-1 C.B. 1096).
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The provision also makes several clerical changes to the
NOL provisions relating to the alternative minimum tax.
New York Liberty Zone bonus depreciation.--Section 301 of
JCWA provides tax benefits for the area of New York City
damaged in terrorist attacks on September 11, 2001 (an area
defined in the provision and named the New York Liberty Zone).
Under these rules, an additional first-year depreciation
deduction is allowed equal to 30 percent of the adjusted basis
of qualified New York Liberty Zone (``Liberty Zone'') property.
A taxpayer is allowed to elect out of the additional first-year
depreciation for any class of property for any taxable year. In
addition, the Act provides a special rule in the case of
certain leased property. In the case of any property that is
originally placed in service by a person and that is sold to
the taxpayer and leased back to such person by the taxpayer
within three months after the date that the property was placed
in service, the property would be treated as originally placed
in service by the taxpayer not earlier than the date that the
property is used under the leaseback. JCWA did not specifically
address the syndication of a lease by the lessor.
The provision clarifies that property qualifying for
additional first-year depreciation does not include any
property if the user or a related party to the user or owner of
such property had a written binding contract in effect for the
acquisition of the property at any time before September 11,
2001 (or in the case of self constructed property the
manufacture, construction, or production of the property began
before September 11, 2001). In addition, the provision provides
that if property is originally placed in service by a lessor
(including by operation of section 168(k)(2)(D)(i)), such
property is sold within three months after the date that the
property was placed in service, and the user of such property
does not change, then the property is treated as originally
placed in service by the taxpayer not earlier than the date of
such sale.
New York Liberty Zone expensing.--Section 301 of JCWA
increases the amount a taxpayer may expense under section 179
to the lesser of $35,000 or the cost of Liberty Zone property
placed in service for the year. In addition, section 301(a) of
the Act states that if property qualifies for both the general
additional first-year depreciation and Liberty Zone additional
first-year depreciation, it is deemed to be eligible for the
general additional first-year depreciation and is not
considered Liberty Zone property (i.e., only one 30-percent
additional first-year depreciation deduction is allowed).
Because only Liberty Zone property is eligible for the
increased section 179 expensing amount, this rule has the
unintended consequence of denying the increased section 179
expensing to Liberty Zone property. The provision corrects this
unintended result (such that qualifying Liberty Zone property
qualifies for both the 30-percent additional first-year
depreciation and the additional section 179 expensing).
Provide election out of Liberty Zone five-year depreciation
for leasehold improvements.--Code section 1400L(c), as added by
section 301 of JCWA, provides for a 5-year recovery period for
depreciation of qualified New York Liberty Zone leasehold
improvement property that is placed in service after September
10, 2001, and before January 1, 2007 (and meets certain other
requirements). Unlike the rules relating to bonus depreciation
and to Liberty Zone bonus depreciation property (see Code
sections 168(k)(2)(C)(iii) and 1400L(b)(2)(C)(iv)), which
permit a taxpayer to elect out, this 5-year depreciation rule
is not elective. The provision adds a rule permitting taxpayers
to elect out of the 5-year recovery period.
Interest rate for defined benefit plan funding
requirements.--Section 405(c) of JCWA increases the interest
rate used in determining the amount of unfunded vested benefits
for PBGC variable rate premium purposes for plan years
beginning in 2002 or 2003 from 85 percent to 100 percent of the
interest rate on 30-year Treasury securities for the month
preceding the month in which the applicable plan year begins.
The provision makes conforming changes so that this rule
applies for purposes of notices and reporting required under
Title IV of ERISA with respect to underfunded plans.
Exclusion for employer-provided adoption assistance.--The
provision corrects an incorrect reference in a technical
correction to a provision relating to the exclusion for
employer-provided adoption assistance.
Amendments Related to the Economic Growth and Tax Relief Reconciliation
Act of 2001
Coverdell education savings accounts.--The provision
corrects the application of a conforming change to the rule
coordinating Coverdell education savings accounts with Hope and
Lifetime Learning credits and qualified tuition programs. The
conforming change was made in connection with the expansion of
Coverdell education savings accounts to elementary and
secondary education expenses in section 401 of the Economic
Growth and Tax Relief Reconciliation Act of 2001 (``EGTRRA'').
Base period for cost-of-living adjustments to Indian
employment credit rule.--The Indian employment credit is not
available with respect to an employee whose wages exceed
$30,000 (sec. 45A). For years after 1994, this $30,000 amount
is adjusted for cost-of-living increases at the same time, and
in the same manner, as cost-of-living adjustments to the dollar
limits on qualified retirement plan benefits and contributions
under section 415. Section 611 of EGTRAA increases the dollar
limits under section 415 and adds a new base period for making
cost-of-living adjustments. The provision clarifies that the
pre-existing base period applies for purposes of the Indian
employment credit.
Rounding rule for retirement plan benefit and contribution
limits.--Section 611 of EGTRRA increases the dollar limits on
qualified retirement plan benefits and contributions under Code
section 415, and adds a new rounding rule for cost-of-living
adjustments to the dollar limit on annual additions to defined
contribution plans. This new rounding rule is in addition to a
pre-existing rounding rule that applies to benefits payable
under defined benefit plans. The provision clarifies that the
pre-existing rounding rule applies for purposes of other Code
provisions that refer to Code section 415 and do not contain a
specific rounding rule.
Excise tax on nondeductible contributions.--Under section
614 of EGTRRA, the limits on deductions for employer
contributions to qualified retirement plans do not apply to
elective deferrals, and elective deferrals are not taken into
account in applying the deduction limits to other
contributions. The provision makes a conforming change to the
Code provision that applies an excise tax to nondeductible
contributions.
SIMPLE plan contributions for domestic or similar
workers.--Section 637 of EGTRRA provides an exception to the
application of the excise tax on nondeductible retirement plan
contributions in the case of contributions to a SIMPLE IRA or
SIMPLE section 401(k) plan that are nondeductible solely
because they are not made in connection with a trade or
business of the employer (e.g., contributions on behalf of a
domestic worker). Section 637 of EGTRRA did not specifically
modify the present-law requirement that compensation for
purposes of determining contributions to a SIMPLE plan must be
wages subject to income tax withholding, even though wages paid
to domestic workers are not subject to income tax withholding.
The provision revises the definition of compensation for
purposes of determining contributions to a SIMPLE plan to
include wages paid to domestic workers, even though such
amounts are not subject to income tax withholding.
Rollovers among various types of retirement plans.--Section
641 of EGTRRA expanded the rollover rules to allow rollovers
among various types of tax-favored retirement plans. The
provision makes a conforming change to the cross-reference to
the rollovers rules in the Code provision relating to qualified
retirement annuities.
Amendment Related to the Community Renewal Tax Relief Act of 2000
Tax treatment of options and securities futures
contracts.--The provision clarifies that the Secretary of the
Treasury has the authority to prescribe regulations regarding
the status of an option or a contract the value of which is
determined directly or indirectly by reference to an index
which becomes (or ceases to be) a narrow-based security index
(as defined in section 1256(g)(6)). This authority includes,
but is not limited to, regulations that provide for preserving
the status of such an option or contract as appropriate.
Amendments Related to the Taxpayer Relief Act of 1997
Qualified tuition programs.--Section 211 of the Taxpayer
Relief Act of 1997 modified section 529(c)(5), relating to gift
tax rules for qualified tuition programs, but did not include
in the statutory language the requirement that, upon a change
in the designated beneficiary of the program, the new
beneficiary must be a member of the family of the old
beneficiary for gift taxes not to apply. The legislative
history for the provision stated that the new beneficiary had
to be of the same generation as the old beneficiary and a
member of the family of the old beneficiary for gift taxes not
to apply. The provision clarifies that the gift taxes apply
unless the new beneficiary is of the same (or higher)
generation than the old beneficiary and is a member of the
family of the old beneficiary.
Coverdell education savings accounts.--The provision
corrects Code section 530(d)(4)(B)(iii), relating to Coverdell
education savings accounts, by substituting for the undefined
term ``account holder'' the defined term ``designated
beneficiary.''
Constructive sale exception.--Section 1001(a) of the
Taxpayer Relief Act of 1997 provides an exception from
constructive sale treatment for any transaction that is closed
before the end of the thirtieth day after the close of the
taxable year in which the transaction was entered into,
provided certain requirements are met after closing the
transaction (section 1259(c)(3)). In the case of positions that
are reestablished following a closed transaction but prior to
satisfying the requirements for the exception from constructive
sale treatment, the exception applies in a similar manner if
the reestablished position itself is closed and similar
requirements are met after closing the reestablished position.
The provision clarifies that the exception applies in the same
manner to all closed transactions, including reestablished
positions that are closed.
Basis adjustments for QZAB held by S corporation.--Under
present law, a shareholder of an S corporation that is an
eligible financial institution may claim a credit with respect
to a qualified zone academy bond (``QZAB'') held by the S
corporation. The amount of the credit is included in gross
income of the shareholder. An unintended interpretation of
these rules would be that the shareholder's basis in the stock
of the S corporation is increased by the amount of the income
inclusion, notwithstanding that the benefit of the credit flows
directly to the shareholder rather than to the corporation, and
the corporation has no additional assets to support the basis
increase. The provision clarifies that the basis of stock in an
S corporation is not affected by the QZAB credit.
Capital gains and AMT.--The provision provides that the
maximum amount of adjusted net capital gain eligible for the
five-percent rate under the alternative minimum tax is the
excess of the maximum amount of taxable income that may be
taxed at a rate of less than 25 percent under the regular tax
(for example, $56,800 for a joint return in 2003) over the
taxable income reduced by the adjusted net capital gain.
The provision may be illustrated by the following example:
For example, assume that a married couple with no
dependents in 2003 has $32,100 of salary, $82,000 of long-term
capital gain from the sale of stock, $73,000 of itemized
deductions consisting entirely of state and local taxes and
allowable miscellaneous itemized deductions. For purposes of
the regular tax, the taxable income is $35,000 ($32,100 plus
$82,000 minus $73,000 minus $6,100 deduction for personal
exemptions). For purposes of the alternative minimum tax, the
taxable excess is $56,100 ($32,100 plus $82,000 less the
$58,000 exemption amount).
The amount taxed under the regular tax at five percent is
$35,000 (the lesser of (i) taxable income ($35,000), (ii)
adjusted net capital gain ($82,000), or (iii) the excess of the
maximum amount taxed at the 10- and 15-percent rates ($56,800
in 2003) over the ordinary taxable income (zero)). Thus, the
regular tax is $1,750.
Under prior law, $35,000 was taxed at five percent in
computing the alternative minimum tax (the lesser of (i) amount
of the adjusted net capital gain which is taxed at the five
percent under the regular tax ($35,000), or (ii) the taxable
excess ($56,100)). The remaining $21,100 of taxable excess was
taxed at 15 percent, for a total tentative minimum tax of
$4,915.
Under the provision, in computing the alternative minimum
tax, $56,100 is taxed at five percent (the lesser of (i) the
taxable excess ($56,100), (ii) the adjusted net capital gain
($82,000), or (iii) the excess of the maximum amount taxed at
the 10- and 15-percent rates under the regular tax ($56,800)
over the ordinary taxable income (zero)). The tentative minimum
tax is $2,805.
Amendment Related to the Small Business Job Protection Act of 1996
S corporation post-termination transition period.--
Shareholders of an S corporation whose status as an S
corporation terminates are allowed a period of time after the
termination (the post-termination transition period (``PTTP''))
to utilize certain of the benefits of S corporation status. The
shareholders may claim losses and deductions previously
suspended due to lack of stock or debt basis up to the amount
of the stock basis as of the last day of the PTTP (sec.
1366(d)). Also, shareholders may receive cash distributions
from the corporation during the PTTP that are treated as
returns of capital to the extent of any balance in the S
corporation's accumulated adjustments account (``AAA'') (sec.
1371(e)).
The PTTP generally begins on the day after the last day of
the corporation's last tax year as an S corporation and ends on
the later of the day which is one year after such last day or
the due date for filing the return for such last year as an S
corporation (including extensions). Section 1307 of the Small
Business Job Protection Act of 1996 added a new 120-day PTTP
following an audit of the corporation that adjusts an S
corporation item of income, loss, or deduction arising during
the most recent period while the corporation was an S
corporation. This provision was enacted to allow the tax-free
distribution of any additional income determined in the audit.
As a result of the 1996 legislation, an S corporation
shareholder might take the position that an audit adjustment
allows the shareholder to utilize suspended losses and
deductions in excess of the amount of the audit deficiency. For
example, assume that, at the end of the one-year PTTP following
the termination of a corporation's S corporation status, a
shareholder has $1 million of suspended losses in the
corporation. Later, the shareholder purchases additional stock
in the corporation for $1 million. The corporation's audit
determines a $25,000 increase in the S corporation's income.
Although the $25,000 increase in income would allow $25,000 of
suspended losses to be allowed, the shareholder might take the
position that the entire $1,000,000 of suspended losses could
be utilized during the 120-day PTTP following the end of the
audit. Similarly, an S corporation that had failed to
distribute the entire amount in its AAA during the one-year
PTTP following the loss of S corporation status might argue
that it could distribute that amount, in addition to the amount
determined in the audit, during the 120-day period following
the audit.
The provision provides that the 120-day PTTP added by the
1996 Act does not apply for purposes of allowing suspended
losses to be deducted (since the increased income determined in
the audit can be offset with the losses), and allows tax-free
distributions of money by the corporation during the 120-day
period only to the extent of any increase in the AAA by reason
of adjustments from the audit.
Defined contribution plans.--The Small Business Job
Protection Act of 1996 amended section 401(a)(26) (generally
requiring that a qualified retirement plan benefit the lesser
of 50 employees or 40 percent of the employer's workforce) so
that it no longer applies to defined contribution plans.
Section 401(a)(26)(C) (which treats employees as benefiting in
certain circumstances) was not repealed even though it relates
only to defined contribution plans. The provision repeals
section 401(a)(26)(C).
Clerical amendments
The provision makes a number of clerical and typographical
amendments.
PART SIXTEEN: TO CLARIFY THE TAX TREATMENT OF BONDS AND OTHER
OBLIGATIONS ISSUED BY THE GOVERNMENT OF AMERICAN SAMOA (PUBLIC LAW 108-
326) \272\
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\272\ H.R. 982. The House Committee on Judiciary reported the bill
on May 15, 2003, (H.R. Rep. No. 108-102, Part I) and the House
Committee on Resources reported the bill on October 7, 2003, (H.R. Rep.
No. 108-102 Part II). The House passed the bill on the suspension
calendar on November 4, 2003. The Senate Committee on Finance reported
the bill, without amendment, on July 20, 2004. The Senate passed the
bill by unanimous consent on September 29, 2004. The President signed
the bill on October 16, 2004.
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A. Clarification of Tax Treatment of Bonds and Other Obligations Issued
by the Government of American Samoa (secs. 1 and 2 of the Act)
Present and Prior Law
The interest on obligations issued by American Samoa is
generally exempt from Federal income tax.\273\ This is
consistent with the treatment of interest on obligations issued
by other possessions of the United States. Prior law did not,
however, provide an exemption from State, local, and
territorial taxes for the interest paid on all obligations
issued by American Samoa.\274\ Rather, prior law only provided
an exemption from State, local, and territorial taxes for
certain industrial development bonds issued by American
Samoa.\275\ In contrast, Congress has provided statutory
exemptions from State, local, and territorial taxes for all
obligations issued by Guam,\276\ the Virgin Islands,\277\
Puerto Rico,\278\ and the Northern Mariana Islands,\279\ in
addition to the exemption from Federal income tax.
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\273\ 26 U.S.C. sec. 103(c).
\274\ 48 U.S.C. sec. 1670.
\275\ 48 U.S.C. sec. 1670(b). The power of Congress to make rules
and regulations respecting ``the Territory or other Property belonging
to the United States'' is generally derived from Article IV, section 3,
clause 2 of the Constitution.
\276\ ``All bonds issued by the government of Guam or by its
authority shall be exempt . . . from taxation by the Government of the
United States or by the government of Guam, or by any State or
Territory or any political subdivision thereof, or by the District of
Columbia.'' 48 U.S.C. sec. 1423a.
\277\ Bonds issued by the government of the Virgin Islands are
``exempt from taxation . . . by any State, Territory, or possession or
by any political subdivision of any State, Territory, or possession, or
by the District of Columbia.'' 48 U.S.C. sec. 1403.
\278\ ``All bonds issued by the Government of Puerto Rico, or by
its authority, shall be exempt from taxation by the Government of the
United States, or by the Government of Puerto Rico or of any political
or municipal subdivision thereof, or by any State, Territory, or
possession, or by any county, municipality, or other municipal
subdivision of any State, Territory, or possession of the United
States, or by the District of Columbia.'' 48 U.S.C. sec. 745.
\279\ Bonds issued by the Northern Mariana Islands are ``exempt, as
to principal and interest, from taxation by the United States, or by
any State, territory or possession of the United States, or any
political subdivision of any of them.'' 48 U.S.C. sec. 1801.
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Explanation of Provision
The Act provides that the interest on any obligation issued
by the Government of American Samoa is exempt from State,
local, and territorial taxes. This exemption does not apply to
gift, estate, inheritance, legacy, succession, or other wealth
transfer taxes.
Effective Date
The provision is effective for obligations issued after the
date of enactment (October 16, 2004).
PART SEVENTEEN: AMERICAN JOBS CREATION ACT OF 2004 (PUBLIC LAW 108-357)
\280\
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\280\ H.R. 4520. The House Committee on Ways and Means reported the
bill on June 16, 2004 (H.R. Rep. No. 108-548). The House passed the
bill on June 17, 2004. The Senate Committee on Finance reported S. 1637
on November 7, 2003 (S. Rep. No. 108-192). The Senate passed H.R. 4520,
as amended by the provisions of S. 1637, on July 15, 2004. The
conference report was filed on October 7, 2004 (H.R. Rep No. 108-755),
and was passed by the House on October 7, 2004, and the Senate on
October 11, 2004. The President signed the bill on October 22, 2004.
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I. PROVISIONS RELATING TO REPEAL OF EXCLUSION FOR EXTRATERRITORIAL
INCOME
A. Repeal of Extraterritorial Income Regime (sec. 101 of the Act and
secs. 114 and 941 through 943 of the Code)
Present and Prior Law
Like many other countries, the United States has long
provided export-related benefits under its tax law. In the
United States, for most of the last two decades, these benefits
were provided under the foreign sales corporation (``FSC'')
regime. In 2000, the European Union succeeded in having the FSC
regime declared a prohibited export subsidy by the World Trade
Organization (``WTO''). In response to this WTO finding, the
United States repealed the FSC rules and enacted a new regime,
under the FSC Repeal and Extraterritorial Income Exclusion Act
of 2000.\281\ The European Union immediately challenged the
extraterritorial income (``ETI'') regime in the WTO, and in
January of 2002 the WTO Appellate Body held that the ETI regime
also constituted a prohibited export subsidy under the relevant
trade agreements.
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\281\ Transition rules delayed the repeal of the FSC rules and the
effective date of ETI for transactions before January 1, 2002. An
election was provided, however, under which taxpayers could adopt ETI
at an earlier date for transactions after September 30, 2000. This
election allowed the ETI rules to apply to transactions after September
30, 2000, including transactions occurring pursuant to pre-existing
binding contracts.
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Under the ETI regime, an exclusion from gross income
applies with respect to ``extraterritorial income,'' which is a
taxpayer's gross income attributable to ``foreign trading gross
receipts.'' This income is eligible for the exclusion to the
extent that it is ``qualifying foreign trade income.''
Qualifying foreign trade income is the amount of gross income
that, if excluded, would result in a reduction of taxable
income by the greatest of: (1) 1.2 percent of the foreign
trading gross receipts derived by the taxpayer from the
transaction; (2) 15 percent of the ``foreign trade income''
derived by the taxpayer from the transaction;\282\ or (3) 30
percent of the ``foreign sale and leasing income'' derived by
the taxpayer from the transaction.\283\
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\282\ ``Foreign trade income'' is the taxable income of the
taxpayer (determined without regard to the exclusion of qualifying
foreign trade income) attributable to foreign trading gross receipts.
\283\ ``Foreign sale and leasing income'' is the amount of the
taxpayer's foreign trade income (with respect to a transaction) that is
properly allocable to activities that constitute foreign economic
processes. Foreign sale and leasing income also includes foreign trade
income derived by the taxpayer in connection with the lease or rental
of qualifying foreign trade property for use by the lessee outside the
United States.
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Foreign trading gross receipts are gross receipts derived
from certain activities in connection with ``qualifying foreign
trade property'' with respect to which certain economic
processes take place outside of the United States.
Specifically, the gross receipts must be: (1) from the sale,
exchange, or other disposition of qualifying foreign trade
property; (2) from the lease or rental of qualifying foreign
trade property for use by the lessee outside the United States;
(3) for services which are related and subsidiary to the sale,
exchange, disposition, lease, or rental of qualifying foreign
trade property (as described above); (4) for engineering or
architectural services for construction projects located
outside the United States; or (5) for the performance of
certain managerial services for unrelated persons. A taxpayer
may elect to treat gross receipts from a transaction as not
foreign trading gross receipts. As a result of such an
election, a taxpayer may use any related foreign tax credits in
lieu of the exclusion.
Qualifying foreign trade property generally is property
manufactured, produced, grown, or extracted within or outside
the United States that is held primarily for sale, lease, or
rental in the ordinary course of a trade or business for direct
use, consumption, or disposition outside the United States. No
more than 50 percent of the fair market value of such property
can be attributable to the sum of: (1) the fair market value of
articles manufactured outside the United States; and (2) the
direct costs of labor performed outside the United States. With
respect to property that is manufactured outside the United
States, certain rules are provided to ensure consistent U.S.
tax treatment with respect to manufacturers.
Reasons for Change
While recognizing that there are problems with the WTO
dispute settlement system that need to be addressed, the
Congress believed it is important that the United States, and
all members of the WTO, make every effort to come into
compliance with their WTO obligations. The Appellate Body found
that the ETI regime constitutes a prohibited export-contingent
subsidy contrary to U.S. obligations under the WTO. The
Congress believed that the ETI regime should be repealed, and
that it was necessary and appropriate to provide transition
relief comparable to that which has been included in measures
taken by WTO members to bring their laws into compliance with
WTO decisions and obligations.
In developing a transition for this provision, the Congress
was guided by the latitude demonstrated by the United States
toward the European Union in the context of the so-called
``Bananas'' dispute. With respect to both the Bananas and FSC/
ETI disputes, the efforts to comply with the applicable WTO
decisions entail the sizable disruption of commercial relations
and expectations that developed over the course of decades.
In the Bananas case, the United States joined other
complainants in challenging the European Union's banana import
regime under the WTO. The United States and the European Union
eventually reached an Understanding to resolve the WTO dispute
over the European Union's import regime for bananas. By virtue
of that Understanding, the European Union imposed a
transitional banana import regime that will not end until seven
years after the initial deadline established by the WTO for the
European Union to come into compliance. The European Union
subsequently obtained from the Doha Ministerial Conference of
the WTO a waiver from paragraphs 1 and 2 of Article XIII of the
GATT 1994 with respect to its transitional banana import
regime. That waiver was necessary for the transitional banana
import regime to remain consistent with the WTO obligations of
the European Union. The United States did not object to that
waiver. The United States also did not object to a second
waiver granted to the European Union by the Doha Ministerial
Conference, under which paragraph 1 of Article I of the GATT
1994 was waived with respect to the European Union's
preferential tariff treatment for products originating in the
African, Caribbean and Pacific Group of States. This latter
waiver extends until December 31, 2007. As a result of the
foregoing waivers consented to by the United States, the
European Union will not be required to grant non-discriminatory
market access for bananas until a full nine years after the
compliance deadline established by the WTO. The Congress noted
that the transition provided for in the provision expires well
before the nine-year anniversary of the compliance deadline
established by the WTO with respect to the FSC regime. Just as
the European Union approached the issue of compliance in the
Bananas dispute, the Congress believed that it is necessary and
appropriate to provide a reasonable transition period during
which the affected businesses may adjust to the new environment
following repeal of the ETI regime.
A second transitional element provided for in the provision
is the grandfathering of existing contracts entered into under
the FSC and ETI tax regimes. These contracts are comprised
primarily of long-term leasing arrangements. These arrangements
typically entail a U.S. lessor purchasing the manufactured good
from the manufacturer and subsequently entering into a long-
term lease with a foreign lessee. Under these circumstances,
the FSC/ETI tax benefit accrues to the lessor rather than the
manufacturer of the leased good. The lessor must report the
FSC/ETI tax benefit immediately for purposes of financial
statement accounting under generally accepted accounting
principles.
Leasing is a service and is recognized as such within the
WTO. The provision of non-discriminatory subsidies to service
suppliers is not prohibited under the WTO General Agreement on
Trade in Services (``GATS''). Thus, an extension of FSC/ETI
benefits for suppliers of leasing services under existing long-
term contracts does not appear to be inconsistent with the WTO
obligations of the United States under GATS. Moreover, the
extension of FSC/ETI benefits for existing long-term leasing
contracts will have no effect on future exports. Accordingly, a
principal rationale for the European Union's challenge to the
FSC/ETI regimes is not implicated because future trade patterns
will not be distorted by virtue of the grandfather clause. On
the other hand, the absence of a grandfather clause for
existing long-term contracts would effectively dictate winners
and losers based upon preexisting contractual relationships,
and would inflict additional harm by forcing lessors to restate
their financial statements. Neither of those outcomes was
equitable in the view of the Congress, nor did the architects
of the WTO dispute settlement system contemplate such punitive
results. Accordingly, the Congress believed it was necessary
and appropriate to continue to provide FSC and ETI tax benefits
to existing long-term contracts that currently benefit from the
FSC/ETI tax regimes.
The Congress also believed that it was important to use the
opportunity afforded by the repeal of the ETI regime to reform
the U.S. tax system in a manner that makes U.S. businesses and
workers more productive and competitive. To this end, the
Congress believed that it was important to provide tax cuts to
U.S. domestic manufacturers and to update the U.S.
international tax rules, which are over 40 years old and which
the Congress concluded made U.S. companies uncompetitive in the
United States and abroad. The Congress believed that the
replacement tax regime provided for in the Act was consistent
with U.S. obligations under the WTO and brought the United
States into compliance with the Appellate Body decision.
Explanation of Provision
The Act repeals the ETI exclusion. For transactions prior
to 2005, taxpayers retain 100 percent of their ETI benefits.
For transactions after 2004, the Act provides taxpayers with 80
percent of their otherwise-applicable ETI benefits for
transactions during 2005 and 60 percent of their otherwise-
applicable ETI benefits for transactions during 2006. However,
the Act provides that the ETI exclusion provisions remain in
effect for transactions in the ordinary course of a trade or
business if such transactions are pursuant to a binding
contract \284\ between the taxpayer and an unrelated person and
such contract is in effect on September 17, 2003, and at all
times thereafter.
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\284\ This rule also applies to a purchase option, renewal option,
or replacement option that is included in such contract. For this
purpose, a replacement option will be considered enforceable against a
lessor notwithstanding the fact that a lessor retained approval of the
replacement lessee.
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In addition, foreign corporations that elected to be
treated for all Federal tax purposes as domestic corporations
in order to facilitate the claiming of ETI benefits are allowed
to revoke such elections within one year of the date of
enactment of the Act without recognition of gain or loss,
subject to anti-abuse rules.
Effective Date
The provision is effective for transactions after December
31, 2004.
B. Deduction Relating to Income Attributable to United States
Production Activities (sec. 102 of the Act and new sec. 199 of the
Code)
Present and Prior Law
Under prior law, there was no provision in the Code that
generally permitted taxpayers to claim a deduction equal to a
percentage of taxable income attributable to domestic
production activities.
Reasons for Change
The Congress believed that creating new jobs is an
essential element of economic recovery and expansion, and that
tax policies designed to foster economic strength also will
contribute to the continuation of the recent increases in
employment levels. To accomplish this objective, the Congress
believed that it should enact tax laws that enhance the ability
of domestic businesses, and domestic manufacturing firms in
particular, to compete in the global marketplace. The Congress
further believed that it should enact tax laws that enable
small businesses to maintain their position as the primary
source of new jobs in this country.
The Congress understood that simply repealing the ETI
regime, while bringing our tax laws into compliance with our
obligations under the WTO, would diminish the prospects for
recovery from the recent economic downturn by the manufacturing
sector. Consequently, the Congress believed that it was
appropriate and necessary to replace the ETI regime with new
provisions that reduce the tax burden on domestic
manufacturers, including small businesses engaged in
manufacturing. The Congress was of the view that a reduced tax
burden on domestic manufacturers will improve the cash flow of
domestic manufacturers and make investments in domestic
manufacturing facilities more attractive. Such investment will
assist in the creation and preservation of U.S. manufacturing
jobs.
Explanation of Provision
In general
The Act provides a deduction equal to a specified percent
of the lesser of the taxpayer's (1) qualified production
activities income or (2) taxable income (determined without
regard to this deduction) for the taxable year.\285\ For
taxable years beginning after 2009, the percent is nine
percent; for taxable years beginning in 2005 and 2006, the
percent is three percent; and for taxable years beginning 2007,
2008, and 2009, the percent is six percent. However, the
deduction for a taxable year is limited to 50 percent of the
wages paid by the taxpayer during the calendar year that ends
in such taxable year.\286\ In the case of corporate taxpayers
that are members of certain affiliated groups \287\, the
deduction is determined by treating all members of such groups
as a single taxpayer and the deduction is allocated among such
members in proportion to each member's respective amount (if
any) of qualified production activities income.
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\285\ In the case of an individual, the limit is applied using
adjusted gross income rather than taxable income.
\286\ For purposes of the Act, ``wages'' include the sum of the
aggregate amounts of wages and elective deferrals that the taxpayer is
required to include on statements with respect to the employment of
employees of the taxpayer during the taxpayer's taxable year. Elective
deferrals include elective deferrals as defined in section 402(g)(3),
amounts deferred under section 457, and, for taxable years beginning
after December 31, 2005, designated Roth contributions (as defined in
section 402A). The Act does not specifically require such statements
(i.e., Forms W-2) actually to be filed, and does not specify whether
the employees must be the common law employees of the taxpayer.
However, it is intended that a taxpayer may take into account only
wages that are paid to the common law employees of the taxpayer and
that are reported on a Form W-2 filed with the Social Security
Administration no later than 60 days after the extended due date for
the Form W-2. Thus, the taxpayer may not take into account wages that
were not actually reported. A technical correction may be necessary so
that the statute reflects this intent, and to address situations in
which the employer uses an agent to report its wages.
\287\ Members of an expanded affiliated group for purposes of the
provision generally include those corporations which would be members
of an affiliated group if such membership were determined based on an
ownership threshold of ``more than 50%'' rather than ``at least 80%.''
A technical correction may be necessary to reflect this intent.
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Qualified production activities income
In general, ``qualified production activities income'' is
equal to domestic production gross receipts, reduced by the sum
of: (1) the costs of goods sold that are allocable to such
receipts;\288\ (2) other deductions, expenses, or losses that
are directly allocable to such receipts; and (3) a proper share
of other deductions, expenses, and losses that are not directly
allocable to such receipts or another class of income.\289\
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\288\ For purposes of determining such costs, any item or service
that is imported into the United States without an arm's length
transfer price shall be treated as acquired by purchase, and its cost
shall be treated as not less than its value when it entered the United
States. A similar rule shall apply in determining the adjusted basis of
leased or rented property where the lease or rental gives rise to
domestic production gross receipts. With regard to property previously
exported by the taxpayer for further manufacture, the increase in cost
or adjusted basis shall not exceed the difference between the value of
the property when exported and the value of the property when re-
imported into the United States after further manufacture. Except as
provided by the Secretary, the value of property for this purpose shall
be its customs value (as defined in section 1059A(b)(1)).
\289\ The Secretary shall prescribe rules for the proper allocation
of items of income, deduction, expense, and loss for purposes of
determining qualified production activities income. Where appropriate,
such rules shall be similar to and consistent with relevant present-law
rules (e.g., sec. 263A, in determining the cost of goods sold, and sec.
861, in determining the source of such items). Other deductions,
expenses or losses that are directly allocable to such receipts
include, for example, selling and marketing expenses. A proper share of
other deductions, expenses, and losses that are not directly allocable
to such receipts or another class of income include, for example,
general and administrative expenses allocable to selling and marketing
expenses. It is intended that, in computing qualified production
activities income, the domestic production activities deduction itself
is not an allocable deduction. In addition, no inference is intended
with regard to the interpretive relationship between the cost
allocation rules provided in this provision and cost allocation rules
provided in provisions elsewhere in the Act (e.g., incentives to
reinvest foreign earnings in the United States). Technical corrections
may be necessary so that the statute reflects this intent.
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Domestic production gross receipts
``Domestic production gross receipts'' generally are gross
receipts of a taxpayer that are derived from: (1) any sale,
exchange or other disposition, or any lease, rental or license,
of qualifying production property that was manufactured,
produced, grown or extracted by the taxpayer in whole or in
significant part within the United States;\290\ (2) any sale,
exchange or other disposition, or any lease, rental or license,
of qualified film produced by the taxpayer; (3) any sale,
exchange or other disposition electricity, natural gas, or
potable water produced by the taxpayer in the United States;
(4) construction activities performed in the United
States;\291\ or (5) engineering or architectural services
performed in the United States for construction projects
located in the United States.\292\ However, domestic production
gross receipts do not include any gross receipts of the
taxpayer derived from property that is leased, licensed or
rented by the taxpayer for use by any related person.\293\
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\290\ Domestic production gross receipts include gross receipts of
a taxpayer derived from any sale, exchange or other disposition of
agricultural products with respect to which the taxpayer performs
storage, handling or other processing activities (other than
transportation activities) within the United States, provided such
products are consumed in connection with, or incorporated into, the
manufacturing, production, growth or extraction of qualifying
production property (whether or not by the taxpayer).
\291\ For this purpose, construction activities include activities
that are directly related to the erection or substantial renovation of
residential and commercial buildings and infrastructure. Substantial
renovation would include structural improvements, but not mere cosmetic
changes, such as painting that is not performed in connection with
activities that otherwise constitute substantial renovation.
\292\ With regard to the definition of ``domestic production gross
receipts'' as it relates to construction performed in the United States
and engineering or architectural services performed in the United
States for construction projects in the United States, it is intended
that the term refer only to gross receipts derived from the
construction of real property by a taxpayer engaged in the active
conduct of a construction trade or business, or from engineering or
architectural services performed with respect to real property by a
taxpayer engaged in the active conduct of an engineering or
architectural services trade or business. Technical corrections may be
necessary so that the statute reflects this intent.
\293\ It is intended that principles similar to those under the
present-law extraterritorial income regime apply for this purpose. See
Temp. Treas. Reg. sec. 1.927(a)-1T(f)(2)(i). For example, this
exclusion generally does not apply to property leased by the taxpayer
to a related person if the property is held for sublease, or is
subleased, by the related person to an unrelated person for the
ultimate use of such unrelated person. Similarly, the license of
computer software to a related person for reproduction and sale,
exchange, lease, rental or sublicense to an unrelated person for the
ultimate use of such unrelated person is not treated as excluded
property by reason of the license to the related person.
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Sale of food or beverages prepared at a retail establishment
The Act provides that domestic production gross receipts do
not include any gross receipts of the taxpayer that are derived
from the sale of food or beverages prepared by the taxpayer at
a retail establishment. It is intended that food processing,
which generally is a qualified production activity under the
Act, does not include food preparation activities carried out
at a retail establishment. Thus, under the Act, while the gross
receipts of a meat packing establishment are qualified domestic
production gross receipts, the activities of a master chef who
creates a venison sausage for his or her restaurant menu cannot
be construed as a qualified production activity.
However, it is recognized that some taxpayers may own
facilities at which the predominant activity is domestic
production as defined in the Act and other facilities at which
they engage in the retail sale of the taxpayer's produced goods
and also sell food and beverages that are prepared by the
taxpayer at the retail establishment. It is intended that the
Act draw a distinction between activities that constitute
domestic production under the Act and other activities.
Therefore, it is not intended that the retail activities of the
taxpayer, which themselves do not constitute domestic
production under the Act, also disqualify other activities of
the taxpayer that do constitute domestic production under the
Act. As is the case under the Act generally, with respect to
gross receipts that are attributable to both domestic
production activities and other activities performed by the
taxpayer, gross receipts that are attributable to both the
domestic production of food or beverages by the taxpayer and
the sale of food or beverages prepared by the taxpayer at a
retail establishment are to be allocated or apportioned between
the domestic production activities and retail activities,
including circumstances in which the food or beverages
domestically produced by the taxpayer also are involved
subsequently in the preparation of food or beverages by the
taxpayer at a retail establishment.
For example, assume that the taxpayer buys coffee beans and
roasts those beans at a facility, the primary activity of which
is the roasting and packaging of roasted coffee. The taxpayer
sells the roasted coffee beans (either whole or ground) through
a variety of unrelated third-party vendors and also sells
roasted coffee beans at the taxpayer's own retail
establishments. In addition, at the taxpayer's retail
establishments, the taxpayer prepares brewed coffee and other
foods. Consistent with the general operation of the Act, it is
intended that to the extent the gross receipts of the
taxpayer's retail establishment represent receipts from the
sale of its roasted coffee beans to customers, the receipts are
qualified domestic production gross receipts, but to the extent
that the gross receipts of the taxpayer's retail establishment
represent receipts from the sale of brewed coffee or food
prepared at the retail establishment, the receipts are not
qualified domestic production gross receipts. To the extent
that the taxpayer uses its own roasted coffee beans in the
brewing of coffee at the taxpayer's retail establishment, the
taxpayer may allocate part of the receipts from the sale of the
brewed coffee as qualified domestic production gross receipts
to the extent of the value of the roasted coffee beans used to
brew the coffee. It is anticipated that the Secretary will
provide guidance drawing on the principles of section 482 by
which such a taxpayer can allocate gross receipts between
qualified domestic production gross receipts and other,
nonqualified, gross receipts. In the preceding example, the
taxpayer's sales of roasted coffee beans to unrelated third
parties would provide a value for the beans used in brewing a
cup of coffee for retail sale.
It is intended that the disqualification of gross receipts
derived from the sale of food and beverage prepared by the
taxpayer at a retail establishment not be construed narrowly to
apply only to establishments at which customers dine on
premises. The receipts of a facility that prepares food and
beverage solely for take out service would not be qualified
production gross receipts. Likewise, it is intended that the
disqualification of gross receipts derived from the sale of
food and beverages prepared by the taxpayer need not be limited
to retail establishments primarily engaged in the dining trade.
For example, if a taxpayer operates a supermarket and as part
of the supermarket the taxpayer operates an in-store bakery,
the same allocation described above would apply to determine
the extent to which the taxpayer's gross receipts represent
qualified domestic production gross receipts.
Electricity, natural gas, or potable water transmission or distribution
Although domestic production gross receipts include the
gross receipts from the production in the United States of
electricity, gas, and potable water, the Act excludes gross
receipts from the transmission or distribution of electricity,
gas, and potable water. Thus, in the case of a taxpayer who
owns a facility for the production of electricity (either as
part of a regulated utility or an independent power facility),
the taxpayer's gross receipts from the production of
electricity at that facility are qualified domestic production
gross receipts. However, to the extent that the taxpayer is an
integrated producer that generates electricity and delivers
electricity to end users, any gross receipts properly
attributable to the transmission of electricity from the
generating facility to a point of local distribution and any
gross receipts properly attributable to the distribution of
electricity to final customers are not qualified domestic
production gross receipts.
For example, taxpayer A owns a wind turbine that generates
electricity and taxpayer B owns a high-voltage transmission
line that passes near taxpayer A's wind turbine and ends near
the system of local distribution lines of taxpayer C. Taxpayer
A sells the electricity produced at the wind turbine to
taxpayer C and contracts with taxpayer B to transmit the
electricity produced at the wind turbine to taxpayer C who
sells the electricity to his or her customers using taxpayer
C's distribution network. The gross receipts received by
taxpayer A for the sale of electricity produced at the wind
turbine constitute qualifying domestic production gross
receipts. The gross receipts of taxpayer B from transporting
taxpayer A's electricity to taxpayer C are not qualifying
domestic production gross receipts. Likewise, the gross
receipts of taxpayer C from distributing the electricity are
not qualifying domestic production gross receipts. Also, if
taxpayer A made direct sales of electricity to customers in
taxpayer C's service area and taxpayer C received remuneration
for the distribution of electricity, the gross receipts of
taxpayer C are not qualifying domestic production gross
receipts. If taxpayers A, B, and C are all related taxpayers,
then taxpayers A, B, and C must allocate gross receipts to
production activities, transmission activities, and
distribution activities in a manner consistent with the
preceding example.
The same principles apply in the case of the natural gas
and water supply industries. In the case of natural gas,
production activities generally are all activities involved in
extracting natural gas from the ground and processing the gas
into pipeline quality gas. Such activities would produce
qualifying domestic production gross receipts. However, gross
receipts of a taxpayer attributable to transmission of pipeline
quality gas from a natural gas field (or from a natural gas
processing plant) to a local distribution company's citygate
(or to another customer) are not qualified domestic production
gross receipts. Likewise, gas purchased by a local gas
distribution company and distributed from the citygate to the
local customers does not give rise to domestic production gross
receipts.
In the case of the production of potable water, activities
involved in the production of potable water include the
acquisition, collection, and storage of raw water (untreated
water). It also includes the transportation of raw water to a
water treatment facility and treatment of raw water at such a
facility. However, any gross receipts from the storage of
potable water after the water treatment facility or delivery of
potable water to customers does not give rise to qualifying
domestic production gross receipts. It is intended that a
taxpayer that both produces potable water and distributes
potable water will properly allocate gross receipts across
qualifying and non-qualifying activities.
Qualifying production property
``Qualifying production property'' generally includes any
tangible personal property, computer software, or sound
recordings. ``Qualified film'' includes any motion picture film
or videotape \294\ (including live or delayed television
programming, but not including certain sexually explicit
productions) if 50 percent or more of the total compensation
relating to the production of such film (including compensation
in the form of residuals and participations \295\) constitutes
compensation for services performed in the United States by
actors, production personnel, directors, and producers.\296\
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\294\ The Congress intends that the nature of the material on which
properties described in section 168(f)(3) are embodied and the methods
and means of distribution of such properties shall not affect their
qualification under this provision.
\295\ To the extent that a taxpayer has included an estimate of
participations and/or residuals in its income forecast calculation
under section 167(g), the taxpayer must use the same estimate of
participations and/or residuals for purposes of determining total
compensation.
\296\ It is intended that the Secretary will provide appropriate
rules governing the determination of total compensation for services
performed in the United States.
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Other rules
Qualified production activities income of partnerships and
S corporations
With respect to the domestic production activities of a
partnership or S corporation, the deduction under the Act is
determined at the partner or shareholder level. In performing
the calculation, each partner or shareholder generally will
take into account such person's allocable share of the
components of the calculation (including domestic production
gross receipts; the cost of goods sold allocable to such
receipts; and other expenses, losses, or deductions allocable
to such receipts) from the partnership or S corporation as well
as any items relating to the partner or shareholder's own
qualified production activities, if any.\297\
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\297\ A technical correction may be necessary so that the statute
reflects this intent.
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In applying the wage limitation, each partner or
shareholder is treated as having been allocated wages from the
partnership or S corporation in an amount that is equal to the
lesser of: (1) such person's allocable share of wages, as
determined under regulations prescribed by the Secretary; or
(2) twice the appropriate deductible percentage of such
person's qualified production activities income attributable to
items allocated from the partnership or S corporation. This
limitation is intended to prevent a partner or shareholder from
claiming a deduction with respect to its own activities in
excess of that which would be allowed if such person were not a
member of the partnership or S corporation.
Qualified production activities of trusts and estates
In the case of a trust or estate, the components of the
calculation are to be apportioned between (and among) the
beneficiaries and the fiduciary under regulations prescribed by
the Secretary.\298\
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\298\ A technical correction may be necessary so that the statute
reflects this intent.
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Qualified production activities income of agricultural and
horticultural cooperatives
With regard to member-owned agricultural and horticultural
cooperatives formed under Subchapter T of the Code, the Act
provides the same treatment of qualified production activities
income derived from agricultural or horticultural products that
are manufactured, produced, grown, or extracted by
cooperatives,\299\ or that are marketed through cooperatives,
as it provides for qualified production activities income of
other taxpayers (i.e., the cooperative may claim a deduction
from qualified production activities income).
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\299\ For this purpose, agricultural or horticultural products also
include fertilizer, diesel fuel and other supplies used in agricultural
or horticultural production that are manufactured, produced, grown, or
extracted by the cooperative.
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Alternatively, the Act provides that the amount of any
patronage dividends or per-unit retain allocations paid to a
member of an agricultural or horticultural cooperative (to
which Part I of Subchapter T applies), which is allocable to
the portion of qualified production activities income of the
cooperative that is deductible under the provision, is
deductible from the gross income of the member. In order to
qualify, such amount must be designated by the organization as
allocable to the deductible portion of qualified production
activities income in a written notice mailed to its patrons not
later than the payment period described in section 1382(d). The
cooperative cannot reduce its income under section 1382 (e.g.,
cannot claim a dividends-paid deduction) for such amounts.
Alternative minimum tax
The deduction provided by the Act is allowed for purposes
of computing alternative minimum taxable income (including
adjusted current earnings). The deduction in computing
alternative minimum taxable income is determined by reference
to the lesser of the qualified production activities income (as
determined for the regular tax) or the alternative minimum
taxable income (in the case of an individual, adjusted gross
income as determined for the regular tax) without regard to
this deduction.\300\
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\300\ A technical correction may be necessary so that the statute
reflects this intent.
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Timber cutting
Under the Act, an election made for a taxable year ending
on or before the date of enactment, to treat the cutting of
timber as a sale or exchange, may be revoked by the taxpayer
without the consent of the IRS for any taxable year ending
after that date. The prior election (and revocation) is
disregarded for purposes of making a subsequent election.
Exploration of fundamental tax reform
The Congress acknowledges that it has not reduced the
statutory corporate income tax rate since 1986. According to
the Organisation of Economic Cooperation and Development
(``OECD''), the combined corporate income tax rate, as defined
by the OECD, in most instances is lower than the U.S. corporate
income tax rate.\301\ Higher corporate tax rates factor into
the United States' ability to attract and retain economically
vibrant industries, which create good jobs and contribute to
overall economic growth.
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\301\Organisation of Economic Cooperation and Development, Table
1.5, Tax Data Base Statistics, Tax Policy and Administration, Summary
Tables (2003).
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This legislation was crafted to repeal an export tax
benefit that was deemed inconsistent with obligations of the
United States under the Agreement on Subsidies and
Countervailing Measures and other international trade
agreements. This legislation replaces the benefit with tax
relief specifically designed to be economically equivalent to a
3-percentage point reduction in U.S.-based manufacturing.
The Congress recognizes that manufacturers are a segment of
the economy that has faced significant challenges during the
nation's recent economic slowdown. The Congress recognizes that
trading partners of the United States retain subsidies for
domestic manufacturers and exports through their indirect tax
systems. The Congress is concerned about the adverse
competitive impact of these subsidies on U.S. manufacturers.
These concerns should be considered in the context of the
benefits of a unified top tax rate for all corporate taxpayers,
including manufacturers, in terms of efficiency and fairness.
The Congress also expects that the tax-writing committees will
explore a unified top corporate tax rate in the context of
fundamental tax reform.
Effective Date
The provision is effective for taxable years beginning
after December 31, 2004.
II. BUSINESS TAX INCENTIVES
A. Two-Year Extension of Increased Expensing for Small Business (sec.
201 of the Act and sec. 179 of the Code)
Present and Prior Law
In lieu of depreciation, a taxpayer with a sufficiently
small amount of annual investment may elect to deduct such
costs. The Jobs and Growth Tax Relief Reconciliation Act of
2003 (``JGTRRA'') \302\ increased the amount a taxpayer may
deduct, for taxable years beginning in 2003 through 2005, to
$100,000 of the cost of qualifying property placed in service
for the taxable year.\303\ In general, qualifying property is
defined as depreciable tangible personal property (and certain
computer software) that is purchased for use in the active
conduct of a trade or business. The $100,000 amount is reduced
(but not below zero) by the amount by which the cost of
qualifying property placed in service during the taxable year
exceeds $400,000. The $100,000 and $400,000 amounts are indexed
for inflation.
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\302\ Pub. L. No. 108-27, sec. 202 (2003).
\303\ Additional section 179 incentives are provided with respect
to a qualified property used by a business in the New York Liberty Zone
(sec. 1400L(f)), an empowerment zone (sec. 1397A), or a renewal
community (sec. 1400J).
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Prior to the enactment of JGTRRA (and for taxable years
beginning in 2006 and thereafter) a taxpayer with a
sufficiently small amount of annual investment could elect to
deduct up to $25,000 of the cost of qualifying property placed
in service for the taxable year. The $25,000 amount was reduced
(but not below zero) by the amount by which the cost of
qualifying property placed in service during the taxable year
exceeds $200,000. In general, qualifying property is defined as
depreciable tangible personal property that is purchased for
use in the active conduct of a trade or business.
The amount eligible to be expensed for a taxable year may
not exceed the taxable income for a taxable year that is
derived from the active conduct of a trade or business
(determined without regard to this provision). Any amount that
is not allowed as a deduction because of the taxable income
limitation may be carried forward to succeeding taxable years
(subject to similar limitations). No general business credit
under section 38 is allowed with respect to any amount for
which a deduction is allowed under section 179.
An expensing election is made under rules prescribed by the
Secretary.\304\ Applicable Treasury regulations provide that an
expensing election generally is made on the taxpayer's original
return for the taxable year to which the election relates.\305\
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\304\ Sec. 179(c)(1).
\305\ Under Treas. Reg. sec. 1.179-5, applicable to property placed
in service in taxable years ending after January 25, 1993 (but not
including property placed in service in taxable years beginning after
2002 and before 2006), a taxpayer may make the election on the original
return (whether or not the return is timely), or on an amended return
filed by the due date (including extensions) for filing the return for
the tax year the property was placed in service. If the taxpayer timely
filed an original return without making the election, the taxpayer may
still make the election by filing an amended return within six months
of the due date of the return (excluding extensions).
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Prior to the enactment of JGTRRA (and for taxable years
beginning in 2006 and thereafter), an expensing election may be
revoked only with consent of the Commissioner.\306\ JGTRRA
permits taxpayers to revoke expensing elections on amended
returns without the consent of the Commissioner with respect to
a taxable year beginning after 2002 and before 2006.\307\
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\306\ Sec. 179(c)(2).
\307\ Id. Under Prop. and Temp. Treas. Reg. sec. 179-5T, applicable
to property placed in service in taxable years beginning after 2002 and
before 2006, a taxpayer is permitted to make or revoke an election
under section 179 without the consent of the Commissioner on an amended
Federal tax return for that taxable year. This amended return must be
filed within the time prescribed by law for filing an amended return
for the taxable year. T.D. 9146, August 3, 2004.
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Reasons for Change
The Congress believed that section 179 expensing provides
two important benefits for small businesses. First, it lowers
the cost of capital for property used in a trade or business.
With a lower cost of capital, the Congress believed small
businesses will invest in more equipment and employ more
workers. Second, it eliminates depreciation recordkeeping
requirements with respect to expensed property. In JGTRRA,
Congress acted to increase the value of these benefits and to
increase the number of taxpayers eligible for taxable years
through 2005. The Congress believed that these changes to
section 179 expensing will continue to provide important
benefits if extended, and the Act therefore extends these
changes for an additional two years.
Explanation of Provision
The Act extends the increased amount that a taxpayer may
deduct, and other changes that were made by JGTRRA, for an
additional two years. Thus, the Act provides that the maximum
dollar amount that may be deducted under section 179 is
$100,000 for property placed in service in taxable years
beginning before 2008 ($25,000 for taxable years beginning in
2008 and thereafter). In addition, the $400,000 amount applies
for property placed in service in taxable years beginning
before 2008 ($200,000 for taxable years beginning in 2008 and
thereafter). The Act extends, through 2007 (from 2005), the
indexing for inflation of both the maximum dollar amount that
may be deducted and the $400,000 amount. The Act also includes
off-the-shelf computer software placed in service in taxable
years beginning before 2008 as qualifying property. The Act
permits taxpayers to revoke expensing elections on amended
returns without the consent of the Commissioner with respect to
a taxable year beginning before 2008. The Congress expects that
the Secretary will prescribe regulations to permit a taxpayer
to make an expensing election on an amended return without the
consent of the Commissioner.
Effective Date
The provision is effective on the date of enactment
(October 22, 2004).
B. Depreciation
1. Recovery period for depreciation of certain leasehold improvements
(sec. 211 of the Act and sec. 168 of the Code)
Present and Prior Law
In general
A taxpayer generally must capitalize the cost of property
used in a trade or business and recover such cost over time
through annual deductions for depreciation or amortization.
Tangible property generally is depreciated under the modified
accelerated cost recovery system (``MACRS''), which determines
depreciation by applying specific recovery periods, placed-in-
service conventions, and depreciation methods to the cost of
various types of depreciable property (sec. 168). The cost of
nonresidential real property is recovered using the straight-
line method of depreciation and a recovery period of 39 years.
Nonresidential real property is subject to the mid-month
placed-in-service convention. Under the mid-month convention,
the depreciation allowance for the first year property is
placed in service is based on the number of months the property
was in service, and property placed in service at any time
during a month is treated as having been placed in service in
the middle of the month.
Depreciation of leasehold improvements
Depreciation allowances for improvements made on leased
property are determined under MACRS, even if the MACRS recovery
period assigned to the property is longer than the term of the
lease.\308\ This rule applies regardless of whether the lessor
or the lessee places the leasehold improvements in
service.\309\ If a leasehold improvement constitutes an
addition or improvement to nonresidential real property already
placed in service, the improvement is depreciated using the
straight-line method over a 39-year recovery period, beginning
in the month the addition or improvement was placed in
service.\310\
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\308\ Sec. 168(i)(8). The Tax Reform Act of 1986 modified the
Accelerated Cost Recovery System (``ACRS'') to institute MACRS. Prior
to the adoption of ACRS by the Economic Recovery Tax Act of 1981,
taxpayers were allowed to depreciate the various components of a
building as separate assets with separate useful lives. The use of
component depreciation was repealed upon the adoption of ACRS. The Tax
Reform Act of 1986 also denied the use of component depreciation under
MACRS.
\309\ Former sections 168(f)(6) and 178 provided that, in certain
circumstances, a lessee could recover the cost of leasehold
improvements made over the remaining term of the lease. The Tax Reform
Act of 1986 repealed these provisions.
\310\ Secs. 168(b)(3), (c), (d)(2), and (i)(6). If the improvement
is characterized as tangible personal property, ACRS or MACRS
depreciation is calculated using the shorter recovery periods,
accelerated methods, and conventions applicable to such property. The
determination of whether improvements are characterized as tangible
personal property or as nonresidential real property often depends on
whether or not the improvements constitute a ``structural component''
of a building (as defined by Treas. Reg. sec. 1.48-1(e)(1)). See, e.g.,
Metro National Corp v. Commissioner, 52 TCM (CCH) 1440 (1987); King
Radio Corp Inc. v. U.S., 486 F.2d 1091 (10th Cir. 1973); Mallinckrodt,
Inc. v. Commissioner, 778 F.2d 402 (8th Cir. 1985) (with respect to
various leasehold improvements).
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Qualified leasehold improvement property
The additional first-year depreciation deduction generally
equals either 30 percent or 50 percent of the adjusted basis of
qualified property placed in service before January 1, 2005.
Qualified property includes qualified leasehold improvement
property. For this purpose, qualified leasehold improvement
property is any improvement to an interior portion of a
building that is nonresidential real property, provided certain
requirements are met. The improvement must be made under or
pursuant to a lease either by the lessee (or sublessee), or by
the lessor, of that portion of the building to be occupied
exclusively by the lessee (or sublessee). The improvement must
be placed in service more than three years after the date the
building was first placed in service. Qualified leasehold
improvement property does not include any improvement for which
the expenditure is attributable to the enlargement of the
building, any elevator or escalator, any structural component
benefiting a common area, or the internal structural framework
of the building.
Treatment of dispositions of leasehold improvements
A lessor of leased property that disposes of a leasehold
improvement that was made by the lessor for the lessee of the
property may take the adjusted basis of the improvement into
account for purposes of determining gain or loss if the
improvement is irrevocably disposed of or abandoned by the
lessor at the termination of the lease. This rule conforms the
treatment of lessors and lessees with respect to leasehold
improvements disposed of at the end of a term of lease.
Reasons for Change
The Congress believed that taxpayers should not be required
to recover the costs of certain leasehold improvements beyond
the useful life of the investment. The 39-year recovery period
for leasehold improvements extends well beyond the useful life
of such investments. Although lease terms differ, the Congress
believed that lease terms for commercial real estate typically
are shorter than the present-law 39-year recovery period. In
the interests of simplicity and administrability, a uniform
period for recovery of leasehold improvements is desirable. The
Act therefore shortened the recovery period for leasehold
improvements to a more realistic 15 years.
Explanation of Provision
The Act provides a statutory 15-year recovery period for
qualified leasehold improvement property placed in service
before January 1, 2006.\311\ The Act requires that qualified
leasehold improvement property be recovered using the straight-
line method.
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\311\ Qualified leasehold improvement property continues to be
eligible for the additional first-year depreciation deduction under
sec. 168(k).
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Qualified leasehold improvement property is defined as
under present and prior law for purposes of the additional
first-year depreciation deduction,\312\ with the following
modification. If a lessor makes an improvement that qualifies
as qualified leasehold improvement property, such improvement
does not qualify as qualified leasehold improvement property to
any subsequent owner of such improvement. An exception to the
rule applies in the case of death and certain transfers of
property that qualify for non-recognition treatment.
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\312\ Sec. 168(k).
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Effective Date
The provision is effective for property placed in service
after the date of enactment (October 22, 2004).
2. Recovery period for depreciation of certain restaurant improvements
(sec. 211 of the Act and sec. 168 of the Code)
Present and Prior Law
A taxpayer generally must capitalize the cost of property
used in a trade or business and recover such cost over time
through annual deductions for depreciation or amortization.
Tangible property generally is depreciated under the modified
accelerated cost recovery system (``MACRS''), which determines
depreciation by applying specific recovery periods, placed-in-
service conventions, and depreciation methods to the cost of
various types of depreciable property (sec. 168). The cost of
nonresidential real property is recovered using the straight-
line method of depreciation and a recovery period of 39 years.
Nonresidential real property is subject to the mid-month
placed-in-service convention. Under the mid-month convention,
the depreciation allowance for the first year property is
placed in service is based on the number of months the property
was in service, and property placed in service at any time
during a month is treated as having been placed in service in
the middle of the month.
Reasons for Change
The Congress believed that unlike other commercial
buildings, restaurant buildings generally are more specialized
structures. Restaurants also experience considerably more
traffic, and remain open longer than most retail properties.
This daily assault causes rapid deterioration of restaurant
properties and forces restaurateurs to constantly repair and
upgrade their facilities. As such, restaurant facilities have a
much shorter life span than other commercial establishments.
The Act reduced the 39-year recovery period for improvements
made to restaurant buildings and more accurately reflected the
true economic life of the properties by reducing the recovery
period to 15 years.
Explanation of Provision
The Act provides a statutory 15-year recovery period for
qualified restaurant property placed in service before January
1, 2006.\313\ For purposes of the provision, qualified
restaurant property means any improvement to a building if such
improvement is placed in service more than three years after
the date such building was first placed in service and more
than 50 percent of the building's square footage is devoted to
the preparation of, and seating for, on-premises consumption of
prepared meals. The Act requires that qualified restaurant
property be recovered using the straight-line method.
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\313\ Qualified restaurant property becomes eligible for the
additional first-year depreciation deduction under sec. 168(k) by
virtue of the assigned 15-year recovery period.
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Effective Date
The provision is effective for property placed in service
after the date of enactment (October 22, 2004).
C. Community Revitalization
1. Modification of targeted areas and low-income communities designated
for new markets tax credit (sec. 221 of the Act and sec. 45D of
the Code)
Present and Prior Law
Section 45D provides a new markets tax credit for qualified
equity investments made to acquire stock in a corporation, or a
capital interest in a partnership, that is a qualified
community development entity (``CDE'').\314\ The amount of the
credit allowable to the investor (either the original purchaser
or a subsequent holder) is (1) a five-percent credit for the
year in which the equity interest is purchased from the CDE and
for each of the following two years, and (2) a six-percent
credit for each of the following four years. The credit is
determined by applying the applicable percentage (five or six
percent) to the amount paid to the CDE for the investment at
its original issue, and is available for a taxable year to the
taxpayer who holds the qualified equity investment on the date
of the initial investment or on the respective anniversary date
that occurs during the taxable year. The credit is recaptured
if at any time during the seven-year period that begins on the
date of the original issue of the investment the entity ceases
to be a qualified CDE, the proceeds of the investment cease to
be used as required, or the equity investment is redeemed.
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\314\ Section 45D was added by section 121(a) of the Community
Renewal Tax Relief Act of 2000, Pub. L. No. 106-554 (December 21,
2000).
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A qualified CDE is any domestic corporation or partnership:
(1) whose primary mission is serving or providing investment
capital for low-income communities or low-income persons; (2)
that maintains accountability to residents of low-income
communities by their representation on any governing board of
or any advisory board to the CDE; and (3) that is certified by
the Secretary as being a qualified CDE. A qualified equity
investment means stock (other than nonqualified preferred
stock) in a corporation or a capital interest in a partnership
that is acquired directly from a CDE for cash, and includes an
investment of a subsequent purchaser if such investment was a
qualified equity investment in the hands of the prior holder.
Substantially all of the investment proceeds must be used by
the CDE to make qualified low-income community investments. For
this purpose, qualified low-income community investments
include: (1) capital or equity investments in, or loans to,
qualified active low-income community businesses; (2) certain
financial counseling and other services to businesses and
residents in low-income communities; (3) the purchase from
another CDE of any loan made by such entity that is a qualified
low-income community investment; or (4) an equity investment
in, or loan to, another CDE.
Under prior law, a ``low-income community'' was defined as
a population census tract with either (1) a poverty rate of at
least 20 percent or (2) median family income which does not
exceed 80 percent of the greater of metropolitan area median
family income or statewide median family income (for a non-
metropolitan census tract, does not exceed 80 percent of
statewide median family income). Under prior law, the Secretary
could designate any area within any census tract as a low-
income community provided that (1) the boundary is continuous,
(2) the area (if it were a census tract) would otherwise
satisfy the poverty rate or median income requirements, and (3)
an inadequate access to investment capital exists in the area.
A qualified active low-income community business is defined
as a business that satisfies, with respect to a taxable year,
the following requirements: (1) at least 50 percent of the
total gross income of the business is derived from the active
conduct of trade or business activities in any low-income
community; (2) a substantial portion of the tangible property
of such business is used in a low-income community; (3) a
substantial portion of the services performed for such business
by its employees is performed in a low-income community; and
(4) less than five percent of the average of the aggregate
unadjusted bases of the property of such business is
attributable to certain financial property or to certain
collectibles.
The maximum annual amount of qualified equity investments
is capped at $2.0 billion per year for calendar years 2004 and
2005, and at $3.5 billion per year for calendar years 2006 and
2007.
Explanation of Provision
The Act modifies the Secretary's authority to designate
certain areas as low-income communities to provide that the
Secretary shall prescribe regulations to designate ``targeted
populations'' as low-income communities for purposes of the new
markets tax credit. For this purpose, a ``targeted population''
is defined by reference to section 103(20) of the Riegle
Community Development and Regulatory Improvement Act of 1994
(12 U.S.C. 4702(20)) to mean individuals, or an identifiable
group of individuals, including an Indian tribe, who (A) are
low-income persons; or (B) otherwise lack adequate access to
loans or equity investments. Under the Act, ``low-income''
means (1) for a targeted population within a metropolitan area,
less than 80 percent of the area median family income; and (2)
for a targeted population within a non-metropolitan area, less
than the greater of 80 percent of the area median family income
or 80 percent of the statewide non-metropolitan area median
family income.\315\ Under the Act, a targeted population is not
required to be within any census tract. In addition, a
population census tract with a population of less than 2,000 is
treated under the Act as a low-income community for purposes of
the credit if such tract is within an empowerment zone, the
designation of which is in effect under section 1391, and is
contiguous to one or more low-income communities.
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\315\ 12. U.S.C. 4702(17) (defines ``low-income'' for purposes of
12. U.S.C. 4702(20)).
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Effective Date
The targeted population provision is effective for
designations made after the date of enactment (October 22,
2004). The low-population provision is effective for
investments made after the date of enactment (October 22,
2004).
2. Expansion of designated renewal community area based on 2000 census
data (sec. 222 of the Act and sec. 1400E of the Code)
Present and Prior Law
Section 1400E provides for the designation of certain
communities as renewal communities.\316\ An area designated as
a renewal community is eligible for the following tax
incentives: (1) a zero-percent rate for capital gain from the
sale of qualifying assets; (2) a 15-percent wage credit to
employers for the first $10,000 of qualified wages; (3) a
``commercial revitalization deduction'' that allows taxpayers
(to the extent allocated by the appropriate State agency) to
deduct either (a) 50 percent of qualifying expenditures for the
taxable year in which a qualified building is placed in
service, or (b) all of the qualifying expenditures ratably over
a 10-year period beginning with the month in which such
building is placed in service; (4) an additional $35,000 of
section 179 expensing for qualified property; and (5) an
expansion of the work opportunity tax credit with respect to
individuals who live in a renewal community.
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\316\ Section 1400E was added by section 101(a) of the Community
Renewal Tax Relief Act of 2000, Pub. L. No. 106-554 (December 21,
2000).
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Under prior law, to be designated as a renewal community, a
nominated area was required to meet the following criteria: (1)
each census tract must have a poverty rate of at least 20
percent; (2) in the case of an urban area, at least 70 percent
of the households have incomes below 80 percent of the median
income of households within the local government jurisdiction;
(3) the unemployment rate is at least 1.5 times the national
unemployment rate; and (4) the area is one of pervasive
poverty, unemployment, and general distress. There are no
geographic size limitations placed on renewal communities.
Instead, the boundary of a renewal community must be
continuous. In addition, under prior law, the renewal community
must have had a minimum population of 4,000 if the community is
located within a metropolitan statistical area (at least 1,000
in all other cases), and a maximum population of not more than
200,000. Under present and prior law, the population
limitations do not apply to any renewal community that is
entirely within an Indian reservation.
The designations of renewal communities were required to
have been made by December 31, 2001, using 1990 census data to
determine relevant populations and poverty rates.
Explanation of Provision
The Act authorizes the Secretary of Housing and Urban
Development, at the request of all of the governments that
nominated a renewal community, to add a contiguous census tract
to a renewal community in the following circumstances. First,
the renewal community, including any tract to be added, would
have met the renewal community eligibility requirements at the
time of the community's original nomination, and any tract to
be added has a poverty rate using 2000 census data that exceeds
the poverty rate of such tract using 1990 census data. Second,
a tract may be added to a renewal community even if the
addition of such tract to such community would have caused the
community to fail one or more eligibility requirements when
originally nominated using 1990 census data, provided that: (1)
the renewal community after the inclusion of such tract does
not have a population that exceeds 200,000 using either 1990 or
2000 census data; (2) such tract has a poverty rate of at least
20 percent using 2000 census data; and (3) such tract has a
poverty rate using 2000 census data that exceeds the poverty
rate of such tract using 1990 census data. Census tracts that
did not have a poverty rate determined by the Bureau of the
Census using 1990 data may be added to an existing renewal
community without satisfying requirement (3) above. Third, a
tract may be added to an existing renewal community if such
tract: (1) has no population using 2000 census data or no
poverty rate for such tract is determined by the Bureau of the
Census using 2000 census data; (2) such tract is one of general
distress; and (3) the renewal community, including such tract,
is within the jurisdiction of one or more local governments and
has a continuous boundary.
Effective Date
The provision is effective as if included in the amendments
made by section 101 of the Community Renewal Tax Relief Act of
2000.
3. Modification of income requirement for census tracts within high
migration rural counties for new markets tax credit (sec. 223
of the Act and sec. 45D of the Code)
Present and Prior Law
Section 45D provides a new markets tax credit for qualified
equity investments made to acquire stock in a corporation, or a
capital interest in a partnership, that is a qualified
community development entity (``CDE'').\317\ The amount of the
credit allowable to the investor (either the original purchaser
or a subsequent holder) is (1) a five-percent credit for the
year in which the equity interest is purchased from the CDE and
for each of the following two years, and (2) a six-percent
credit for each of the following four years. The credit is
determined by applying the applicable percentage (five or six
percent) to the amount paid to the CDE for the investment at
its original issue, and is available for the taxable year to
the taxpayer who holds the qualified equity investment on the
date of the initial investment or on the respective anniversary
date that occurs during the taxable year. The credit is
recaptured if at any time during the seven-year period that
begins on the date of the original issue of the investment the
entity ceases to be a qualified CDE, the proceeds of the
investment cease to be used as required, or the equity
investment is redeemed.
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\317\ Section 45D was added by section 121(a) of the Community
Renewal Tax Relief Act of 2000, Pub. L. No. 106-554 (December 21,
2000).
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A qualified CDE is any domestic corporation or partnership:
(1) whose primary mission is serving or providing investment
capital for low-income communities or low-income persons; (2)
that maintains accountability to residents of low-income
communities by their representation on any governing board of
or any advisory board to the CDE; and (3) that is certified by
the Secretary as being a qualified CDE. A qualified equity
investment means stock (other than nonqualified preferred
stock) in a corporation or a capital interest in a partnership
that is acquired directly from a CDE for cash, and includes an
investment of a subsequent purchaser if such investment was a
qualified equity investment in the hands of the prior holder.
Substantially all of the investment proceeds must be used by
the CDE to make qualified low-income community investments. For
this purpose, qualified low-income community investments
include: (1) capital or equity investments in, or loans to,
qualified active low-income community businesses; (2) certain
financial counseling and other services to businesses and
residents in low-income communities; (3) the purchase from
another CDE of any loan made by such entity that is a qualified
low-income community investment; or (4) an equity investment
in, or loan to, another CDE.
Under prior law, a ``low-income community'' was defined as
a population census tract with either (1) a poverty rate of at
least 20 percent or (2) median family income which does not
exceed 80 percent of the greater of metropolitan area median
family income or statewide median family income (for a non-
metropolitan census tract, does not exceed 80 percent of
statewide median family income). Under prior law, the Secretary
could designate any area within any census tract as a low-
income community provided that (1) the boundary is continuous,
(2) the area (if it were a census tract) would otherwise
satisfy the poverty rate or median income requirements, and (3)
an inadequate access to investment capital exists in the area.
A qualified active low-income community business is defined
as a business that satisfies, with respect to a taxable year,
the following requirements: (1) at least 50 percent of the
total gross income of the business is derived from the active
conduct of trade or business activities in any low-income
community; (2) a substantial portion of the tangible property
of such business is used in a low-income community; (3) a
substantial portion of the services performed for such business
by its employees is performed in a low-income community; and
(4) less than five percent of the average of the aggregate
unadjusted bases of the property of such business is
attributable to certain financial property or to certain
collectibles.
The maximum annual amount of qualified equity investments
is capped at $2.0 billion per year for calendar years 2004 and
2005, and at $3.5 billion per year for calendar years 2006 and
2007.
Explanation of Provision
The Act modifies the low-income test for high migration
rural counties. Under the Act, in the case of a population
census tract located within a high migration rural county, low-
income is defined by reference to 85 percent (rather than 80
percent) of statewide median family income. For this purpose, a
high migration rural county is any county that, during the 20-
year period ending with the year in which the most recent
census was conducted, has a net out-migration of inhabitants
from the county of at least 10 percent of the population of the
county at the beginning of such period.
Effective Date
The provision is effective as if included in the amendment
made by section 121(a) of the Community Renewal Tax Relief Act
of 2000.
D. S Corporation Reform and Simplification (secs. 231-240 of the Act
and secs. 1361-1379 and 4975 of the Code)
Overview
In general, an S corporation is not subject to corporate-
level income tax on its items of income and loss. Instead, an S
corporation passes through its items of income and loss to its
shareholders. The shareholders take into account separately
their shares of these items on their individual income tax
returns. To prevent double taxation of these items when the
stock is later disposed of, each shareholder's basis in the
stock of the S corporation is increased by the amount included
in income (including tax-exempt income) and is decreased by the
amount of any losses (including nondeductible losses) taken
into account. A shareholder's loss may be deducted only to the
extent of his or her basis in the stock or debt of the S
corporation. To the extent a loss is not allowed due to this
limitation, the loss generally is carried forward with respect
to the shareholder.
Reasons for Change
The Act contains a number of general provisions relating to
S corporations. The Congress adopted these provisions that
modernize the S corporation rules and eliminate undue
restrictions on S corporations in order to expand the
application of the S corporation provisions so that more
corporations and their shareholders will be able to enjoy the
benefits of subchapter S status.
The Congress was aware of obstacles that have prevented
banks from electing subchapter S status.\318\ The Act contains
provisions that apply specifically to banks in order to remove
these obstacles and make S corporation status more readily
available to banks.
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\318\ See, for example, General Accounting Office GAO/GGD-00-159,
Banking Taxation: Implications of Proposed Revisions Governing S-
Corporations on Community Banks (June 23, 2000).
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The Act also revises the prohibited transaction rules
applicable to employee stock ownership plans (``ESOPs'')
maintained by S corporations in order to expand the ability to
use distributions made with respect to S corporation stock held
by an ESOP to repay a loan used to purchase the stock, subject
to the same conditions that apply to C corporation dividends
used to repay such a loan.
1. Members of family treated as one shareholder
Present and Prior Law
A small business corporation may elect to be an S
corporation with the consent of all its shareholders, and may
terminate its election with the consent of shareholders holding
more than 50 percent of the stock. Under prior law, a ``small
business corporation'' was defined as a domestic corporation
which is not an ineligible corporation and which has (1) no
more than 75 shareholders, all of whom are individuals (and
certain trusts, estates, charities, and qualified retirement
plans) \319\ who are citizens or residents of the United
States, and (2) only one class of stock. For purposes of the
numerical-shareholder limitation, a husband and wife are
treated as one shareholder. An ``ineligible corporation'' means
a corporation that is a financial institution using the reserve
method of accounting for bad debts, an insurance company, a
corporation electing the benefits of the Puerto Rico and
possessions tax credit, or a Domestic International Sales
Corporation (``DISC'') or former DISC.
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\319\ If a qualified retirement plan (other than an employee stock
ownership plan) or a charity holds stock in an S corporation, the
interest held is treated as an interest in an unrelated trade or
business, and the plan or charity's share of the S corporation's items
of income, loss, or deduction, and gain or loss on the disposition of
the S corporation stock, are taken into account in computing unrelated
business taxable income.
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Explanation of Provision
The Act provides an election to allow all members of a
family (and their estates) \320\ to be treated as one
shareholder in determining the number of shareholders in the
corporation (for purposes of section 1361(b)(1)(A)).
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\320\ A technical correction may be necessary so that the statute
reflects this intent.
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A family is defined as the common ancestor and all lineal
descendants of the common ancestor, as well as the spouses, or
former spouses, of these individuals. An individual shall not
be a common ancestor if, as of the later of the time of the
election or the effective date of this provision, the
individual is more than six generations removed from the
youngest generation of shareholders who would (but for this
rule) be members of the family. For purposes of this rule, a
spouse or former spouse is treated as being in the same
generation as the member of the family to whom the individual
is (or was) married.\321\
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\321\ Members of a family may be treated as one shareholder for the
purpose of determining the number of shareholders, whether a family
member holds stock directly or is treated as a shareholder under
section 1361(c)(2)(B) by reason being a beneficiary of certain types of
trusts.
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Except as provided by Treasury regulations, the election
for a family may be made by any member of the family, and the
election remains in effect until terminated.
Effective Date
The provision applies to taxable years beginning after
December 31, 2004.
2. Increase in maximum number of shareholders to 100
Present and Prior Law
A small business corporation may elect to be an S
corporation with the consent of all its shareholders, and may
terminate its election with the consent of shareholders holding
more than 50 percent of the stock. Under prior law, a ``small
business corporation'' was defined as a domestic corporation
which is not an ineligible corporation and which has (1) no
more than 75 shareholders, all of whom are individuals (and
certain trusts, estates, charities, and qualified retirement
plans) \322\ who are citizens or residents of the United
States, and (2) only one class of stock. For purposes of the
numerical-shareholder limitation, a husband and wife are
treated as one shareholder. An ``ineligible corporation'' means
a corporation that is a financial institution using the reserve
method of accounting for bad debts, an insurance company, a
corporation electing the benefits of the Puerto Rico and
possessions tax credit, or a Domestic International Sales
Corporation (``DISC'') or former DISC.
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\322\ If a qualified retirement plan (other than an employee stock
ownership plan) or a charity holds stock in an S corporation, the
interest held is treated as an interest in an unrelated trade or
business, and the plan or charity's share of the S corporation's items
of income, loss, or deduction, and gain or loss on the disposition of
the S corporation stock, are taken into account in computing unrelated
business taxable income.
---------------------------------------------------------------------------
Explanation of Provision
The Act increases the maximum number of shareholders from
75 to 100.
Effective Date
The provision applies to taxable years beginning after
December 31, 2004.
3. Expansion of bank S corporation eligible shareholders to include
IRAs
Present and Prior Law
An individual retirement account (``IRA'') is a trust or
account established for the exclusive benefit of an individual
and his or her beneficiaries. There are two general types of
IRAs: traditional IRAs, to which both deductible and
nondeductible contributions may be made, and Roth IRAs,
contributions to which are not deductible. Amounts held in a
traditional IRA are includible in income when withdrawn (except
to the extent the withdrawal is a return of nondeductible
contributions). Amounts held in a Roth IRA that are withdrawn
as a qualified distribution are not includible in income;
distributions from a Roth IRA that are not qualified
distributions are includible in income to the extent
attributable to earnings. 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) 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.
Under prior law, an IRA could not be a shareholder of an S
corporation.
Certain transactions are prohibited between an IRA and the
individual for whose benefit the IRA is established, including
a sale of property by the IRA to the individual. If a
prohibited transaction occurs between an IRA and the IRA
beneficiary, the account ceases to be an IRA, and an amount
equal to the fair market value of the assets held in the IRA is
deemed distributed to the beneficiary.
Explanation of Provision
The Act allows an IRA (including a Roth IRA) to be a
shareholder of a bank that is an S corporation, but only to the
extent of bank stock held by the IRA on the date of enactment
of the provision (October 22, 2004). Under the Act, the
present-law rules treating S corporation stock held by a
qualified retirement plan (other than an employee stock
ownership plan) or a charity as an interest in an unrelated
trade or business apply to the IRA with respect to its holding
in the stock.
The Act also provides an exemption from prohibited
transaction treatment for the sale by an IRA to the IRA
beneficiary of bank stock held by the IRA on the date of
enactment (October 22, 2004) of the provision. Under the Act, a
sale is not a prohibited transaction if: (1) the sale is
pursuant to an S corporation election by the bank; (2) the sale
is for fair market value (as established by an independent
appraiser) and is on terms at least as favorable to the IRA as
the terms would be on a sale to an unrelated party; (3) the IRA
incurs no commissions, costs, or other expenses in connection
with the sale; and (4) the stock is sold in a single
transaction for cash not later than 120 days after the S
corporation election is made.
Effective Date
The provision takes effect on the date of enactment
(October 22, 2004).
4. Disregard of unexercised powers of appointment in determining
potential current beneficiaries of ESBT
Present and Prior Law
An electing small business trust (``ESBT'') holding stock
in an S corporation is taxed at the maximum individual tax rate
on its ratable share of items of income, deduction, gain, or
loss passing through from the S corporation. An ESBT generally
is an electing trust all of whose beneficiaries are eligible S
corporation shareholders. For purposes of determining the
maximum number of shareholders, each person who is entitled to
receive a distribution from the trust (``potential current
beneficiary'') is treated as a shareholder during the period
the person may receive a distribution from the trust.
Under prior law, an ESBT had 60 days to dispose of the S
corporation stock after an ineligible shareholder became a
potential current beneficiary to avoid disqualification.
Explanation of Provision
Under the Act, powers of appointment to the extent not
exercised are disregarded in determining the potential current
beneficiaries of an electing small business trust.
The Act increases the period during which an ESBT can
dispose of S corporation stock, after an ineligible shareholder
becomes a potential current beneficiary, from 60 days to one
year.
Effective Date
The provision applies to taxable years beginning after
December 31, 2004.
5. Transfers of suspended losses incident to divorce, etc.
Present and Prior Law
Under prior law, any loss or deduction that was not allowed
to a shareholder of an S corporation, because the loss exceeded
the shareholder's basis in stock and debt of the corporation,
was treated as incurred by the S corporation with respect to
that shareholder in the subsequent taxable year.
Explanation of Provision
Under the Act, if a shareholder's stock in an S corporation
is transferred to a spouse, or to a former spouse incident to a
divorce, any suspended loss or deduction with respect to that
stock is treated as incurred by the corporation with respect to
the transferee in the subsequent taxable year.
Effective Date
The provision applies to transfers of stock after December
31, 2004.\323\
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\323\ A technical correction may be necessary so that the statute
reflects this intent.
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6. Use of passive activity loss and at-risk amounts by qualified
subchapter S trust income beneficiaries
Present and Prior Law
Under present and prior law, the share of income of an S
corporation, whose stock is held by a qualified subchapter S
trust (``QSST'') with respect to which the beneficiary makes an
election, is taxed to the beneficiary. However, the trust, and
not the beneficiary, is treated as the owner of the S
corporation stock for purposes of determining the tax
consequences of the disposition of the S corporation stock by
the trust. A QSST generally is a trust with one individual
income beneficiary for the life of the beneficiary.
Explanation of Provision
Under the Act, the beneficiary of a qualified subchapter S
trust is generally allowed to deduct suspended losses under the
at-risk rules and the passive loss rules when the trust
disposes of the S corporation stock.
Effective Date
The provision applies to transfers made after December 31,
2004.
7. Exclusion of investment securities income from passive investment
income test for bank S corporations
Present and Prior Law
An S corporation is subject to corporate-level tax, at the
highest corporate tax rate, on its excess net passive income if
the corporation has (1) accumulated earnings and profits at the
close of the taxable year and (2) gross receipts more than 25
percent of which are passive investment income.
Excess net passive income is the net passive income for a
taxable year multiplied by a fraction, the numerator of which
is the amount of passive investment income in excess of 25
percent of gross receipts and the denominator of which is the
passive investment income for the year. Net passive income is
defined as passive investment income reduced by the allowable
deductions that are directly connected with the production of
that income. Passive investment income generally means gross
receipts derived from royalties, rents, dividends, interest,
annuities, and sales or exchanges of stock or securities (to
the extent of gains). Passive investment income generally does
not include interest on accounts receivable, gross receipts
that are derived directly from the active and regular conduct
of a lending or finance business, gross receipts from certain
liquidations, or gain or loss from any section 1256 contract
(or related property) of an options or commodities dealer.\324\
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\324\ Notice 97-5, 1997-1 C.B. 352, sets forth guidance relating to
passive investment income on banking assets.
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In addition, an S corporation election is terminated
whenever the S corporation has accumulated earnings and profits
at the close of each of three consecutive taxable years and has
gross receipts for each of those years more than 25 percent of
which are passive investment income.
Explanation of Provision
The Act provides that, in the case of a bank (as defined in
section 581), a bank holding company (as defined in section
2(a) of the Bank Holding Company Act of 1956) or a financial
holding company (as defined in section 2(p) of that Act),
interest income and dividends on assets required to be held by
the bank or holding company are not treated as passive
investment income for purposes of the S corporation passive
investment income rules.
Effective Date
The provision applies to taxable years beginning after
December 31, 2004.
8. Relief from inadvertently invalid qualified subchapter S subsidiary
elections and terminations
Present and Prior Law
Under present and prior law, inadvertent invalid subchapter
S elections and terminations may be waived.
Explanation of Provision
The Act allows inadvertent invalid qualified subchapter S
subsidiary elections and terminations to be waived by the IRS.
Effective Date
The provision applies to elections made and terminations
made after December 31, 2004.
9. Information returns for qualified subchapter S subsidiaries
Present and Prior Law
A corporation all of whose stock is held by an S
corporation is treated as a qualified subchapter S subsidiary
if the S corporation so elects. The assets, liabilities, and
items of income, deduction, and credit of the subsidiary are
treated as assets, liabilities, and items of the parent S
corporation.
Explanation of Provision
The Act provides authority to the Secretary to provide
guidance regarding information returns of qualified subchapter
S subsidiaries.
Effective Date
The provision applies to taxable years beginning after
December 31, 2004.
10. Repayment of loans for qualifying employer securities
Present and Prior Law
An employee stock ownership plan (an ``ESOP'') is a defined
contribution plan that is designated as an ESOP and is designed
to invest primarily in qualifying employer securities. For
purposes of ESOP investments, a ``qualifying employer
security'' is defined as: (1) publicly traded common stock of
the employer or a member of the same controlled group; (2) if
there is no such publicly traded common stock, common stock of
the employer (or member of the same controlled group) that has
both voting power and dividend rights at least as great as any
other class of common stock; or (3) noncallable preferred stock
that is convertible into common stock described in (1) or (2)
and that meets certain requirements. In some cases, an employer
may design a class of preferred stock that meets these
requirements and that is held only by the ESOP. Special rules
apply to ESOPs that do not apply to other types of qualified
retirement plans, including a special exemption from the
prohibited transaction rules.
Certain transactions between an employee benefit plan and a
disqualified person, including the employer maintaining the
plan, are prohibited transactions that result in the imposition
of an excise tax.\325\ Prohibited transactions include, among
other transactions, (1) the sale, exchange or leasing of
property between a plan and a disqualified person, (2) the
lending of money or other extension of credit between a plan
and a disqualified person, and (3) the transfer to, or use by
or for the benefit of, a disqualified person of the income or
assets of the plan. However, certain transactions are exempt
from prohibited transaction treatment, including certain loans
to enable an ESOP to purchase qualifying employer
securities.\326\ In such a case, the employer securities
purchased with the loan proceeds are generally pledged as
security for the loan. Contributions to the ESOP and dividends
paid on employer securities held by the ESOP are used to repay
the loan. The employer securities are held in a suspense
account and released for allocation to participants' accounts
as the loan is repaid.
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\325\ Sec. 4975.
\326\ Sec. 4975(d)(3). An ESOP that borrows money to purchase
employer stock is referred to as a ``leveraged'' ESOP.
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A loan to an ESOP is exempt from prohibited transaction
treatment if the loan is primarily for the benefit of the
participants and their beneficiaries, the loan is at a
reasonable rate of interest, and the collateral given to a
disqualified person consists of only qualifying employer
securities. No person entitled to payments under the loan can
have the right to any assets of the ESOP other than (1)
collateral given for the loan, (2) contributions made to the
ESOP to meet its obligations on the loan, and (3) earnings
attributable to the collateral and the investment of
contributions described in (2).\327\ In addition, the payments
made on the loan by the ESOP during a plan year cannot exceed
the sum of those contributions and earnings during the current
and prior years, less loan payments made in prior years.
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\327\ Treas. Reg. sec. 54.4975-7(b)(5).
---------------------------------------------------------------------------
An ESOP of a C corporation is not treated as violating the
qualification requirements of the Code or as engaging in a
prohibited transaction merely because, in accordance with plan
provisions, a dividend paid with respect to qualifying employer
securities held by the ESOP is used to make payments on a loan
(including payments of interest as well as principal) that was
used to acquire the employer securities (whether or not
allocated to participants).\328\ In the case of a dividend paid
with respect to any employer security that is allocated to a
participant, this relief does not apply unless the plan
provides that employer securities with a fair market value of
not less than the amount of the dividend are allocated to the
participant for the year which the dividend would have been
allocated to the participant.\329\
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\328\ Sec. 404(k)(5)(B).
\329\ Sec. 404(k)(2)(B).
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Explanation of Provision
Under the Act, an ESOP maintained by an S corporation is
not treated as violating the qualification requirements of the
Code or as engaging in a prohibited transaction merely because,
in accordance with plan provisions, a distribution made with
respect to S corporation stock that constitutes qualifying
employer securities held by the ESOP is used to repay a loan
that was used to acquire the securities (whether or not
allocated to participants). This relief does not apply in the
case of a distribution with respect to S corporation stock that
is allocated to a participant unless the plan provides that
stock with a fair market value of not less than the amount of
such distribution is allocated to the participant for the year
which the distribution would have been allocated to the
participant.
Effective Date
The provision is effective for distributions made with
respect to S corporation stock after December 31, 1997.
E. Other Business Incentives
1. Repeal certain excise taxes on rail diesel fuel and inland waterway
barge fuels (sec. 241 of the Act and secs. 4041, 4042, 6421,
and 6427 of the Code)
Present and Prior Law
Diesel fuel used in trains is subject to a 4.4-cents-per-
gallon excise tax. Revenues from 4.3 cents per gallon of this
excise tax are retained in the General Fund of the Treasury.
The remaining 0.1 cent per gallon is deposited in the Leaking
Underground Storage Tank (``LUST'') Trust Fund.
Similarly, fuels used in barges operating on the designated
inland waterways system are subject to a 4.3-cents-per-gallon
General Fund excise tax. This tax is in addition to the 20.1-
cents-per-gallon tax rates that are imposed on fuels used in
these barges to fund the Inland Waterways Trust Fund and the
Leaking Underground Storage Tank Trust Fund.
Under prior law, the 4.3-cents-per-gallon excise tax rates
were permanent. The LUST Trust Fund tax was scheduled to expire
after March 31, 2005.\330\
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\330\ On March 31, 2005, Pub. L. No. 109-6 extended the LUST Trust
Fund tax through September 30, 2005.
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Reasons for Change \331\
In 1993, the Congress enacted the present-law 4.3-cents-
per-gallon excise tax on motor fuels as a deficit reduction
measure, with the receipts payable to the General Fund. Since
that time, the Congress has diverted the 4.3-cents-per-gallon
excise tax for most uses to specified trust funds that provide
benefits for those motor fuel users who ultimately bear the
burden of these taxes. As a result, the Congress found that
generally only rail and barge operators remain as motor fuel
users subject to the 4.3-cents-per-gallon excise tax who
receive no benefits from a dedicated trust fund as a result of
their tax burden. The Congress observed that rail and barge
operators compete with other transportation service providers
who benefit from expenditures paid from dedicated trust funds.
The Congress concluded that it is inequitable and distortive of
transportation decisions to continue to impose the 4.3-cents-
per-gallon excise tax on diesel fuel used in trains and barges.
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\331\ See H.R. 1537, the ``Energy Tax Policy Act of 2003'', which
was reported by the House Committee on Ways and Means on April 9, 2003
(H.R. Rep. No. 108-67).
---------------------------------------------------------------------------
Explanation of Provision
The Act repeals the 4.3-cents-per-gallon General Fund
excise tax rates on diesel fuel used in trains and fuels used
in barges operating on the designated inland waterways system
over a prescribed phase-out period. The 4.3-cent-per-gallon tax
is reduced by 1 cent per gallon for the first six months of
calendar year 2005 (January 1, 2005 through June 30, 2005). The
reduction is 2 cents per gallon from July 1, 2005 through
December 31, 2006, and 4.3 cents/gallon thereafter. Thus, the
tax is fully repealed effective January 1, 2007. The 0.1 cent
per gallon tax for the LUST Trust Fund is unchanged by the
provision.
Effective Date
The provision is effective on January 1, 2005.
2. Modification of application of income forecast method of
depreciation (sec. 242 of the Act and sec. 167 of the Code)
Present and Prior Law
In general
The modified accelerated cost recovery system (``MACRS'')
does not apply to certain property, including any motion
picture film, video tape, or sound recording, or to any other
property if the taxpayer elects to exclude such property from
MACRS and the taxpayer properly applies a unit-of-production
method or other method of depreciation not expressed in a term
of years. Section 197 does not apply to certain intangible
property, including property produced by the taxpayer or any
interest in a film, sound recording, video tape, book or
similar property not acquired in a transaction (or a series of
related transactions) involving the acquisition of assets
constituting a trade or business or substantial portion
thereof. Thus, the recovery of the cost of a film, video tape,
or similar property that is produced by the taxpayer or is
acquired on a ``stand-alone'' basis by the taxpayer may not be
determined under either the MACRS depreciation provisions or
under the section 197 amortization provisions. The cost
recovery of such property may be determined under section 167,
which allows a depreciation deduction for the reasonable
allowance for the exhaustion, wear and tear, or obsolescence of
the property. A taxpayer is allowed to recover, through annual
depreciation deductions, the cost of certain property used in a
trade or business or for the production of income. Section
167(g) provides that the cost of motion picture films, sound
recordings, copyrights, books, and patents are eligible to be
recovered using the income forecast method of depreciation.
Income forecast method of depreciation
Under the income forecast method, a property's depreciation
deduction for a taxable year is determined by multiplying the
adjusted basis of the property by a fraction, the numerator of
which is the income generated by the property during the year
and the denominator of which is the total forecasted or
estimated income expected to be generated prior to the close of
the tenth taxable year after the year the property was placed
in service. Any costs that are not recovered by the end of the
tenth taxable year after the property was placed in service may
be taken into account as depreciation in such year.
The adjusted basis of property that may be taken into
account under the income forecast method only includes amounts
that satisfy the economic performance standard of section
461(h). In addition, taxpayers that claim depreciation
deductions under the income forecast method are required to pay
(or receive) interest based on a recalculation of depreciation
under a ``look-back'' method.
The ``look-back'' method is applied in any ``recomputation
year'' by (1) comparing depreciation deductions that had been
claimed in prior periods to depreciation deductions that would
have been claimed had the taxpayer used actual, rather than
estimated, total income from the property; (2) determining the
hypothetical overpayment or underpayment of tax based on this
recalculated depreciation; and (3) applying the overpayment
rate of section 6621 of the Code. Except as provided in
Treasury regulations, a ``recomputation year'' is the third and
tenth taxable year after the taxable year the property was
placed in service, unless the actual income from the property
for each taxable year ending with or before the close of such
years was within 10 percent of the estimated income from the
property for such years.
Reasons for Change
The Congress was aware that taxpayers and the IRS have
expended significant resources in auditing and litigating
disputes regarding the proper treatment of participations and
residuals for purposes of computing depreciation under the
income forecast method of depreciation. The Congress understood
that these issues related solely to the timing of deductions
and not to whether such costs are valid deductions. In
addition, the Congress was aware of other disagreements between
taxpayers and the Treasury Department regarding the mechanics
of the income forecast formula. The Congress believed expending
taxpayer and government resources disputing these items was an
unproductive use of economic resources. As such, the Act
addressed the issues and eliminated any uncertainty as to the
proper tax treatment of these items.
Explanation of Provision
The Act clarifies that, solely for purposes of computing
the allowable deduction for property under the income forecast
method of depreciation, participations and residuals may be
included in the adjusted basis of the property beginning in the
year such property is placed in service, but only if such
participations and residuals relate to income to be derived
from the property before the close of the tenth taxable year
following the year the property is placed in service (as
defined in section 167(g)(1)(A)). For purposes of the Act,
participations and residuals are defined as costs the amount of
which, by contract, varies with the amount of income earned in
connection with such property. The Act also clarifies that the
income from the property to be taken into account under the
income forecast method is the gross income from such property.
The Act also grants authority to the Treasury Department to
prescribe appropriate adjustments to the basis of property (and
the look-back method) to reflect the treatment of
participations and residuals under the Act.
In addition, the Act clarifies that, in the case of
property eligible for the income forecast method that the
holding in the Associated Patentees \332\ decision will
continue to constitute a valid method. Thus, rather than
accounting for participations and residuals as a cost of the
property under the income forecast method of depreciation, the
taxpayer may deduct those payments as they are paid as under
the Associated Patentees decision. This may be done on a
property-by-property basis and shall be applied consistently
with respect to a given property thereafter. The Act also
clarifies that distribution costs are not taken into account
for purposes of determining the taxpayer's current and total
forecasted income with respect to a property.
---------------------------------------------------------------------------
\332\ Associated Patentees, Inc. v. Commissioner, 4 T.C. 979
(1945).
---------------------------------------------------------------------------
Effective Date
The provision applies to property placed in service after
date of enactment (October 22, 2004). No inference is intended
as to the appropriate treatment under present and prior law. It
is intended that the Treasury Department and the IRS expedite
the resolution of open cases. In resolving these cases in an
expedited and balanced manner, the Treasury Department and IRS
are encouraged to take into account the principles of the
provision.
3. Improvements related to real estate investment trusts (sec. 243 of
the Act and secs. 856, 857 and 860 of the Code)
Present and Prior Law
In general
Under present and prior law, real estate investment trusts
(``REITs'') are treated, in substance, as pass through
entities. Pass through status is achieved by allowing the REIT
a deduction for dividends paid to its shareholders. The REIT's
shareholders, in turn, include REIT dividends in their taxable
income. REITs are generally restricted to investing in passive
investments primarily in real estate and certain securities.
A REIT must satisfy four tests on a year-by-year basis:
organizational structure, source of income, nature of its
assets, and distribution of income. Whether the REIT meets the
asset tests is generally measured each quarter.
Organizational structure requirements
Under present and prior law, to qualify as a REIT, an
entity must be for its entire taxable year a corporation or a
trust or association that would be taxable as a domestic
corporation but for the REIT provisions, and must be managed by
one or more trustees. The beneficial ownership of the entity
must be evidenced by transferable shares or certificates of
ownership. Except for the first taxable year for which an
entity elects to be a REIT, the beneficial ownership of the
entity must be held by 100 or more persons, and the entity may
not be so closely held by individuals that it would be treated
as a personal holding company if all its adjusted gross income
constituted personal holding company income. A REIT is required
to comply with regulations to ascertain the actual ownership of
the REIT's outstanding shares.
Income requirements
In general
Under present and prior law, in order for an entity to
qualify as a REIT, at least 95 percent of its gross income
generally must be derived from certain passive sources (the
``95-percent income test''). In addition, at least 75 percent
of its income generally must be from certain real estate
sources (the ``75-percent income test''), including rents from
real property (as defined) and gain from the sale or other
disposition of real property, and income and gain derived from
foreclosure property.
Qualified rental income
Under present and prior law, amounts received as
impermissible ``tenant services income'' are not treated as
rents from real property.\333\ In general, such amounts are for
services rendered to tenants that are not ``customarily
furnished'' in connection with the rental of real
property.\334\
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\333\ A REIT is not treated as providing services that produce
impermissible tenant services income if such services are provided by
an independent contractor from whom the REIT does not derive or receive
any income. An independent contractor is defined as a person who does
not own, directly or indirectly, more than 35 percent of the shares of
the REIT. Also, no more than 35 percent of the total shares of stock of
an independent contractor (or of the interests in net assets or net
profits, if not a corporation) can be owned directly or indirectly by
persons owning 35 percent or more of the interests in the REIT.
\334\ Rents for certain personal property leased in connection with
the rental of real property are treated as rents from real property if
the fair market value of the personal property does not exceed 15
percent of the aggregate fair market values of the real and personal
property.
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Rents from real property, for purposes of the 95-percent
and 75-percent income tests, generally do not include any
amount received or accrued from any person in which the REIT
owns, directly or indirectly, 10 percent or more of the vote or
value.\335\ An exception applies to rents received from a
taxable REIT subsidiary (``TRS'') (described further below) if
at least 90 percent of the leased space of the property is
rented to persons other than a TRS or certain related persons,
and if the rents from the TRS are substantially comparable to
unrelated party rents.\336\
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\335\ Sec. 856(d)(2)(B).
\336\ Sec. 856(d)(8).
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Certain hedging instruments
Under prior law, except as provided in regulations, a
payment to a REIT under an interest rate swap or cap agreement,
option, futures contract, forward rate agreement, or any
similar financial instrument, entered into by the trust in a
transaction to reduce the interest rate risks with respect to
any indebtedness incurred or to be incurred by the REIT to
acquire or carry real estate assets, and any gain from the sale
or disposition of any such investment, was treated as income
qualifying for the 95-percent income test.
Tax if qualified income tests not met
Under present and prior law, if a REIT fails to meet the
95-percent or 75-percent income tests but has set out the
income it did receive in a schedule and any error in the
schedule is not due to fraud with intent to evade tax, then the
REIT does not lose its REIT status provided that the failure to
meet the 95-percent or 75-percent test is due to reasonable
cause and not due to willful neglect. If the REIT qualifies for
this relief, the REIT must pay a tax measured by the greater of
the amount by which 90 percent under prior law \337\ of the
REIT's gross income exceeds the amount of items subject to the
95-percent test, or the amount by which 75 percent of the
REIT's gross income exceeds the amount of items subject to the
75-percent test.\338\
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\337\ Prior to 1999, the rule had applied to the amount by which 95
percent of the income exceeded the items subject to the 95 percent
test. Between 1999 and the effective date of the Act, the percent of
income used in the fraction was reduced to 90 percent. The Act restored
the 95 percent of income factor.
\338\ The ratio of the REIT's net to gross income is applied to the
excess amount, to determine the amount of tax (disregarding certain
items otherwise subject to a 100-percent tax). In effect, the formula
seeks to require that all of the REIT net income attributable to the
failure of the income tests will be paid as tax. Sec. 857(b)(5).
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Asset requirements
75-percent asset test
Under present and prior law, to satisfy the asset
requirements to qualify for treatment as a REIT, at the close
of each quarter of its taxable year, an entity must have at
least 75 percent of the value of its assets invested in real
estate assets, cash and cash items, and government securities
(the ``75-percent asset test''). The term real estate asset is
defined to mean real property (including interests in real
property and mortgages on real property) and interests in
REITs.
Limitation on investment in other entities
Under present and prior law, a REIT is limited in the
amount that it can own in other corporations. Specifically, a
REIT cannot own securities (other than Government securities
and certain real estate assets) in an amount greater than 25
percent of the value of REIT assets. In addition, it cannot own
such securities of any one issuer representing more than 5
percent of the total value of REIT assets or more than 10
percent of the voting securities or 10 percent of the value of
the outstanding securities of any one issuer. Securities for
purposes of these rules are defined by reference to the
Investment Company Act of 1940.
``Straight debt'' exception
Under prior law, securities of an issuer that are within a
safe-harbor definition of ``straight debt'' (as defined for
purposes of subchapter S) \339\ were not taken into account in
applying the limitation that a REIT may not hold more than 10
percent of the value of outstanding securities of a single
issuer, if: (1) the issuer was an individual; (2) the only
securities of such issuer held by the REIT or a taxable REIT
subsidiary of the REIT were straight debt; or (3) the issuer
was a partnership and the trust holds at least a 20 percent
profits interest in the partnership.
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\339\ Sec. 1361(c)(5), without regard to paragraph (B)(iii)
thereof.
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Under prior law, straight debt for purposes of the REIT
provision was defined as a written or unconditional promise to
pay on demand or on a specified date a sum certain in money if
(i) the interest rate (and interest payment dates) were not
contingent on profits, the borrower's discretion, or similar
factors, and (ii) there was no convertibility (directly or
indirectly) into stock.
Certain subsidiary ownership permitted with income treated
as income of the REIT
Under present and prior law, one exception to the rule
limiting a REIT's securities holdings to no more than 10
percent of the vote or value of a single issuer allows a REIT
to own 100 percent of the stock of a corporation, but in that
case the income and assets of such corporation are treated as
income and assets of the REIT.
Special rules for taxable REIT subsidiaries
Under present and prior law, another exception to the
general rule limiting REIT securities ownership of other
entities allows a REIT to own stock of a taxable REIT
subsidiary (``TRS''), generally, a corporation other than a
real estate investment trust \340\ with which the REIT makes a
joint election to be subject to special rules. A TRS can engage
in active business operations that would produce income that
would not be qualified income for purposes of the 95-percent or
75-percent income tests for a REIT, and that income is not
attributed to the REIT. For example a TRS could provide
noncustomary services to REIT tenants, or it could engage
directly in the active operation and management of real estate
(without use of an independent contractor); and the income the
TRS derived from these nonqualified activities would not be
treated as disqualified REIT income. Transactions between a TRS
and a REIT are subject to a number of specified rules that are
intended to prevent the TRS (taxable as a separate corporate
entity) from shifting taxable income from its activities to the
pass-through entity REIT or from absorbing more than its share
of expenses. Under one rule, a 100-percent excise tax is
imposed on rents to the extent that the amount of the rents
would be reduced on distribution, apportionment, or allocation
under section 482 to clearly reflect income as a result of
services furnished by a TRS of the REIT to a tenant of the
REIT.\341\
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\340\ Certain corporations are not eligible to be a TRS, such as a
corporation which directly or indirectly operates or manages a lodging
facility or a health care facility, or directly or indirectly provides
to any other person rights to a brand name under which any lodging
facility or health care facility is operated. Sec. 856(l)(3).
\341\ If the excise tax applies, then the item is not reallocated
back to the TRS under section 482.
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Under prior law, the 100-percent excise tax did not apply
to amounts received directly or indirectly by a REIT from a TRS
that would be excluded from unrelated taxable income if
received by an organization described in section 511(a)(2).
Such amounts are defined in section 512(b)(3). Also, the tax
did not apply to income received by the REIT for services
performed by the TRS that could have been performed directly by
the REIT and produced qualified rental income, because they
were customary services.
Under present and prior law, rents paid by a TRS to a REIT
generally are treated as rents from real property if at least
90 percent of the leased space of the property is rented to
persons other than the REIT's TRSs and other than persons
related to the REIT. In such a case, the rent paid by the TRS
to the REIT is treated as rent from real property only to the
extent that it is substantially comparable to rents from other
tenants of the REIT's property for comparable space.
Income distribution requirements
Under present and prior law, a REIT is generally required
to distribute 90 percent of its income before the end of its
taxable year, as deductible dividends paid to shareholders.
This rule is similar to a rule for regulated investment
companies (``RICs'') that requires distribution of 90 percent
of income. If a REIT declares certain dividends after the end
of its taxable year but before the time prescribed for filing
its return for that year and distributes those amounts to
shareholders within the 12 months following the close of that
taxable year, such distributions are treated as made during
such taxable year for this purpose. As described further below,
a REIT can also make certain ``deficiency dividends'' after the
close of the taxable year after a determination that it has not
distributed the correct amount for qualification as a REIT.
Consequences of failure to meet requirements
Under present and prior law, unless the REIT satisfies
rules allowing the cure of a failure, a REIT loses its status
as a REIT, and becomes subject to tax as a C corporation, if it
fails to meet specified tests regarding the sources of its
income, the nature and amount of its assets, its structure, and
the amount of its income distributed to shareholders.
Under present and prior law, if a REIT fails to meet the
source of income requirements, but has set out the income it
did receive in a schedule and any error in the schedule is not
due to fraud with intent to evade tax, then the REIT does not
lose its REIT status, provided that the failure to meet the 95-
percent or 75-percent test is due to reasonable cause and not
to willful neglect. If the REIT qualifies for this relief, the
REIT must pay the disallowed income as a tax to the
Treasury.\342\
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\342\ Secs. 856(c)(6) and 857(b)(5).
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Failure to satisfy the asset test by reason of certain
acquisitions during a quarter is excused if the REIT eliminates
the discrepancy within 30 days. Failure to meet distribution
requirements may also be excused if the REIT establishes to the
satisfaction of the Secretary that it was unable to meet such
requirement by reason of distributions previously made to meet
the requirements of section 4981.
Under prior law, there were no similar provisions that
allow a REIT to pay a penalty and avoid disqualification in the
case of other qualification failures.
Under present and prior law, a REIT may make a deficiency
dividend after a determination is made that it has not
distributed the correct amount of its income, and avoid
disqualification. Under prior law, the Code provided only for
determinations involving a controversy with or closing
agreement or other allowed agreement with the IRS, and did not
provide for a REIT to make such a distribution on its own
initiative. Deficiency dividends could be declared on or after
the date of ``determination''. A determination was defined to
include only (i) a final decision by the Tax Court or other
court of competent jurisdiction, (ii) a closing agreement under
section 7121, or (iii) under Treasury regulations, an agreement
signed by the Secretary and the REIT.
Reasons for Change
The Congress believed that a number of simplifying and
conforming changes should be made to the ``straight debt''
provisions that exempt certain securities from the rule that a
REIT may not hold more than 10 percent of the value of
securities of a single issuer, as well as to the TRS rules, the
rules relating to certain hedging arrangements, and the
computation of tax liability when the 95-percent gross income
test is not met.
The Congress also believed it was desirable to provide
rules under which a REIT that inadvertently fails to meet
certain REIT qualification requirements can correct such
failure without losing REIT status.
Explanation of Provision
In general
The Act makes a number of modifications to the REIT rules.
Straight debt modification
In general
The Act modifies the definition of ``straight debt'' for
purposes of the limitation that a REIT may not hold more than
10 percent of the value of the outstanding securities of a
single issuer, to provide more flexibility than the present law
rule. In addition, except as provided in regulations, neither
such straight debt nor certain other types of securities are
considered ``securities'' for purposes of this rule.
Straight debt securities
As under prior law, ``straight-debt'' is still defined by
reference to section 1361(c)(5), without regard to subparagraph
(B)(iii) thereof (limiting the nature of the creditor).
Special rules are provided permitting certain contingencies
for purposes of the REIT provision. Any interest or principal
shall not be treated as failing to satisfy section
1361(c)(5)(B)(i) solely by reason of the fact that the time of
payment of such interest or principal is subject to a
contingency, but only if (i) the contingency is one that does
not have the effect of changing the effective yield to
maturity, as determined under section 1272, other than a change
in the annual yield to maturity that does not exceed the
greater of \1/4\ of one percent or five percent of the annual
yield to maturity, or (ii) neither the aggregate issue price
nor the aggregate face amount of the issuer's debt instruments
held by the REIT exceeds $1,000,000 and not more than 12 months
of unaccrued interest can be required to be prepaid thereunder.
Also, the time or amount of any payment is permitted to be
subject to a contingency upon a default or the exercise of a
prepayment right by the issuer of the debt, provided that such
contingency is consistent with customary commercial
practice.\343\
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\343\ The prior law rules that limit qualified interest income to
amounts the determination of which do not depend, in whole or in part,
on the income or profits of any person, continue to apply to such
contingent interest. See, e.g., secs. 856(c)(2)(G), 856(c)(3)(G) and
856(f).
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The Act eliminates the prior law rule that straight debt
securities are not counted if the REIT owns at least a 20
percent equity interest in a partnership. The Act instead
provides new ``look-through'' rules determining a REIT
partner's share of partnership securities, generally treating
debt to the REIT as part of the REIT's partnership interest for
this purpose, except in the case of otherwise qualifying debt
of the partnership.\344\
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\344\ Secs. 856(m)(3) and 856(m)(4)(A).
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Certain corporate or partnership issues that otherwise
would be permitted to be held without limitation under the new
special straight debt rules described above will not be so
permitted if the REIT holding such securities, and any of its
taxable REIT subsidiaries, holds any securities of the issuer
which are not permitted securities (prior to the application of
this rule) and have an aggregate value greater than one percent
of the issuer's outstanding securities.
Other securities
Except as provided in regulations, the following also are
not considered ``securities'' for purposes of the rule that a
REIT cannot own more than 10 percent of the value of the
outstanding securities of a single issuer: (i) any loan to an
individual or an estate, (ii) any section 467 rental agreement,
(as defined in section 467(d)), other than with a person
described in section 856(d)(2)(B), (iii) any obligation to pay
rents from real property, (iv) any security issued by a State
or any political subdivision thereof, the District of Columbia,
a foreign government, or any political subdivision thereof, or
the Commonwealth of Puerto Rico, but only if the determination
of any payment received or accrued under such security does not
depend in whole or in part on the profits of any entity not
described in this category, or payments on any obligation
issued by such an entity, (v) any security issued by a real
estate investment trust; and (vi) any other arrangement that,
as determined by the Secretary, is excepted from the definition
of a security.
In addition, any debt instrument issued by a partnership
and not otherwise exempted from the definition of a
``security'' under the straight debt exception or under the
categories listed above shall not be considered a security if
at least 75 percent of the partnership's gross income
(excluding gross income from prohibited transactions) is
derived from sources referred to in section 856(c)(3).\345\
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\345\ Sec. 856(m)(4)(B). Section 856(c)(3) describes the permitted
real estate-related sources from which 75 percent of a qualified REIT's
gross income must be derived.
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Safe harbor testing date for certain rents
The Act provides specific safe-harbor rules regarding the
dates for testing whether 90 percent of a REIT property is
rented to unrelated persons and whether the rents paid by
related persons are substantially comparable to unrelated party
rents. These testing rules are provided solely for purposes of
the special provision permitting rents received from a TRS to
be treated as qualified rental income for purposes of the
income tests.\346\
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\346\ The Act does not modify any of the standards of section 482
as they apply to REITs and to TRSs.
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Customary services exception
The Act prospectively eliminates the safe harbor allowing
rents received by a REIT to be exempt from the 100 percent
excise tax if the rents are for customary services performed by
the TRS \347\ or are from a TRS and are described in section
512(b)(3). Instead, such payments are free of the excise tax if
they satisfy the present law safe-harbor that applies if the
REIT pays the TRS at least 150 percent of the cost to the TRS
of providing any services.
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\347\ Although a REIT could itself provide such service and receive
the income without receiving any disqualified income, in that case the
REIT itself would be bearing the cost of providing the service. Under
the prior law exception for a TRS providing such service, there was no
explicit requirement that the TRS be reimbursed for the full cost of
the service.
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Hedging rules
The rules governing the tax treatment of arrangements
engaged in by a REIT to reduce certain interest rate risks are
prospectively generally conformed to the rules included in
section 1221. Also, the income of a REIT from such a hedging
transaction is excluded from gross income for purposes of the
95-percent of gross income requirement to the extent the
transaction hedges any indebtedness incurred or to be incurred
by the REIT to acquire or carry real estate assets.
95-percent of gross income requirement
The Act prospectively amends the tax liability owed by a
REIT when it fails to meet the 95-percent of gross income test
by applying a taxable fraction based on 95 percent, rather than
90 percent, of the REIT's gross income.
Consequences of failure to meet REIT requirements
In general
Under the Act, a REIT may avoid disqualification in the
event of certain failures of the requirements for REIT status,
provided that (1) the failure was due to reasonable cause and
not willful neglect, (2) the failure is corrected, and (3)
except for certain failures not exceeding a specified de
minimis amount, a penalty amount is paid.
Certain de minimis asset failures of 5-percent or 10-
percent tests
One requirement of present and prior law is that, with
certain exceptions, (i) not more than 5 percent of the value of
total REIT assets may be represented by securities of one
issuer, and (ii) a REIT may not hold securities possessing more
than 10 percent of the total voting power or 10 percent of the
total value of the outstanding securities of any one
issuer.\348\ The requirements must be satisfied each quarter.
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\348\ Sec. 856(c)(4)(B)(iii). These rules do not apply to
securities of a TRS, or to securities that qualify for the 75 percent
asset test of section 856(c)(4)(A), such as real estate assets, cash
items (including receivables), or Government securities.
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The Act provides that a REIT will not lose its REIT status
for failing to satisfy these requirements in a quarter if the
failure is due to the ownership of assets the total value of
which does not exceed the lesser of (i) one percent of the
total value of the REIT's assets at the end of the quarter for
which such measurement is done or (ii) 10 million dollars;
provided in either case that the REIT either disposes of the
assets within six months after the last day of the quarter in
which the REIT identifies the failure (or such other time
period prescribed by the Treasury), or otherwise meets the
requirements of those rules by the end of such time
period.\349\
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\349\ A REIT might satisfy the requirements without a disposition,
for example, by increasing its other assets in the case of the 5
percent rule; or by the issuer modifying the amount or value of its
total securities outstanding in the case of the 10 percent rule.
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Other asset test failures (whether of 5-percent or 10-
percent tests, or of 75-percent or other asset
tests)
Under the Act, if a REIT fails to meet any of the asset
test requirements for a particular quarter and the failure
exceeds the de minimis threshold described above,\350\ then the
REIT still will be deemed to have satisfied the requirements
if: (i) following the REIT's identification of the failure, the
REIT files a schedule with a description of each asset that
caused the failure, in accordance with regulations prescribed
by the Treasury; (ii) the failure was due to reasonable cause
and not to willful neglect, (iii) the REIT disposes of the
assets within 6 months after the last day of the quarter in
which the identification occurred or such other time period as
is prescribed by the Treasury (or the requirements of the rules
are otherwise met within such period), and (iv) the REIT pays a
tax on the failure.
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\350\ It is intended that a REIT may also use the following
procedure to cure de minimis failures of asset tests other than the 5-
percent or 10-percent tests. A technical correction may be necessary so
that the statute reflects this intent.
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The tax that the REIT must pay on the failure is the
greater of (i) $50,000, or (ii) an amount determined (pursuant
to regulations) by multiplying the highest rate of tax for
corporations under section 11, by the net income generated by
the assets for the period beginning on the first date of the
failure and ending on the date the REIT has disposed of the
assets (or otherwise satisfies the requirements).
Such taxes are treated as excise taxes, for which the
deficiency provisions of the excise tax subtitle of the Code
(subtitle F) apply.
Conforming reasonable cause and reporting standard for
failures of income tests
The Act conforms the reporting and reasonable cause
standards for failure to meet the income tests to the new asset
test standards. However, the Act does not change the rule under
section 857(b)(5) that for income test failures, all of the net
income attributed to the disqualified gross income is paid as
tax.
Other failures
The Act adds a provision under which, if a REIT fails to
satisfy one or more requirements for REIT qualification, other
than the 95-percent and 75-percent gross income tests and other
than the new rules provided for failures of the asset tests,
the REIT may retain its REIT qualification if the failures are
due to reasonable cause and not willful neglect, and if the
REIT pays a penalty of $50,000 for each such failure.
Taxes and penalties paid deducted from amount required to
be distributed
Any taxes or penalties paid under the Act are deducted from
the net income of the REIT in determining the amount the REIT
must distribute under the 90-percent distribution requirement.
Expansion of deficiency dividend procedure
The Act expands the circumstances in which a REIT may
declare a deficiency dividend, by allowing such a declaration
to occur after the REIT has attached a statement to its
amendment or supplement to its tax return for the relevant tax
year. Thus, the declaration need not await a decision of the
Tax Court, a closing agreement, or an agreement signed by the
Secretary of the Treasury.
Effective Date
The provision is generally effective for taxable years
beginning after December 31, 2000.
However, some of the provisions are effective for taxable
years beginning after the date of enactment (October 22, 2004).
These are: the new ``look through'' rules determining a REIT
partner's share of partnership securities for purposes of the
``straight debt'' rules; the provision changing the 90-percent
of gross income reference to 95 percent, for purposes of the
tax liability if a REIT fails to meet the 95-percent of gross
income test; the new hedging definition; \351\ the rule
modifying the treatment of rents with respect to customary
services; and the new rules for correction of certain failures
to satisfy the REIT requirements.
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\351\ In light of the fact that the identification rules of the
applicable Treasury Regulations require identification within 30 days
of entering a hedge, the new hedging rules are intended to apply to
hedges entered into in taxable years beginning after the date of
enactment. A technical correction may be necessary so that the statute
reflects this intent.
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4. Special rules for certain film and television production (sec. 244
of the Act and new sec. 181 of the Code)
Present and Prior Law
The modified Accelerated Cost Recovery System (``MACRS'')
does not apply to certain property, including any motion
picture film, video tape, or sound recording, or to any other
property if the taxpayer elects to exclude such property from
MACRS and the taxpayer properly applies a unit-of-production
method or other method of depreciation not expressed in a term
of years. Section 197 does not apply to certain intangible
property, including property produced by the taxpayer or any
interest in a film, sound recording, video tape, book or
similar property not acquired in a transaction (or a series of
related transactions) involving the acquisition of assets
constituting a trade or business or substantial portion
thereof. Thus, the recovery of the cost of a film, video tape,
or similar property that is produced by the taxpayer or is
acquired on a ``stand-alone'' basis by the taxpayer may not be
determined under either the MACRS depreciation provisions or
under the section 197 amortization provisions. The cost
recovery of such property may be determined under section 167,
which allows a depreciation deduction for the reasonable
allowance for the exhaustion, wear and tear, or obsolescence of
the property. A taxpayer is allowed to recover, through annual
depreciation deductions, the cost of certain property used in a
trade or business or for the production of income. Section
167(g) provides that the cost of motion picture films, sound
recordings, copyrights, books, and patents are eligible to be
recovered using the income forecast method of depreciation.
Reasons for Change
The Congress understood that over the past decade,
production of American film projects has moved to foreign
locations. Specifically, in recent years, a number of foreign
governments have offered tax and other incentives designed to
entice production of U.S. motion pictures and television
programs to their countries. These governments have recognized
that the benefits of hosting such productions do not flow only
to the film and television industry. These productions create
broader economic effects, with revenues and jobs generated in a
variety of other local businesses. Hotels, restaurants,
catering companies, equipment rental facilities, transportation
vendors, and many others benefit from these productions.
This has become a significant trend affecting the film and
television industry as well as the small businesses that they
support. The Congress understood that a recent report by the
U.S. Department of Commerce estimated that runaway production
drains as much as $10 billion per year from the U.S. economy.
These losses have been most pronounced in made-for-television
movies and miniseries productions. According to the report, out
of the 308 U.S.-developed television movies produced in 1998,
139 were produced abroad. This is a significant increase from
the 30 produced abroad in 1990.
The Congress believed the report made a compelling case
that runaway film and television production has eroded
important segments of a vital American industry. According to
official labor statistics, more than 270,000 jobs in the U.S.
are directly involved in film production. By industry
estimates, 70 to 80 percent of these workers are hired at the
location where the production is filmed.
The Congress believed this legislation would encourage
producers to bring feature film and television production
projects to cities and towns across the United States, thereby
decreasing the runaway production problem.
Explanation of Provision
The Act permits taxpayers to elect to deduct the cost of
any qualifying film and television production in the year the
expenditure is incurred in lieu of capitalizing the cost and
recovering it through depreciation allowances.\352\
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\352\ An election to deduct such costs shall be made in such manner
as prescribed by the Secretary and by the due date (including
extensions of time) for filing the taxpayer's return of tax for the
taxable year in which production costs of such property are first
incurred. An election may not be revoked without the consent of the
Secretary. The Congress intends that, in the absence of specific
guidance by the Secretary, deducting qualifying costs on the
appropriate tax return shall constitute a valid election.
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The Act does not apply to any qualified film or television
production the aggregate cost of which exceeds $15
million.\353\ The threshold is increased to $20 million if a
significant amount of the production expenditures are incurred
in areas eligible for designation as a low-income community or
eligible for designation by the Delta Regional Authority as a
distressed county or isolated area of distress.
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\353\ A qualifying film or television production that is co-
produced is eligible for the benefits of the provision only if its
aggregate cost, regardless of funding source, does not exceed the
threshold.
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The Act defines a qualified film or television production
as any production of a motion picture (whether released
theatrically or directly to video cassette or any other
format); miniseries; scripted, dramatic television episode; or
movie of the week if at least 75 percent of the total
compensation expended on the production are for services
performed in the United States.\354\ With respect to property
which is one or more episodes in a television series, only the
first 44 episodes qualify under the provision.\355\ Qualified
property does not include sexually explicit productions as
defined by section 2257 of title 18 of the U.S. Code.
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\354\ The term compensation does not include participations and
residuals.
\355\ It is intended that, with respect to episodes in a television
series, the aggregate cost threshold and the 75-percent-of-total-
compensation test be applied on an episode-by-episode basis. A
technical correction may be necessary so that the statute reflects this
intent.
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The Congress intended that, for purposes of recapture under
section 1245, any deduction allowed under this the Act shall be
treated as if it were a deduction allowable for
amortization.\356\
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\356\ A technical correction may be necessary so that the statute
reflects this intent.
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Effective Date
The provision is effective for qualified productions
commencing after the date of enactment (October 22, 2004) and
before January 1, 2009.\357\
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\357\ For this purpose, a production is treated as commencing on
the first date of principal photography.
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5. Provide a tax credit for maintenance of railroad track (sec. 245 of
the Act and new sec. 45G of the Code)
Present and Prior Law
Under prior law, there was no provision that provided for a
railroad track maintenance tax credit.
Explanation of Provision
The Act provides a 50-percent business tax credit for
qualified railroad track maintenance expenditures paid or
incurred in a taxable year by eligible taxpayers. The credit is
limited to the product of $3,500 times the number of miles of
railroad track owned or leased by an eligible taxpayer as of
the close of its taxable year. Each mile of railroad track may
be taken into account only once, either by the owner of such
mile or by the owner's assignee, in computing the per-mile
limitation. Qualified railroad track maintenance expenditures
are defined as amounts expended (whether or not chargeable to a
capital account) for maintaining railroad track (including
roadbed, bridges, and related track structures) owned or leased
as of January 1, 2005, by a Class II or Class III railroad. An
eligible taxpayer is defined as: (1) any Class II or Class III
railroad; and (2) any person who transports property using the
rail facilities of a Class II or Class III railroad or who
furnishes railroad-related property or services to such person.
The taxpayer's basis in railroad track is reduced by the amount
of the credit allowed. No portion of the credit may be carried
back to any taxable year beginning before January 1, 2005.
Other rules apply.
This credit applies to qualified railroad track maintenance
expenditures paid or incurred during taxable years beginning
after December 31, 2004, and before January 1, 2008.
Effective Date
The provision is effective for taxable years beginning
after December 31, 2004.
6. Suspension of occupational taxes relating to distilled spirits,
wine, and beer (sec. 246 of the Act and new sec. 5148 of the
Code)
Present and Prior Law
Special occupational taxes are imposed on producers and
others engaged in the marketing of distilled spirits, wine, and
beer. These excise taxes are imposed as part of a broader
Federal tax and regulatory regime governing the production and
marketing of alcoholic beverages. The special occupational
taxes are payable annually, on July 1 of each year. The present
tax rates are as follows:
------------------------------------------------------------------------
------------------------------------------------------------------------
Producers: \358\
Distilled spirits and wines (sec. $1,000 per year, per premise
5081).............................
Brewers (sec. 5091)................ $1,000 per year, per premise
Wholesale dealers (sec. 5111)
Liquors, wines, or beer............ $500 per year
Retail dealers (sec. 5121)
Liquors, wines, or beer............ $250 per year
Nonbeverage use of distilled spirits $500 per year
(sec. 5131)...........................
Industrial use of distilled spirits $250 per year
(sec. 5276)...........................
------------------------------------------------------------------------
\358\ A reduced rate of tax in the amount of $500 is imposed on small
proprietors. Secs. 5081(b), 5091(b).
The Code requires every wholesale or retail dealer in
liquors, wine or beer to keep records of its transactions.\359\
A delegate of the Secretary of the Treasury is authorized to
inspect the records of any dealer during business hours.\360\
There are penalties for failing to comply with the
recordkeeping requirements.\361\
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\359\ Secs. 5114, 5124.
\360\ Sec. 5146.
\361\ Sec. 5603.
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The Code limits the persons from whom dealers may purchase
their liquor stock intended for resale. Under the Code, a
dealer may only purchase from:
1. a wholesale dealer in liquors who has paid the special
occupational tax as such dealer to cover the place where such
purchase is made; or
2. a wholesale dealer in liquors who is exempt, at the
place where such purchase is made, from payment of such tax
under any provision of chapter 51 of the Code; or
3. a person who is not required to pay special occupational
tax as a wholesale dealer in liquors.\362\
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\362\ Sec. 5117. For example, purchases from a proprietor of a
distilled spirits plant at his principal business office would be
covered under item (2) since such a proprietor is not subject to the
special occupational tax on account of sales at his principal business
office. Sec. 5113(a). Purchases from a State-operated liquor store
would be covered under item (3). Sec. 5113(b).
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In addition, a limited retail dealer (such as a charitable
organization selling liquor at a picnic) may lawfully purchase
distilled spirits for resale from a retail dealer in
liquors.\363\
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\363\ Sec. 5117(b).
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Violation of this restriction is punishable by $1,000 fine,
imprisonment of one year, or both.\364\ A violation also makes
the alcohol subject to seizure and forfeiture.\365\
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\364\ Sec. 5687.
\365\ Sec. 7302.
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Reasons for Change
The special occupational tax is not a tax on alcoholic
products but rather operates as a license fee on businesses.
The Congress believed that this tax places an unfair burden on
business owners. However, the Congress recognized that the
recordkeeping and registration requirements applicable to
wholesalers and retailers engaged in such businesses are
necessary enforcement tools to ensure the protection of the
revenue arising from the excise taxes on these products. Thus,
the Congress believed it appropriate to suspend the tax for a
three-year period, while retaining present-law recordkeeping
and registration requirements.
Explanation of Provision
Under the Act, the special occupational taxes on producers
and marketers of alcoholic beverages are suspended for a three-
year period, July 1, 2005 through June 30, 2008. Present-law
recordkeeping and registration requirements continue to apply,
notwithstanding the suspension of the special occupation taxes.
In addition, during the suspension period, it shall be unlawful
for any dealer to purchase distilled spirits for resale from
any person other than a wholesale dealer in liquors who is
subject to the recordkeeping requirements, except that a
limited retail dealer may purchase distilled spirits for resale
from a retail dealer in liquors, as permitted under present
law.
Effective Date
The provision is effective on the date of enactment
(October 22, 2004).
7. Modification of unrelated business income limitation on investment
in certain small business investment companies (sec. 247 of the
Act and sec. 514 of the Code)
Present and Prior Law
In general, an organization that is otherwise exempt from
Federal income tax is taxed on income from a trade or business
regularly carried on that is not substantially related to the
organization's exempt purposes. Certain types of income, such
as rents, royalties, dividends, and interest, generally are
excluded from unrelated business taxable income except when
such income is derived from ``debt-financed property.'' Debt-
financed property generally means any property that is held to
produce income and with respect to which there is acquisition
indebtedness at any time during the taxable year.
In general, income of a tax-exempt organization that is
produced by debt-financed property is treated as unrelated
business income in proportion to the acquisition indebtedness
on the income-producing property. Acquisition indebtedness
generally means the amount of unpaid indebtedness incurred by
an organization to acquire or improve the property and
indebtedness that would not have been incurred but for the
acquisition or improvement of the property. Under present and
prior law, acquisition indebtedness does not include, however,
(1) certain indebtedness incurred in the performance or
exercise of a purpose or function constituting the basis of the
organization's exemption, (2) obligations to pay certain types
of annuities, (3) an obligation, to the extent it is insured by
the Federal Housing Administration, to finance the purchase,
rehabilitation, or construction of housing for low and moderate
income persons, or (4) indebtedness incurred by certain
qualified organizations to acquire or improve real property.
Special rules apply in the case of an exempt organization
that owns a partnership interest in a partnership that holds
debt-financed income-producing property. An exempt
organization's share of partnership income that is derived from
such debt-financed property generally is taxed as debt-financed
income unless an exception provides otherwise.
Reasons for Change
Small business investment companies obtain financial
assistance from the Small Business Administration in the form
of equity or by incurring indebtedness that is held or
guaranteed by the Small Business Administration pursuant to the
Small Business Investment Act of 1958. Tax-exempt organizations
that invest in small business investment companies who are
treated as partnerships and who incur indebtedness that is held
or guaranteed by the Small Business Administration may be
subject to unrelated business income tax on their distributive
shares of income from the small business investment company.
Congress believed that the imposition of unrelated business
income tax in such cases creates a disincentive for tax-exempt
organizations to invest in small business investment companies,
thereby reducing the amount of investment capital that may be
provided by small business investment companies to the nation's
small businesses. Congress believed, however, that ownership
limitations on the percentage interests that may be held by
exempt organizations are appropriate to prevent all or most of
a small business investment company's income from escaping
Federal income tax.
Explanation of Provision
The Act modifies the debt-financed property provisions by
excluding from the definition of acquisition indebtedness any
indebtedness incurred by a small business investment company
licensed after the date of enactment (October 22, 2004) under
the Small Business Investment Act of 1958 that is evidenced by
a debenture (1) issued by such company under section 303(a) of
said Act, and (2) held or guaranteed by the Small Business
Administration. The exclusion does not apply during any period
that any exempt organization (other than a governmental unit)
owns more than 25 percent of the capital or profits interest in
the small business investment company, or exempt organizations
(including governmental units other than any agency or
instrumentality of the United States) own, in the aggregate, 50
percent or more of the capital or profits interest in such
company.
Effective Date
The provision is effective for debt incurred after the date
of enactment (October 22, 2004) by small business investment
companies licensed after the date of enactment (October 22,
2004).
8. Election to determine taxable income from certain international
shipping activities using per ton rate (sec. 248 of the Act and
new secs. 1352-1359 of the Code)
Present and Prior Law
The United States employs a ``worldwide'' tax system, under
which domestic corporations generally are taxed on all income,
including income from shipping operations, whether derived in
the United States or abroad. In order to mitigate double
taxation, a foreign tax credit for income taxes paid to foreign
countries is provided to reduce or eliminate the U.S. tax owed
on such income, subject to certain limitations.
Generally, the United States taxes foreign corporations
only on income that has a sufficient nexus to the United
States. Thus, a foreign corporation is generally subject to
U.S. tax only on income, including income from shipping
operations, which is ``effectively connected'' with the conduct
of a trade or business in the United States (sec. 882). Such
``effectively connected income'' generally is taxed in the same
manner and at the same rates as the income of a U.S.
corporation.
The United States imposes a four percent tax on the amount
of a foreign corporation's U.S. gross transportation income
(sec. 887). Transportation income includes income from the use
(or hiring or leasing for use) of a vessel and income from
services directly related to the use of a vessel. Fifty percent
of the transportation income attributable to transportation
that either begins or ends (but not both) in the United States
is treated as U.S. source gross transportation income. The tax
does not apply, however, to U.S. gross transportation income
that is treated as income effectively connected with the
conduct of a U.S. trade or business. U.S. gross transportation
income is not treated as effectively connected income unless
(1) the taxpayer has a fixed place of business in the United
States involved in earning the income, and (2) substantially
all the income is attributable to regularly scheduled
transportation.
The taxes imposed by section 882 and 887 on income from
shipping operations may be limited by an applicable U.S. income
tax treaty or by an exemption of a foreign corporation's
international shipping operations income in instances where a
foreign country grants an equivalent exemption (sec. 883).
Under prior law, there was no provision that provided an
alternative to the corporate income tax for taxable income
attributable to international shipping activities.
Reasons for Change
In general, the Congress believed operators of U.S.-flag
vessels in international trade were subject to higher taxes
than their foreign-based competition. The uncompetitive U.S.
taxation of shipping income caused a steady and substantial
decline of the U.S. shipping industry. The Congress believed
that the Act provides operators of U.S.-flag vessels in
international trade the opportunity to be competitive with
their tax-advantaged foreign competitors.
Explanation of Provision
In general
The Act generally allows corporations to elect a ``tonnage
tax'' in lieu of the corporate income tax on taxable income
from certain shipping activities. Accordingly, an electing
corporation's gross income does not include its income from
qualifying shipping activities, and electing corporations are
only subject to tax on these activities at the maximum
corporate income tax rate on their notional shipping income,
which is based on the net tonnage of the corporation's
qualifying vessels. An electing corporation is treated as a
separate trade or business activity distinct from all other
activities conducted by such corporation.
Notional shipping income
An electing corporation's notional shipping income for the
taxable year is the sum of the products of the following
amounts for each of the qualifying vessels it operates: (1) the
daily notional shipping income \366\ from the operation of the
qualifying vessel in United States foreign trade,\367\ and (2)
the number of days during the taxable year that the electing
corporation operated such vessel as a qualifying vessel in
United States foreign trade.\368\ However, in the case of a
qualifying vessel any of the income of which is not included in
gross income, the amount of notional shipping income from such
vessel is equal to the notional shipping income from such
vessel (determined without regard to this provision) that bears
the same ratio as the gross income from the operation of such
vessel in the United States foreign trade bears to the sum of
such gross income and the income so excluded. Generally, a
``qualifying vessel'' is described as a self-propelled U.S.-
flag vessel of not less than 10,000 deadweight tons used
exclusively in U.S. foreign trade.
---------------------------------------------------------------------------
\366\ The daily notional shipping income from the operation of a
qualifying vessel is 40 cents for each 100 tons of the net tonnage of
the vessel (up to 25,000 net tons), and 20 cents for each 100 tons of
the net tonnage of the vessel, in excess of 25,000 net tons.
\367\ ``United States foreign trade'' means the transportation of
goods or passengers between a place in the United States and a foreign
place or between foreign places. The temporary use in the United States
domestic trade (i.e., the transportation of goods or passengers between
places in the United States) of any qualifying vessel is deemed to be
the use in the United States foreign trade of such vessel, if such use
does not exceed 30 days in a taxable year.
\368\ Special rules apply in the case of multiple operators of a
vessel.
---------------------------------------------------------------------------
Items not subject to corporate income tax
Generally, a corporate member of an electing group \369\
does not include in gross income its income from qualifying
shipping activities. Qualifying shipping activities consist of
(1) core qualifying activities, (2) qualifying secondary
activities, and (3) qualifying incidental activities. All of an
electing entity's core qualifying activities are excluded from
gross income. However, only a portion of an electing
corporation's secondary and incidental activities are treated
as qualifying income and thus, are excluded from gross income.
---------------------------------------------------------------------------
\369\ An electing group means any group that would be treated as a
single employer under subsection (a) or (b) of section 52 if paragraphs
(1) and (2) of section 52(a) did not apply.
---------------------------------------------------------------------------
Core qualifying activities consist of the operation of
qualifying vessels.\370\ Secondary activities generally consist
of (1) the active management or operation of vessels in U.S.
foreign trade; (2) the provision of vessels, barge, container
or cargo-related facilities or services; and (3) other
activities of the electing corporation and other members of its
electing group that are an integral part of its business of
operating qualifying vessels in United States foreign trade.
Secondary activities do not include any core qualifying
activities.\371\ Incidental activities are activities that are
incidental to core qualifying activities and are not qualifying
secondary activities.
---------------------------------------------------------------------------
\370\ It is intended that the operation of a lighter-aboard-ship be
treated as the operation of a vessel and not the operation of a barge.
\371\ The Act also provides any activities that would otherwise
constitute core qualifying activities of a corporation, who is a member
of an electing group but is not an electing corporation, are treated as
qualifying secondary activities. A technical correction may be
necessary so that the statute reflects this intent. See section 2(a)(3)
of H.R. 5395 and S. 3019, the ``Tax Technical Corrections Act of
2004,'' introduced November 19, 2004.
---------------------------------------------------------------------------
Denial of credits, income and deductions
Each item of loss, deduction, or credit of any taxpayer is
disallowed with respect to the income that is excluded from
gross income under the Act. An electing corporation's interest
expense is disallowed in the ratio that the fair market value
of its qualifying vessels bears to the fair market value of its
total assets; special rules apply for disallowing interest
expense in the context of an electing group.
No deductions are allowed against the notional shipping
income of an electing corporation, and no credit is allowed
against the notional tax imposed under the tonnage tax regime.
No deduction is allowed for any net operating loss attributable
to the qualifying shipping activities of a corporation to the
extent that such loss is carried forward by the corporation
from a taxable year preceding the first taxable year for which
such corporation was an electing corporation.
Dispositions of qualifying vessels
Generally, if a qualifying vessel operator sells or
disposes of a qualifying vessel in an otherwise taxable
transaction, at the election of the operator no gain is
recognized if a replacement qualifying vessel is acquired
during a limited replacement period except to the extent that
the amount realized upon such sale or disposition exceeds the
cost of the replacement qualifying vessel. Generally, in the
case of the replacement of a qualifying vessel that results in
the nonrecognition of any part of the gain under the rule
above, the basis of the replacement vessel is the cost of such
replacement property decreased in the amount of gain not
recognized.
Generally, a qualifying vessel operator is a corporation
that (1) operates one or more qualifying vessels and (2) meets
certain requirements with respect to its shipping
activities.\372\ Special rules apply in determining whether
corporate partners in pass-through entities are treated as
qualifying vessel operators.
---------------------------------------------------------------------------
\372\ A person is generally treated as operating any vessel during
a period if such vessel is owned by or chartered to such person (the
term ``charter'' includes an operating agreement), and is in use as a
qualifying vessel during such period. Special rules apply in the case
of pass-through entities, and special rules apply in an instance in
which an electing entity temporarily ceases to operate a qualifying
vessel due to dry-docking, surveying, inspection, repairs and the like.
---------------------------------------------------------------------------
Election
Generally, any qualifying vessel operator may elect into
the tonnage tax regime and such election is made in the form
prescribed by Treasury. An election is only effective if made
on or before the due date (including extensions) for filing the
corporation's return for such taxable year.\373\ However, a
qualifying vessel operator, which is a member of a controlled
group, may only make an election into the tonnage tax regime if
all qualifying vessel operators that are members of the
controlled group make such an election. Once made, an election
is effective for the taxable year in which it was made and for
all succeeding taxable years of the entity until the election
is terminated.
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\373\ A technical correction may be necessary so that the statute
reflects this intent.
---------------------------------------------------------------------------
Effective Date
The provision is effective for taxable years beginning
after the date of enactment (October 22, 2004).
F. Exclusion of Incentive Stock Options and Employee Stock Purchase
Plan Stock Options from Wages (sec. 251 of the Act and secs. 421(b),
423(c), 3121(a), 3231, and 3306(b) of the Code)
Present and Prior Law
Generally, when an employee exercises a compensatory option
on employer stock, the difference between the option price and
the fair market value of the stock (i.e., the ``spread'') is
includible in income as compensation. In the case of an
incentive stock option or an option to purchase stock under an
employee stock purchase plan (collectively referred to as
``statutory stock options''), the spread is not included in
income at the time of exercise.\374\
---------------------------------------------------------------------------
\374\ Sec. 421. For purposes of the individual alternative minimum
tax, the transfer of stock pursuant to an incentive stock option is
generally treated as the transfer of stock pursuant to a nonstatutory
option. Sec. 56(b)(3).
---------------------------------------------------------------------------
If the statutory holding period requirements are satisfied
with respect to stock acquired through the exercise of a
statutory stock option, the spread, and any additional
appreciation, will be taxed as capital gain upon disposition of
such stock. Compensation income is recognized, however, if
there is a disqualifying disposition (i.e., if the statutory
holding period is not satisfied) of stock acquired pursuant to
the exercise of a statutory stock option.
Federal Insurance Contribution Act (``FICA'') and Federal
Unemployment Tax Act (``FUTA'') taxes (collectively referred to
as ``employment taxes'') are generally imposed in an amount
equal to a percentage of wages paid by the employer with
respect to employment.\375\ Under prior law, the applicable
Code provisions \376\ did not provide an exception from FICA
and FUTA taxes for wages paid to an employee arising from the
exercise of a statutory stock option.
---------------------------------------------------------------------------
\375\ Secs. 3101, 3111 and 3301.
\376\ Secs. 3121 and 3306.
---------------------------------------------------------------------------
There had been uncertainty in the past as to employer
withholding obligations upon the exercise of statutory stock
options. On June 25, 2002, the IRS announced that until further
guidance is issued, it would not assess FICA or FUTA taxes, or
impose Federal income tax withholding obligations, upon either
the exercise of a statutory stock option or the disposition of
stock acquired pursuant to the exercise of a statutory stock
option.\377\
---------------------------------------------------------------------------
\377\ Notice 2002-47, 2002-28 I.R.B. 97.
---------------------------------------------------------------------------
Reasons for Change
To provide taxpayers certainty, the Congress believed that
it was appropriate to clarify the treatment of statutory stock
options for employment tax and income tax withholding purposes.
The Congress believed that, in the past, the IRS had been
inconsistent in its treatment of taxpayers with respect to this
issue and did not uniformly challenge taxpayers who did not
collect employment taxes and withhold income taxes on statutory
stock options.
Until January 2001, the IRS had not published guidance with
respect to the imposition of employment taxes and income tax
withholding on statutory stock options. Many taxpayers relied
on guidance published with respect to qualified stock options
(the predecessor to incentive stock options) to take the
position that no employment taxes or income tax withholding
were required with respect to statutory stock options. It was
the Congress' belief that a majority of taxpayers did not
withhold employment and income taxes with respect to statutory
stock options. Thus, proposed IRS regulations, if implemented,
would have altered the treatment of statutory stock options for
most employers.
Because there is a specific income tax exclusion with
respect to statutory stock options, the Congress believed it
was appropriate to clarify that there is a conforming exclusion
for employment taxes and income tax withholding. Statutory
stock options are required to meet certain Code requirements
that do not apply to nonqualified stock options. The Congress
believed that such requirements are intended to make statutory
stock options a tool of employee ownership rather than a form
of compensation subject to employment taxes. Furthermore,
Congress believed that this clarification would ensure that, if
further IRS guidance is issued, employees would not be faced
with a tax increase that would reduce their net paychecks even
though their total compensation had not changed.
The clarification would also eliminate the administrative
burden and cost to employers who, in the absence of the Act,
could be required to modify their payroll systems to provide
for the withholding of income and employment taxes on statutory
stock options that they were not currently required to
withhold.
Explanation of Provision
The Act provides specific exclusions from FICA and FUTA
wages for remuneration on account of the transfer of stock
pursuant to the exercise of an incentive stock option or under
an employee stock purchase plan, or any disposition of such
stock. Thus, under the Act, FICA and FUTA taxes do not apply
upon the exercise of a statutory stock option.\378\ The Act
also provides that such remuneration is not taken into account
for purposes of determining Social Security benefits.
---------------------------------------------------------------------------
\378\ The Act also provides a similar exclusion under the Railroad
Retirement Tax Act.
---------------------------------------------------------------------------
Additionally, the Act provides that Federal income tax
withholding is not required on a disqualifying disposition, nor
when compensation is recognized in connection with an employee
stock purchase plan discount. Present law reporting
requirements continue to apply.
Effective Date
The provision is effective for stock acquired pursuant to
options exercised after the date of enactment (October 22,
2004).
III. TAX RELIEF FOR AGRICULTURE AND SMALL MANUFACTURERS
A. Volumetric Ethanol Excise Tax Credit
1. Incentives for alcohol and biodiesel fuels (sec. 301 of the Act and
secs. 4041, 4081, 4091, 6427, 9503 and new section 6426 of the
Code)
Present and Prior Law
Alcohol fuels income tax credit
The alcohol fuels credit is the sum of three credits: the
alcohol mixture credit, the alcohol credit, and the small
ethanol producer credit. Generally, under prior law the alcohol
fuels credit was scheduled to expire after December 31,
2007.\379\
---------------------------------------------------------------------------
\379\ The alcohol fuels credit is unavailable when, for any period
before January 1, 2008, the tax rates for gasoline and diesel fuels
drop to 4.3 cents per gallon.
---------------------------------------------------------------------------
A taxpayer (generally a petroleum refiner, distributor, or
marketer) who mixes ethanol with gasoline (or a special fuel
\380\) is an ``ethanol blender.'' In 2004, ethanol blenders
were eligible for an income tax credit of 52 cents per gallon
of ethanol used in the production of a qualified mixture (the
``alcohol mixture credit''). A qualified mixture means a
mixture of alcohol and gasoline (or of alcohol and a special
fuel) sold by the blender as fuel or used as fuel by the
blender in producing the mixture. The term alcohol includes
methanol and ethanol but does not include (1) alcohol produced
from petroleum, natural gas, or coal (including peat), or (2)
alcohol with a proof of less than 150. In 2004, businesses also
may reduce their income taxes by 52 cents for each gallon of
ethanol (not mixed with gasoline or other special fuel) that
they sell at the retail level as vehicle fuel or use themselves
as a fuel in their trade or business (``the alcohol credit'').
Beginning on January 1, 2005, the credits are reduced to 51
cents per gallon.
---------------------------------------------------------------------------
\380\ A special fuel includes any liquid (other than gasoline) that
is suitable for use in an internal combustion engine.
---------------------------------------------------------------------------
A separate income tax credit is available for small ethanol
producers (the ``small ethanol producer credit''). A small
ethanol producer is defined as a person whose ethanol
production capacity does not exceed 30 million gallons per
year. The small ethanol producer credit is 10 cents per gallon
of ethanol produced during the taxable year for up to a maximum
of 15 million gallons.
The credits that comprise the alcohol fuels tax credit are
includible in income. The credit may not be used to offset
alternative minimum tax liability. The credit is treated as a
general business credit, subject to the ordering rules and
carryforward/carryback rules that apply to business credits
generally.
Excise tax reductions for alcohol mixture fuels
In general
Generally, motor fuels tax rates are as follows: \381\
---------------------------------------------------------------------------
\381\ These fuels are also subject to an additional 0.1 cent-per-
gallon excise tax to fund the Leaking Underground Storage Tank Trust
Fund. See secs. 4041(d) and 4081(a)(2)(B). In addition, the basic fuel
tax rate will drop to 4.3 cents per gallon beginning on October 1,
2005.
------------------------------------------------------------------------
Cents per
gallon
------------------------------------------------------------------------
Gasoline................................................... 18.3
Diesel fuel and kerosene................................... 24.3
Special motor fuels........................................ 18.3
------------------------------------------------------------------------
Under prior law, alcohol-blended fuels were subject to a
reduced rate of tax. The benefits provided by the alcohol fuels
income tax credit and the excise tax reduction were integrated
such that the alcohol fuels credit was reduced to take into
account the benefit of any excise tax reduction.
Gasohol
Under prior law, registered ethanol blenders could forgo
the full income tax credit and instead pay reduced rates of
excise tax on gasoline that they purchased for blending with
ethanol. Most of the benefit of the alcohol fuels credit was
claimed through the excise tax system.
The reduced excise tax rates applied to gasohol upon its
removal or entry. Gasohol was defined as a gasoline/ethanol
blend that contains 5.7 percent ethanol, 7.7 percent ethanol,
or 10 percent ethanol. For the calendar year 2004, the
following reduced rates applied to gasohol: \382\
---------------------------------------------------------------------------
\382\ These rates include the additional 0.1 cent-per-gallon excise
tax to fund the Leaking Underground Storage Tank Trust Fund. These
special rates will terminate after September 30, 2007 (sec.
4081(c)(8)).
------------------------------------------------------------------------
Cents per
gallon
------------------------------------------------------------------------
5.7 percent ethanol........................................ 15.436
7.7 percent ethanol........................................ 14.396
10.0 percent ethanol....................................... 13.200
------------------------------------------------------------------------
Reduced excise tax rates also applied when gasoline was
purchased for the production of ``gasohol.'' When gasoline was
purchased for blending into gasohol, the rates above were
multiplied by a fraction (e.g., 10/9 for 10-percent gasohol) so
that the increased volume of motor fuel will be subject to tax.
The reduced tax rates applied if the person liable for the tax
was registered with the IRS and (1) that person produced
gasohol with gasoline within 24 hours of removing or entering
the gasoline or (2) the gasoline was sold upon its removal or
entry and the person liable for the tax has an unexpired
certificate from the buyer and has no reason to believe the
certificate is false.\383\
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\383\ Treas. Reg. sec. 48.4081-6(c). A certificate from the buyer
assures that the gasoline will be used to produce gasohol within 24
hours after purchase. A copy of the registrant's letter of registration
cannot be used as a gasohol blender's certificate.
---------------------------------------------------------------------------
Qualified methanol and ethanol fuels
Under prior law, qualified methanol or ethanol fuel was any
liquid that contains at least 85 percent methanol or ethanol or
other alcohol produced from a substance other than petroleum or
natural gas. These fuels were taxed at reduced rates.\384\ The
rate of tax on qualified methanol was 12.35 cents per gallon.
The rate on qualified ethanol in 2004 was 13.15 cents. From
January 1, 2005, through September 30, 2007, the rate of tax on
qualified ethanol was 13.25 cents.
---------------------------------------------------------------------------
\384\ These reduced rates terminate after September 30, 2007.
Included in these rates is the 0.05-cent-per-gallon Leaking Underground
Storage Tank Trust Fund tax imposed on such fuel. (sec. 4041(b)(2)).
---------------------------------------------------------------------------
Alcohol produced from natural gas
A mixture of methanol, ethanol, or other alcohol produced
from natural gas that consists of at least 85 percent alcohol
is also taxed at reduced rates.\385\ For mixtures not
containing ethanol, the applicable rate of tax is 9.25 cents
per gallon before October 1, 2005. In all other cases, the rate
is 11.4 cents per gallon. After September 30, 2005, the rate is
reduced to 2.15 cents per gallon when the mixture does not
contain ethanol and 4.3 cents per gallon in all other cases.
---------------------------------------------------------------------------
\385\ These rates include the additional 0.1 cent-per-gallon excise
tax to fund the Leaking Underground Storage Tank Trust Fund (sec.
4041(d)(1)).
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Blends of alcohol and diesel fuel or special motor fuels
A reduced rate of tax applied to diesel fuel or kerosene
that was combined with alcohol as long as at least 10 percent
of the finished mixture was alcohol. If none of the alcohol in
the mixture was ethanol, the rate of tax is 18.4 cents per
gallon. For alcohol mixtures containing ethanol, the rate of
tax in 2004 was 19.2 cents per gallon and 19.3 cents per gallon
for 2005 through September 30, 2007. Fuel removed or entered
for use in producing a 10 percent diesel-alcohol fuel mixture
(without ethanol), was subject to a tax of 20.44 cents per
gallon. The rate of tax for fuel removed or entered for use to
produce a 10 percent diesel-ethanol fuel mixture is 21.333
cents per gallon for 2004 and 21.444 cents per gallon for the
period January 1, 2005, through September 30, 2007.\386\
---------------------------------------------------------------------------
\386\ These rates include the additional 0.1 cent-per-gallon excise
tax to fund the Leaking Underground Storage Tank Trust Fund.
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Special motor fuel (nongasoline) mixtures with alcohol also
were taxed at reduced rates.
Aviation fuel
Noncommercial aviation fuel is subject to a tax of 21.9
cents per gallon.\387\ Fuel mixtures containing at least 10
percent alcohol were taxed at lower rates.\388\ In the case of
10 percent ethanol mixtures, for any sale or use during 2004,
the 21.9 cents was reduced by 13.2 cents (for a tax of 8.7
cents per gallon), for 2005, 2006, and 2007 the reduction was
13.1 cents (for a tax of 8.8 cents per gallon) and was reduced
by 13.4 cents in the case of any sale during 2008 or
thereafter. For mixtures not containing ethanol, the 21.9 cents
was reduced by 14 cents for a tax of 7.9 cents. These reduced
rates were scheduled to expire after September 30, 2007.\389\
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\387\ This rate includes the additional 0.1 cent-per-gallon tax for
the Leaking Underground Storage Tank Trust fund.
\388\ Secs. 4041(k)(1) and 4091(c).
\389\ Sec. 4091(c)(1).
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When aviation fuel was purchased for blending with alcohol,
the rates above were multiplied by a fraction (10/9) so that
the increased volume of aviation fuel will be subject to tax.
Refunds and payments
If fully taxed gasoline (or other taxable fuel) was used to
produce a qualified alcohol mixture, the Code permitted the
blender to file a claim for a quick excise tax refund. The
refund was equal to the difference between the gasoline (or
other taxable fuel) excise tax that was paid and the tax that
would have been paid by a registered blender on the alcohol
fuel mixture being produced. Generally, the IRS paid these
quick refunds within 20 days. Interest accrued if the refund
was paid more than 20 days after filing. A claim could be filed
by any person with respect to gasoline, diesel fuel, or
kerosene used to produce a qualified alcohol fuel mixture for
any period for which $200 or more was payable and which was not
less than one week.
Ethyl tertiary butyl ether (ETBE)
Ethyl tertiary butyl ether (``ETBE'') is an ether that is
manufactured using ethanol. Unlike ethanol, ETBE can be blended
with gasoline before the gasoline enters a pipeline because
ETBE does not result in contamination of fuel with water while
in transport. Treasury regulations provide that gasohol
blenders could claim (under prior law) the income tax credit
and excise tax rate reductions for ethanol used in the
production of ETBE. The regulations also provide a special
election allowing refiners to claim the benefit of the prior-
law excise-tax-rate reduction even though the fuel being
removed from terminals did not contain the requisite
percentages of ethanol for claiming the excise tax rate
reduction.
Highway Trust Fund
With certain exceptions, the taxes imposed by section 4041
(relating to retail taxes on diesel fuels and special motor
fuels) and section 4081 (relating to tax on gasoline, diesel
fuel and kerosene) are credited to the Highway Trust Fund.
Under prior law, in the case of alcohol fuels, 2.5 cents per
gallon of the tax imposed was retained in the General
Fund.\390\ Under prior law, in the case of a taxable fuel taxed
at a reduced rate upon removal or entry prior to mixing with
alcohol, 2.8 cents of the reduced rate was retained in the
General Fund.\391\
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\390\ Sec. 9503(b)(4)(E).
\391\ Sec. 9503(b)(4)(F).
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Biodiesel
If biodiesel is used in the production of blended taxable
fuel, the Code imposes tax on the removal or sale of the
blended taxable fuel.\392\ In addition, the Code imposes tax on
any liquid other than gasoline sold for use or used as a fuel
in a diesel-powered highway vehicle or diesel-powered train
unless tax was previously imposed and not refunded or
credited.\393\ If biodiesel that was not previously taxed or
exempt is sold for use or used as a fuel in a diesel-powered
highway vehicle or a diesel-powered train, tax is imposed.\394\
There are no reduced excise tax rates for biodiesel.
---------------------------------------------------------------------------
\392\ Sec. 4081(b); Rev. Rul. 2002-76, 2002-46 I.R.B. 841 (2002).
``Taxable fuels'' are gasoline, diesel and kerosene (sec. 4083).
Biodiesel, although suitable for use as a fuel in a diesel-powered
highway vehicle or diesel-powered train, contains less than four
percent normal paraffins and, therefore, is not treated as diesel fuel
under the applicable Treasury regulations. Treas. Reg. secs. 48.4081-
1(c)(2)(i) and (ii), and 48.4081-1(b); Rev. Rul. 2002-76, 2002-46
I.R.B. 841 (2002). As a result, biodiesel alone is not a taxable fuel
for purposes of section 4081. As noted above, however, tax is imposed
upon the removal or entry of blended taxable fuel made with biodiesel.
\393\ Sec. 4041. The tax imposed under section 4041 also will not
apply if an exemption from tax applies.
\394\ Rev. Rul. 2002-76, 2002-46 I.R.B. 841 (2002).
---------------------------------------------------------------------------
Reasons for Change
Highway vehicles using alcohol-blended fuels contribute to
the wear and tear of the same highway system used by gasoline
or diesel vehicles. Therefore, the Congress believed that
alcohol-blended fuels should be taxed at rates equal to
gasoline or diesel. The Congress believed that prior law
provided opportunities for fraud because individuals could buy
gasoline at reduced tax rates for blending with alcohol, but
never actually use the gasoline to make an alcohol fuel blend,
The Congress believed that eliminating the reduced tax rate on
gasoline prior to blending with alcohol would reduce such
opportunities for fraud. The Congress also believed that
providing a tax credit based on the gallons of alcohol used to
make an alcohol fuel and eliminating the various blend tiers
associated with reduced tax rates for alcohol-blended fuels
would simplify present law.
Explanation of Provision
Overview
The Act eliminates reduced rates of excise tax for most
alcohol-blended fuels. The Act imposes the full rate of excise
tax on most alcohol-blended fuels (18.3 cents per gallon on
gasoline blends and 24.3 cents per gallon of diesel blended
fuel). In place of reduced rates, the Act creates two new
excise tax credits: the alcohol fuel mixture credit and the
biodiesel mixture credit. The sum of these credits may be taken
against the tax imposed on taxable fuels (by section 4081). The
Act allows taxpayers to file a claim for payment equal to the
amount of these credits for biodiesel or alcohol used to
produce an eligible mixture.
Under certain circumstances, a tax is imposed if an alcohol
fuel mixture credit or biodiesel fuel mixture credit is claimed
with respect to alcohol or biodiesel used in the production of
any alcohol or biodiesel mixture, which is subsequently used
for a purpose for which the credit is not allowed or changed
into a substance that does not qualify for the credit.
The Act eliminates the General Fund retention of certain
taxes on alcohol fuels, and credits these taxes to the Highway
Trust Fund. The Highway Trust Fund is credited with the full
amount of tax imposed on alcohol and biodiesel fuel mixtures.
The Act also extends the present-law alcohol fuels income
tax credit through December 31, 2010.
Alcohol fuel mixture excise tax credit
The Act eliminates the reduced rates of excise tax for most
alcohol-blended fuels.\395\ Under the Act, the full rate of tax
for taxable fuels is imposed on both alcohol fuel mixtures and
the taxable fuel used to produce an alcohol fuel mixture.
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\395\ The Act does not change the present-law treatment of fuels
blended with alcohol derived from natural gas (under sec. 4041(m)), or
alcohol derived from coal or peat (under sec. 4041(b)(2)). The Act does
not change the taxes imposed to fund the Leaking Underground Storage
Tank Trust Fund.
---------------------------------------------------------------------------
In lieu of the reduced excise tax rates, the Act provides
for an excise tax credit, the alcohol fuel mixture credit. The
alcohol fuel mixture credit is 51 cents for each gallon of
alcohol used by a person in producing an alcohol fuel mixture
for sale or use in a trade or business of the taxpayer. For
mixtures not containing ethanol (renewable source methanol),
the credit is 60 cents per gallon.
For purposes of the alcohol fuel mixture credit, an
``alcohol fuel mixture'' is a mixture of alcohol and a taxable
fuel that (1) is sold by the taxpayer producing such mixture to
any person for use as a fuel or (2) is used as a fuel by the
taxpayer producing the mixture. Alcohol for this purpose
includes methanol, ethanol, and alcohol gallon equivalents of
ETBE or other ethers produced from such alcohol. It does not
include alcohol produced from petroleum, natural gas, or coal
(including peat), or alcohol with a proof of less than 190
(determined without regard to any added denaturants). Taxable
fuel is gasoline, diesel, and kerosene.\396\ A mixture that
includes ETBE or other ethers produced from alcohol produced by
any person at a refinery prior to a taxable event is treated as
sold at the time of its removal from the refinery (and only at
such time) to another person for use as a fuel.
---------------------------------------------------------------------------
\396\ Sec. 4083(a)(1). Under present law, dyed fuels are taxable
fuels that have been exempted from tax.
---------------------------------------------------------------------------
The excise tax credit is coordinated with the alcohol fuels
income tax credit and is available through December 31, 2010.
Biodiesel mixture excise tax credit
The Act provides an excise tax credit for biodiesel
mixtures.\397\ The credit is 50 cents for each gallon of
biodiesel used by the taxpayer in producing a qualified
biodiesel mixture for sale or use in a trade or business of the
taxpayer. A qualified biodiesel mixture is a mixture of
biodiesel and diesel fuel that (1) is sold by the taxpayer
producing such mixture to any person for use as a fuel, or (2)
is used as a fuel by the taxpayer producing such mixture. In
the case of agri-biodiesel, the credit is $1.00 per gallon. No
credit is allowed unless the taxpayer obtains a certification
(in such form and manner as prescribed by the Secretary) from
the producer of the biodiesel that identifies the product
produced and the percentage of biodiesel and agri-biodiesel in
the product.
---------------------------------------------------------------------------
\397\ The excise tax credit uses the same definitions as the
biodiesel fuels income tax credit.
---------------------------------------------------------------------------
The credit is not available for any sale or use for any
period after December 31, 2006. This excise tax credit is
coordinated with the income tax credit for biodiesel such that
credit for the same biodiesel cannot be claimed for both income
and excise tax purposes.
Payments with respect to qualified alcohol and biodiesel fuel mixtures
To the extent the alcohol fuel mixture credit exceeds any
section 4081 liability of a person, the Secretary is to pay
such person an amount equal to the alcohol fuel mixture credit
with respect to such mixture. Thus, if the person has no
section 4081 liability, the credit is totally refundable. These
payments are intended to provide an equivalent benefit to
replace the partial exemption for fuels to be blended with
alcohol and alcohol fuels being repealed by the provision.
Similar rules apply to the biodiesel fuel mixture credit.
If claims for payment are not paid within 45 days, the
claim is to be paid with interest. The provision also provides
that in the case of an electronic claim, if such claim is not
paid within 20 days, the claim is to be paid with interest. If
claims are filed electronically, the claimant may make a claim
for less than $200. The Secretary is to describe the electronic
format for filing claims by December 31, 2004.
The payment provision does not apply with respect to
alcohol fuel mixtures sold after December 31, 2010, and
biodiesel fuel mixtures sold after December 31, 2006.
Alcohol and biodiesel fuel subsidies borne by General Fund
The Act eliminates the requirement that 2.5 and 2.8 cents
per gallon of excise taxes be retained in the General Fund with
the result that the full amount of tax on alcohol fuels is
credited to the Highway Trust Fund. The Act also authorizes the
full amount of fuel taxes to be appropriated to the Highway
Trust Fund without reduction for amounts equivalent to the
excise tax credits allowed for alcohol or biodiesel fuel
mixtures and the Highway Trust Fund is not required to
reimburse the General Fund for any credits or payments taken or
made with respect to qualified alcohol fuel mixtures or
biodiesel fuel mixtures.
Registration requirement
Every person producing or importing biodiesel or alcohol is
required to register with the Secretary.
Alcohol fuels income tax credit
The Act extends the alcohol fuels income tax credit through
December 31, 2010.\398\
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\398\ Sec. 40.
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Effective Dates
The provisions generally are effective for fuel sold or
used after December 31, 2004. The repeal of the General Fund
retention of the 2.5/2.8 cents per gallon regarding alcohol
fuels is effective for fuel sold or used after September 30,
2004. The Secretary is to provide electronic filing
instructions by December 31, 2004. The registration requirement
is effective April 1, 2005.
2. Biodiesel income tax credit (sec. 302 of the Act and new sec. 40A of
the Code)
Present and Prior Law
Under prior law, no income tax credit was provided for
biodiesel fuels. However, under present and prior law, a per-
gallon income tax credit (the ``alcohol fuels credit'') is
allowed for ethanol and methanol (derived from renewable
sources) when the alcohol is used as a highway motor fuel.\399\
---------------------------------------------------------------------------
\399\ Sec. 40.
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Reasons for Change
The Congress believed that providing a new income tax
credit for biodiesel fuel will promote energy self-
sufficiency.\400\
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\400\ See S. 1149, the ``Energy Tax Incentives Act of 2003'', which
was reported by the Senate Committee on Finance on May 23, 2003 (S.
Rep. No. 108-54).
---------------------------------------------------------------------------
Explanation of Provision
In general
The Act provides a new income tax credit for biodiesel and
qualified biodiesel mixtures, the biodiesel fuels credit. The
biodiesel fuels credit is the sum of the biodiesel mixture
credit plus the biodiesel credit and is treated as a general
business credit. The amount of the biodiesel fuels credit is
includable in gross income. The biodiesel fuels credit is
coordinated to take into account benefits from the biodiesel
excise tax credit and payment provisions created by the Act.
The credit may not be carried back to a taxable year ending
before or on December 31, 2004. The provision does not apply to
fuel sold or used after December 31, 2006.
Biodiesel is monoalkyl esters of long chain fatty acids
derived from plant or animal matter that meet (1) the
registration requirements established by the Environmental
Protection Agency under section 211 of the Clean Air Act and
(2) the requirements of the American Society of Testing and
Materials D6751. Agri-biodiesel is biodiesel derived solely
from virgin oils including oils from corn, soybeans, sunflower
seeds, cottonseeds, canola, crambe, rapeseeds, safflowers,
flaxseeds, rice bran, mustard seeds, or animal fats.
Biodiesel may be taken into account for purposes of the
credit only if the taxpayer obtains a certification (in such
form and manner as prescribed by the Secretary) from the
producer or importer of the biodiesel which identifies the
product produced and the percentage of the biodiesel and agri-
biodiesel in the product.
Biodiesel mixture credit
The biodiesel mixture credit is 50 cents for each gallon of
biodiesel used by the taxpayer in the production of a qualified
biodiesel mixture. For agri-biodiesel, the credit is $1.00 per
gallon. A qualified biodiesel mixture is a mixture of biodiesel
and diesel fuel that is (1) sold by the taxpayer producing such
mixture to any person for use as a fuel, or (2) is used as a
fuel by the taxpayer producing such mixture. The sale or use
must be in the trade or business of the taxpayer and is to be
taken into account for the taxable year in which such sale or
use occurs. No credit is allowed with respect to any casual
off-farm production of a qualified biodiesel mixture.
Biodiesel credit
The biodiesel credit is 50 cents for each gallon of 100
percent biodiesel which is not in a mixture with diesel fuel
and which during the taxable year is (1) used by the taxpayer
as a fuel in a trade or business or (2) sold by the taxpayer at
retail to a person and placed in the fuel tank of such person's
vehicle. For agri-biodiesel, the credit is $1.00 per gallon.
Later separation or failure to use as fuel
In a manner similar to the treatment of alcohol fuels, a
tax is imposed if a biodiesel fuels credit is claimed with
respect to biodiesel that is subsequently used for a purpose
for which the credit is not allowed or that is changed into a
substance that does not qualify for the credit.
Effective Date
The provision is effective for fuel produced, and sold or
used after December 31, 2004, in taxable years ending after
such date.
3. Information reporting for persons claiming certain tax benefits
(sec. 303 of the Act and new sec. 4104 of the Code)
Present and Prior Law
The Code provides an income tax credit for each gallon of
ethanol and methanol derived from renewable sources (e.g.,
biomass) used or sold as a fuel, or used to produce a qualified
alcohol fuel mixture, such as gasohol. The amount of the credit
is equal to 51 cents per gallon (ethanol) and 60 cents per
gallon (methanol).\401\ This tax credit is provided to blenders
of the alcohols with other taxable fuels, or to the retail
sellers (or users) of unblended alcohol fuels. Under prior law,
part or all of the benefits of the income tax credit could be
claimed through reduced excise taxes paid, either in reduced-
tax sales or by expedited blender refunds on fully taxed sales
of gasoline to obtain the benefit of the reduced rates. The
amount of the income tax credit determined with respect to any
alcohol was reduced to take into account any benefit provided
by the reduced excise tax rates. To obtain a partial refund on
fully taxed gasoline, the following requirements applied: (1)
the claim must be for gasohol sold or used during a period of
at least one week, (2) the claim must be for at least $200, and
(3) the claim must be filed by the last day of the first
quarter following the earliest quarter included in the claim.
If the blender could not meet these requirements, the blender
was generally required to claim a credit on the blender's
income tax return.
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\401\ Ethanol produced by certain ``small producers'' is eligible
for an additional producer tax credit of 10 cents per gallon on up to
15 million gallons of ethanol production. Eligible small producers are
defined as persons whose production capacity does not exceed 30 million
gallons.
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Explanation of Provision
The Act requires persons claiming the Code benefits
(including those created by the Act \402\) related to alcohol
fuels and biodiesel fuels to provide such information related
to such benefits and the coordination of such benefits as the
Secretary may require to ensure the proper administration and
use of such benefits. The Secretary may deny, revoke or suspend
the registration of any person to enforce this requirement.
Persons claiming excise tax benefits are to file quarterly
information returns.
---------------------------------------------------------------------------
\402\ See secs. 301 and 302 of the Act (relating to the credit for
alcohol and biodiesel fuel mixtures and outlay payments for such
mixtures, and the biodiesel income tax credit).
---------------------------------------------------------------------------
Effective Date
The provision is effective January 1, 2005.
B. Agricultural Incentives
1. Special rules for livestock sold on account of weather-related
conditions (sec. 311 of the Act and secs. 1033 and 451 of the
Code)
Present and Prior Law
Generally, a taxpayer realizes gain to the extent the sales
price (and any other consideration received) exceeds the
taxpayer's basis in the property. The realized gain is subject
to current income tax unless the gain is deferred or not
recognized under a special tax provision.
Under section 1033, gain realized by a taxpayer from an
involuntary conversion of property is deferred to the extent
the taxpayer purchases property similar or related in service
or use to the converted property within the applicable period.
The taxpayer's basis in the replacement property generally is
the cost of such property reduced by the amount of gain not
recognized.
The applicable period for the taxpayer to replace the
converted property begins with the date of the disposition of
the converted property (or if earlier, the earliest date of the
threat or imminence of requisition or condemnation of the
converted property) and ends two years after the close of the
first taxable year in which any part of the gain upon
conversion is realized (the ``replacement period''). Special
rules extend the replacement period for certain real property
and principal residences damaged by a Presidentially declared
disaster to three years and four years, respectively, after the
close of the first taxable year in which gain is realized.
Section 1033(e) provides that the sale of livestock (other
than poultry) that is held for draft, breeding, or dairy
purposes in excess of the number of livestock that would have
been sold but for drought, flood, or other weather-related
conditions is treated as an involuntary conversion.
Consequently, gain from the sale of such livestock could be
deferred by reinvesting the proceeds of the sale in similar
property within a two-year period.
In general, cash-method taxpayers report income in the year
it is actually or constructively received. However, section
451(e) provides that a cash-method taxpayer whose principal
trade or business is farming who is forced to sell livestock
due to drought, flood, or other weather-related conditions may
elect to include income from the sale of the livestock in the
taxable year following the taxable year of the sale. This
elective deferral of income is available only if the taxpayer
establishes that, under the taxpayer's usual business
practices, the sale would not have occurred but for drought,
flood, or weather-related conditions that resulted in the area
being designated as eligible for Federal assistance. This
exception is generally intended to put taxpayers who receive an
unusually high amount of income in one year in the position
they would have been in absent the weather-related condition.
Reasons for Change
The Congress was aware of situations in which cattlemen
sold livestock in excess of their usual business practice as a
result of weather-related conditions, but were then unable to
purchase replacement property because the weather-related
conditions have continued. The Congress believed it was
appropriate to extend the time period for cattlemen to purchase
replacement property in such situations.
Explanation of Provision
The Act extends the applicable period for a taxpayer to
replace livestock sold on account of drought, flood, or other
weather-related conditions from two years to four years after
the close of the first taxable year in which any part of the
gain on conversion is realized. The extension is only available
if the taxpayer establishes that, under the taxpayer's usual
business practices, the sale would not have occurred but for
drought, flood, or weather-related conditions that resulted in
the area being designated as eligible for Federal assistance.
In addition, the Secretary of the Treasury is granted authority
to further extend the replacement period on a regional basis
should the weather-related conditions continue longer than
three years. Also, for property eligible for the extended
replacement period, the Act provides that the taxpayer can make
an election under section 451(e) until the period for
reinvestment of such property under section 1033 expires.
The Act also permits the taxpayer to replace compulsorily
or involuntarily converted livestock with other farm property
if, due to drought, flood, or other weather-related conditions,
it is not feasible for the taxpayer to reinvest the proceeds in
property similar or related in use to the livestock so
converted.
Effective Date
The provision is effective for any taxable year with
respect to which the due date (without regard to extensions)
for the return is after December 31, 2002.
2. Payment of dividends on stock of cooperatives without reducing
patronage dividends (sec. 312 of the Act and sec. 1388 of the
Code)
Present and Prior Law
Under present and prior law, cooperatives generally are
entitled to deduct or exclude amounts distributed as patronage
dividends in accordance with Subchapter T of the Code. In
general, patronage dividends are comprised of amounts that are
paid to patrons (1) on the basis of the quantity or value of
business done with or for patrons, (2) under a valid and
enforceable obligation to pay such amounts that was in
existence before the cooperative received the amounts paid, and
(3) which are determined by reference to the net earnings of
the cooperative from business done with or for patrons.
Treasury Regulations provide that net earnings are reduced
by dividends paid on capital stock or other proprietary capital
interests (referred to as the ``dividend allocation
rule'').\403\ The dividend allocation rule has been interpreted
to require that such dividends be allocated between a
cooperative's patronage and nonpatronage operations, with the
amount allocated to the patronage operations reducing the net
earnings available for the payment of patronage dividends.
---------------------------------------------------------------------------
\403\ Treas. Reg. sec. 1.1388-1(a)(1).
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that the dividend allocation rule
should not apply to the extent that the organizational
documents of a cooperative provide that capital stock dividends
do not reduce the amounts owed to patrons as patronage
dividends. To the extent that capital stock dividends are in
addition to amounts paid under the cooperative's organizational
documents to patrons as patronage dividends, the Congress
believed that those capital stock dividends are not being paid
from earnings from patronage business.
In addition, the Congress believed cooperatives should be
able to raise needed equity capital by issuing capital stock
without dividends paid on such stock causing the cooperative to
be taxed on a portion of its patronage income, and without
preventing the cooperative from being treated as operating on a
cooperative basis.
Explanation of Provision
The Act provides a special rule for dividends on capital
stock of a cooperative. To the extent provided in
organizational documents of the cooperative, dividends on
capital stock do not reduce patronage income and do not prevent
the cooperative from being treated as operating on a
cooperative basis.
Effective Date
The provision is effective for distributions made in
taxable years beginning after the date of enactment (October
22, 2004).
3. Small ethanol producer credit (sec. 313 of the Act and sec. 40 of
the Code)
Present and Prior Law
Small ethanol producer credit
Present and prior law provides several tax benefits for
ethanol and methanol produced from renewable sources (e.g.,
biomass) that are used as a motor fuel or that are blended with
other fuels (e.g., gasoline) for such a use. In the case of
ethanol, a separate 10-cents-per-gallon credit on up to 15
million gallons of ethanol production is provided for small
producers, defined generally as persons whose production
capacity does not exceed 30 million gallons per year (the
``small ethanol producer credit''). The small ethanol producer
credit is part of the alcohol fuels tax credit under section 40
of the Code. The alcohol fuels tax credit is includible in
income. Under prior law, the alcohol fuels tax credit could not
be used to offset alternative minimum tax liability.\404\ The
credit is treated as a general business credit, subject to the
ordering rules and carryforward/carryback rules that apply to
business credits generally. The alcohol fuels tax credit was
scheduled to expire after December 31, 2007.\405\
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\404\ Sec. 711 of the Act permits the alcohol fuels tax credit
(which includes the small producer credit) to be allowed against the
alternative minimum tax for taxable years beginning after December 31,
2004.
\405\ Sec. 301 of the Act extends sec. 40 through December 31,
2010.
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Taxation of cooperatives and their patrons
Under present and prior law, cooperatives in essence are
treated as pass-through entities in that the cooperative is not
subject to corporate income tax to the extent the cooperative
timely pays patronage dividends.
Reasons for Change
The Congress believed provisions allowing greater
flexibility in utilizing the benefits of the small ethanol
producer credit are consistent with the objective of increasing
availability of alternative fuels.
Explanation of Provision
The Act allows cooperatives to elect to pass the small
ethanol producer credit through to their patrons. Specifically,
the credit is to be apportioned among patrons eligible to share
in patronage dividends on the basis of the quantity or value of
business done with or for such patrons for the taxable year.
The election must be made on a timely filed return for the
taxable year, and once made, is irrevocable for such taxable
year.
The amount of the credit not apportioned to patrons is
included in the organization's credit for the taxable year of
the organization. The amount of the credit apportioned to
patrons is to be included in the patron's credit for the first
taxable year of each patron ending on or after the last day of
the payment period for the taxable year of the organization,
or, if earlier, for the taxable year of each patron ending on
or after the date on which the patron receives notice from the
cooperative of the apportionment.
If the amount of the credit shown on the cooperative's
return for a taxable year is in excess of the actual amount of
the credit for that year, an amount equal to the excess of the
reduction in the credit over the amount not apportioned to
patrons for the taxable year is treated as an increase in the
cooperative's tax. The increase is not treated as tax imposed
for purposes of determining the amount of any tax credit or for
purposes of the alternative minimum tax.
Effective Date
The provision is effective for taxable years ending after
date of enactment (October 22, 2004).
4. Extend income averaging to fishermen; income averaging for farmers
and fishermen not to increase alternative minimum tax (sec. 314
of the Act and sec. 55 of the Code)
Present and Prior Law
Under present and prior law, an individual taxpayer engaged
in a farming business (as defined by section 263A(e)(4)) may
elect to compute his or her current year regular tax liability
by averaging, over the prior three-year period, all or portion
of his or her taxable income from the trade or business of
farming. Under prior law, because farmer income averaging
reduced the regular tax liability, the AMT may have been
increased. Thus, the benefits of farmer income averaging may
have been reduced or eliminated for farmers subject to the AMT.
Reasons for Change
The Congress believed that farmers and fishermen should be
allowed the full benefits of income averaging without incurring
liability under the AMT.
Explanation of Provision
The Act extends the benefits of income averaging to
fishermen.
The Act provides that, in computing AMT, a farmer or
fisherman's regular tax liability is determined without regard
to income averaging. Thus, a farmer or fisherman receives the
full benefit of income averaging because averaging reduces the
regular tax while the AMT (if any) remains unchanged.
Effective Date
The provision applies to taxable years beginning after
December 31, 2003.
5. Capital gains treatment to apply to outright sales of timber by
landowner (sec. 315 of the Act and sec. 631(b) of the Code)
Present and Prior Law
Under present and prior law, a taxpayer disposing of timber
held for more than one year is eligible for capital gains
treatment in the following situations. First, if the taxpayer
sells or exchanges timber that is a capital asset (sec. 1221)
or property used in the trade or business (sec. 1231), the gain
generally is long-term capital gain; however, if the timber is
held for sale to customers in the taxpayer's business, the gain
will be ordinary income. Second, if the taxpayer disposes of
the timber with a retained economic interest, the gain is
eligible for capital gain treatment (sec. 631(b)). Third, if
the taxpayer cuts standing timber, the taxpayer may elect to
treat the cutting as a sale or exchange eligible for capital
gains treatment (sec. 631(a)).
Reasons for Change
The Congress believed that the requirement that the owner
of timber retain an economic interest in the timber in order to
obtain capital gain treatment under section 631(b) resulted in
poor timber management. Under prior law, the buyer, when
cutting and removing timber, had no incentive to protect young
or other uncut trees because the buyer only paid for the timber
that was cut and removed. Therefore, the Act eliminates this
requirement and provides for capital gain treatment under
section 631(b) in the case of outright sales of timber.
Explanation of Provision
Under the Act, in the case of a sale of timber by the owner
of the land from which the timber is cut, the requirement that
a taxpayer retain an economic interest in the timber in order
to treat gains as capital gain under section 631(b) does not
apply. Outright sales of timber by the landowner will qualify
for capital gains treatment in the same manner as sales with a
retained economic interest qualify under prior law, except that
the usual tax rules relating to the timing of the income from
the sale of the timber will apply (rather than the special rule
of section 631(b) treating the disposal as occurring on the
date the timber is cut).
Effective Date
The provision is effective for sales of timber after
December 31, 2004.
6. Modification to cooperative marketing rules to include value-added
processing involving animals (sec. 316 of the Act and sec. 1388
of the Code)
Present and Prior Law
Under present and prior law, cooperatives generally are
treated similarly to pass-through entities in that the
cooperative is not subject to corporate income tax to the
extent the cooperative timely pays patronage dividends.
Farmers' cooperatives are tax-exempt and include cooperatives
of farmers, fruit growers, and like organizations that are
organized and operated on a cooperative basis for the purpose
of marketing the products of members or other producers and
remitting the proceeds of sales, less necessary marketing
expenses, on the basis of either the quantity or the value of
products furnished by them (sec. 521). Farmers' cooperatives
may claim a limited amount of additional deductions for
dividends on capital stock and patronage-based distributions of
nonpatronage income.
In determining whether a cooperative qualified as a tax-
exempt farmers' cooperative under prior law, the IRS apparently
took the position that a cooperative is not marketing certain
products of members or other producers if the cooperative adds
value through the use of animals (e.g., farmers sell corn to a
cooperative which is fed to chickens that produce eggs sold by
the cooperative).
Reasons for Change
The Congress disagreed with the apparent IRS position
concerning the marketing of certain products by cooperatives
after the cooperative has added value to the products through
the use of animals. Therefore, the Congress believed that the
tax rules should be modified to clarify that cooperatives are
permitted to market such products.
Explanation of Provision
The Act provides that marketing products of members or
other producers includes feeding products of members or other
producers to cattle, hogs, fish, chickens, or other animals and
selling the resulting animals or animal products.
Effective Date
The provision is effective for taxable years beginning
after the date of enactment (October 22, 2004).
7. Extension of declaratory judgment procedures to farmers' cooperative
organizations (sec. 317 of the Act and sec. 7428 of the Code)
Present and Prior Law
In limited circumstances, the Code provides declaratory
judgment procedures, which generally permit a taxpayer to seek
judicial review of an IRS determination prior to the issuance
of a notice of deficiency and prior to payment of tax. Examples
of declaratory judgment procedures that are available include
disputes involving the initial or continuing classification of
a tax-exempt organization described in section 501(c)(3), a
private foundation described in section 509(a), or a private
operating foundation described in section 4942(j)(3), the
qualification of retirement plans, the value of gifts, the
status of certain governmental obligations, or eligibility of
an estate to pay tax in installments under section 6166.\406\
In such cases, taxpayers may challenge adverse administrative
determinations by commencing a declaratory judgment action. For
example, where the IRS denies an organization's application for
recognition of exemption under section 501(c)(3) or fails to
act on such application, or where the IRS informs a section
501(c)(3) organization that it is considering revoking or
adversely modifying its tax-exempt status, the Code authorizes
the organization to seek a declaratory judgment regarding its
tax exempt status.
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\406\ For disputes involving the initial or continuing
qualification of an organization described in sections 501(c)(3),
509(a), or 4942(j)(3), declaratory judgment actions may be brought in
the U.S. Tax Court, a U.S. district court, or the U.S. Court of Federal
Claims. For all other Federal tax declaratory judgment actions,
proceedings may be brought only in the U.S. Tax Court.
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Declaratory judgment procedures were not available under
prior law to a cooperative with respect to an IRS determination
regarding its status as a farmers' cooperative under section
521.
Reasons for Change
The Congress believed that declaratory judgment procedures
currently available to other organizations and in other
situations also should be available to farmers' cooperative
organizations with respect to an IRS determination regarding
the status of an organization as a farmers' cooperative under
section 521.
Explanation of Provision
The Act extends the declaratory judgment procedures to
cooperatives. A declaratory judgment action may be commenced in
the U.S. Tax Court, a U.S. district court, or the U.S. Court of
Federal Claims, and such court would have jurisdiction to
determine a cooperative's initial or continuing qualification
as a farmers' cooperative described in section 521.
Effective Date
The provision is effective for pleadings filed after the
date of enactment (October 22, 2004).
8. Certain expenses of rural letter carriers (sec. 318 of the Act and
sec. 162(o) of the Code)
Prior Law
Under prior law, the deductible automobile expenses of
rural letter carriers were deemed to be equal to the
reimbursements that such carriers receive from the U.S. Postal
Service. Carriers were not allowed to document their actual
costs and claim itemized deductions for costs in excess of
reimbursements,\407\ nor were carriers required to include in
income reimbursements in excess of their actual costs.
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\407\ Section 162(o).
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Explanation of Provision
If the reimbursements a rural letter carrier receives from
the U.S. Postal Service fall short of the carrier's actual
costs, the costs in excess of reimbursements qualify as a
miscellaneous itemized deduction subject to the two-percent
floor. Reimbursements in excess of their actual costs continue
not to be required to be included in gross income.
Effective Date
The provision is effective for taxable years beginning
after December 31, 2003.
9. Treatment of certain income of electric cooperatives (sec. 319 of
the Act and sec. 501 of the Code)
Present and Prior Law
In general
Under present and prior law, an entity must be operated on
a cooperative basis in order to be treated as a cooperative for
Federal income tax purposes. Although not defined by statute or
regulation, the two principal criteria for determining whether
an entity is operating on a cooperative basis are: (1)
ownership of the cooperative by persons who patronize the
cooperative; and (2) return of earnings to patrons in
proportion to their patronage. The IRS requires that
cooperatives must operate under the following principles: (1)
subordination of capital in control over the cooperative
undertaking and in ownership of the financial benefits from
ownership; (2) democratic control by the members of the
cooperative; (3) vesting in and allocation among the members of
all excess of operating revenues over the expenses incurred to
generate revenues in proportion to their participation in the
cooperative (patronage); and (4) operation at cost (not
operating for profit or below cost).\408\
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\408\ Announcement 96-24, ``Proposed Examination Guidelines
Regarding Rural Electric Cooperatives,'' 1996-16 I.R.B. 35.
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In general, cooperative members are those who participate
in the management of the cooperative and who share in patronage
capital. As described below, income from the sale of electric
energy by an electric cooperative may be member or non-member
income to the cooperative, depending on the membership status
of the purchaser. A municipal corporation may be a member of a
cooperative.
For Federal income tax purposes, a cooperative generally
computes its income as if it were a taxable corporation, with
one exception--the cooperative may exclude from its taxable
income distributions of patronage dividends. In general,
patronage dividends are the profits of the cooperative that are
rebated to its patrons pursuant to a pre-existing obligation of
the cooperative to do so. The rebate must be made in some
equitable fashion on the basis of the quantity or value of
business done with the cooperative.
Except for tax-exempt farmers' cooperatives, cooperatives
that are subject to the cooperative tax rules of subchapter T
of the Code (sec. 1381, et seq.) are permitted a deduction for
patronage dividends from their taxable income only to the
extent of net income that is derived from transactions with
patrons who are members of the cooperative.\409\ The
availability of such deductions from taxable income has the
effect of allowing the cooperative to be treated like a conduit
with respect to profits derived from transactions with patrons
who are members of the cooperative.
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\409\ Sec. 1382.
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Cooperatives that qualify as tax-exempt farmers'
cooperatives are permitted to exclude patronage dividends from
their taxable income to the extent of all net income, including
net income that is derived from transactions with patrons who
are not members of the cooperative, provided the value of
transactions with patrons who are not members of the
cooperative does not exceed the value of transactions with
patrons who are members of the cooperative.\410\
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\410\ Sec. 521.
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Taxation of electric cooperatives exempt from subchapter T
In general, the cooperative tax rules of subchapter T apply
to any corporation operating on a cooperative basis (except
mutual savings banks, insurance companies, other tax-exempt
organizations, and certain utilities), including tax-exempt
farmers' cooperatives (described in sec. 521(b)). However,
subchapter T does not apply to an organization that is
``engaged in furnishing electric energy, or providing telephone
service, to persons in rural areas.''\411\ Instead, electric
cooperatives are taxed under rules that were generally
applicable to cooperatives prior to the enactment of subchapter
T in 1962. Under these rules, an electric cooperative can
exclude patronage dividends from taxable income to the extent
of all net income of the cooperative, including net income
derived from transactions with patrons who are not members of
the cooperative.\412\
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\411\ Sec. 1381(a)(2)(C).
\412\ See Rev. Rul. 83-135, 1983-2 C.B. 149.
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Tax exemption of rural electric cooperatives
Present and prior law generally provides an income tax
exemption for rural electric cooperatives if at least 85
percent of the cooperative's income consists of amounts
collected from members for the sole purpose of meeting losses
and expenses of providing service to its members.\413\ The IRS
takes the position that rural electric cooperatives also must
comply with the fundamental cooperative principles described
above in order to qualify for tax exemption under section
501(c)(12).\414\ Under present and prior law, the 85-percent
test is determined without taking into account any income from
qualified pole rentals and cancellation of indebtedness income
from the prepayment of a loan under sections 306A, 306B, or 311
of the Rural Electrification Act of 1936 (as in effect on
January 1, 1987). The exclusion for cancellation of
indebtedness income applies to such income arising in 1987,
1988, or 1989 on debt that either originated with, or is
guaranteed by, the Federal Government.
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\413\ Sec. 501(c)(12).
\414\ Rev. Rul. 72-36, 1972-1 C.B. 151.
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Rural electric cooperatives generally are subject to the
tax on unrelated trade or business income under section 511.
Reasons for Change \415\
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\415\ See S. 1149, the ``Energy Tax Incentives Act of 2003,'' which
was reported by the Committee on Finance on May 23, 2003 (S. Rep. No.
108-54).
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The Congress believed that the nature of an electric
cooperative's activities does not change because it has income
from open access transactions with non-members or from nuclear
decommissioning transactions. Accordingly, the Congress
believed that the 85-percent test for tax exemption under
present law should be applied without regard to such income.
For similar reasons, the Congress believed that the 85-
percent test for tax exemption under present law should be
applied without regard to income from certain asset exchange or
conversion transactions that would otherwise qualify for
deferred gain recognition under section 1031 or 1033.
The Congress further believed that electric energy sales to
non-members should not result in a loss of tax-exempt status or
cooperative status to the extent that such sales are necessary
to replace lost sales of electric energy to members as a result
of restructuring of the electric energy industry. Accordingly,
the Congress believed that replacement electric energy sales to
non-members (defined as ``load loss transactions'' in the Act)
should be treated, for a limited period of time, as member
income in applying the 85-percent test for tax exemption of
rural electric cooperatives. The Congress believed that such
treatment also should apply for purposes of determining whether
tax-exempt and taxable electric cooperatives comply with the
fundamental cooperative principles. Finally, the Congress
believed that income from replacement electric energy sales
should not be subject to the tax on unrelated trade or business
income under Code section 511.
Explanation of Provision
Treatment of income from open access transactions
The Act provides that income received or accrued by a rural
electric cooperative (other than income received or accrued
directly or indirectly from a member of the cooperative) from
the provision or sale of electric energy transmission services
or ancillary services on a nondiscriminatory open access basis
under an open access transmission tariff approved or accepted
by the Federal Energy Regulatory Commission (``FERC'') or under
an independent transmission provider agreement approved or
accepted by FERC (including an agreement providing for the
transfer of control-but not ownership-of transmission
facilities) \416\ is excluded in determining whether a rural
electric cooperative satisfies the 85-percent test for tax
exemption under section 501(c)(12).
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\416\ Under the provision, references to FERC are treated as
including references to the Public Utility Commission of Texas.
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In addition, the Act provides that income is excluded for
purposes of the 85-percent test if it is received or accrued by
a rural electric cooperative (other than income received or
accrued directly or indirectly from a member of the
cooperative) from the provision or sale of electric energy
distribution services or ancillary services, provided such
services are provided on a nondiscriminatory open access basis
to distribute electric energy not owned by the cooperative: (1)
to end-users who are served by distribution facilities not
owned by the cooperative or any of its members; or (2)
generated by a generation facility that is not owned or leased
by the cooperative or any of its members and that is directly
connected to distribution facilities owned by the cooperative
or any of its members.
Treatment of income from nuclear decommissioning transactions
The Act provides that income received or accrued by a rural
electric cooperative from any ``nuclear decommissioning
transaction'' also is excluded in determining whether a rural
electric cooperative satisfies the 85-percent test for tax
exemption under section 501(c)(12). The term ``nuclear
decommissioning transaction'' is defined as (1) any transfer
into a trust, fund, or instrument established to pay any
nuclear decommissioning costs if the transfer is in connection
with the transfer of the cooperative's interest in a nuclear
powerplant or nuclear powerplant unit; (2) any distribution
from a trust, fund, or instrument established to pay any
nuclear decommissioning costs; or (3) any earnings from a
trust, fund, or instrument established to pay any nuclear
decommissioning costs.
Treatment of income from asset exchange or conversion transactions
The Act provides that gain realized by a tax-exempt rural
electric cooperative from a voluntary exchange or involuntary
conversion of certain property is excluded in determining
whether a rural electric cooperative satisfies the 85-percent
test for tax exemption under section 501(c)(12). This provision
only applies to the extent that: (1) the gain would qualify for
deferred recognition under section 1031 (relating to exchanges
of property held for productive use or investment) or section
1033 (relating to involuntary conversions); and (2) the
replacement property that is acquired by the cooperative
pursuant to section 1031 or section 1033 (as the case may be)
constitutes property that is used, or to be used, for the
purpose of generating, transmitting, distributing, or selling
electricity or natural gas.
Treatment of income from load loss transactions
Tax-exempt rural electric cooperatives
The Act provides that income received or accrued by a tax-
exempt rural electric cooperative from a ``load loss
transaction'' is treated under 501(c)(12) as income collected
from members for the sole purpose of meeting losses and
expenses of providing service to its members. Therefore, income
from load loss transactions is treated as member income in
determining whether a rural electric cooperative satisfies the
85-percent test for tax exemption under section 501(c)(12). The
Act also provides that income from load loss transactions does
not cause a tax-exempt electric cooperative to fail to be
treated for Federal income tax purposes as a mutual or
cooperative company under the fundamental cooperative
principles described above.
The term ``load loss transaction'' is generally defined as
any wholesale or retail sale of electric energy (other than to
a member of the cooperative) to the extent that the aggregate
amount of such sales during a seven-year period beginning with
the ``start-up year'' does not exceed the reduction in the
amount of sales of electric energy during such period by the
cooperative to members. The ``start-up year'' is defined as the
first year that the cooperative offers nondiscriminatory open
access or, if later and at the election of the cooperative, the
calendar year that includes the date of enactment of this
provision.
The Act also excludes income received or accrued by rural
electric cooperatives from load loss transactions from the tax
on unrelated trade or business income.
Taxable electric cooperatives
The Act provides that the receipt or accrual of income from
load loss transactions by taxable electric cooperatives is
treated as income from patrons who are members of the
cooperative. Thus, income from a load loss transaction is
excludible from the taxable income of a taxable electric
cooperative if the cooperative distributes such income pursuant
to a pre-existing contract to distribute the income to a patron
who is not a member of the cooperative. The Act also provides
that income from load loss transactions does not cause a
taxable electric cooperative to fail to be treated for Federal
income tax purposes as a mutual or cooperative company under
the fundamental cooperative principles described above.
Effective Date
The provision is effective for taxable years beginning
after the date of enactment (October 22, 2004) and before
January 1, 2007.
10. Exclusion from gross income for amounts paid under National Health
Service Corps Loan Repayment Program (sec. 320 of the Act and
sec. 108 of the Code)
Present and Prior Law
The National Health Service Corps Loan Repayment Program
(the ``NHSC Loan Repayment Program'') provides education loan
repayments to participants on condition that the participants
provide certain services. The recipient of the loan repayment
is obligated to provide medical services in a geographic area
identified by the Public Health Service as having a shortage of
health-care professionals. Loan repayments may be as much as
$35,000 per year of service plus a tax assistance payment of 39
percent of the repayment amount.
States may also provide for education loan repayment
programs for persons who agree to provide primary health
services in health professional shortage areas. Under the
Public Health Service Act, such programs may receive Federal
grants with respect to such repayment programs if certain
requirements are satisfied.
Generally, gross income means all income from whatever
source derived including income for the discharge of
indebtedness. However, gross income does not include discharge
of indebtedness income if: (1) the discharge occurs in a Title
11 case; (2) the discharge occurs when the taxpayer is
insolvent; (3) the indebtedness discharged is qualified farm
indebtedness; or (4) except in the case of a C corporation, the
indebtedness discharged is qualified real property business
indebtedness.
Under prior law, because the loan repayments provided under
the NHSC Loan Repayment Program or similar State programs under
the Public Health Service Act were not specifically excluded
from gross income, they were gross income to the recipient.
There was also no exception from employment taxes (FICA and
FUTA) for such loan repayments.
Reasons for Change \417\
The Congress believed that elimination of the tax on loan
repayments provided under the NHSC Loan Repayment Program and
similar State programs would free up NHSC resources which are
currently being used to pay for services that will be provided
by medical professionals as a condition of loan repayment and
improve the ability of the NHSC to attract medical
professionals to underserved areas.
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\417\ The reasons for change were included for a substantially
similar provision in S. 2424, the ``National Employee Savings and Trust
Equity Guarantee Act,'' which was reported by the Senate Committee on
Finance on May 14, 2004 (S. Rep. No. 108-266).
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Explanation of Provision
The Act excludes from gross income and employment taxes
education loan repayments provided under the NHSC Loan
Repayment Program and State programs eligible for funds under
the Public Health Service Act. The Act also provides that such
repayments are not taken into account as wages in determining
benefits under the Social Security Act.
Effective Date
The provision is effective with respect to amounts received
in taxable years beginning after December 31, 2003.
11. Modified safe harbor rules for timber REITs (sec. 321 of the Act
and sec. 857 of the Code)
Present and Prior Law
In general
Under present law, real estate investment trusts
(``REITs'') are subject to a special taxation regime. Under
this regime, a REIT is allowed a deduction for dividends paid
to its shareholders. As a result, REITs generally do not pay
tax on distributed income. REITs are generally restricted to
earning certain types of passive income, primarily rents from
real property and interests on mortgages secured by real
property.
To qualify as a REIT, a corporation must satisfy a number
of requirements, among which are four tests: organizational
structure, source of income, nature of assets, and distribution
of income.
Income or loss from prohibited transactions
A 100-percent tax is imposed on the net income of a REIT
from ``prohibited transactions''. A prohibited transaction is
the sale or other disposition of property held for sale in the
ordinary course of a trade or business,\418\ other than
foreclosure property.\419\ A safe harbor is provided for
certain sales of land or improvements. To qualify for the safe
harbor, three criteria generally must be met. First, the REIT
must have held the land or improvements for at least four years
for the production of rental income.\420\ Second, the aggregate
expenditures made by the REIT during the four-year period prior
to the date of the sale must not exceed 30 percent of the net
selling price of the property. Third, either (i) the REIT must
make seven or fewer sales of property during the taxable year
or (ii) the aggregate adjusted basis of the property sold must
not exceed 10 percent of the aggregate bases of all the REIT's
assets at the beginning of the REIT's taxable year. In the
latter case, substantially all of the marketing and development
expenditures with respect to the property must be made through
an independent contractor.
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\418\ Sec. 1221(a)(1).
\419\ Thus, the 100-percent tax on prohibited transactions helps to
ensure that the REIT is a passive entity and may not engage in ordinary
retailing activities such as sales to customers of condominium units or
subdivided lots in a development project.
\420\ An exception to the requirement is provided for land or
improvements acquired by foreclosure, deed in lieu of foreclosure, or
lease termination. Sec. 857(b)(6)(C).
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Certain timber income
Some REITs have been formed to hold land on which trees are
grown. Upon maturity of the trees, the standing trees are sold
by the REIT. The Internal Revenue Service has issued private
letter rulings in particular instances stating that the income
from the sale of the trees can qualify as REIT real property
income because the uncut timber and the timberland on which the
timber grew is considered real property and the sale of uncut
trees can qualify as capital gain derived from the sale of real
property.\421\
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\421\ See, e.g., PLR 200052021, PLR 199945055, PLR 19927021, PLR
8838016. A private letter ruling may be relied upon only by the
taxpayer to which the ruling is issued. However, such rulings provide
an indication of administrative practice.
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Limitation on investment in other entities
In general
A REIT is limited in the amount that it can own in other
corporations. Specifically, a REIT cannot own securities (other
than Government securities and certain real estate assets) in
an amount greater than 25 percent of the value of REIT assets.
In addition, it cannot own such securities of any one issuer
representing more than five percent of the total value of REIT
assets or more than 10 percent of the voting securities or 10
percent of the value of the outstanding securities of any one
issuer. Securities for purposes of these rules are defined by
reference to the Investment Company Act of 1940.\422\
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\422\ Certain securities that are within a safe-harbor definition
of ``straight debt'' are not taken into account for purposes of the
limitation to no more than 10 percent of the value of an issuer's
outstanding securities.
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Special rules for taxable REIT subsidiaries
Under an exception to the general rule limiting REIT
securities ownership of other entities, a REIT can own stock of
a taxable REIT subsidiary (``TRS''), generally, a corporation
other than a REIT \423\ with which the REIT makes a joint
election to be subject to special rules. A TRS can engage in
active business operations that would produce income that would
not be qualified income for purposes of the 95-percent or 75-
percent income tests for a REIT, and that income is not
attributed to the REIT. Transactions between a TRS and a REIT
are subject to a number of specified rules that are intended to
prevent the TRS (taxable as a separate corporate entity) from
shifting taxable income from its activities to the pass-through
entity REIT or from absorbing more than its share of expenses.
Under one rule, a 100-percent excise tax is imposed on rents,
deductions, or interest paid by the TRS to the REIT to the
extent such items would exceed an arm's length amount as
determined under section 482.\424\
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\423\ Certain corporations are not eligible to be a TRS, such as a
corporation which directly or indirectly operates or manages a lodging
facility or a health care facility or directly or indirectly provides
to any other person rights to a brand name under which any lodging
facility or health care facility is operated. Sec. 856(1)(3).
\424\ If the excise tax applies, the item is not also reallocated
back to the TRS under section 482.
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Reasons for Change
The Congress believed it was appropriate to provide a safe
harbor from the prohibited transactions rules, to permit a REIT
that holds timberland to make sales of timber property,
provided there is not significant development of the property.
A similar provision already exists for rental properties.
Explanation of Provision
The Act adds a new provision that a sale of a real estate
asset by a REIT will not be a prohibited transaction if the
following six requirements are met:
1. The asset must have been held for at least four years in
the trade or business of producing timber;
2. The aggregate expenditures made by the REIT (or a
partner of the REIT) during the four-year period preceding the
date of sale that are includible in the basis of the property
(other than timberland acquisition expenditures \425\) and that
are directly related to the operation of the property for the
production of timber or for the preservation of the property
for use as timberland must not exceed 30 percent of the net
selling price of the property;
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\425\ The timberland acquisition expenditures that are excluded for
this purpose are those expenditures that are related to timberland
other than the specific timberland that is being sold under the safe
harbor, but costs of which may be combined with costs of such property
in the same ``managaement block'' under Treas. Reg. sec. 1.611-3(d).
Any specific timberland being sold must meet the requirement that it
has been held for at least four years by the REIT in order to qualify
for the safe harbor.
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3. The aggregate expenditures made by the REIT (or a
partner of the REIT) during the four-year period preceding the
date of sale that are includible in the basis of the property
(other than timberland acquisition expenditures) and that are
not directly related to the operation of the property for the
production of timber or the preservation of the property for
use as timberland must not exceed five percent of the net
selling price of the property;
4. The REIT either (a) does not make more than seven sales
of property (other than sales of foreclosure property or sales
to which 1033 applies) or (b) the aggregate adjusted bases (as
determined for purposes of computing earnings and profits) of
property sold during the year (other than sales of foreclosure
property or sales to which 1033 applies) does not exceed 10
percent of the aggregate bases (as determined for purposes of
computing earnings and profits) of all assets of the REIT as of
the beginning of the taxable year;
5. In the case that the seven property sales per year
requirement is not met, substantially all of the marketing
expenditures with respect to the property are made by persons
who are independent contractors (as defined by section
856(d)(3)) with respect to the REIT and from whom the REIT does
not derive or receive any income; and
6. The sales price on the sale of the property cannot be
based in whole or in part on income or profits of any person,
including income or profits derived from the sale or operation
of such properties.
Capital expenditures counted towards the 30-percent limit
are those expenditures that are includible in the basis of the
property (other than timberland acquisition expenditures), and
that are directly related to operation of the property for the
production of timber, or for the preservation of the property
for use as timberland. These capital expenditures are those
incurred directly in the operation of raising timber (i.e.,
silviculture), as opposed to capital expenditures incurred in
the ownership of undeveloped land. In general, these capital
expenditures incurred directly in the operation of raising
timber include capital expenditures incurred by the REIT to
create an established stand of growing trees. A stand of trees
is considered established when a target stand exhibits the
expected growing rate and is free of non-target competition
(e.g., hardwoods, grasses, brush, etc.) that may significantly
inhibit or threaten the target stand survival. The costs
commonly incurred during stand establishment are: (1) site
preparation including manual or mechanical scarification,
manual or mechanical cutting, disking, bedding, shearing,
raking, piling, broadcast and windrow/pile burning (including
slash disposal costs as required for stand establishment); (2)
site regeneration including manual or mechanical hardwood
coppice; (3) chemical application via aerial or ground to
eliminate or reduce vegetation; (4) nursery operating costs
including personnel salaries and benefits, facilities costs,
cone collection and seed extraction, and other costs directly
attributable to the nursery operations (to the extent such
costs are allocable to seedlings used by the REIT); (5)
seedlings including storage, transportation and handling
equipment; (6) direct planting of seedlings; and (7) initial
stand fertilization, up through stand establishment. Other
examples of capital expenditures incurred directly in the
operation of raising timber include construction costs of roads
to be used for managing the timber land (including for removal
of logs or fire protection), environmental costs (i.e., habitat
conservation plans), and any other post stand establishment
capital costs (e.g., ``mid-term fertilization costs.)''
Capital expenditures counted towards the five-percent limit
are those capital expenditures incurred in the ownership of
undeveloped land that are not incurred in the direct operation
of raising timber (i.e., silviculture). This category of
capital expenditures includes: (1) expenditures to separate the
REIT's holdings of land into separate parcels; (2) costs of
granting leases or easements to cable, cellular or similar
companies; (3) costs in determining the presence or quality of
minerals located on the land; (4) costs incurred to defend
changes in law that would limit future use of the land by the
REIT or a purchaser from the REIT; (5) costs incurred to
determine alternative uses of the land (e.g., recreational
use); and (6) development costs of the property incurred by the
REIT (e.g., engineering, surveying, legal, permit, consulting,
road construction, utilities, and other development costs for
use other than to grow timber).
Costs that are not includible in the basis of the property
are not counted towards either the 30-percent or five-percent
requirements.
Effective Date
The provision is effective for taxable years beginning
after the date of enactment (October 22, 2004).
12. Expensing of reforestation expenditures (sec. 322 of the Act and
secs. 48 and 194 of the Code)
Present and Prior Law
Section 194 permits a taxpayer to elect to amortize and
deduct a limited amount of certain reforestation expenditures.
No more than $10,000 of reforestation expenditures made by a
taxpayer in any year can qualify for amortization.\426\
Reforestation expenditures include direct costs incurred in
connection with forestation or reforestation by planting or
artificial or natural seeding, including costs for site
preparation, seeds and seeding, labor and tools, and
depreciation on equipment used in planting or seeding. Only
reforestation expenditures that are included in the basis of
qualified timber property qualify for amortization.\427\
Qualified timber property means ``a woodlot or other site
located in the United States which will contain trees in
significant commercial quantities and which is held by the
taxpayer for the planting, cultivating, caring for, and cutting
of trees for sale or use in the commercial production of timber
products.'' If a taxpayer's otherwise qualifying reforestation
expenditures exceed the amount permitted to be amortized under
section 194 and are incurred with respect to more than one
qualified timber property, the taxpayer may allocate the
permitted amount between or among the properties in any manner
the taxpayer chooses.\428\
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\426\ The limit is reduced to $5,000 for married taxpayers filing
separate returns. All members of a controlled group of corporations (as
defined under section 1563(a) except that the 80-percent ownership
requirement is reduced to a more than 50-percent requirement) must
share a single $10,000 limit. If a partnership or S corporation incurs
reforestation expenditures, the $10,000 limit applies separately to the
partnership or S corporation and to each partner or shareholder. For an
estate with reforestation expenditures, the $10,000 limit is
apportioned between the estate and its beneficiaries. Section 194 does
not apply to trusts.
\427\ Section 194 applies only to costs required to be capitalized
under the general rules of capitalization; costs that could be deducted
in the absence of section 194 are not required to be amortized.
\428\ Treas. Reg. sec. 1.194-2(b)(2).
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Reforestation expenditures qualifying for amortization are
deducted in 84 equal monthly installments starting with the
seventh month of the taxable year during which the expenditures
are paid or incurred.
Under prior law, section 48(b) allowed a tax credit of up
to $10,000 each year for 10 percent of the costs eligible for
amortization under section 194. The amount permitted to be
amortized under section 194 was reduced by half the amount of
the credit determined under section 48(b).
Explanation of Provision
The Act amends section 194(b)(1) to permit a taxpayer to
elect to deduct (expense) reforestation expenditures paid or
incurred with respect to any qualified timber property. The
amount permitted to be deducted with respect to each qualified
timber property in any taxable year generally is $10,000
($5,000 in the case of a married individual filing a separate
return).\429\ The prior law rules governing the allocation of
the amortization limitation among partnerships, S corporations,
and members of a controlled group of corporations now apply in
allocating among those entities the limitation on the amount
eligible for expensing.
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\429\ The Act therefore changes the $10,000 ceiling from an
aggregate to a per-property limit.
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The Act restricts the amount permitted to be amortized and
deducted during the 84-month period described above to the
amount not taken as a deduction under amended section
194(b)(1).
The Congress intended that, for purposes of recapture under
section 1245, any deduction allowed under this provision shall
be treated as if it were a deduction allowable for
amortization.\430\
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\430\ A technical correction may be necessary so that the statute
reflects this intent.
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The section 194(b)(1) expensing election is not available
for trusts. Reforestation expenditures incurred by a trust or
estate are apportioned between the income beneficiaries and the
fiduciary under regulations prescribed by the Secretary, and
amounts apportioned to any beneficiary are treated as incurred
by such beneficiary for purposes of applying section 194.\431\
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\431\ A technical correction may be necessary so that the statute
reflects this intent.
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The Act repeals the prior law section 48(b) reforestation
credit.
Effective Date
The provision is effective for expenditures paid or
incurred after the date of enactment (October 22, 2004).
C. Incentives for Small Manufacturers
1. Net income from publicly traded partnerships treated as qualifying
income of regulated investment company (sec. 331 of the Act and
secs. 851(b), 469(k), 7704(d) and new sec. 851(h) of the Code)
Present and Prior Law
Treatment of RICs
A regulated investment company (``RIC'') generally is
treated as a conduit for Federal income tax purposes. In
computing its taxable income, a RIC deducts dividends paid to
its shareholders to achieve conduit treatment.\432\ In order to
qualify for conduit treatment, a RIC must generally be a
domestic corporation that, at all times during the taxable
year, is registered under the Investment Company Act of 1940 as
a management company or as a unit investment trust, or has
elected to be treated as a business development company under
that Act.\433\ In addition, the corporation must elect RIC
status, and must satisfy certain other requirements.\434\
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\432\ Sec. 852(b).
\433\ Sec. 851(a).
\434\ Sec. 851(b).
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One of the RIC qualification requirements is that at least
90 percent of the RIC's gross income is derived from dividends,
interest, payments with respect to securities loans, and gains
from the sale or other disposition of stock or securities or
foreign currencies, or other income (including but not limited
to gains from options, futures, or forward contracts) derived
with respect to its business of investing in such stock,
securities, or currencies.\435\ Income derived from a
partnership is treated as meeting this requirement only to the
extent such income is attributable to items of income of the
partnership that would meet the requirement if realized by the
RIC in the same manner as realized by the partnership (the
``look-through'' rule for partnership income).\436\ Under prior
law, no distinction was made under this rule between a publicly
traded partnership and any other partnership.
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\435\ Sec. 851(b)(2).
\436\ Sec. 851(b).
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The RIC qualification rules include limitations on the
ownership of assets and on the composition of the RIC's
assets.\437\ Under the ownership limitation, at least 50
percent of the value of the RIC's total assets must be
represented by cash, government securities and securities of
other RICs, and other securities; however, in the case of such
other securities, the RIC may invest no more than five percent
of the value of the total assets of the RIC in the securities
of any one issuer, and may hold no more than 10 percent of the
outstanding voting securities of any one issuer. Under the
limitation on the composition of the RIC's assets, no more than
25 percent of the value of the RIC's total assets may be
invested in the securities of any one issuer (other than
Government securities or securities of other RICs), or in
securities of two or more controlled issuers in the same or
similar trades or businesses. These limitations generally are
applied at the end of each quarter.\438\
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\437\ Sec. 851(b)(3).
\438\ Sec. 851(d).
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Treatment of publicly traded partnerships
Present law provides that a publicly traded partnership
means a partnership, interests in which are traded on an
established securities market, or are readily tradable on a
secondary market (or the substantial equivalent thereof). In
general, a publicly traded partnership is treated as a
corporation, but an exception to corporate treatment is
provided if 90 percent or more of its gross income is interest,
dividends, real property rents, or certain other types of
qualifying income.\439\
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\439\ Sec. 7704(a), (c), and (d).
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A special rule for publicly traded partnerships applies
under the passive loss rules. The passive loss rules limit
deductions and credits from passive trade or business
activities.\440\ Deductions attributable to passive activities,
to the extent they exceed income from passive activities,
generally may not be deducted against other income. Deductions
and credits that are suspended under these rules are carried
forward and treated as deductions and credits from passive
activities in the next year. The suspended losses from a
passive activity are allowed in full when a taxpayer disposes
of his entire interest in the passive activity to an unrelated
person. The special rule for publicly traded partnerships
provides that the passive loss rules are applied separately
with respect to items attributable to each publicly traded
partnership.\441\ Thus, income or loss from the publicly traded
partnership is treated as separate from income or loss from
other passive activities.
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\440\ Sec. 469.
\441\ Sec. 469(k).
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Reasons for Change
The Congress understood that publicly traded partnerships
generally are treated as corporations under rules enacted to
address Congress' view that publicly traded partnerships
resemble corporations in important respects.\442\ Publicly
traded partnerships with specified types of income are not
treated as corporations, however, for the reason that if the
income is from sources that are commonly considered to be
passive investments, then there is less reason to treat the
publicly traded partnership as a corporation.\443\ The Congress
understood that these types of publicly traded partnerships may
have improved access to capital markets if their interests were
permitted investments of mutual funds. Therefore, the Act
treats publicly traded partnership interests as permitted
investments for mutual funds (``RICs'').
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\442\ H.R. Rep. No. 100-391, pt. 2 of 2, at 1006 (1987)
\443\ Id.
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Nevertheless, the Congress believed that permitting mutual
funds to hold interests in a publicly traded partnership should
not give rise to avoidance of unrelated business income tax or
withholding of income tax that would apply if tax-exempt
organizations or foreign persons held publicly traded
partnership interests directly rather than through a mutual
fund. Therefore, the Act requires that existing limitations on
ownership and composition of assets of mutual funds apply to
any investment in a publicly traded partnership by a mutual
fund. The Congress believed that these limitations will serve
to limit the use of mutual funds as conduits for avoidance of
unrelated business income tax or withholding rules that would
otherwise apply with respect to publicly traded partnership
income.
Explanation of Provision
The Act modifies the 90-percent test with respect to income
of a RIC to include net income derived from an interest in a
publicly traded partnership. The Act also modifies the look-
through rule for partnership income of a RIC so that it applies
only to income from a partnership other than a publicly traded
partnership.
In addition, the Act provides that net income from an
interest in a publicly traded partnership is used for purposes
of both the numerator and denominator of the 90-percent test.
As under prior law with respect to other permitted investments,
the Act also provides that gains from the sale or other
disposition of interests in publicly traded partnerships
constitute qualifying income of regulated investment companies.
The Act provides that the limitation on ownership and the
limitation on composition of assets that apply to other
investments of a RIC also apply to RIC investments in publicly
traded partnership interests.
The Act provides that the special rule for publicly traded
partnerships under the passive loss rules (requiring separate
treatment) applies to a RIC holding an interest in a publicly
traded partnership, with respect to items attributable to the
interest in the publicly traded partnership.
Effective Date
The provision is effective for taxable years beginning
after the date of enactment (October 22, 2004).
2. Simplification of excise tax imposed on bows and arrows (sec. 332 of
the Act and sec. 4161 of the Code)
Present and Prior Law
Under prior law, the Code imposed an excise tax of 11
percent on the sale by a manufacturer, producer or importer of
any bow with a draw weight of 10 pounds or more.\444\ An excise
tax of 12.4 percent is imposed on the sale by a manufacturer or
importer of any shaft, point, nock, or vane designed for use as
part of an arrow which after its assembly (1) is over 18 inches
long, or (2) is designed for use with a taxable bow (if shorter
than 18 inches).\445\ No tax is imposed on finished arrows. An
11-percent excise tax also is imposed on any part of an
accessory for taxable bows and on quivers for use with arrows
(1) over 18 inches long or (2) designed for use with a taxable
bow (if shorter than 18 inches).\446\
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\444\ Sec. 4161(b)(1)(A).
\445\ Sec. 4161(b)(2).
\446\ Sec. 4161(b)(1)(B).
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Reasons for Change
Under prior law, foreign manufacturers and importers of
arrows were able to avoid the 12.4 percent excise tax paid by
domestic manufacturers because the tax was placed on arrow
components rather than finished arrows. As a result, arrows
assembled outside of the United States had a price advantage
over domestically manufactured arrows. The Congress believed it
was appropriate to close this loophole. The Congress also
believed that adjusting the minimum draw weight for taxable
bows from 10 pounds to 30 pounds would better target the excise
tax to actual hunting use by eliminating the excise tax on
instructional (``youth'') bows.
Explanation of Provision
The Act increases the draw weight for a taxable bow from 10
pounds or more to a peak draw weight of 30 pounds or more.\447\
The Act subjects certain broadheads (a type of arrow point) to
an excise tax equal to 11 percent of the sales price instead of
12.4 percent.
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\447\ Draw weight is the maximum force required to bring the
bowstring to a full-draw position not less than 26\1/4\ inches,
measured from the pressure point of the hand grip to the nocking
position on the bowstring.
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Section 332 of the Act included other provisions which were
subsequently modified by Pub. L. No. 108-493. See Part Twenty-
One for description of those provisions as modified.
Effective Date
The provisions of this section of the Act relating to the
taxation of broadheads and bows are effective for articles sold
by the manufacturer, producer or importer 30 days after the
date of enactment (October 22, 2004) of the Act.
3. Reduce rate of excise tax on fishing tackle boxes to three percent
(sec. 333 of the Act and sec. 4162 of the Code)
Present and Prior Law
A 10-percent manufacturer's excise tax is imposed on
specified sport fishing equipment. Examples of taxable
equipment include fishing rods and poles, fishing reels,
artificial bait, fishing lures, line and hooks, and fishing
tackle boxes. Revenues from the excise tax on sport fishing
equipment are deposited in the Sport Fishing Account of the
Aquatic Resources Trust Fund. Monies in the fund are spent,
subject to an existing permanent appropriation, to support
Federal-State sport fish enhancement and safety programs.
Reasons for Change
The Congress believed that fishing ``tackle boxes'' were
little different in design and appearance from ``tool boxes,''
yet the former were subject to a Federal excise tax at a rate
of 10 percent, while the latter were not subject to Federal
excise tax. This excise tax can create a sufficiently large
price difference that some fishermen will choose to use a
``tool box'' to hold their hooks and lures rather than a
traditional ``tackle box.'' The Congress found that such a
distortion of consumer choice placed an inappropriate burden on
the manufacturers and purchasers of traditional tackle boxes,
particularly in comparison to the modest amount of revenue
raised by the excise tax, and that this burden warranted a
reduction in the rate of tax.
Explanation of Provision
Under the Act, the rate of excise tax imposed on fishing
tackle boxes is reduced to three percent.
Effective Date
The provision is effective for articles sold by the
manufacturer, producer, or importer after December 31, 2004.
4. Repeal of excise tax on sonar devices suitable for finding fish
(sec. 334 of the Act and secs. 4161 and 4162 of the Code)
Present and Prior Law
In general, the Code imposes a 10-percent tax on the sale
by the manufacturer, producer, or importer of specified sport
fishing equipment.\448\ A three-percent rate, however, applies
to the sale of electric outboard motors, and applied to the
sale of sonar devices suitable for finding fish.\449\ Further,
the tax imposed on the sale of sonar devices suitable for
finding fish was limited to $30. A sonar device suitable for
finding fish did not include any device that was a graph
recorder, a digital type, a meter readout, a combination graph
recorder or combination meter readout.\450\
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\448\ Sec. 4161(a)(1).
\449\ Sec. 4161(a)(2).
\450\ Sec. 4162(b).
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Revenues from the excise tax on sport fishing equipment are
deposited in the Sport Fishing Account of the Aquatic Resources
Trust Fund. Monies in the fund are spent, subject to an
existing permanent appropriation, to support Federal-State
sport fish enhancement and safety programs.
Reasons for Change
The Congress observed that the exemption for certain forms
of sonar devices had the effect of exempting almost all of the
devices currently on the market. The Congress understood that
only one form of sonar device was not exempt from the tax,
those units utilizing light-emitting diode (``LED'') display
technology. The Congress further understood that LED devices
were not exempt from the tax because the technology was
developed after the exemption for the other technologies was
enacted. In the view of Congress, the application of the tax to
LED display devices, and not to devices performing the same
function with a different technology, created an unfair
advantage for the exempt devices. Because most of the devices
on the market were already exempt, the Congress believed it was
appropriate to level the playing field by repealing the tax
imposed on all sonar devices suitable for finding fish. The
Congress believed that was a more suitable solution than
exempting a device from the tax based on the type of technology
used.
Explanation of Provision
The Act repeals the excise tax on all sonar devices
suitable for finding fish.\451\
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\451\ A clerical technical correction may be necessary to eliminate
deadwood in connection with the provision. See section 2(g)(18) of H.R.
5395 and S. 3019, the ``Tax Technical Corrections Act of 2004,''
introduced November 19, 2004.
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Effective Date
The provision is effective for articles sold by the
manufacturer, producer, or importer after December 31, 2004.
5. Charitable contribution deduction for certain expenses in support of
Native Alaskan subsistence whaling (sec. 335 of the Act and
sec. 170 of the Code)
Present and Prior Law
In computing taxable income, individuals who do not elect
the standard deduction may claim itemized deductions, including
a deduction (subject to certain limitations) for charitable
contributions or gifts made during the taxable year to a
qualified charitable organization or governmental entity.
Individuals who elect the standard deduction may not claim a
deduction for charitable contributions made during the taxable
year.
No charitable contribution deduction is allowed for a
contribution of services. However, unreimbursed expenditures
made incident to the rendition of services to an organization,
contributions to which are deductible, may constitute a
deductible contribution.\452\ Specifically, section 170(j)
provides that no charitable contribution deduction is allowed
for traveling expenses (including amounts expended for meals
and lodging) while away from home, whether paid directly or by
reimbursement, unless there is no significant element of
personal pleasure, recreation, or vacation in such travel.
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\452\ Treas. Reg. sec. 1.170A-1(g).
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Reasons for Change
Congress believes that subsistence bowhead whale hunting
activities are important to certain native peoples of Alaska
and further charitable purposes, and that certain expenses paid
by individuals recognized as whaling captains by the Alaska
Eskimo Whaling Commission in the conduct of sanctioned whaling
activities conducted pursuant to the management plan of that
Commission should be deductible expenses.
Explanation of Provision
The Act allows individuals to claim a deduction under
section 170 not exceeding $10,000 per taxable year for certain
expenses incurred in carrying out sanctioned whaling
activities. The deduction is available only to an individual
who is recognized by the Alaska Eskimo Whaling Commission as a
whaling captain charged with the responsibility of maintaining
and carrying out sanctioned whaling activities. The deduction
is available for reasonable and necessary expenses paid by the
taxpayer during the taxable year for: (1) the acquisition and
maintenance of whaling boats, weapons, and gear used in
sanctioned whaling activities; (2) the supplying of food for
the crew and other provisions for carrying out such activities;
and (3) the storage and distribution of the catch from such
activities. Under the Act, the Secretary shall issue guidance
regarding substantiation of amounts claimed as deductible
whaling expenses, such as by maintaining appropriate written
records that show, for example, the time, place, date, amount,
and nature of the expense, as well as the taxpayer's
eligibility for the deduction, and may require that such
substantiation be provided as part of the taxpayer's income tax
return.
For purposes of the provision, the term ``sanctioned
whaling activities'' means subsistence bowhead whale hunting
activities conducted pursuant to the management plan of the
Alaska Eskimo Whaling Commission.
Effective Date
The provision is effective for contributions made after
December 31, 2004.
6. Extended placed in service date for bonus depreciation for certain
aircraft (excluding aircraft used in the transportation
industry) (sec. 336 of the Act and sec. 168 of the Code)
Present and Prior Law
In general
A taxpayer is allowed to recover, through annual
depreciation deductions, the cost of certain property used in a
trade or business or for the production of income. The amount
of the depreciation deduction allowed with respect to tangible
property for a taxable year is determined under the modified
accelerated cost recovery system (``MACRS''). Under MACRS,
different types of property generally are assigned applicable
recovery periods and depreciation methods. The recovery periods
applicable to most tangible personal property range from three
to 25 years. The depreciation methods generally applicable to
tangible personal property are the 200-percent and 150-percent
declining balance methods, switching to the straight-line
method for the taxable year in which the depreciation deduction
would be maximized.
Thirty-percent additional first-year depreciation deduction
JCWAA allows an additional first-year depreciation
deduction equal to 30 percent of the adjusted basis of
qualified property.\453\ The amount of the additional first-
year depreciation deduction is not affected by a short taxable
year. The additional first-year depreciation deduction is
allowed for both regular tax and alternative minimum tax
purposes for the taxable year in which the property is placed
in service.\454\ The basis of the property and the depreciation
allowances in the placed-in-service year and later years are
appropriately adjusted to reflect the additional first-year
depreciation deduction. In addition, there are generally no
adjustments to the allowable amount of depreciation for
purposes of computing a taxpayer's alternative minimum taxable
income with respect to property to which the provision applies.
A taxpayer is allowed to elect out of the additional first-year
depreciation for any class of property for any taxable
year.\455\
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\453\ The additional first-year depreciation deduction is subject
to the general rules regarding whether an item is deductible under
section 162 or subject to capitalization under section 263 or section
263A.
\454\ However, the additional first-year depreciation deduction is
not allowed for purposes of computing earnings and profits.
\455\ A taxpayer may elect out of the 50-percent additional first-
year depreciation (discussed below) for any class of property and still
be eligible for the 30-percent additional first-year depreciation.
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In order for property to qualify for the additional first-
year depreciation deduction, it must meet all of the following
requirements. First, the property must be (1) property to which
MACRS applies with an applicable recovery period of 20 years or
less, (2) water utility property (as defined in section
168(e)(5)), (3) computer software other than computer software
covered by section 197, or (4) qualified leasehold improvement
property (as defined in section 168(k)(3)).\456\ Second, the
original use \457\ of the property must commence with the
taxpayer on or after September 11, 2001. Third, the taxpayer
must acquire the property within the applicable time period.
Finally, the property must be placed in service before January
1, 2005.
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\456\ A special rule precludes the additional first-year
depreciation deduction for any property that is required to be
depreciated under the alternative depreciation system of MACRS.
\457\ The term ``original use'' means the first use to which the
property is put, whether or not such use corresponds to the use of such
property by the taxpayer.
If, in the normal course of its business, a taxpayer sells
fractional interests in property to unrelated third parties, then the
original use of such property begins with the first user of each
fractional interest (i.e., each fractional owner is considered the
original user of its proportionate share of the property).
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An extension of the placed-in-service date of one year
(i.e., January 1, 2006) is provided for certain property with a
recovery period of ten years or longer and certain
transportation property.\458\ Transportation property is
defined as tangible personal property used in the trade or
business of transporting persons or property.
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\458\ In order for property to qualify for the extended placed-in-
service date, the property must be subject to section 263A and have an
estimated production period exceeding two years or an estimated
production period exceeding one year and a cost exceeding $1 million.
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The applicable time period for acquired property is (1)
after September 10, 2001 and before January 1, 2005, but only
if no binding written contract for the acquisition is in effect
before September 11, 2001, or (2) pursuant to a binding written
contract which was entered into after September 10, 2001, and
before January 1, 2005.\459\ With respect to property that is
manufactured, constructed, or produced by the taxpayer for use
by the taxpayer, the taxpayer must begin the manufacture,
construction, or production of the property after September 10,
2001. For property eligible for the extended placed-in-service
date, a special rule limits the amount of costs eligible for
the additional first-year depreciation. With respect to such
property, only the portion of the basis that is properly
attributable to the costs incurred before January 1, 2005
(``progress expenditures'') is eligible for the additional
first-year depreciation.\460\
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\459\ Property does not fail to qualify for the additional first-
year depreciation merely because a binding written contract to acquire
a component of the property is in effect prior to September 11, 2001.
\460\ For purposes of determining the amount of eligible progress
expenditures, it is intended that rules similar to sec. 46(d)(3) as in
effect prior to the Tax Reform Act of 1986 shall apply.
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Fifty-percent additional first-year depreciation
JGTRRA provides an additional first-year depreciation
deduction equal to 50 percent of the adjusted basis of
qualified property. Qualified property is defined in the same
manner as for purposes of the 30-percent additional first-year
depreciation deduction provided by the JCWAA except that the
applicable time period for acquisition (or self construction)
of the property is modified. Property eligible for the 50-
percent additional first-year depreciation deduction is not
eligible for the 30-percent additional first-year depreciation
deduction.
In order to qualify, the property must be acquired after
May 5, 2003 and before January 1, 2005, and no binding written
contract for the acquisition can be in effect before May 6,
2003.\461\ With respect to property that is manufactured,
constructed, or produced by the taxpayer for use by the
taxpayer, the taxpayer must begin the manufacture,
construction, or production of the property after May 5, 2003.
For property eligible for the extended placed-in-service date
(i.e., certain property with a recovery period of ten years or
longer and certain transportation property), a special rule
limits the amount of costs eligible for the additional first-
year depreciation. With respect to such property, only progress
expenditures properly attributable to the costs incurred before
January 1, 2005 are eligible for the additional first-year
depreciation.\462\
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\461\ Property does not fail to qualify for the additional first-
year depreciation merely because a binding written contract to acquire
a component of the property is in effect prior to May 6, 2003. However,
no 50-percent additional first-year depreciation is permitted on any
such component. No inference is intended as to the proper treatment of
components placed in service under the 30-percent additional first-year
depreciation provided by the JCWAA.
\462\ For purposes of determining the amount of eligible progress
expenditures, it is intended that rules similar to sec. 46(d)(3) as in
effect prior to the Tax Reform Act of 1986 shall apply.
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Reasons for Change
The Congress believed that certain non-commercial aircraft
represent property having characteristics that should qualify
for the extended placed-in-service date accorded for property
having long production periods. This treatment should be
available only if the purchaser makes a substantial deposit,
the expected cost exceeds certain thresholds, and the
production period is sufficiently long.
Explanation of Provision
Due to the extended production period, the Act provides
criteria under which certain non-commercial aircraft can
qualify for the extended placed-in-service date. Qualifying
aircraft are eligible for the additional first-year
depreciation deduction if placed in service before January 1,
2006. In order to qualify, the aircraft must:
1. be acquired by the taxpayer during the applicable
time period as under present law;\463\
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\463\ Property that is otherwise eligible for the extended placed-
in-service rules, and that is acquired and placed in service during
2005 pursuant to a written binding contract which was entered into
after May 5, 2003, and before January 1, 2005, is eligible for the 50-
percent additional first-year depreciation deduction. A technical
correction may be necessary so that the statute reflects this intent.
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2. meet the appropriate placed-in-service date
requirements;
3. not be tangible personal property used in the
trade or business of transporting persons or property
(except for agricultural or firefighting purposes);
4. be purchased \464\ by a purchaser who, at the time
of the contract for purchase, has made a nonrefundable
deposit of the lesser of ten percent of the cost or
$100,000; and
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\464\ For this purpose, it is intended that the term ``purchase''
be interpreted as it is defined in sec. 179(d)(2).
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5. have an estimated production period exceeding four
months and a cost exceeding $200,000.
The progress expenditures limitation does not apply to non-
commercial aircraft which qualify under the provision.
Effective Date
The provision is effective as if included in the amendments
made by section 101 of JCWAA, which applies to property placed
in service after September 10, 2001. However, because the
property described by the provision qualifies for the
additional first-year depreciation deduction under present law
if placed in service prior to January 1, 2005, the provision
will modify the treatment only of property placed in service
during calendar year 2005.
7. Special placed in service rule for bonus depreciation for certain
property subject to syndication (sec. 337 of the Act and sec.
168 of the Code)
Present and Prior Law
Section 101 of JCWAA provides generally for 30-percent
additional first-year depreciation, and provides a binding
contract rule in determining property that qualifies for it. In
order for property to qualify, (1) the original use of the
property must commence with the taxpayer on or after September
11, 2001, and (2) the taxpayer must acquire the property (i)
after September 10, 2001 and before January 1, 2005, but only
if no binding written contract for the acquisition is in effect
before September 11, 2001, or (ii) pursuant to a binding
contract which was entered into after September 10, 2001, and
before January 1, 2005. In addition, JCWAA provides a special
rule in the case of certain leased property. In the case of any
property that is originally placed in service by a person and
that is sold to the taxpayer and leased back to such person by
the taxpayer within three months after the date that the
property was placed in service, the property is treated as
originally placed in service by the taxpayer not earlier than
the date that the property is used under the leaseback. JCWAA
did not specifically address the syndication of a lease by the
lessor.
The Working Families Tax Relief Act of 2004 (``H.R. 1308'')
included a technical correction regarding the syndication of a
lease by the lessor. The technical correction provides that if
property is originally placed in service by a lessor (including
by operation of the special rule for self-constructed
property), such property is sold within three months after the
date that the property was placed in service, and the user of
such property does not change, then the property is treated as
originally placed in service by the taxpayer not earlier than
the date of such sale.
JGTRRA provides an additional first-year depreciation
deduction equal to 50 percent of the adjusted basis of
qualified property. Qualified property is defined in the same
manner as for purposes of the 30-percent additional first-year
depreciation deduction provided by the JCWAA except that the
applicable time period for acquisition (or self construction)
of the property is modified. Property with respect to which the
50-percent additional first-year depreciation deduction is
claimed is not also eligible for the 30-percent additional
first-year depreciation deduction. In order to qualify, the
property must be acquired after May 5, 2003 and before January
1, 2005, and no binding written contract for the acquisition
can be in effect before May 6, 2003. With respect to property
that is manufactured, constructed, or produced by the taxpayer
for use by the taxpayer, the taxpayer must begin the
manufacture, construction, or production of the property after
May 5, 2003.
Reasons for Change
The Congress was aware that certain syndication
arrangements are entered into with respect to multiple units of
property (such as rail cars) that, for logistical reasons, must
be placed in service over a period of time that exceeds three
months. In such cases, it would be impractical for the sale of
the earlier produced units to occur within three months of its
placed-in-service date. Thus, the Congress deemed it
appropriate to provide a special rule with respect to the
syndication of multiple units of property that will be placed
in service over a period of up to twelve months.
Explanation of Provision
The Act provides a special rule in the case of multiple
units of property subject to the same lease. In such cases,
property will qualify as placed in service on the date of sale
if it is sold within three months after the final unit is
placed in service, so long as the period between the time the
first and last units are placed in service does not exceed 12
months.
Effective Date
The provision applies to property sold after June 4, 2004.
8. Expensing of capital costs incurred for production in complying with
Environmental Protection Agency sulfur regulations for small
refiners (sec. 338 of the Act and new sec. 179B of the Code)
Present and Prior Law
Taxpayers generally may recover the costs of investments in
refinery property through annual depreciation deductions.
Reasons for Change \465\
The Congress believed it was important for all refiners to
meet applicable pollution control standards. However, the
Congress was concerned that the cost of complying with the
Highway Diesel Fuel Sulfur Control Requirement of the
Environmental Protection Agency (``EPA'') may force some small
refiners out of business. To maintain this refining capacity
and to foster compliance with pollution control standards the
Congress believed it was appropriate to modify cost recovery
provisions for small refiners to reduce their capital costs of
complying with the Highway Diesel Fuel Sulfur Control
Requirement of the EPA.
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\465\ These reasons for change were included for similar provisions
included in H.R. 1531, the ``Energy Tax Policy Act of 2003,'' which was
reported by the House Committee on Ways and Means on April 9, 2003
(H.R. Rep. No. 108-67) and S. 1149, the ``Energy Tax Incentive Act of
2003,'' which was reported by the Senate Committee on Finance on May 2,
2003 (S. Rep. No. 108-54). The two bills were conferenced to produce
H.R. 6, the ``Energy Policy Act of 2003,'' (H.R. Conf. Rep. 108-375).
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Explanation of Provision
The Act permits small business refiners to immediately
deduct as an expense up to 75 percent of the costs paid or
incurred for the purpose of complying with the Highway Diesel
Fuel Sulfur Control Requirements of the EPA. Costs qualifying
for the deduction are those costs paid or incurred with respect
to any facility of a small business refiner during the period
beginning on January 1, 2003 and ending on the earlier of the
date that is one year after the date on which the taxpayer must
comply with the applicable EPA regulations or December 31,
2009.
For these purposes a small business refiner is a taxpayer
who is in the business of refining petroleum products and
employs not more than 1,500 employees directly in refining and
has less than 205,000 barrels per day (average) of total
refinery capacity. The deduction is reduced ratably for
taxpayers with capacity between 155,000 barrels per day and
205,000 barrels per day. With respect to the definition of a
small business refiner, the Congress intends that, in any case
in which refinery through-put or retained production of the
refinery differs substantially from its average daily output or
refined product, capacity be measured by reference to the
average daily output of refined product.
Effective Date
The provision is effective for expenses paid or incurred
after December 31, 2002, in taxable years ending after that
date.
9. Credit for small refiners for production of diesel fuel in
compliance with Environmental Protection Agency sulfur
regulations for small refiners (sec. 339 of the Act and new
sec. 45H of the Code)
Present and Prior Law
Prior law did not provide a credit for the production of
low-sulfur diesel fuel.
Reasons for Change \466\
The Congress believed it was important for all refiners to
meet applicable pollution control standards. However, the
Congress was concerned that the cost of complying with the
Highway Diesel Fuel Sulfur Control Requirement of the
Environmental Protection Agency (``EPA'') may force some small
refiners out of business. To maintain this refining capacity
and to foster compliance with pollution control standards the
Congress believed it was appropriate to modify cost recovery
provisions for small refiners to reduce their capital costs of
complying with the Highway Diesel Fuel Sulfur Control
Requirement of the EPA.
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\466\ These reasons for change were included for similar provisions
included in H.R. 1531, the ``Energy Tax Policy Act of 2003,'' which was
reported by the House Committee on Ways and Means on April 9, 2003
(H.R. Rep. No. 108-67) and S. 1149, the ``Energy Tax Incentive Act of
2003,'' which was reported by the Senate Committee on Finance on May 2,
2003 (S. Rep. No. 108-54). The two bills were conferenced to produce
H.R. 6, the ``Energy Policy Act of 2003,'' (H.R. Conf. Rep. 108-375).
---------------------------------------------------------------------------
Explanation of Provision
The Act provides that a small business refiner may claim
credit equal to five cents per gallon for each gallon of low
sulfur diesel fuel produced during the taxable year that is in
compliance with the Highway Diesel Fuel Sulfur Control
Requirements of the EPA. The total production credit claimed by
the taxpayer is limited to 25 percent of the capital costs
incurred to come into compliance with the EPA diesel fuel
requirements. Costs qualifying for the credit are those costs
paid or incurred with respect to any facility of a small
business refiner during the period beginning on January 1, 2003
and ending on the earlier of the date that is one year after
the date on which the taxpayer must comply with the applicable
EPA regulations or December 31, 2009. The taxpayer's basis in
property with respect to which the credit applies is reduced by
the amount of production credit claimed.
In the case of a qualifying small business refiner that is
owned by a cooperative, the cooperative is allowed to elect to
pass any production credits to patrons of the organization.
The Act makes the low sulfur diesel fuel credit a qualified
business credit under section 169(c). Therefore, if any portion
of the credit has not been allowed to the taxpayer as a general
business credit (sec. 38) for any taxable year, an amount equal
to that portion may be deducted by the taxpayer in the first
taxable year following the last taxable year for which such
portion could have been allowed as a credit under the carryback
and carryforward rules (sec. 39).
For these purposes a small business refiner is a taxpayer
who is in the business of refining petroleum products, employs
not more than 1,500 employees directly in refining, and has
less than 205,000 barrels per day (average) of total refinery
capacity. The credit is reduced ratably for taxpayers with
capacity between 155,000 barrels per day and 205,000 barrels
per day. With respect to the definition of a small business
refiner, the Congress intends that, in any case where refinery
through-put or retained production of the refinery differs
substantially from its average daily output of refined product,
capacity be measured by reference to the average daily output
of refined product.
Effective Date
The provision is effective for expenses paid or incurred
after December 31, 2002, in taxable years ending after that
date.
10. Modification to qualified small issue bonds (sec. 340 of the Act
and sec. 144 of the Code)
Present and Prior Law
Qualified small-issue bonds are tax-exempt bonds issued by
State and local governments to finance private business
manufacturing facilities (including certain directly related
and ancillary facilities) or the acquisition of land and
equipment by certain farmers. In both instances, these bonds
are subject to limits on the amount of financing that may be
provided, both for a single borrowing and in the aggregate. In
general, no more than $1 million of small-issue bond financing
may be outstanding at any time for property of a business
(including related parties) located in the same municipality or
county. Generally, this $1 million limit may be increased to
$10 million if in addition to outstanding bonds, all other
capital expenditures of the business (including related
parties) in the same municipality or county are counted toward
the limit over a six-year period that begins three years before
the issue date of the bonds and ends three years after such
date. For example, assume that City, on October 22, 2003,
issues $6 million principal amount of small issue bonds and
loans the proceeds to Corporation to finance a manufacturing
facility located in City. Further assume that Corporation
incurred $4 million of capital expenditures on May 17, 2001,
with respect to a separate facility also located in City. The
capital expenditures incurred in 2001 must be taken into
account for purposes of the $10 million limitation. Moreover,
any additional capital expenditures Corporation (or any related
party) incurred or incurs with respect to facilities located in
City either three years before or three years after October 22,
2003, will cause the bonds issued on that date to lose the tax
exemption.
Outstanding aggregate borrowing is limited to $40 million
per borrower (including related parties) regardless of where
the property is located.
Reasons for Change
The Congress believed it was appropriate to increase the
$10 million capital expenditures limit for small-issue bonds
because the limit had not been adjusted for many years.
Explanation of Provision
The Act increases the maximum allowable amount of total
capital expenditures by an eligible business (or related party)
in the same municipality or county from $10 million to $20
million for bonds issued after September 30, 2009.
Effective Date
The provision is effective for bonds issued after September
30, 2009.
11. Oil and gas production from marginal wells (sec. 341 of the Act and
new sec. 45I of the Code)
Prior Law
Under prior law, there was no credit for the production of
oil and gas from marginal wells. The costs of such production
were recoverable under the Code's depreciation and depletion
rules and in other cases as a deduction for ordinary and
necessary business expenses.
Reasons for Change
The highly volatile price of oil and gas can result in lost
production during periods when prices are low. The Congress
learned that once a producing well is shut in, that source of
supply may be forever lost. To increase domestic supply, the
Congress determined that a tax credit will help ensure that
supply is not lost as a result of low market prices.\467\
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\467\ See H.R. 1531, the ``Energy Tax Policy of 2003,'' which was
reported by the House Committee on Ways and Means on April 9, 2003
(H.R. Rep. No. 108-67).
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Explanation of Provision
The Act creates a new, $3-per-barrel credit for the
production of crude oil and a $0.50 credit per 1,000 cubic feet
of qualified natural gas production. In both cases, the credit
is available only for production from a ``qualified marginal
well.'' A qualified marginal well is defined as a domestic
well: (1) production from which is treated as marginal
production for purposes of the Code percentage depletion rules;
or (2) that during the taxable year had average daily
production of not more than 25 barrel equivalents and produces
water at a rate of not less than 95 percent of total well
effluent. Under the Act, the maximum amount of production
during any taxable year on which credit could be claimed is
1,095 barrels or barrel equivalents.
The credit is not available to production occurring if the
reference price of oil exceeds $18 ($2.00 for natural gas). The
credit is reduced proportionately as for reference prices
between $15 and $18 ($1.67 and $2.00 for natural gas).
Reference prices are determined on a one-year look-back basis.
In the case of production from a qualified marginal well
which is eligible for the credit allowed under section 29 for
the taxable year, no marginal well credit is allowable unless
the taxpayer elects not to claim the credit under section 29
with respect to the well. Under the Act, the credit is treated
as part of the general business credit; however, unused credits
can be carried back for up to five years rather than the
generally applicable carryback period of one year. The credit
is indexed for inflation for taxable years beginning in a
calendar year after 2005.
Effective Date
The provision is effective for production in taxable years
beginning after December 31, 2004.
IV. TAX REFORM AND SIMPLIFICATION FOR UNITED STATES BUSINESSES
A. Interest Expense Allocation Rules (sec. 401 of the Act and sec. 864
of the Code)
Present and Prior Law
In general
In order to compute the foreign tax credit limitation, a
taxpayer must determine the amount of its taxable income from
foreign sources. Thus, the taxpayer must allocate and apportion
deductions between items of U.S.-source gross income, on the
one hand, and items of foreign-source gross income, on the
other.
In the case of interest expense, the rules generally are
based on the approach that money is fungible and that interest
expense is properly attributable to all business activities and
property of a taxpayer, regardless of any specific purpose for
incurring an obligation on which interest is paid.\468\ For
interest allocation purposes, the Code provides that all
members of an affiliated group of corporations generally are
treated as a single corporation (the so-called ``one-taxpayer
rule'') and allocation must be made on the basis of assets
rather than gross income.
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\468\ However, exceptions to the fungibility principle are provided
in particular cases, some of which are described below.
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Affiliated group
In general
The term ``affiliated group'' in this context generally is
defined by reference to the rules for determining whether
corporations are eligible to file consolidated returns.
However, some groups of corporations are eligible to file
consolidated returns yet are not treated as affiliated for
interest allocation purposes, and other groups of corporations
are treated as affiliated for interest allocation purposes even
though they are not eligible to file consolidated returns.
Thus, under the one-taxpayer rule, the factors affecting the
allocation of interest expense of one corporation may affect
the sourcing of taxable income of another related corporation
even if the two corporations do not elect to file, or are
ineligible to file, consolidated returns.
Definition of affiliated group--consolidated return rules
For consolidation purposes, the term ``affiliated group''
means one or more chains of includible corporations connected
through stock ownership with a common parent corporation which
is an includible corporation, but only if: (1) the common
parent owns directly stock possessing at least 80 percent of
the total voting power and at least 80 percent of the total
value of at least one other includible corporation; and (2)
stock meeting the same voting power and value standards with
respect to each includible corporation (excluding the common
parent) is directly owned by one or more other includible
corporations.
Generally, the term ``includible corporation'' means any
domestic corporation except certain corporations exempt from
tax under section 501 (for example, corporations organized and
operated exclusively for charitable or educational purposes),
certain life insurance companies, corporations electing
application of the possession tax credit, regulated investment
companies, real estate investment trusts, and domestic
international sales corporations. A foreign corporation
generally is not an includible corporation.
Definition of affiliated group--special interest allocation
rules
Subject to exceptions, the consolidated return and interest
allocation definitions of affiliation generally are consistent
with each other.\469\ For example, both definitions generally
exclude all foreign corporations from the affiliated group.
Thus, while debt generally is considered fungible among the
assets of a group of domestic affiliated corporations, prior
law did not apply such fungibility principles as between the
domestic and foreign members of a group with the same degree of
common control as the domestic affiliated group.
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\469\ One such exception is that the affiliated group for interest
allocation purposes includes section 936 corporations that are excluded
from the consolidated group.
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Banks, savings institutions, and other financial affiliates
The affiliated group for interest allocation purposes
generally excludes what are referred to in the Treasury
regulations as ``financial corporations'' (Treas. Reg. sec.
1.861-11T(d)(4)). These include any corporation, otherwise a
member of the affiliated group for consolidation purposes, that
is a financial institution (described in section 581 or section
591), the business of which is predominantly with persons other
than related persons or their customers, and which is required
by State or Federal law to be operated separately from any
other entity which is not a financial institution (sec.
864(e)(5)(C)). The category of financial corporations also
includes, to the extent provided in regulations, bank holding
companies (including financial holding companies), subsidiaries
of banks and bank holding companies (including financial
holding companies), and savings institutions predominantly
engaged in the active conduct of a banking, financing, or
similar business (sec. 864(e)(5)(D)).
A financial corporation is not treated as a member of the
regular affiliated group for purposes of applying the one-
taxpayer rule to other non-financial members of that group.
Instead, all such financial corporations that would be so
affiliated are treated as a separate single corporation for
interest allocation purposes.
Reasons for Change
The Congress observed that a U.S.-based multinational
corporate group with a significant portion of its assets
overseas would be required to allocate a significant portion of
its interest expense to foreign-source income, which would
reduce the foreign tax credit limitation and thus the credits
allowable, even though the interest expense incurred in the
United States would not be deductible in computing the actual
tax liability under foreign law. The Congress believed that
this approach unduly limited such a taxpayer's ability to claim
foreign tax credits and left it excessively exposed to double
taxation of foreign-source income. The Congress observed that
the United States was the only country to impose what it
considered to be harsh and anti-competitive interest expense
allocation rules on its businesses and workers. The Congress
believed that the practical effect of these rules was to
increase the cost for U.S. companies to borrow in the United
States, and to make it more expensive to invest in the United
States. The Congress believed that interest expense instead
should be allocated using an elective ``worldwide fungibility''
approach, under which interest expense incurred in the United
States is allocated against foreign-source income only if the
debt-to-asset ratio is higher for U.S. than for foreign
investments.
Explanation of Provision
In general
The Act modifies the interest expense allocation rules
(which generally apply for purposes of computing the foreign
tax credit limitation) by providing a one-time election under
which the taxable income of the domestic members of an
affiliated group from sources outside the United States
generally is determined by allocating and apportioning interest
expense of the domestic members of a worldwide affiliated group
on a worldwide-group basis (i.e., as if all members of the
worldwide group were a single corporation). If a group makes
this election, the taxable income of the domestic members of a
worldwide affiliated group from sources outside the United
States is determined by allocating and apportioning the third-
party interest expense of those domestic members to foreign-
source income in an amount equal to the excess (if any) of (1)
the worldwide affiliated group's worldwide third-party interest
expense multiplied by the ratio which the foreign assets of the
worldwide affiliated group bears to the total assets of the
worldwide affiliated group,\470\ over (2) the third-party
interest expense incurred by foreign members of the group to
the extent such interest would be allocated to foreign sources
if the Act's principles were applied separately to the foreign
members of the group.\471\
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\470\ For purposes of determining the assets of the worldwide
affiliated group, neither stock in corporations within the group nor
indebtedness (including receivables) between members of the group is
taken into account. It is anticipated that the Treasury Secretary will
adopt regulations addressing the allocation and apportionment of
interest expense on such indebtedness that follow principles analogous
to those of existing regulations. Income from holding stock or
indebtedness of another group member is taken into account for all
purposes under the present-law rules of the Code, including the foreign
tax credit provisions.
\471\ Although the interest expense of a foreign subsidiary is
taken into account for purposes of allocating the interest expense of
the domestic members of the electing worldwide affiliated group for
foreign tax credit limitation purposes, the interest expense incurred
by a foreign subsidiary is not deductible on a U.S. return.
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For purposes of the new elective rules based on worldwide
fungibility, the worldwide affiliated group means all
corporations in an affiliated group (as that term is defined
under present law for interest allocation purposes) \472\ as
well as all controlled foreign corporations that, in the
aggregate, either directly or indirectly,\473\ would be members
of such an affiliated group if section 1504(b)(3) did not apply
(i.e., in which at least 80 percent of the vote and value of
the stock of such corporations is owned by one or more other
corporations included in the affiliated group). Thus, if an
affiliated group makes this election, the taxable income from
sources outside the United States of domestic group members
generally is determined by allocating and apportioning interest
expense of the domestic members of the worldwide affiliated
group as if all of the interest expense and assets of 80-
percent or greater owned domestic corporations (i.e.,
corporations that are part of the affiliated group under
present-law section 864(e)(5)(A) as modified to include
insurance companies) and certain controlled foreign
corporations were attributable to a single corporation.
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\472\ The Act expands the definition of an affiliated group for
interest expense allocation purposes to include certain insurance
companies that are generally excluded from an affiliated group under
section 1504(b)(2) (without regard to whether such companies are
covered by an election under section 1504(c)(2)).
\473\ Indirect ownership is determined under the rules of section
958(a)(2) or through applying rules similar to those of section
958(a)(2) to stock owned directly or indirectly by domestic
partnerships, trusts, or estates.
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In addition, if an affiliated group elects to apply the new
elective rules based on worldwide fungibility, the rules
regarding the treatment of tax-exempt assets and the basis of
stock in nonaffiliated 10-percent owned corporations apply on a
worldwide affiliated group basis.
The common parent of the domestic affiliated group must
make the worldwide affiliated group election. It must be made
for the first taxable year beginning after December 31, 2008 in
which a worldwide affiliated group exists that includes at
least one foreign corporation that meets the requirements for
inclusion in a worldwide affiliated group. Once made, the
election applies to the common parent and all other members of
the worldwide affiliated group for the taxable year for which
the election was made and all subsequent taxable years, unless
revoked with the consent of the Secretary of the Treasury.
Financial institution group election
The Act allows taxpayers to apply the bank group rules to
exclude certain financial institutions from the affiliated
group for interest allocation purposes under the worldwide
fungibility approach. The Act also provides a one-time
``financial institution group'' election that expands the
prior-law bank group. Under the Act, at the election of the
common parent of the pre-election worldwide affiliated group,
the interest expense allocation rules are applied separately to
a subgroup of the worldwide affiliated group that consists of:
(1) all corporations that are part of the prior-law bank group,
and (2) all ``financial corporations.'' For this purpose, a
corporation is a financial corporation if at least 80 percent
of its gross income is financial services income (as described
in section 904(d)(2)(C)(i) and the regulations thereunder) that
is derived from transactions with unrelated persons.\474\ For
these purposes, items of income or gain from a transaction or
series of transactions are disregarded if a principal purpose
for the transaction or transactions is to qualify any
corporation as a financial corporation.
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\474\ See Treas. Reg. sec. 1.904-4(e)(2).
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The common parent of the pre-election worldwide affiliated
group must make the election for the first taxable year
beginning after December 31, 2008 in which a worldwide
affiliated group includes a financial corporation. Once made,
the election applies to the financial institution group for the
taxable year and all subsequent taxable years. In addition, the
Act provides anti-abuse rules under which certain transfers
from one member of a financial institution group to a member of
the worldwide affiliated group outside of the financial
institution group are treated as reducing the amount of
indebtedness of the separate financial institution group. The
Act provides regulatory authority with respect to the election
to provide for the direct allocation of interest expense in
circumstances in which such allocation is appropriate to carry
out the purposes of the provision, prevent assets or interest
expense from being taken into account more than once, or
address changes in members of any group (through acquisitions
or otherwise) treated as affiliated under this provision.
Effective Date
The provision is effective for taxable years beginning
after December 31, 2008.
B. Recharacterize Overall Domestic Loss (sec. 402 of the Act and sec.
904 of the Code)
Present and Prior Law
The United States provides a credit for foreign income
taxes paid or accrued. The foreign tax credit generally is
limited to the U.S. tax liability on a taxpayer's foreign-
source income, in order to ensure that the credit serves the
purpose of mitigating double taxation of foreign-source income
without offsetting the U.S. tax on U.S.-source income. This
overall limitation is calculated by prorating a taxpayer's pre-
credit U.S. tax on its worldwide income between its U.S.-source
and foreign-source taxable income. The ratio (not exceeding 100
percent) of the taxpayer's foreign-source taxable income to
worldwide taxable income is multiplied by its pre-credit U.S.
tax to establish the amount of U.S. tax allocable to the
taxpayer's foreign-source income and, thus, the upper limit on
the foreign tax credit for the year.
In addition, this limitation is calculated separately for
various categories of income, generally referred to as
``separate limitation categories.'' The total amount of the
foreign tax credit used to offset the U.S. tax on income in
each separate limitation category may not exceed the proportion
of the taxpayer's U.S. tax which the taxpayer's foreign-source
taxable income in that category bears to its worldwide taxable
income.
If a taxpayer's losses from foreign sources exceed its
foreign-source income, the excess (``overall foreign loss,'' or
``OFL'') may offset U.S.-source income. Such an offset reduces
the effective rate of U.S. tax on U.S.-source income.
In order to eliminate a double benefit (that is, the
reduction of U.S. tax previously noted and, later, full
allowance of a foreign tax credit with respect to foreign-
source income), present and prior law includes an OFL recapture
rule. Under this rule, a portion of foreign-source taxable
income earned after an OFL year is recharacterized as U.S.-
source taxable income for foreign tax credit purposes (and for
purposes of the possessions tax credit). Unless a taxpayer
elects a higher percentage, however, generally no more than 50
percent of the foreign-source taxable income earned in any
particular taxable year is recharacterized as U.S.-source
taxable income. The effect of the recapture is to reduce the
foreign tax credit limitation in one or more years following an
OFL year and, therefore, the amount of U.S. tax that can be
offset by foreign tax credits in the later year or years.
Losses for any taxable year in separate foreign limitation
categories (to the extent that they do not exceed foreign
income for the year) are apportioned on a proportionate basis
among (and operate to reduce) the foreign income categories in
which the entity earns income in the loss year. A separate
limitation loss recharacterization rule applies to foreign
losses apportioned to foreign income pursuant to the above
rule. If a separate limitation loss was apportioned to income
subject to another separate limitation category and the loss
category has income for a subsequent taxable year, then that
income (to the extent that it does not exceed the aggregate
separate limitation losses in the loss category not previously
recharacterized) must be recharacterized as income in the
separate limitation category that was previously offset by the
loss. Such recharacterization must be made in proportion to the
prior loss apportionment not previously taken into account.
A U.S.-source loss reduces pre-credit U.S. tax on worldwide
income to an amount less than the hypothetical tax that would
apply to the taxpayer's foreign-source income if viewed in
isolation. The existence of foreign-source taxable income in
the year of the U.S.-source loss reduces or eliminates any net
operating loss carryover that the U.S.-source loss would
otherwise have generated absent the foreign income. In
addition, as the pre-credit U.S. tax on worldwide income is
reduced, so is the foreign tax credit limitation. Moreover, any
U.S.-source loss for any taxable year is apportioned among (and
operates to reduce) foreign income in the separate limitation
categories on a proportionate basis. As a result, some foreign
tax credits in the year of the U.S.-source loss must be
credited, if at all, in a carryover year. Tax on U.S.-source
taxable income in a subsequent year may be offset by a net
operating loss carryforward, but not by a foreign tax credit
carryforward. Prior law provided no mechanism for
recharacterizing such subsequent U.S.-source income as foreign-
source income.
For example, suppose a taxpayer generates a $100 U.S.-
source loss and earns $100 of foreign-source income in Year 1,
and pays $30 of foreign tax on the $100 of foreign-source
income. Because the taxpayer has no net taxable income in Year
1, no foreign tax credit can be claimed in Year 1 with respect
to the $30 of foreign taxes. If the taxpayer then earns $100 of
U.S.-source income and $100 of foreign-source income in Year 2,
prior law did not recharacterize any portion of the $100 of
U.S.-source income as foreign-source income to reflect the fact
that the previous year's $100 U.S.-source loss reduced the
taxpayer's ability to claim foreign tax credits.
Reasons for Change
The Congress believed that the overall foreign loss rules
continue to represent sound tax policy, but that concerns of
parity dictate that overall domestic loss rules be provided to
address situations in which a domestic loss may restrict a
taxpayer's ability to claim foreign tax credits. The Congress
believed that it was important to create this parity in order
to prevent the double taxation of income. The Congress believed
that preventing double taxation would make U.S. businesses more
competitive and lead to increased export sales. The Congress
believed that this increase in export sales would increase
production in the United States and increase jobs in the United
States to support the increased exports.
Explanation of Provision
The Act applies a re-sourcing rule to U.S.-source income in
cases in which a taxpayer's foreign tax credit limitation has
been reduced as a result of an overall domestic loss. Under the
Act, a portion of the taxpayer's U.S.-source income for each
succeeding taxable year is recharacterized as foreign-source
income in an amount equal to the lesser of: (1) the amount of
the unrecharacterized overall domestic losses for years prior
to such succeeding taxable year, and (2) 50 percent of the
taxpayer's U.S.-source income for such succeeding taxable year.
The Act defines an overall domestic loss for this purpose
as any domestic loss to the extent it offsets foreign-source
taxable income for the current taxable year or for any
preceding taxable year by reason of a loss carryback. For this
purpose, a domestic loss means the amount by which the U.S.-
source gross income for the taxable year is exceeded by the sum
of the deductions properly apportioned or allocated thereto,
determined without regard to any loss carried back from a
subsequent taxable year. Under the Act, an overall domestic
loss does not include any loss for any taxable year unless the
taxpayer elected the use of the foreign tax credit for such
taxable year.
Any U.S.-source income recharacterized under the Act is
allocated among and increases the various foreign tax credit
separate limitation categories in the same proportion that
those categories were reduced by the prior overall domestic
losses, in a manner similar to the recharacterization rules for
separate limitation losses.
It is anticipated that situations may arise in which a
taxpayer generates an overall domestic loss in a year following
a year in which it had an overall foreign loss, or vice versa.
In such a case, it would be necessary for ordering and other
coordination rules to be developed for purposes of computing
the foreign tax credit limitation in subsequent taxable years.
The Act grants the Treasury Secretary authority to prescribe
such regulations as may be necessary to coordinate the
operation of the OFL recapture rules with the operation of the
overall domestic loss recapture rules added by the Act.
Effective Date
The provision applies to losses incurred in taxable years
beginning after December 31, 2006.
C. Apply Look-Through Rules for Dividends from Noncontrolled Section
902 Corporations (sec. 403 of the Act and sec. 904 of the Code)
Present and Prior Law
U.S. persons may credit foreign taxes against U.S. tax on
foreign-source income. In general, the amount of foreign tax
credits that may be claimed in a year is subject to a
limitation that prevents taxpayers from using foreign tax
credits to offset U.S. tax on U.S.-source income. Separate
limitations are also applied to specific categories of income.
Prior law applied special foreign tax credit limitations in
the case of dividends received from a foreign corporation in
which the taxpayer owned at least 10 percent of the stock by
vote and which was not a controlled foreign corporation (a so-
called ``10/50 company''). Dividends paid by a 10/50 company
that was not a passive foreign investment company out of
earnings and profits accumulated in taxable years beginning
before January 1, 2003 were subject to a single foreign tax
credit limitation for all 10/50 companies (other than passive
foreign investment companies).\475\ Dividends paid by a 10/50
company that was a passive foreign investment company out of
earnings and profits accumulated in taxable years beginning
before January 1, 2003 continued to be subject to a separate
foreign tax credit limitation for each such 10/50 company.
Dividends paid by a 10/50 company out of earnings and profits
accumulated in taxable years after December 31, 2002 were
treated as income in a foreign tax credit limitation category
in proportion to the ratio of the 10/50 company's earnings and
profits attributable to income in such foreign tax credit
limitation category to its total earnings and profits (a
``look-through'' approach).
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\475\ Dividends paid by a 10/50 company in taxable years beginning
before January 1, 2003 were subject to a separate foreign tax credit
limitation for each 10/50 company.
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For these purposes, distributions were treated as made from
the most recently accumulated earnings and profits. Regulatory
authority was granted to provide rules regarding the treatment
of distributions out of earnings and profits for periods prior
to the taxpayer's acquisition of such stock.
Reasons for Change
The Congress believed that significant simplification could
be achieved by eliminating the requirement that taxpayers
segregate the earnings and profits of 10/50 companies on the
basis of when such earnings and profits arose.
Explanation of Provision
The Act generally applies the look-through approach to
dividends paid by a 10/50 company regardless of the year in
which the earnings and profits out of which the dividend is
paid were accumulated.\476\ If the Treasury Secretary
determines that a taxpayer has inadequately substantiated that
it assigned a dividend from a 10/50 company to the proper
foreign tax credit limitation category, the dividend is treated
as passive category income for foreign tax credit basketing
purposes.\477\
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\476\ This look-through treatment also applies to dividends that a
controlled foreign corporation receives from a 10/50 company and then
distributes to a U.S. shareholder.
\477\ It is anticipated that the Treasury Secretary will reconsider
the operation of the foreign tax credit regulations to ensure that the
high-tax income rules apply appropriately to dividends treated as
passive category income because of inadequate substantiation.
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Effective Date
The provision is effective for taxable years beginning
after December 31, 2002. The provision also provides transition
rules regarding the use of pre-effective-date foreign tax
credits associated with a 10/50-company separate limitation
category in post-effective-date years. Look-through principles
similar to those applicable to post-effective-date dividends
from a 10/50 company apply to determine the appropriate foreign
tax credit limitation category or categories with respect to
carrying forward foreign tax credits into future years. The
provision allows the Treasury Secretary to issue regulations
addressing the carryback of foreign tax credits associated with
a dividend from a 10/50 company to pre-effective-date years.
D. Foreign Tax Credit Baskets and ``Base Differences'' (sec. 404 of the
Act and sec. 904 of the Code)
Present and Prior Law
In general
The United States taxes its citizens and residents on their
worldwide income. Because the countries in which income is
earned also may assert their jurisdiction to tax the same
income on the basis of source, foreign-source income earned by
U.S. persons may be subject to double taxation. In order to
mitigate this possibility, the United States provides a credit
against U.S. tax liability for foreign income taxes paid,
subject to a number of limitations. The foreign tax credit
generally is limited to the U.S. tax liability on a taxpayer's
foreign-source income, in order to ensure that the credit
serves its purpose of mitigating double taxation of cross-
border income without offsetting the U.S. tax on U.S.-source
income.
Under prior law, the foreign tax credit limitation was
applied separately to the following categories of income: (1)
passive income; (2) high withholding tax interest; (3)
financial services income; (4) shipping income; (5) certain
dividends received from noncontrolled section 902 foreign
corporations (``10/50 companies'');\478\ (6) certain dividends
from a domestic international sales corporation or former
domestic international sales corporation; (7) taxable income
attributable to certain foreign trade income; (8) certain
distributions from a foreign sales corporation or former
foreign sales corporation; and (9) any other income not
described in items (1) through (8) (so-called ``general
basket'' income). In addition, a number of other provisions of
the Code and U.S. tax treaties effectively create additional
separate limitations in certain circumstances.\479\
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\478\ Under prior law, subject to certain exceptions, dividends
paid by a 10/50 company in taxable years beginning after December 31,
2002 were subject to either a look-through approach in which the
dividend was attributed to a particular limitation category based on
the underlying earnings which gave rise to the dividend (for post-2002
earnings and profits), or a single-basket limitation approach for
dividends from all 10/50 companies that were not passive foreign
investment companies (for pre-2003 earnings and profits). Under the
Act, these dividends are subject to a look-through approach,
irrespective of when the underlying earnings and profits arose.
\479\ See, e.g., sec. 56(g)(4)(C)(iii)(IV) (relating to certain
dividends from corporations eligible for the sec. 936 credit); sec.
245(a)(10) (relating to certain dividends treated as foreign source
under treaties); sec. 865(h)(1)(B) (relating to certain gains from
stock and intangibles treated as foreign source under treaties); sec.
901(j)(1)(B) (relating to income from certain specified countries); and
sec. 904(g)(10)(A) (relating to interest, dividends, and certain other
amounts derived from U.S.-owned foreign corporations and treated as
foreign source under treaties).
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Financial services income
In general, the term ``financial services income'' includes
income received or accrued by a person predominantly engaged in
the active conduct of a banking, insurance, financing, or
similar business, if the income is derived in the active
conduct of a banking, financing or similar business, or is
derived from the investment by an insurance company of its
unearned premiums or reserves ordinary and necessary for the
proper conduct of its insurance business (sec. 904(d)(2)(C)).
The Code also provides that financial services income includes
income, received or accrued by a person predominantly engaged
in the active conduct of a banking, insurance, financing, or
similar business, of a kind which would generally be insurance
income (as defined in section 953(a)), among other items.
Treasury regulations provide that a person is predominantly
engaged in the active conduct of a banking, insurance,
financing, or similar business for any year if for that year at
least 80 percent of its gross income is ``active financing
income.'' \480\ The regulations further provide that a
corporation that is not predominantly engaged in the active
conduct of a banking, insurance, financing, or similar business
under the preceding definition can derive financial services
income if the corporation is a member of an affiliated group
(as defined in section 1504(a), but expanded to include foreign
corporations) that, as a whole, meets the regulatory test of
being ``predominantly engaged.'' \481\ In determining whether
an affiliated group is ``predominantly engaged,'' only the
income of members of the group that are U.S. corporations, or
controlled foreign corporations in which such U.S. corporations
own (directly or indirectly) at least 80 percent of the total
voting power and value of the stock, are counted.
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\480\ Treas. Reg. sec. 1.904-4(e)(3)(i) and (2)(i).
\481\ Treas. Reg. sec. 1.904-4(e)(3)(ii).
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``Base difference'' items
Under Treasury regulations, foreign taxes are allocated and
apportioned to the same limitation categories as the income to
which they relate.\482\ In cases in which foreign law imposes
tax on an item of income that does not constitute income under
U.S. tax principles (a ``base difference'' item), these
regulations treat the tax as being imposed on income in the
general limitation category.\483\
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\482\ Treas. Reg. sec. 1.904-6.
\483\ Treas. Reg. sec. 1.904-6(a)(1)(iv).
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Reasons for Change
The Congress believed that requiring taxpayers to separate
income and tax credits into nine separate tax baskets created
some of the most complex tax reporting and compliance issues in
the Code. The Congress believed that reducing the number of
foreign tax credit baskets to two would greatly simplify the
Code and undo much of the complexity created by the Tax Reform
Act of 1986. The Congress believed that simplifying these rules
would reduce double taxation, make U.S. businesses more
competitive, and create jobs in the United States.
Explanation of Provision
In general
The Act generally reduces the number of foreign tax credit
limitation categories to two: passive category income and
general category income. Other income is included in one of the
two categories, as appropriate. For example, shipping income
generally falls into the general limitation category, whereas
high withholding tax interest generally could fall into the
passive income or the general limitation category, depending on
the circumstances. Dividends from a domestic international
sales corporation or former domestic international sales
corporation, income attributable to certain foreign trade
income, and certain distributions from a foreign sales
corporation or former foreign sales corporation all are
assigned to the passive income limitation category. The Act
does not affect the separate computation of foreign tax credit
limitations under special provisions of the Code relating to,
for example, treaty-based sourcing rules or specified countries
under section 901(j).
Financial services income
In the case of a member of a financial services group or
any other person predominantly engaged in the active conduct of
a banking, insurance, financing or similar business, the Act
treats income meeting the definition of financial services
income as general category income. Under the Act, a financial
services group is an affiliated group that is predominantly
engaged in the active conduct of a banking, insurance,
financing or similar business. For this purpose, the definition
of an affiliated group under section 1504(a) is applied, but
expanded to include certain insurance companies (without regard
to whether such companies are covered by an election under
section 1504(c)(2)) and foreign corporations. In determining
whether such a group is predominantly engaged in the active
conduct of a banking, insurance, financing, or similar
business, only the income of members of the group that are U.S.
corporations or controlled foreign corporations in which such
U.S. corporations own (directly or indirectly) at least 80
percent of total voting power and value of the stock are taken
into account.
The Act does not alter the existing interpretation of what
it means to be a ``person predominantly engaged in the active
conduct of a banking, insurance, financing, or similar
business.'' \484\ Thus, other provisions of the Code that rely
on this same concept of a ``person predominantly engaged in the
active conduct of a banking, insurance, financing, or similar
business'' are not affected by the provision. For example,
under the ``accumulated deficit rule'' of section 952(c)(1)(B),
subpart F income inclusions of a U.S. shareholder attributable
to a ``qualified activity'' of a controlled foreign corporation
may be reduced by the amount of the U.S. shareholder's pro rata
share of certain prior year deficits attributable to the same
qualified activity. In the case of a qualified financial
institution, qualified activity consists of any activity giving
rise to foreign personal holding company income, but only if
the controlled foreign corporation was predominantly engaged in
the active conduct of a banking, financing, or similar business
in both the year in which the corporation earned the income and
the year in which the corporation incurred the deficit.
Similarly, in the case of a qualified insurance company,
qualified activity consists of activity giving rise to
insurance income or foreign personal holding company income,
but only if the controlled foreign corporation was
predominantly engaged in the active conduct of an insurance
business in both the year in which the corporation earned the
income and the year in which the corporation incurred the
deficit. For this purpose, ``predominantly engaged in the
active conduct of a banking, insurance, financing, or similar
business'' is defined under present law by reference to the use
of the term for purposes of the separate foreign tax credit
limitations.\485\ The existing meaning of ``predominantly
engaged'' for purposes of section 952(c)(1)(B) remains
unchanged under the provision.
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\484\ See Treas. Reg. sec. 1.904-4(e).
\485\ See H.R. Rep. No. 99-841, 99th Cong., 2d Sess. II-621 (1986);
Staff of the Joint Committee on Taxation, 100th Cong., 1st Sess.,
General Explanation of the Tax Reform Act of 1986, at 984 (1987).
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The Act requires the Treasury Secretary to specify the
treatment of financial services income received or accrued by
pass-through entities that are not members of a financial
services group. It is expected that these regulations will be
generally consistent with regulations currently in effect.
``Base difference'' items
Creditable foreign taxes that are imposed on amounts that
do not constitute income under U.S. tax principles are treated
as imposed on general limitation income.
Effective Date
The provision is effective for taxable years beginning
after December 31, 2006. Taxes paid or accrued in a taxable
year beginning before January 1, 2007, and carried to any
subsequent taxable year are treated as if this provision were
in effect on the date such taxes were paid or accrued. Thus,
such taxes are assigned to one of the two foreign tax credit
limitation categories, as appropriate. The Treasury Secretary
is given authority to provide by regulations for the allocation
of income with respect to taxes carried back to pre-effective-
date years (in which more than two limitation categories are in
effect).
Creditable foreign taxes that are imposed on amounts that
do not constitute income under U.S. tax principles are treated
as imposed on general limitation income, as of the general
effective date of the provision. Any such taxes arising in
taxable years beginning after December 31, 2004, but before
January 1, 2007 (when the number of limitation categories is
reduced to two), are treated as imposed on either general
limitation income or financial services income, at the
taxpayer's election. Once made, this election applies to all
such taxes for the taxable years described above and is
revocable only with the consent of the Treasury Secretary.
E. Attribution of Stock Ownership Through Partnerships in Determining
Section 902 and 960 Credits (sec. 405 of the Act and sec. 902 of the
Code)
Present and Prior Law
Under section 902, a domestic corporation that receives a
dividend from a foreign corporation in which it owns 10 percent
or more of the voting stock is deemed to have paid a portion of
the foreign taxes paid by such foreign corporation. Thus, such
a domestic corporation is eligible to claim a foreign tax
credit with respect to such deemed-paid taxes. The domestic
corporation that receives a dividend is deemed to have paid a
portion of the foreign corporation's post-1986 foreign income
taxes based on the ratio of the amount of the dividend to the
foreign corporation's post-1986 undistributed earnings and
profits.
Foreign income taxes paid or accrued by lower-tier foreign
corporations also are eligible for the deemed-paid credit if
the foreign corporation falls within a qualified group (sec.
902(b)). A ``qualified group'' includes certain foreign
corporations within the first six tiers of a chain of foreign
corporations if, among other things, the product of the
percentage ownership of voting stock at each level of the chain
(beginning from the domestic corporation) equals at least five
percent. In addition, in order to claim indirect credits for
foreign taxes paid by certain fourth-, fifth-, and sixth-tier
corporations, such corporations must be controlled foreign
corporations (within the meaning of sec. 957) and the
shareholder claiming the indirect credit must be a U.S.
shareholder (as defined in sec. 951(b)) with respect to the
controlled foreign corporations. The application of the
indirect foreign tax credit below the third tier is limited to
taxes paid in taxable years during which the payor is a
controlled foreign corporation. Foreign taxes paid below the
sixth tier of foreign corporations are ineligible for the
indirect foreign tax credit.
Section 960 similarly permits a domestic corporation with
subpart F inclusions from a controlled foreign corporation to
claim deemed-paid foreign tax credits with respect to foreign
taxes paid or accrued by the controlled foreign corporation on
its subpart F income.
The foreign tax credit provisions in the Code under prior
law did not specifically address whether a domestic corporation
owning 10 percent or more of the voting stock of a foreign
corporation through a partnership is entitled to a deemed-paid
foreign tax credit.\486\ In Rev. Rul. 71-141,\487\ the IRS held
that a foreign corporation's stock held indirectly by two
domestic corporations through their interests in a domestic
general partnership is attributed to such domestic corporations
for purposes of determining the domestic corporations'
eligibility to claim a deemed-paid foreign tax credit with
respect to the foreign taxes paid by such foreign corporation.
Accordingly, a general partner of a domestic general
partnership is permitted to claim deemed-paid foreign tax
credits with respect to a dividend distribution from the
foreign corporation to the partnership.
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\486\ Under section 901(b)(5), an individual member of a
partnership or a beneficiary of an estate or trust generally may claim
a direct foreign tax credit with respect to the amount of his or her
proportionate share of the foreign taxes paid or accrued by the
partnership, estate, or trust. This rule does not specifically apply to
corporations that are either members of a partnership or beneficiaries
of an estate or trust. However, section 702(a)(6) provides that each
partner (including individuals or corporations) of a partnership must
take into account separately its distributive share of the
partnership's foreign taxes paid or accrued. In addition, under section
703(b)(3), the election under section 901 (whether to credit the
foreign taxes) is made by each partner separately.
\487\ 1971-1 C.B. 211.
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However, in 1997, the Treasury Department issued final
regulations under section 902, and the preamble to the
regulations states that ``[t]he final regulations do not
resolve under what circumstances a domestic corporate partner
may compute an amount of foreign taxes deemed paid with respect
to dividends received from a foreign corporation by a
partnership or other pass-through entity.'' \488\ In
recognition of the holding in Rev. Rul. 71-141, the preamble to
the final regulations under section 902 states that a
``domestic shareholder'' for purposes of section 902 is a
domestic corporation that ``owns'' the requisite voting stock
in a foreign corporation rather than one that ``owns directly''
the voting stock. At the same time, the preamble states that
the IRS is still considering under what other circumstances
Rev. Rul. 71-141 should apply. Consequently, uncertainty
remained regarding whether a domestic corporation owning 10
percent or more of the voting stock of a foreign corporation
through a partnership was entitled to a deemed-paid foreign tax
credit (other than through a domestic general partnership).
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\488\ T.D. 8708, 1997-1 C.B. 137.
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Reasons for Change
The Congress believed that a clarification was appropriate
regarding the ability of a domestic corporation owning ten
percent or more of the voting stock of a foreign corporation
through a partnership to claim a deemed-paid foreign tax
credit.
Explanation of Provision
The Act clarifies that a domestic corporation is entitled
to claim deemed-paid foreign tax credits with respect to a
foreign corporation that is held indirectly through a foreign
or domestic partnership, provided that the domestic corporation
owns (indirectly through the partnership) 10 percent or more of
the foreign corporation's voting stock. No inference is
intended as to the treatment of such deemed-paid foreign tax
credits under prior law. The Act also clarifies that both
individual and corporate partners (or estate or trust
beneficiaries) may claim direct foreign tax credits with
respect to their proportionate shares of taxes paid or accrued
by a partnership (or estate or trust).
Effective Date
The provision applies to taxes of foreign corporations for
taxable years of such corporations beginning after the date of
enactment (October 22, 2004).
F. Foreign Tax Credit Treatment of Deemed Payments Under Section 367(d)
of the Code (sec. 406 of the Act and sec. 367(d) of the Code)
Present and Prior Law
In the case of transfers of intangible property to foreign
corporations by means of contributions and certain other
nonrecognition transactions, special rules apply that are
designed to mitigate the tax avoidance that may arise from
shifting the income attributable to intangible property
offshore. Under section 367(d), the outbound transfer of
intangible property is treated as a sale of the intangible for
a stream of contingent payments. The amounts of these deemed
payments must be commensurate with the income attributable to
the intangible. The deemed payments are included in gross
income of the U.S. transferor as ordinary income, and the
earnings and profits of the foreign corporation to which the
intangible was transferred are reduced by such amounts.
The Taxpayer Relief Act of 1997 (the ``1997 Act'') repealed
a rule that treated all such deemed payments as giving rise to
U.S.-source income. Because the foreign tax credit is generally
limited to the U.S. tax imposed on foreign-source income, the
pre-1997 Act rule reduced the taxpayer's ability to claim
foreign tax credits. As a result of the repeal of the rule, the
source of payments deemed received under section 367(d) is
determined under general sourcing rules. These rules treat
income from sales of intangible property for contingent
payments the same as royalties, with the result that the deemed
payments may give rise to foreign-source income.\489\
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\489\ Secs. 865(d) and 862(a).
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The 1997 Act did not address the characterization of the
deemed payments for purposes of applying the foreign tax credit
separate limitation categories.\490\ If the deemed payments
were treated like proceeds of a sale, then they could fall into
the passive category; if the deemed payments were treated like
royalties, then in many cases they could fall into the general
category (under look-through rules applicable to payments of
dividends, interest, rents, and royalties received from
controlled foreign corporations).\491\
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\490\ Sec. 904(d).
\491\ Sec. 904(d)(3).
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Reasons for Change
The Congress believed that it is appropriate to
characterize deemed payments under section 367(d) as royalties
for purposes of applying the separate limitation categories of
the foreign tax credit, and that this treatment should be
effective for all transactions subject to the underlying
provision of the 1997 Act.
Explanation of Provision
The Act specifies that deemed payments under section 367(d)
are treated as royalties for purposes of applying the separate
limitation categories of the foreign tax credit.
Effective Date
The provision is effective for amounts treated as received
on or after August 5, 1997 (the effective date of the relevant
provision of the 1997 Act).
G. United States Property Not to Include Certain Assets of Controlled
Foreign Corporations (sec. 407 of the Act and sec. 956 of the Code)
Present and Prior Law
In general, the subpart F rules \492\ require U.S.
shareholders with a 10-percent or greater interest in a
controlled foreign corporation (``U.S. 10-percent
shareholders'') to include in taxable income their pro rata
shares of certain income of the controlled foreign corporation
(referred to as ``subpart F income'') when such income is
earned, whether or not the earnings are distributed currently
to the shareholders. In addition, the U.S. 10-percent
shareholders of a controlled foreign corporation are subject to
U.S. tax on their pro rata shares of the controlled foreign
corporation's earnings to the extent invested by the controlled
foreign corporation in certain U.S. property in a taxable
year.\493\
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\492\ Secs. 951-964.
\493\ Sec. 951(a)(1)(B).
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A shareholder's income inclusion with respect to a
controlled foreign corporation's investment in U.S. property
for a taxable year is based on the controlled foreign
corporation's average investment in U.S. property for such
year. For this purpose, the U.S. property held (directly or
indirectly) by the controlled foreign corporation must be
measured as of the close of each quarter in the taxable
year.\494\ The amount taken into account with respect to any
property is the property's adjusted basis as determined for
purposes of reporting the controlled foreign corporation's
earnings and profits, reduced by any liability to which the
property is subject. The amount determined for inclusion in
each taxable year is the shareholder's pro rata share of an
amount equal to the lesser of: (1) the controlled foreign
corporation's average investment in U.S. property as of the end
of each quarter of such taxable year, to the extent that such
investment exceeds the foreign corporation's earnings and
profits that were previously taxed on that basis; or (2) the
controlled foreign corporation's current or accumulated
earnings and profits (but not including a deficit), reduced by
distributions during the year and by earnings that have been
taxed previously as earnings invested in U.S. property.\495\ An
income inclusion is required only to the extent that the amount
so calculated exceeds the amount of the controlled foreign
corporation's earnings that have been previously taxed as
subpart F income.\496\
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\494\ Sec. 956(a).
\495\ Secs. 956 and 959.
\496\ Secs. 951(a)(1)(B) and 959.
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For purposes of section 956, U.S. property generally is
defined to include tangible property located in the United
States, stock of a U.S. corporation, an obligation of a U.S.
person, and certain intangible assets including a patent or
copyright, an invention, model or design, a secret formula or
process or similar property right which is acquired or
developed by the controlled foreign corporation for use in the
United States.\497\
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\497\ Sec. 956(c)(1).
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Specified exceptions from the definition of U.S. property
are provided for: (1) obligations of the United States, money,
or deposits with certain financial institutions (as amended by
section 837 of the Act); (2) certain export property; (3)
certain trade or business obligations; (4) aircraft, railroad
rolling stock, vessels, motor vehicles or containers used in
transportation in foreign commerce and used predominantly
outside of the United States; (5) certain insurance company
reserves and unearned premiums related to insurance of foreign
risks; (6) stock or debt of certain unrelated U.S.
corporations; (7) moveable property (other than a vessel or
aircraft) used for the purpose of exploring, developing, or
certain other activities in connection with the ocean waters of
the U.S. Continental Shelf; (8) an amount of assets equal to
the controlled foreign corporation's accumulated earnings and
profits attributable to income effectively connected with a
U.S. trade or business; (9) property (to the extent provided in
regulations) held by a foreign sales corporation and related to
its export activities; (10) certain deposits or receipts of
collateral or margin by a securities or commodities dealer, if
such deposit is made or received on commercial terms in the
ordinary course of the dealer's business as a securities or
commodities dealer; and (11) certain repurchase and reverse
repurchase agreement transactions entered into by or with a
dealer in securities or commodities in the ordinary course of
its business as a securities or commodities dealer.\498\
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\498\ Sec. 956(c)(2).
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that the acquisition of securities by
a controlled foreign corporation in the ordinary course of its
business as a securities dealer generally should not give rise
to an income inclusion as an investment in U.S. property under
the provisions of subpart F. Similarly, the Congress believed
that the acquisition by a controlled foreign corporation of
obligations issued by unrelated U.S. noncorporate persons
generally should not give rise to an income inclusion as an
investment in U.S. property.
Explanation of Provision
The Act adds two new exceptions from the definition of U.S.
property for determining current income inclusion by a U.S. 10-
percent shareholder with respect to an investment in U.S.
property by a controlled foreign corporation.
The first exception generally applies to securities
acquired and held by a controlled foreign corporation in the
ordinary course of its trade or business as a dealer in
securities. The exception applies only if the controlled
foreign corporation dealer: (1) accounts for the securities as
securities held primarily for sale to customers in the ordinary
course of business; and (2) disposes of such securities (or
such securities mature while being held by the dealer) within a
period consistent with the holding of securities for sale to
customers in the ordinary course of business.
The second exception generally applies to the acquisition
by a controlled foreign corporation of obligations issued by a
U.S. person that is not a domestic corporation and that is not
(1) a U.S. 10-percent shareholder of the controlled foreign
corporation, or (2) a partnership, estate or trust in which the
controlled foreign corporation or any related person is a
partner, beneficiary or trustee immediately after the
acquisition by the controlled foreign corporation of such
obligation.
Effective Date
The provision is effective for taxable years of foreign
corporations beginning after December 31, 2004, and for taxable
years of United States shareholders with or within which such
taxable years of such foreign corporations end.
H. Election Not to Use Average Exchange Rate for Foreign Tax Paid Other
Than in Functional Currency (sec. 408 of the Act and sec. 986 of the
Code)
Prior Law
For taxpayers that take foreign income taxes into account
when accrued, prior law provided that the amount of the foreign
tax credit generally was determined by translating the amount
of foreign taxes paid in foreign currencies into a U.S. dollar
amount at the average exchange rate for the taxable year to
which such taxes relate.\499\ This rule applied to foreign
taxes paid directly by U.S. taxpayers, which taxes were
creditable in the year paid or accrued, and to foreign taxes
paid by foreign corporations that are deemed paid by a U.S.
corporation that is a shareholder of the foreign corporation,
and hence creditable in the year that the U.S. corporation
receives a dividend or has an income inclusion from the foreign
corporation. This rule did not apply to any foreign income tax:
(1) that was paid after the date that was two years after the
close of the taxable year to which such taxes relate; (2) of an
accrual-basis taxpayer that was actually paid in a taxable year
prior to the year to which the tax relates; or (3) that was
denominated in an inflationary currency (as defined by
regulations).
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\499\ Sec. 986(a)(1).
---------------------------------------------------------------------------
Foreign taxes that were not eligible for translation at the
average exchange rate generally were translated into U.S.
dollar amounts using the exchange rates as of the time such
taxes are paid. However, the Secretary was authorized to issue
regulations that would allow foreign tax payments to be
translated into U.S. dollar amounts using an average exchange
rate for a specified period.\500\
---------------------------------------------------------------------------
\500\ Sec. 986(a)(2).
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that taxpayers generally should be
permitted to elect whether to translate foreign income tax
payments using an average exchange rate for the taxable year or
the exchange rate when the taxes are paid, provided the elected
method does not provide opportunities for abuse and continues
to be applied consistently unless revoked with the consent of
the Treasury Secretary.
Explanation of Provision
For taxpayers that were required under prior law to
translate foreign income tax payments at the average exchange
rate, the Act provides an election to translate such taxes into
U.S. dollar amounts using the exchange rates as of the time
such taxes are paid, provided the foreign income taxes are
denominated in a currency other than the taxpayer's functional
currency.\501\ Any election under the provision applies to the
taxable year for which the election is made and to all
subsequent taxable years unless revoked with the consent of the
Secretary. The Act authorizes the Secretary to issue
regulations that apply the election to foreign income taxes
attributable to a qualified business unit.
---------------------------------------------------------------------------
\501\ Electing taxpayers translate foreign income tax payments
pursuant to the same prior-law rules that applied to taxpayers that
were required to translate foreign income taxes using the exchange
rates as of the time such taxes are paid.
---------------------------------------------------------------------------
The election does not apply to regulated investment
companies that take into account income on an accrual basis.
Instead, the Act provides that foreign income taxes paid or
accrued by a regulated investment company with respect to such
income are translated into U.S. dollar amounts using the
exchange rate as of the date the income accrues.
Effective Date
The provision is effective with respect to taxable years
beginning after December 31, 2004.
I. Eliminate Secondary Withholding Tax with Respect to Dividends Paid
by Certain Foreign Corporations (sec. 409 of the Act and sec. 871 of
the Code)
Present and Prior Law
Nonresident individuals who are not U.S. citizens and
foreign corporations (collectively, foreign persons) are
subject to U.S. tax on income that is effectively connected
with the conduct of a U.S. trade or business; the U.S. tax on
such income is calculated in the same manner and at the same
graduated rates as the tax on U.S. persons (secs. 871(b) and
882). Foreign persons also are subject to a 30-percent gross
basis tax, collected by withholding, on certain U.S.-source
passive income (e.g., interest and dividends) that is not
effectively connected with a U.S. trade or business. This 30-
percent withholding tax may be reduced or eliminated pursuant
to an applicable tax treaty. Foreign persons generally are not
subject to U.S. tax on foreign-source income that is not
effectively connected with a U.S. trade or business.
In general, dividends paid by a domestic corporation are
treated as being from U.S. sources and dividends paid by a
foreign corporation are treated as being from foreign sources.
Thus, dividends paid by foreign corporations to foreign persons
generally are not subject to withholding tax because such
income generally is treated as foreign-source income.
An exception from this general rule applies in the case of
dividends paid by certain foreign corporations. If a foreign
corporation derives 25 percent or more of its gross income as
income effectively connected with a U.S. trade or business for
the three-year period ending with the close of the taxable year
preceding the declaration of a dividend, then a portion of any
dividend paid by the foreign corporation to its shareholders is
treated as U.S.-source income and, in the case of dividends
paid to foreign shareholders, was subject under prior law to
the 30-percent withholding tax (sec. 861(a)(2)(B)). This rule
was sometimes referred to as the ``secondary withholding tax.''
The portion of the dividend treated as U.S.-source income is
equal to the ratio of the gross income of the foreign
corporation that is effectively connected with its U.S. trade
or business over the total gross income of the foreign
corporation during the three-year period ending with the close
of the preceding taxable year. The U.S.-source portion of the
dividend paid by the foreign corporation to its foreign
shareholders was subject to the 30-percent withholding tax.
Under the branch profits tax provisions of present and
prior law, the United States taxes foreign corporations engaged
in a U.S. trade or business on amounts of U.S. earnings and
profits that are shifted out of the U.S. branch of the foreign
corporation. The branch profits tax is comparable to the
second-level taxes imposed on dividends paid by a domestic
corporation to its foreign shareholders. The branch profits tax
is 30 percent of the foreign corporation's ``dividend
equivalent amount,'' which generally is the earnings and
profits of a U.S. branch of a foreign corporation attributable
to its income effectively connected with a U.S. trade or
business (secs. 884(a) and (b)).
Under prior law, if a foreign corporation was subject to
the branch profits tax, then no secondary withholding tax would
be imposed on dividends paid by the foreign corporation to its
shareholders (sec. 884(e)(3)(A)). If a foreign corporation was
a qualified resident of a tax treaty country and claimed an
exemption from the branch profits tax pursuant to the treaty,
the secondary withholding tax could apply with respect to
dividends it paid to its shareholders. Several tax treaties
(including treaties that prevent imposition of the branch
profits tax), however, exempted dividends paid by the foreign
corporation from the secondary withholding tax.
Reasons for Change
The Congress observed that the secondary withholding tax
with respect to dividends paid by certain foreign corporations
was largely superseded by the branch profits tax and applicable
income tax treaties. Accordingly, the Congress believed that
the tax should be repealed in the interest of simplification.
Explanation of Provision
The Act eliminates the secondary withholding tax with
respect to dividends paid by certain foreign corporations.
Effective Date
The provision is effective for payments made after December
31, 2004.
J. Equal Treatment for Interest Paid by Foreign Partnership and Foreign
Corporations (sec. 410 of the Act and sec. 861 of the Code)
Present and Prior Law
In general, interest income from bonds, notes or other
interest-bearing obligations of noncorporate U.S. residents or
domestic corporations is treated as U.S.-source income.\502\
Other interest (e.g., interest on obligations of foreign
corporations and foreign partnerships) generally is treated as
foreign-source income. However, Treasury regulations provide
that a foreign partnership is a U.S. resident for purposes of
this rule if at any time during its taxable year it is engaged
in a trade or business in the United States.\503\ Therefore,
any interest received from such a foreign partnership is U.S.-
source income.
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\502\ Sec. 861(a)(1).
\503\ Treas. Reg. sec. 1.861-2(a)(2).
---------------------------------------------------------------------------
Notwithstanding the general rule described above, in the
case of a foreign corporation engaged in a U.S. trade or
business (or having gross income that is treated as effectively
connected with the conduct of a U.S. trade or business),
interest paid by such U.S. trade or business is treated as if
it were paid by a domestic corporation (i.e., such interest is
treated as U.S.-source income).\504\
---------------------------------------------------------------------------
\504\ Sec. 884(f)(1).
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that the source of interest income
received from a foreign partnership or foreign corporation
should be consistent. The Congress believed that interest
payments from a foreign partnership engaged in a trade or
business in the United States should be sourced in the same
manner as interest payments from a foreign corporation engaged
in a trade or business in the United States.
Explanation of Provision
The Act treats interest paid by foreign partnerships in a
manner similar to the treatment of interest paid by foreign
corporations. Thus, interest paid by a foreign partnership is
treated as U.S.-source income only if the interest is paid by a
U.S. trade or business conducted by the partnership or is
allocable to income that is treated as effectively connected
with the conduct of a U.S. trade or business. The Act applies
only to foreign partnerships that are predominantly engaged in
the active conduct of a trade or business outside the United
States.
Effective Date
The provision is effective for taxable years beginning
after December 31, 2003.
K. Treatment of Certain Dividends of Regulated Investment Companies
(sec. 411 of the Act and secs. 871, 881, 897, and 2105 of the Code)
Present and Prior Law
Regulated investment companies
A regulated investment company (``RIC'') is a domestic
corporation that, at all times during the taxable year, is
registered under the Investment Company Act of 1940 as a
management company or as a unit investment trust, or has
elected to be treated as a business development company under
that Act.\505\
---------------------------------------------------------------------------
\505\Sec. 851(a).
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In addition, to qualify as a RIC, a corporation must elect
such status and must satisfy certain tests.\506\ These tests
include a requirement that the corporation derive at least 90
percent of its gross income from dividends, interest, payments
with respect to certain securities loans, and gains on the sale
or other disposition of stock or securities or foreign
currencies, or other income derived with respect to its
business of investment in such stock, securities, or
currencies.
---------------------------------------------------------------------------
\506\ Sec. 851(b).
---------------------------------------------------------------------------
Generally, a RIC pays no income tax because it is permitted
to deduct dividends paid to its shareholders in computing its
taxable income. The amount of any distribution generally is not
considered as a dividend for purposes of computing the
dividends paid deduction unless the distribution is pro rata,
with no preference to any share of stock as compared with other
shares of the same class.\507\ However, for distributions by
RICs to shareholders who made initial investments of at least
$10,000,000, the distribution is not treated as non-pro rata or
preferential solely by reason of an increase in the
distribution due to reductions in administrative expenses of
the company.
---------------------------------------------------------------------------
\507\ Sec. 562(c).
---------------------------------------------------------------------------
A RIC generally may pass through to its shareholders the
character of its long-term capital gains. It does this by
designating a dividend it pays as a capital gain dividend to
the extent that the RIC has net capital gain (i.e., net long-
term capital gain over net short-term capital loss). These
capital gain dividends are treated as long-term capital gain by
the shareholders. A RIC generally also can pass through to its
shareholders the character of tax-exempt interest from State
and local bonds, but only if, at the close of each quarter of
its taxable year, at least 50 percent of the value of the total
assets of the RIC consists of these obligations. In this case,
the RIC generally may designate a dividend it pays as an
exempt-interest dividend to the extent that the RIC has tax-
exempt interest income. These exempt-interest dividends are
treated as interest excludable from gross income by the
shareholders.
U.S. source investment income of foreign persons
In general
The United States generally imposes a flat 30-percent tax,
collected by withholding, on the gross amount of U.S.-source
investment income payments, such as interest, dividends, rents,
royalties or similar types of income, to nonresident alien
individuals and foreign corporations (``foreign
persons'').\508\ Under treaties, the United States may reduce
or eliminate such taxes. However, even taking into account U.S.
treaties, the tax on a dividend generally is not entirely
eliminated. Instead, U.S.-source portfolio investment dividends
received by foreign persons generally are subject to U.S.
withholding tax at a rate of at least 15 percent.
---------------------------------------------------------------------------
\508\ Secs. 871(a), 881, 1441, and 1442.
---------------------------------------------------------------------------
Interest
Although payments of U.S.-source interest that is not
effectively connected with a U.S. trade or business generally
are subject to the 30-percent withholding tax, there are
exceptions to this rule. For example, interest from certain
deposits with banks and other financial institutions is exempt
from tax.\509\ Original issue discount on obligations maturing
in 183 days or less from the date of original issue (without
regard to the period held by the taxpayer) also is exempt from
tax.\510\ An additional exception is provided for certain
interest paid on portfolio obligations.\511\ ``Portfolio
interest'' generally is defined as any U.S.-source interest
(including original issue discount), not effectively connected
with the conduct of a U.S. trade or business, (i) on an
obligation that satisfies certain registration requirements or
specified exceptions thereto (i.e., the obligation is ``foreign
targeted''), and (ii) that is not received by a 10-percent
shareholder.\512\ With respect to a registered obligation, a
statement that the beneficial owner is not a U.S. person is
required.\513\ This exception is not available for any interest
received either by a bank on a loan extended in the ordinary
course of its business (except in the case of interest paid on
an obligation of the United States), or by a controlled foreign
corporation from a related person.\514\ Moreover, this
exception is not available for certain contingent interest
payments.\515\
---------------------------------------------------------------------------
\509\ Secs. 871(i)(2)(A) and 881(d).
\510\ Sec. 871(g).
\511\ Secs. 871(h) and 881(c).
\512\ Secs. 871(h)(3) and 881(c)(3).
\513\ Secs. 871(h)(2), (5) and 881(c)(2).
\514\ Sec. 881(c)(3).
\515\ Secs. 871(h)(4) and 881(c)(4).
---------------------------------------------------------------------------
Capital gains
Foreign persons generally are not subject to U.S. tax on
gain realized on the disposition of stock or securities issued
by a U.S. person (other than a ``U.S. real property holding
corporation,'' as described below), unless the gain is
effectively connected with the conduct of a trade or business
in the United States. This exemption does not apply, however,
if the foreign person is a nonresident alien individual present
in the United States for a period or periods aggregating 183
days or more during the taxable year.\516\ A RIC may elect not
to withhold on a distribution to a foreign person representing
a capital gain dividend.\517\
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\516\ Sec. 871(a)(2).
\517\ Treas. reg. sec. 1.1441-3(c)(2)(D).
---------------------------------------------------------------------------
Gain or loss of a foreign person from the disposition of a
U.S. real property interest is subject to net basis tax as if
the taxpayer were engaged in a trade or business within the
United States and the gain or loss were effectively connected
with such trade or business.\518\ In addition to an interest in
real property located in the United States or the Virgin
Islands, U.S. real property interests include (among other
things) any interest in a domestic corporation unless the
taxpayer establishes that the corporation was not, during a 5-
year period ending on the date of the disposition of the
interest, a U.S. real property holding corporation (which is
defined generally to mean a corporation the fair market value
of whose U.S. real property interests equals or exceeds 50
percent of the sum of the fair market values of its real
property interests and any other of its assets used or held for
use in a trade or business).
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\518\ Sec. 897.
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Estate taxation
Decedents who were citizens or residents of the United
States are generally subject to Federal estate tax on all
property, wherever situated.\519\ Nonresidents who are not U.S.
citizens, however, are subject to estate tax only on their
property which is within the United States. Property within the
United States generally includes debt obligations of U.S.
persons, including the Federal government and State and local
governments,\520\ but does not include either bank deposits or
portfolio obligations, the interest on which would be exempt
from U.S. income tax under section 871.\521\ Stock owned and
held by a nonresident who is not a U.S. citizen is treated as
property within the United States only if the stock was issued
by a domestic corporation.\522\
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\519\ The Economic Growth and Tax Relief Reconciliation Act of 2001
(``EGTRRA'') repealed the estate tax for estates of decedents dying
after December 31, 2009. However, EGTRRA included a ``sunset''
provision, pursuant to which EGTRRA's provisions (including estate tax
repeal) do not apply to estates of decedents dying after December 31,
2010.
\520\ Sec. 2104(c).
\521\ Sec. 2105(b).
\522\ Sec. 2104(a); Treas. Reg. sec. 20.2104-1(a)(5).
---------------------------------------------------------------------------
Treaties may reduce U.S. taxation on transfers by estates
of nonresident decedents who are not U.S. citizens. Under
recent treaties, for example, U.S. tax may generally be
eliminated except insofar as the property transferred includes
U.S. real property or business property of a U.S. permanent
establishment.
Reasons for Change
Under prior law, a disparity existed between foreign
persons who invest directly in certain interest-bearing and
other securities and foreign persons who invest in such
securities indirectly through U.S. mutual funds. In general,
certain amounts received by the direct foreign investor (or a
foreign investor through a foreign fund) could be exempt from
the U.S. gross-basis withholding tax. In contrast,
distributions from a RIC generally were treated as dividends
subject to the withholding tax, notwithstanding that the
distributions may be attributable to amounts that otherwise
could qualify for an exemption from withholding tax. U.S.
financial institutions often responded to this disparate
treatment by forming ``mirror funds'' outside the United
States. The Congress believed that such disparate treatment
should be eliminated so that U.S. financial institutions will
be encouraged to form and operate their mutual funds within the
United States rather than outside the United States.
Therefore, the Congress believed that, to the extent a RIC
distributes to a foreign person a dividend attributable to
amounts that would have been exempt from U.S. withholding tax
had the foreign person received it directly (such as portfolio
interest and capital gains, including short-term capital
gains), such dividend similarly should be exempt from the U.S.
gross-basis withholding tax. The Congress also believed that
comparable treatment should be afforded for estate tax purposes
to foreign persons who invest in certain assets through a RIC
to the extent that such assets would not be subject to the
estate tax if held directly.
Explanation of Provision
In general
Under the Act, a RIC that earns certain interest income
that would not be subject to U.S. tax if earned by a foreign
person directly may, to the extent of such income, designate a
dividend it pays as derived from such interest income. A
foreign person who is a shareholder in the RIC generally would
treat such a dividend as exempt from gross-basis U.S. tax, as
if the foreign person had earned the interest directly.
Similarly, a RIC that earns an excess of net short-term capital
gains over net long-term capital losses, which excess would not
be subject to U.S. tax if earned by a foreign person, generally
may, to the extent of such excess, designate a dividend it pays
as derived from such excess. A foreign person who is a
shareholder in the RIC generally would treat such a dividend as
exempt from gross-basis U.S. tax, as if the foreign person had
realized the excess directly. The Act also provides that the
estate of a foreign decedent is exempt from U.S. estate tax on
a transfer of stock in the RIC in the proportion that the
assets held by the RIC are debt obligations, deposits, or other
property that would generally be treated as situated outside
the United States if held directly by the estate.
Interest-related dividends
Under the Act, a RIC may, under certain circumstances,
designate all or a portion of a dividend as an ``interest-
related dividend'' by written notice mailed to its shareholders
not later than 60 days after the close of its taxable year. In
addition, an interest-related dividend received by a foreign
person generally is exempt from U.S. gross-basis tax under
sections 871(a), 881, 1441 and 1442.
However, this exemption does not apply to a dividend on
shares of RIC stock if the withholding agent does not receive a
statement, similar to that required under the portfolio
interest rules, that the beneficial owner of the shares is not
a U.S. person. The exemption does not apply to a dividend paid
to any person within a foreign country (or dividends addressed
to, or for the account of, persons within such foreign country)
with respect to which the Treasury Secretary has determined,
under the portfolio interest rules, that exchange of
information is inadequate to prevent evasion of U.S. income tax
by U.S. persons.
In addition, the exemption generally does not apply to
dividends paid to a controlled foreign corporation to the
extent such dividends are attributable to income received by
the RIC on a debt obligation of a person with respect to which
the recipient of the dividend (i.e., the controlled foreign
corporation) is a related person. Nor does the exemption
generally apply to dividends to the extent such dividends are
attributable to income (other than short-term original issue
discount or bank deposit interest) received by the RIC on
indebtedness issued by the RIC-dividend recipient or by any
corporation or partnership with respect to which the recipient
of the RIC dividend is a 10-percent shareholder. However, in
these two circumstances the RIC remains exempt from its
withholding obligation unless the RIC knows that the dividend
recipient is such a controlled foreign corporation or 10-
percent shareholder. To the extent that an interest-related
dividend received by a controlled foreign corporation is
attributable to interest income of the RIC that would be
portfolio interest if received by a foreign corporation, the
dividend is treated as portfolio interest for purposes of the
de minimis rules, the high-tax exception, and the same country
exceptions of subpart F.\523\
---------------------------------------------------------------------------
\523\ See sec. 881(c)(5)(A).
---------------------------------------------------------------------------
The aggregate amount designated as interest-related
dividends for the RIC's taxable year (including dividends so
designated that are paid after the close of the taxable year
but treated as paid during that year as described in section
855) generally is limited to the qualified net interest income
of the RIC for the taxable year. The qualified net interest
income of the RIC equals the excess of: (1) the amount of
qualified interest income of the RIC; over (2) the amount of
expenses of the RIC properly allocable to such interest income.
Qualified interest income of the RIC is equal to the sum of
its U.S.-source income with respect to: (1) bank deposit
interest; (2) short term original issue discount that is
currently exempt from the gross-basis tax under section 871;
(3) any interest (including amounts recognized as ordinary
income in respect of original issue discount, market discount,
or acquisition discount under the provisions of sections 1271-
1288, and such other amounts as regulations may provide) on an
obligation which is in registered form, unless it is earned on
an obligation issued by a corporation or partnership in which
the RIC is a 10-percent shareholder or is contingent interest
not treated as portfolio interest under section 871(h)(4); and
(4) any interest-related dividend from another RIC.
If the amount designated as an interest-related dividend is
greater than the qualified net interest income described above,
the portion of the distribution so designated which constitutes
an interest-related dividend will be only that proportion of
the amount so designated as the amount of the qualified net
interest income bears to the amount so designated.
Short-term capital gain dividends
Under the Act, a RIC also may, under certain circumstances,
designate all or a portion of a dividend as a ``short-term
capital gain dividend,'' by written notice mailed to its
shareholders not later than 60 days after the close of its
taxable year. For purposes of the U.S. gross-basis tax, a
short-term capital gain dividend received by a foreign person
generally is exempt from U.S. gross-basis tax under sections
871(a), 881, 1441 and 1442. This exemption does not apply to
the extent that the foreign person is a nonresident alien
individual present in the United States for a period or periods
aggregating 183 days or more during the taxable year. However,
in this circumstance the RIC remains exempt from its
withholding obligation unless the RIC knows that the dividend
recipient has been present in the United States for such
period.
The aggregate amount qualified to be designated as short-
term capital gain dividends for the RIC's taxable year
(including dividends so designated that are paid after the
close of the taxable year but treated as paid during that year
as described in sec. 855) is equal to the excess of the RIC's
net short-term capital gains over net long-term capital losses.
The short-term capital gain includes short-term capital gain
dividends from another RIC. As provided under present law for
purposes of computing the amount of a capital gain dividend,
the amount is determined (except in the case where an election
under sec. 4982(e)(4) applies) without regard to any net
capital loss or net short-term capital loss attributable to
transactions after October 31 of the year. Instead, that loss
is treated as arising on the first day of the next taxable
year. To the extent provided in regulations, this rule also
applies for purposes of computing the taxable income of the
RIC.
In computing the amount of short-term capital gain
dividends for the year, no reduction is made for the amount of
expenses of the RIC allocable to such net gains. In addition,
if the amount designated as short-term capital gain dividends
is greater than the amount of qualified short-term capital
gain, the portion of the distribution so designated which
constitutes a short-term capital gain dividend is only that
proportion of the amount so designated as the amount of the
excess bears to the amount so designated.
As under present and prior law for distributions from
REITs, the Act provides that any distribution by a RIC to a
foreign person shall, to the extent attributable to gains from
sales or exchanges by the RIC of an asset that is considered a
U.S. real property interest, be treated as gain recognized by
the foreign person from the sale or exchange of a U.S. real
property interest. The Act also extends the special rules for
domestically-controlled REITs to domestically-controlled RICs.
Estate tax treatment
Under the Act, a portion of the stock in a RIC held by the
estate of a nonresident decedent who is not a U.S. citizen is
treated as property outside the United States. The portion so
treated is based upon the proportion of the assets held by the
RIC at the end of the quarter immediately preceding the
decedent's death (or such other time as the Secretary may
designate in regulations) that are ``qualifying assets''.
Qualifying assets for this purpose are bank deposits of the
type that are exempt from gross-basis income tax, portfolio
debt obligations, certain original issue discount obligations,
debt obligations of a domestic corporation that are treated as
giving rise to foreign source income, and other property not
within the United States.
Effective Date
The provision generally applies to dividends with respect
to taxable years of RICs beginning after December 31, 2004, and
before January 1, 2008. With respect to the treatment of a RIC
for estate tax purposes, the provision applies to estates of
decedents dying after December 31, 2004, and before January 1,
2008. With respect to the treatment of RICs under section 897
(relating to U.S. real property interests), the provision is
effective after December 31, 2004, and before January 1, 2008.
L. Look-Through Treatment Under Subpart F for Sales of Partnership
Interests (sec. 412 of the Act and sec. 954 of the Code)
Present and Prior Law
In general, the subpart F rules (secs. 951-964) require
U.S. shareholders with a 10-percent or greater interest in a
controlled foreign corporation to include in income currently
for U.S. tax purposes certain types of income of the controlled
foreign corporation, whether or not such income is actually
distributed currently to the shareholders (referred to as
``subpart F income''). Subpart F income includes foreign
personal holding company income. Foreign personal holding
company income generally consists of the following: (1)
dividends, interest, royalties, rents, and annuities; (2) net
gains from the sale or exchange of (a) property that gives rise
to the preceding types of income, (b) property that does not
give rise to income, and (c) interests in trusts, partnerships,
and real estate mortgages investment conduits (``REMICs''); (3)
net gains from commodities transactions; (4) net gains from
foreign currency transactions; (5) income that is equivalent to
interest; (6) income from notional principal contracts; and (7)
payments in lieu of dividends. Thus, under prior law, if a
controlled foreign corporation sold a partnership interest at a
gain, regardless of the percentage of such interest, the gain
generally constituted foreign personal holding company income
and was included in the income of 10-percent U.S. shareholders
of the controlled foreign corporation as subpart F income.
Reasons for Change
The Congress believed that the sale of a partnership
interest by a controlled foreign corporation that owns a
sufficiently large interest in the partnership should
constitute subpart F income only to the extent that a
proportionate sale of the underlying partnership assets
attributable to the partnership interest would constitute
subpart F income.
Explanation of Provision
The Act treats the sale by a controlled foreign corporation
of a partnership interest as a sale of the proportionate share
of partnership assets attributable to such interest for
purposes of determining subpart F foreign personal holding
company income. This rule applies only to partners owning
directly, indirectly, or constructively at least 25 percent of
a capital or profits interest in the partnership. Thus, the
sale of a partnership interest by a controlled foreign
corporation that meets this ownership threshold constitutes
subpart F income under the Act only to the extent that a
proportionate sale of the underlying partnership assets
attributable to the partnership interest would constitute
subpart F income. The Secretary is directed to prescribe such
regulations as may be appropriate to prevent the abuse of this
provision.
Effective Date
The provision is effective for taxable years of foreign
corporations beginning after December 31, 2004, and taxable
years of U.S. shareholders with or within which such taxable
years of such foreign corporations end.
M. Repeal of Foreign Personal Holding Company Rules and Foreign
Investment Company Rules (sec. 413 of the Act and secs. 542, 551-558,
954, 1246, and 1247 of the Code)
Present and Prior Law
Income earned by a foreign corporation from its foreign
operations generally is subject to U.S. tax only when such
income is distributed to any U.S. persons that hold stock in
such corporation. Accordingly, a U.S. person that conducts
foreign operations through a foreign corporation generally is
subject to U.S. tax on the income from those operations when
the income is repatriated to the United States through a
dividend distribution to the U.S. person. The income is
reported on the U.S. person's tax return for the year the
distribution is received, and the United States imposes tax on
such income at that time. The foreign tax credit may reduce the
U.S. tax imposed on such income.
Several sets of anti-deferral rules impose current U.S. tax
on certain income earned by a U.S. person through a foreign
corporation. Detailed rules for coordination among the anti-
deferral rules are provided to prevent the U.S. person from
being subject to U.S. tax on the same item of income under
multiple rules.
Prior law included the following anti-deferral rules: the
controlled foreign corporation rules of subpart F (secs. 951-
964); the passive foreign investment company rules (secs. 1291-
1298); the foreign personal holding company rules (secs. 551-
558); the personal holding company rules (secs. 541-547); the
accumulated earnings tax rules (secs. 531-537); and the foreign
investment company rules (secs. 1246-1247).
Reasons for Change
The Congress believed that the overlap among the various
anti-deferral regimes resulted in significant complexity,
usually with little or no ultimate tax consequences. These
overlaps required the application of specific rules of priority
for income inclusions among the regimes, as well as additional
coordination provisions pertaining to other operational
differences among the various regimes. The Congress believed
that significant simplification would be achieved by
streamlining these rules.
Explanation of Provision
The Act: (1) eliminates the rules applicable to foreign
personal holding companies and foreign investment companies;
(2) excludes foreign corporations from the application of the
personal holding company rules; and (3) includes as subpart F
foreign personal holding company income personal services
contract income that was subject to the prior-law foreign
personal holding company rules.
Effective Date
The provision is effective for taxable years of foreign
corporations beginning after December 31, 2004, and taxable
years of U.S. shareholders with or within which such taxable
years of foreign corporations end.
N. Determination of Foreign Personal Holding Company Income with
Respect to Transactions in Commodities (sec. 414 of the Act and sec.
954 of the Code)
Present and Prior Law
Subpart F foreign personal holding company income
Under the subpart F rules, U.S. shareholders with a 10-
percent or greater interest in a controlled foreign corporation
(``U.S. 10-percent shareholders'') are subject to U.S. tax
currently on certain income earned by the controlled foreign
corporation, whether or not such income is distributed to the
shareholders. The income subject to current inclusion under the
subpart F rules includes, among other things, ``foreign
personal holding company income.''
Foreign personal holding company income generally consists
of the following: dividends, interest, royalties, rents and
annuities; net gains from sales or exchanges of (1) property
that gives rise to the foregoing types of income, (2) property
that does not give rise to income, and (3) interests in trusts,
partnerships, and real estate mortgage investment conduits
(``REMICs''); net gains from commodities transactions; net
gains from foreign currency transactions; income that is
equivalent to interest; income from notional principal
contracts; and payments in lieu of dividends.
With respect to transactions in commodities, prior law
provided that foreign personal holding company income did not
consist of gains or losses which arise out of bona fide hedging
transactions that are reasonably necessary to the conduct of
any business by a producer, processor, merchant, or handler of
a commodity in the manner in which such business is customarily
and usually conducted by others.\524\ In addition, foreign
personal holding company income did not consist of gains or
losses which are comprised of active business gains or losses
from the sale of commodities, but only if substantially all of
the controlled foreign corporation's business is as an active
producer, processor, merchant, or handler of commodities.\525\
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\524\ For hedging transactions entered into on or after January 31,
2003, Treasury regulations provide that gains or losses from a
commodities hedging transaction generally are excluded from the
definition of foreign personal holding company income if the
transaction is with respect to the controlled foreign corporation's
business as a producer, processor, merchant or handler of commodities,
regardless of whether the transaction is a hedge with respect to a sale
of commodities in the active conduct of a commodities business by the
controlled foreign corporation. The regulations also provide that, for
purposes of satisfying the requirements for exclusion from the
definition of foreign personal holding company income, a producer,
processor, merchant or handler of commodities includes a controlled
foreign corporation that regularly uses commodities in a manufacturing,
construction, utilities, or transportation business (Treas. Reg. sec.
1.954-2(f)(2)(v)). However, the regulations provide that a controlled
foreign corporation is not a producer, processor, merchant or handler
of commodities (and therefore would not satisfy the requirements for
exclusion) if its business is primarily financial (Treas. Reg. sec.
1.954-2(f)(2)(v)).
\525\ Treasury regulations provide that substantially all of a
controlled foreign corporation's business is as an active producer,
processor, merchant or handler of commodities if: (1) the sum of its
gross receipts from all of its active sales of commodities in such
capacity and its gross receipts from all of its commodities hedging
transactions that qualify for exclusion from the definition of foreign
personal holding company income, equals or exceeds (2) 85 percent of
its total receipts for the taxable year (computed as though the
controlled foreign corporation was a domestic corporation). Treas. Reg.
sec. 1.954-2(f)(2)(iii)(C).
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Hedging transactions
Under present law, the term ``capital asset'' does not
include any hedging transaction which is clearly identified as
such before the close of the day on which it was acquired,
originated, or entered into (or such other time as the
Secretary may by regulations prescribe).\526\ The term
``hedging transaction'' means any transaction entered into by
the taxpayer in the normal course of the taxpayer's trade or
business primarily: (1) to manage risk of price changes or
currency fluctuations with respect to ordinary property which
is held or to be held by the taxpayer; (2) to manage risk of
interest rate or price changes or currency fluctuations with
respect to borrowings made or to be made, or ordinary
obligations incurred or to be incurred, by the taxpayer; or (3)
to manage such other risks as the Secretary may prescribe in
regulations.\527\
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\526\ Sec. 1221(a)(7).
\527\ Sec. 1221(b)(2)(A).
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Reasons for Change
The Congress believed that exceptions from subpart F
foreign personal holding company income for commodities hedging
transactions and active business sales of commodities should be
modified to better reflect current active business practices
and, in the case of hedging transactions, to conform to recent
tax law changes concerning hedging transactions generally.
Explanation of Provision
The Act modifies the requirements that must be satisfied
for gains or losses from a commodities hedging transaction to
qualify for exclusion from the definition of subpart F foreign
personal holding company income. Under the Act, gains or losses
from a transaction with respect to a commodity are not treated
as foreign personal holding company income if the transaction
satisfies the general definition of a hedging transaction under
section 1221(b)(2). For purposes of the Act, the general
definition of a hedging transaction under section 1221(b)(2) is
modified to include any transaction with respect to a commodity
entered into by a controlled foreign corporation in the normal
course of the controlled foreign corporation's trade or
business primarily: (1) to manage risk of price changes or
currency fluctuations with respect to ordinary property or
property described in section 1231(b) which is held or to be
held by the controlled foreign corporation; or (2) to manage
such other risks as the Secretary may prescribe in regulations.
Gains or losses from a transaction that satisfies the modified
definition of a hedging transaction are excluded from the
definition of foreign personal holding company income only if
the transaction is clearly identified as a hedging transaction
in accordance with the hedge identification requirements that
apply generally to hedging transactions under section
1221(b)(2).\528\
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\528\ Sec. 1221(a)(7) and (b)(2)(B).
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The Act also changes the requirements that must be
satisfied for active business gains or losses from the sale of
commodities to qualify for exclusion from the definition of
foreign personal holding company income. Under the Act, such
gains or losses are not treated as foreign personal holding
company income if substantially all of the controlled foreign
corporation's commodities are comprised of: (1) stock in trade
of the controlled foreign corporation or other property of a
kind which would properly be included in the inventory of the
controlled foreign corporation if on hand at the close of the
taxable year, or property held by the controlled foreign
corporation primarily for sale to customers in the ordinary
course of the controlled foreign corporation's trade or
business; (2) property that is used in the trade or business of
the controlled foreign corporation and is of a character which
is subject to the allowance for depreciation under section 167;
or (3) supplies of a type regularly used or consumed by the
controlled foreign corporation in the ordinary course of a
trade or business of the controlled foreign corporation.\529\
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\529\ For purposes of determining whether substantially all of the
controlled foreign corporation's commodities are comprised of such
property, it is intended that the 85-percent requirement provided in
the current Treasury regulations (as modified to reflect the changes
made by the provision) continue to apply.
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For purposes of applying the requirements for active
business gains or losses from commodities sales to qualify for
exclusion from the definition of foreign personal holding
company income, the Act also provides that commodities with
respect to which gains or losses are not taken into account as
foreign personal holding company income by a regular dealer in
commodities (or financial instruments referenced to
commodities) are not taken into account in determining whether
substantially all of the dealer's commodities are comprised of
the property described above.
Effective Date
The provision is effective with respect to transactions
entered into after December 31, 2004.
O. Modifications to Treatment of Aircraft Leasing and Shipping Income
(sec. 415 of the Act and sec. 954 of the Code)
Present and Prior Law
In general, the subpart F rules (secs. 951-964) require
U.S. shareholders with a 10-percent or greater interest in a
controlled foreign corporation (``CFC'') to include currently
in income for U.S. tax purposes certain income of the CFC
(referred to as ``subpart F income''), without regard to
whether the income is distributed to the shareholders (sec.
951(a)(1)(A)). In effect, the Code treats the U.S. 10-percent
shareholders of a CFC as having received a current distribution
of their pro rata shares of the CFC's subpart F income. The
amounts included in income by the CFC's U.S. 10-percent
shareholders under these rules are subject to U.S. tax
currently. The U.S. tax on such amounts may be reduced through
foreign tax credits.
Under prior law, subpart F income included foreign base
company shipping income (sec. 954(f)). Foreign base company
shipping income generally included income derived from the use
of an aircraft or vessel in foreign commerce, the performance
of services directly related to the use of any such aircraft or
vessel, the sale or other disposition of any such aircraft or
vessel, and certain space or ocean activities (e.g., leasing of
satellites for use in space). Foreign commerce generally
involves the transportation of property or passengers between a
port (or airport) in the U.S. and a port (or airport) in a
foreign country, two ports (or airports) within the same
foreign country, or two ports (or airports) in different
foreign countries. In addition, foreign base company shipping
income included dividends and interest that a CFC received from
certain foreign corporations and any gains from the disposition
of stock in certain foreign corporations, to the extent the
dividends, interest, or gains were attributable to foreign base
company shipping income. Foreign base company shipping income
also included incidental income derived in the course of active
foreign base company shipping operations (e.g., income from
temporary investments in or sales of related shipping assets),
foreign exchange gain or loss attributable to foreign base
company shipping operations, and a CFC's distributive share of
gross income of any partnership and gross income received from
certain trusts to the extent that the income would have been
foreign base company shipping income had it been realized
directly by the corporation.
Subpart F income also includes foreign personal holding
company income (sec. 954(c)). For subpart F purposes, foreign
personal holding company income generally consists of the
following: (1) dividends, interest, royalties, rents and
annuities; (2) net gains from the sale or exchange of (a)
property that gives rise to the preceding types of income, (b)
property that does not give rise to income, and (c) interests
in trusts, partnerships, and real estate mortgage investment
conduits (``REMICs''); (3) net gains from commodities
transactions; (4) net gains from foreign currency transactions;
(5) income that is equivalent to interest; (6) income from
notional principal contracts; and (7) payments in lieu of
dividends.
Subpart F foreign personal holding company income does not
include rents and royalties received by a CFC in the active
conduct of a trade or business from unrelated persons (sec.
954(c)(2)(A)). The determination of whether rents or royalties
are derived in the active conduct of a trade or business is
based on all the facts and circumstances. However, the Treasury
regulations provide certain types of rents are treated as
derived in the active conduct of a trade or business. These
include rents derived from property that is leased as a result
of the performance of marketing functions by the lessor if the
lessor (through its own officers or employees located in a
foreign country) maintains and operates an organization in such
country that regularly engages in the business of marketing, or
marketing and servicing, the leased property and that is
substantial in relation to the amount of rents derived from the
leasing of such property. An organization in a foreign country
is substantial in relation to rents if the active leasing
expenses \530\ equal at least 25 percent of the adjusted
leasing profit.\531\
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\530\ ``Active-leasing expenses'' are section 162 expenses properly
allocable to rental income other than (1) deductions for compensation
for personal services rendered by the lessor's shareholders or a
related person, (2) deductions for rents, (3) section 167 and 168
expenses, and (4) deductions for payments to independent contractors
with respect to leased property. Treas. Reg. sec. 1.954-2(c)(2)(iii).
\531\ Generally, ``adjusted leasing profit'' is rental income less
the sum of (1) rents paid or incurred by the CFC with respect to such
rental income; (2) section 167 and 168 expenses with respect to such
rental income; and (3) payments to independent contractors with respect
to such rental income. Treas. Reg. sec. 1.954-2(c)(2)(iv).
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Also generally excluded from subpart F foreign personal
holding company income are rents and royalties received by the
CFC from a related corporation for the use of property within
the country in which the CFC was organized (sec. 954(c)(3)).
However, rent and royalty payments do not qualify for this
exclusion to the extent that such payments reduce subpart F
income of the payor.
Reasons for Change
In general, other countries do not tax foreign shipping
income, whereas the United States imposed immediate U.S. tax on
such income. The Congress believed that the uncompetitive U.S.
taxation of shipping income directly caused a steady and
substantial decline of the U.S. shipping industry. The Congress
further believed that the provision provides U.S. shippers the
opportunity to be competitive with their tax-advantaged foreign
competitors.
In addition, the Congress believed that the prior-law
exception from foreign base company income for rents and
royalties received by a CFC in the active conduct of a trade or
business from unrelated persons was too narrow in the context
of the leasing of an aircraft or vessel in foreign commerce.
The Congress believed that the income earned by a CFC in
connection with an active foreign aircraft or vessel leasing
business should be excluded from the anti-deferral rules of
subpart F, provided that the CFC conducts substantial
activities with respect to such business. The Congress also
believed the provision of a safe harbor under the Act improves
the competitiveness of U.S.-based multinationals engaging in
these activities.
Explanation of Provision
The Act repeals the subpart F rules relating to foreign
base company shipping income. The Act also amends the exception
from foreign personal holding company income applicable to
rents or royalties derived from unrelated persons in an active
trade or business by providing a safe harbor for rents derived
from leasing an aircraft or vessel in foreign commerce. Such
rents are excluded from foreign personal holding company income
if the active leasing expenses comprise at least 10 percent of
the profit on the lease. The provision is to be applied in
accordance with existing regulations under section 954(c)(2)(A)
by comparing the lessor's ``active leasing expenses'' for its
pool of leased assets to its ``adjusted leasing profit.''
The safe harbor will not prevent a lessor from otherwise
showing that it actively carries on a trade or business. In
this regard, the requirements of section 954(c)(2)(A) will be
met if a lessor regularly and directly performs active and
substantial marketing, remarketing, management and operational
functions with respect to the leasing of an aircraft or vessel
(or component engines).\532\ This will be the case regardless
of whether the lessor engages in marketing of the lease as a
form of financing (versus marketing the property as such) or
whether the lease is classified as a finance lease or operating
lease for financial accounting purposes. If a lessor acquires,
from an unrelated or related party, a vessel or aircraft
subject to an existing lease, the requirements of section
954(c)(2)(A) will be satisfied if, following the acquisition,
the lessor performs active and substantial management,
operational, and remarketing functions with respect to the
leased property. However, if an existing FSC or ETI lease is
transferred to a CFC lessor, the lease will no longer be
eligible for FSC or ETI benefits.
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\532\ An ``aircraft or vessel'' also includes engines that are
leased separately from an aircraft or vessel.
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An aircraft or vessel is considered to be leased in foreign
commerce if it is used for the transportation of property or
passengers between a port (or airport) in the United States and
one in a foreign country or between foreign ports (or
airports), provided the aircraft or vessel is used
predominantly outside the United States. An aircraft or vessel
will be considered used predominantly outside the United States
if more than 50 percent of the miles during the taxable year
are traversed outside the United States or the aircraft or
vessel is located outside the United States more than 50
percent of the time during such taxable year.
It is expected that the Secretary of the Treasury will
issue timely guidance to make conforming changes to existing
regulations, including guidance that aircraft or vessel leasing
activity that satisfies the requirements of section
954(c)(2)(A) shall also satisfy the requirements for avoiding
income inclusion under section 956 and section 367(a).
It is anticipated that taxpayers now eligible for the
benefits of the ETI exclusion (or the FSC provisions pursuant
to the FSC Repeal and Extraterritorial Income Exclusion Act of
2000), will find it appropriate, as a matter of sound business
judgment, to restructure their business operations to take into
account the tax law changes brought about by the Act. It is
noted that courts have recognized the validity of structuring
operations for the purpose of obtaining the benefit of tax
regimes expressly intended by Congress. It is intended that
structuring or restructuring of operations for the purposes of
adapting to the repeal of the ETI exclusion (or the FSC regime)
will be considered to serve a valid business purpose and will
not constitute tax avoidance, where the restructured operations
conform to the requirements expressly mandated by Congress for
obtaining tax benefits that remain available. For example, it
is intended that a restructuring undertaken to transfer
aircraft subject to existing FSC or ETI leases to a CFC lessor,
to take advantage of the amendments made by the Act, would
serve a valid business purpose and would not constitute tax
avoidance, for purposes of determining whether a particular tax
treatment (such as nonrecognition of gain) applies to such
restructuring. It is intended, for example, that if such a
restructuring meets the other requirements necessary to qualify
as a ``reorganization'' under section 368, the transaction will
also be deemed to meet the ``business purpose'' requirements
under section 368, and thus, qualify as a reorganization under
that section.
Effective Date
The provision is effective for taxable years of foreign
corporations beginning after December 31, 2004, and taxable
years of U.S. shareholders with or within which such taxable
years of such foreign corporations end.
P. Modification of Exceptions Under Subpart F for Active Financing
(sec. 416 of the Act and sec. 954 of the Code)
Present and Prior Law
Under the subpart F rules, U.S. shareholders with a 10-
percent or greater interest in a controlled foreign corporation
(``CFC'') are subject to U.S. tax currently on certain income
earned by the CFC, whether or not such income is distributed to
the shareholders. The income subject to current inclusion under
the subpart F rules includes, among other things, foreign
personal holding company income and insurance income. In
addition, 10-percent U.S. shareholders of a CFC are subject to
current inclusion with respect to their shares of the CFC's
foreign base company services income (i.e., income derived from
services performed for a related person outside the country in
which the CFC is organized).
Foreign personal holding company income generally consists
of the following: (1) dividends, interest, royalties, rents,
and annuities; (2) net gains from the sale or exchange of (a)
property that gives rise to the preceding types of income, (b)
property that does not give rise to income, and (c) interests
in trusts, partnerships, and real estate mortgage investment
conduits (``REMICs''); (3) net gains from commodities
transactions; (4) net gains from foreign currency transactions;
(5) income that is equivalent to interest; (6) income from
notional principal contracts; and (7) payments in lieu of
dividends.
Insurance income subject to current inclusion under the
subpart F rules includes any income of a CFC attributable to
the issuing or reinsuring of any insurance or annuity contract
in connection with risks located in a country other than the
CFC's country of organization. Subpart F insurance income also
includes income attributable to an insurance contract in
connection with risks located within the CFC's country of
organization, as the result of an arrangement under which
another corporation receives a substantially equal amount of
consideration for insurance of other country risks. Investment
income of a CFC that is allocable to any insurance or annuity
contract related to risks located outside the CFC's country of
organization is taxable as subpart F insurance income.\533\
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\533\ Treas. Reg. sec. 1.953-1(a).
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Temporary exceptions from foreign personal holding company
income, foreign base company services income, and insurance
income apply for subpart F purposes for certain income that is
derived in the active conduct of a banking, financing, or
similar business, or in the conduct of an insurance business
(so-called ``active financing income'').\534\
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\534\ Temporary exceptions from the subpart F provisions for
certain active financing income applied only for taxable years
beginning in 1998. Those exceptions were modified and extended for one
year, applicable only for taxable years beginning in 1999. The Tax
Relief Extension Act of 1999 (Pub. L. No. 106-170) clarified and
extended the temporary exceptions for two years, applicable only for
taxable years beginning after 1999 and before 2002. The Job Creation
and Worker Assistance Act of 2002 (Pub L. No. 107-147) extended the
temporary exceptions for five years, applicable only for taxable years
beginning after 2001 and before 2007, with a modification relating to
insurance reserves.
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With respect to income derived in the active conduct of a
banking, financing, or similar business, a CFC is required to
be predominantly engaged in such business and to conduct
substantial activity with respect to such business in order to
qualify for the exceptions. In addition, certain nexus
requirements apply, which provide that income derived by a CFC
or a qualified business unit (``QBU'') of a CFC from
transactions with customers is eligible for the exceptions if,
among other things, substantially all of the activities in
connection with such transactions are conducted directly by the
CFC or QBU in its home country, and such income is treated as
earned by the CFC or QBU in its home country for purposes of
such country's tax laws. Moreover, the exceptions apply to
income derived from certain cross-border transactions, provided
that certain requirements are met. Additional exceptions from
foreign personal holding company income apply for certain
income derived by a securities dealer within the meaning of
section 475 and for gain from the sale of active financing
assets.
In the case of insurance, in addition to temporary
exceptions from insurance income and from foreign personal
holding company income for certain income of a qualifying
insurance company with respect to risks located within the
CFC's country of creation or organization, temporary exceptions
from insurance income and from foreign personal holding company
income apply for certain income of a qualifying branch of a
qualifying insurance company with respect to risks located
within the home country of the branch, provided certain
requirements are met under each of the exceptions. Further,
additional temporary exceptions from insurance income and from
foreign personal holding company income apply for certain
income of certain CFCs or branches with respect to risks
located in a country other than the United States, provided
that the requirements for these exceptions are met.
Reasons for Change
The Congress understood that banking and financial
regulatory requirements in many foreign countries require
different financial services activities to be conducted in
separate entities, and that the interaction of these
requirements with the prior-law rules regarding active
financing income often required financial services firms to
operate inefficiently. Therefore, the Congress believed that
the rules for determining whether income earned by an eligible
CFC or QBU is active financing income should be more consistent
with the rules for determining whether a CFC or QBU is eligible
to earn active financing income. In particular, the Congress
believed that activities performed by employees of certain
affiliates of a CFC or QBU should be taken into account in
determining whether income of the CFC or QBU is active
financing income in a manner similar to the rules for
determining whether the CFC or QBU is eligible to earn active
financing income.
Explanation of Provision
The Act modifies the temporary exceptions from subpart F
foreign personal holding company income and foreign base
company services income for income derived in the active
conduct of a banking, financing, or similar business. For
purposes of determining whether a CFC or QBU has conducted
directly in its home country substantially all of the
activities in connection with transactions with customers, the
Act provides that an activity is treated as conducted directly
by the CFC or QBU in its home country if the activity is
performed by employees of a related person and: (1) the related
person is itself an eligible CFC the home country of which is
the same as that of the CFC or QBU; (2) the activity is
performed in the home country of the related person; and (3)
the related person is compensated on an arm's length basis for
the performance of the activity by its employees and such
compensation is treated as earned by such person in its home
country for purposes of the tax laws of such country. For
purposes of determining whether a CFC or QBU is eligible to
earn active financing income, such activity may not be taken
into account by any CFC or QBU (including the employer of the
employees performing the activity) other than the CFC or QBU
for which the activities are performed.
Effective Date
The provision is effective for taxable years of foreign
corporations beginning after December 31, 2004, and taxable
years of U.S. shareholders with or within which such taxable
years of foreign corporations end.
Q. Ten-Year Foreign Tax Credit Carryover; One-Year Foreign Tax Credit
Carryback (sec. 417 of the Act and sec. 904 of the Code)
Present and Prior Law
U.S. persons may credit foreign taxes against U.S. tax on
foreign-source income. The amount of foreign tax credits that
may be claimed in a year is subject to a limitation that
prevents taxpayers from using foreign tax credits to offset
U.S. tax on U.S.-source income. The amount of foreign tax
credits generally is limited to a portion of the taxpayer's
U.S. tax which portion is calculated by multiplying the
taxpayer's total U.S. tax by a fraction, the numerator of which
is the taxpayer's foreign-source taxable income (i.e., foreign-
source gross income less allocable expenses or deductions) and
the denominator of which is the taxpayer's worldwide taxable
income for the year.\535\
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\535\ Sec. 904(a).
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In addition, this limitation is calculated separately for
various categories of income, generally referred to as
``separate limitation categories.'' The total amount of the
foreign tax credit used to offset the U.S. tax on income in
each separate limitation category may not exceed the proportion
of the taxpayer's U.S. tax which the taxpayer's foreign-source
taxable income in that category bears to its worldwide taxable
income.
Under prior law, the amount of creditable taxes paid or
accrued (or deemed paid) in any taxable year which exceeded the
foreign tax credit limitation was permitted to be carried back
to the two immediately preceding taxable years (to the earliest
year first) and carried forward five taxable years (in
chronological order) and credited (not deducted) to the extent
that the taxpayer otherwise had excess foreign tax credit
limitation for those years. Under present and prior law, excess
credits that are carried back or forward are usable only to the
extent that there is excess foreign tax credit limitation in
the carryover or carryback year. Consequently, foreign tax
credits arising in a taxable year are utilized before excess
credits from another taxable year may be carried forward or
backward. In addition, excess credits are carried forward or
carried back on a separate limitation basis. Thus, if a
taxpayer has excess foreign tax credits in one separate
limitation category for a taxable year, those excess credits
may be carried back and forward only as taxes allocable to that
category, notwithstanding the fact that the taxpayer may have
excess foreign tax credit limitation in another category for
that year. If credits cannot be so utilized, they are
permanently disallowed.
Reasons for Change
The Congress was concerned that excessive double taxation
of foreign earnings could result from the expiration of foreign
tax credits under prior law. The Congress believed that the
purposes of the foreign tax credit would be better served by
providing a larger window within which credits may be used,
thereby reducing the likelihood that credits may expire.
Explanation of Provision
The Act extends the excess foreign tax credit carryforward
period to ten years and limits the carryback period to one
year.
Effective Date
The extension of the carryforward period is effective for
excess foreign tax credits that may be carried to any taxable
years ending after the date of enactment (October 22, 2004) of
the provision; the limited carryback period is effective for
excess foreign tax credits arising in taxable years beginning
after the date of enactment (October 22, 2004) of the
provision.
R. Modify FIRPTA Rules for Real Estate Investment Trusts (sec. 418 of
the Act and secs. 857 and 897 of the Code)
Present and Prior Law
A real estate investment trust (``REIT'') is a U.S. entity
that derives most of its income from passive real estate-
related investments. A REIT must satisfy a number of tests on
an annual basis that relate to the entity's organizational
structure, the source of its income, the nature of its assets,
and the distribution of its income. If an electing entity meets
the requirements for REIT status, the portion of its income
that is distributed to its investors each year generally is
treated as a dividend deductible by the REIT and includible in
income by its investors. In this manner, the distributed income
of the REIT is not taxed at the entity level. The distributed
income is taxed only at the investor level. A REIT generally is
required to distribute 90 percent of its income to its
investors before the end of its taxable year. A REIT may
designate a dividend as a capital gain dividend under certain
circumstances.
Special U.S. tax rules apply to gains of foreign persons
attributable to dispositions of interests in U.S. real
property, including certain transactions involving REITs. The
rules governing the imposition and collection of tax on such
dispositions are contained in a series of provisions that were
enacted in 1980 and that are collectively referred to as the
Foreign Investment in Real Property Tax Act (``FIRPTA'').
In general, FIRPTA provides that gain or loss of a foreign
person from the disposition of a U.S. real property interest is
taken into account for U.S. tax purposes as if such gain or
loss were effectively connected with a U.S. trade or business
during the taxable year. Accordingly, foreign persons generally
are subject to U.S. tax on any gain from a disposition of a
U.S. real property interest at the same rates that apply to
similar income received by U.S. persons. For these purposes,
under prior law there was no exception to the rule that the
receipt of a distribution from a REIT was treated as a
disposition of a U.S. real property interest by the recipient,
and thus as income effectively connected with a U.S, trade or
business, to the extent that it is attributable to a sale or
exchange of a U.S. real property interest by the REIT. Capital
gains distributions from REITs treated in this manner generally
are subject to withholding tax at a rate of 35 percent (or a
lower treaty rate). In addition, the recipients of these
capital gains distributions are required to file Federal income
tax returns in the United States, since the recipients are
treated as earning income effectively connected with a U.S.
trade or business.
In addition, foreign corporations that have effectively
connected income generally are subject to the branch profits
tax at a 30-percent rate (or a lower treaty rate).
Reasons for Change
The Congress believed that it was appropriate to provide
greater conformity in the tax consequences of REIT
distributions and other corporate stock distributions.
Explanation of Provision
The Act removes from treatment as effectively connected
income for a foreign investor a capital gain distribution from
a REIT,\536\ provided that (1) the distribution is received
with respect to a class of stock that is regularly traded on an
established securities market located in the United States and
(2) the foreign investor does not own more than five percent of
the class of stock at any time during the taxable year within
which the distribution is received.
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\536\ It is not intended that regulated investment companies
(``RICs'') are eligible for this new exception from FIRPTA. A technical
correction may be necessary so that the statute reflects this intent.
See section 2(a)(6)(A) of H.R. 5395 and of S. 3019, the ``Tax Technical
Corrections Act of 2004,'' introduced November 19, 2004.
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Thus, a foreign investor is not required to file a U.S.
Federal income tax return by reason of receiving such a
distribution. The distribution is to be treated as a REIT
dividend to that investor, taxed as a REIT dividend that is not
a capital gain. Also, the branch profits tax no longer applies
to such a distribution.
Effective Date
The provision applies to taxable years beginning after the
date of enactment (October 22, 2004).\537\
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\537\ It is intended that the provision applies to any distribution
of a REIT that is treated as a deduction for a taxable year of the REIT
beginning after the date of enactment. A technical correction may be
necessary so that the statute reflects this intent. See sec. 2(a)(6)(B)
of H.R. 5395 and of S. 3019, the ``Tax Technical Corrections Act of
2004,'' introduced November 19, 2004.
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S. Exclusion of Income Derived from Certain Wagers on Horse Races and
Dog Races from Gross Income of Nonresident Aliens (sec. 419 of the Act
and sec. 872 of the Code)
Present and Prior Law
Under section 871, certain items of gross income received
by a nonresident alien from sources within the United States
are subject to a flat 30-percent withholding tax. Gambling
winnings received by a nonresident alien from wagers placed in
the United States are U.S.-source and thus generally are
subject to this withholding tax, unless exempted by treaty.
Currently, several U.S. income tax treaties exempt U.S.-source
gambling winnings of residents of the other treaty country from
U.S. withholding tax. In addition, no withholding tax is
imposed under section 871 on the non-business gambling income
of a nonresident alien from wagers on the following games
(except to the extent that the Secretary determines that
collection of the tax would be administratively feasible):
blackjack, baccarat, craps, roulette, and big-6 wheel. Various
other (non-gambling-related) items of income of a nonresident
alien are excluded from gross income under section 872(b) and
are thereby exempt from the 30-percent withholding tax, without
any authority for the Secretary to impose the tax by
regulation. In cases in which a withholding tax on gambling
winnings applies, section 1441(a) of the Code requires the
party making the winning payout to withhold the appropriate
amount and makes that party responsible for amounts not
withheld.
Under prior law, with respect to gambling winnings of a
nonresident alien resulting from a wager initiated outside the
United States on a pari-mutuel \538\ event taking place within
the United States, the source of the winnings, and thus the
applicability of the 30-percent U.S. withholding tax, depended
on the type of wagering pool from which the winnings were paid.
If the payout was made from a separate foreign pool, maintained
completely in a foreign jurisdiction (e.g., a pool maintained
by a racetrack or off-track betting parlor that was showing in
a foreign country a simulcast of a horse race taking place in
the United States), then the winnings paid to a nonresident
alien generally would not be subject to withholding tax,
because the amounts received generally would not be from
sources within the United States. However, if the payout was
made from a ``merged'' or ``commingled'' pool, in which betting
pools in the United States and the foreign country were
combined for a particular event, then the portion of the payout
attributable to wagers placed in the United States could be
subject to withholding tax. The party making the payment, in
this case a racetrack or off-track betting parlor in a foreign
country, would be responsible for withholding the tax.
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\538\ In pari-mutuel wagering (common in horse racing), odds and
payouts are determined by the aggregate bets placed. The money wagered
is placed into a pool, the party maintaining the pool takes a
percentage of the total, and the bettors effectively bet against each
other. Pari-mutuel wagering may be contrasted with fixed-odds wagering
(common in sports wagering), in which odds (or perhaps a point spread)
are agreed to by the bettor and the party taking the bet and are not
affected by the bets placed by other bettors.
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Reasons for Change
The Congress believed that nonresident aliens should be
able to wager outside the United States in pari-mutuel pools on
live horse or dog races taking place within the United States
without any resulting winnings being subjected to U.S. income
tax, regardless of whether the foreign pool is merged with a
U.S. pool.
Explanation of Provision
The Act provides an exclusion from gross income under
section 872(b) for winnings paid to a nonresident alien
resulting from a legal wager initiated outside the United
States in a pari-mutuel pool on a live horse or dog race in the
United States, regardless of whether the pool is a separate
foreign pool or a merged U.S.-foreign pool.
Effective Date
The provision is effective for wagers made after the date
of enactment (October 22, 2004) of the provision.
T. Limitation of Withholding on U.S.-Source Dividends Paid to Puerto
Rico Corporation (sec. 420 of the Act and secs. 881 and 1442 of the
Code)
Present and Prior Law
In general, dividends paid by corporations organized in the
United States \539\ to corporations organized outside of the
United States and its possessions are subject to U.S. income
tax withholding at the flat rate of 30 percent. The rate may be
reduced or eliminated under a tax treaty. Dividends paid by
U.S. corporations to corporations organized in certain U.S.
possessions are subject to different rules.\540\ Corporations
organized in the U.S. possessions of the Virgin Islands, Guam,
American Samoa or the Northern Mariana Islands are not subject
to withholding tax on dividends from corporations organized in
the United States, provided that certain local ownership and
activity requirements are met. Each of those possessions have
adopted local internal revenue codes that provide a zero rate
of withholding tax on dividends paid by corporations organized
in the possession to corporations organized in the United
States.
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\539\ The term ``United States'' does not include its possessions.
Sec. 7701(a)(9).
\540\ The usual method of effecting a mitigation of the flat 30
percent rate--an income tax treaty providing for a lower rate--is not
possible in the case of a possession. See S. Rep. No. 1707, 89th Cong.,
2d Sess. 34 (1966).
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Under the tax laws of Puerto Rico, which is also a U.S.
possession, a 10-percent withholding tax is imposed on
dividends paid by Puerto Rico corporations to non-Puerto Rico
corporations.\541\ Under prior law, dividends paid by
corporations organized in the United States to Puerto Rico
corporations were subject to U.S. withholding tax at a 30-
percent rate. Under Puerto Rico law, Puerto Rico corporations
may elect to credit their U.S. income taxes against their
Puerto Rico income taxes. Creditable income taxes include the
dividend withholding tax and the underlying U.S. corporate tax
attributable to the dividends. However, a Puerto Rico
corporation's tax credit for U.S. income taxes may be limited
because the sum of the U.S. withholding tax and the underlying
U.S. corporate tax generally exceeds the amount of Puerto Rico
corporate income tax imposed on the dividend. Consequently,
Puerto Rico corporations with subsidiaries organized in the
United States may be subject to some degree of double taxation
on their U.S. subsidiaries' earnings.
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\541\ The 10-percent withholding rate may be subject to exemption
or elimination if the dividend is paid out of income that is subject to
certain tax incentives offered by Puerto Rico. These tax incentives may
also reduce the rate of underlying Puerto Rico corporate tax to a flat
rate of between two and seven percent.
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Reasons for Change
The 30-percent withholding tax rate on U.S.-source
dividends to Puerto Rico corporations placed such companies at
an economic disadvantage relative to corporations organized in
foreign countries with which the United States had a tax
treaty, and relative to corporations organized in other
possessions. The Congress believed that creating and
maintaining parity between U.S. and Puerto Rico dividend
withholding tax rates would place Puerto Rico corporations on a
more level playing field with corporations organized in treaty
countries and other possessions.
Explanation of Provision
The Act lowers the withholding income tax rate on U.S.
source dividends paid to a corporation created or organized in
Puerto Rico from 30 percent to 10 percent, to create parity
with the generally applicable 10-percent withholding tax
imposed by Puerto Rico on dividends paid to U.S. corporations.
The lower rate applies only if the same local ownership and
activity requirements are met that are applicable to
corporations organized in other possessions receiving dividends
from corporations organized in the United States. If the
generally applicable withholding tax rate imposed by Puerto
Rico on dividends paid to U.S. corporations increases to
greater than 10 percent, the U.S. withholding rate on dividends
to Puerto Rico corporations reverts to 30 percent.
Effective Date
The provision is effective for dividends paid after the
date of enactment (October 22, 2004).
U. Foreign Tax Credit Under Alternative Minimum Tax (sec. 421 of the
Act and sec. 59 of the Code)
Present and Prior Law
In general
Under present and prior law, taxpayers are subject to an
alternative minimum tax (``AMT''), which is payable, in
addition to all other tax liabilities, to the extent that it
exceeds the taxpayer's regular income tax liability. The tax is
imposed at a flat rate of 20 percent, in the case of corporate
taxpayers, on alternative minimum taxable income (``AMTI'') in
excess of a phased-out exemption amount. AMTI is the taxpayer's
taxable income increased for certain tax preferences and
adjusted by determining the tax treatment of certain items in a
manner that limits the tax benefits resulting from the regular
tax treatment of such items.
Foreign tax credit
Taxpayers are permitted to reduce their AMT liability by an
AMT foreign tax credit. The AMT foreign tax credit for a
taxable year is determined under principles similar to those
used in computing the regular tax foreign tax credit, except
that (1) the numerator of the AMT foreign tax credit limitation
fraction is foreign source AMTI and (2) the denominator of that
fraction is total AMTI. Taxpayers may elect to use as their AMT
foreign tax credit limitation fraction the ratio of foreign
source regular taxable income to total AMTI.
Under prior law, the AMT foreign tax credit for any taxable
year generally could not offset a taxpayer's entire pre-credit
AMT. Rather, the AMT foreign tax credit, under prior law, was
limited to 90 percent of AMT computed without any AMT net
operating loss deduction and the AMT foreign tax credit. For
example, assume that a corporation has $10 million of AMTI, has
no AMT net operating loss deduction, and has no regular tax
liability. In the absence of the AMT foreign tax credit, the
corporation's tax liability would be $2 million. Accordingly,
the AMT foreign tax credit could not be applied to reduce the
taxpayer's tax liability below $200,000. Any unused AMT foreign
tax credit could be carried back two years and carried forward
five years for use against AMT in those years under the
principles of the foreign tax credit carryback and carryover
rules set forth in section 904(c).
Reasons for Change
The Congress believed that taxpayers should be permitted
full use of foreign tax credits in computing the AMT.
Explanation of Provision
The Act repeals the 90-percent limitation on the
utilization of the AMT foreign tax credit.
Effective Date
The provision applies to taxable years beginning after
December 31, 2004.
V. Incentives to Reinvest Foreign Earnings in the United States (sec.
422 of the Act and new sec. 965 of the Code)
Present and Prior Law
The United States employs a ``worldwide'' tax system, under
which domestic corporations generally are taxed on all income,
whether derived in the United States or abroad. Income earned
by a domestic parent corporation from foreign operations
conducted by foreign corporate subsidiaries generally is
subject to U.S. tax when the income is distributed as a
dividend to the domestic corporation. Until such repatriation,
the U.S. tax on such income generally is deferred, and U.S. tax
is imposed on such income when repatriated. However, under
anti-deferral rules, the domestic parent corporation may be
taxed on a current basis in the United States with respect to
certain categories of passive or highly mobile income earned by
its foreign subsidiaries, regardless of whether the income has
been distributed as a dividend to the domestic parent
corporation. The main anti-deferral provisions in this context
are the controlled foreign corporation rules of subpart F \542\
and the passive foreign investment company rules.\543\ A
foreign tax credit generally is available to offset, in whole
or in part, the U.S. tax owed on foreign-source income, whether
earned directly by the domestic corporation, repatriated as a
dividend from a foreign subsidiary, or included in income under
the anti-deferral rules.\544\
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\542\ Secs. 951-964.
\543\ Secs. 1291-1298.
\544\ Secs. 901, 902, 960, and 1291(g).
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Reasons for Change
The Congress observed that the residual U.S. tax imposed on
the repatriation of foreign earnings could serve as a
disincentive to repatriate these earnings. The Congress
believed that a temporary reduction in the U.S. tax on
repatriated dividends would stimulate the U.S. domestic economy
by triggering the repatriation of foreign earnings that
otherwise would have remained abroad. The Congress emphasized
that this tax reduction is a temporary economic stimulus
measure, and that there is no intent to make the measure
permanent, or to ``extend'' or enact it again in the future.
Explanation of Provision
Under the Act, certain dividends received by a U.S.
corporation from controlled foreign corporations are eligible
for an 85-percent dividends-received deduction. At the
taxpayer's election, this deduction is available for dividends
received either during the taxpayer's first taxable year
beginning on or after the date of enactment of the bill, or
during the taxpayer's last taxable year beginning before such
date.\545\ Dividends received after the election period will be
taxed in the normal manner under present law.
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\545\ The election is to be made on a timely filed return
(including extensions) for the taxable year with respect to which the
deduction is claimed.
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The deduction applies only to cash dividends and other cash
amounts included in gross income as dividends, such as cash
amounts treated as dividends under Code sections 302 or 304
(but not to amounts treated as dividends under Code sections
78, 367, or 1248).\546\ The deduction does not apply to items
that are not included in gross income as dividends, such as
subpart F inclusions or deemed repatriations under Code section
956. Similarly, the deduction does not apply to distributions
of earnings previously taxed under subpart F, except to the
extent that the subpart F inclusions result from the payment of
a dividend by one controlled foreign corporation to another
controlled foreign corporation within a certain chain of
ownership during the election period, with the result that cash
travels through a chain of controlled foreign corporations to
the taxpayer within the election period. The amount of
dividends eligible for the deduction is reduced by any increase
in related-party indebtedness on the part of a controlled
foreign corporation between October 3, 2004, and the close of
the taxable year for which the deduction is being claimed,
determined by treating all controlled foreign corporations with
respect to which the taxpayer is a U.S. shareholder as one
controlled foreign corporation.\547\ This rule is intended to
prevent a deduction from being claimed in cases in which the
U.S. shareholder directly or indirectly (e.g., through a
related party) finances the payment of a dividend from a
controlled foreign corporation. In such a case, there may be no
net repatriation of funds, and thus it would be inappropriate
to provide the deduction.\548\
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\546\ However, to the extent that the taxpayer actually receives
cash in an inbound liquidation that is described in Code section 332
and treated as a dividend under Code section 367(b), such amount is
treated as a dividend for these purposes. A deemed liquidation
effectuated by means of a ``check the box'' election under the entity
classification regulations will not involve an actual receipt of cash
that is reinvested in the United States as required for purposes of
this provision.
\547\ Thus, indebtedness between such controlled foreign
corporations is disregarded for purposes of this determination.
\548\ The Treasury Secretary has regulatory authority to prevent
the avoidance of the purposes of this rule. Regulations issued pursuant
to this authority may include rules to provide that cash dividends are
not taken into account under Code section 965(a) to the extent
attributable to the direct or indirect transfer of cash or other
property from a related person to a controlled foreign corporation
(including through the use of intervening entities or capital
contributions). It is expected that this authority, which supplements
existing principles relating to the treatment of circular flows of
cash, will be used to prevent the application of the deduction in the
case of a dividend that is effectively funded by the U.S. shareholder
or its U.S. affiliates. A technical correction may be necessary so that
the statute reflects this intent. See section 2(a)(7)(B) of H.R. 5395
and S. 3019, the ``Tax Technical Corrections Act of 2004,'' introduced
November 19, 2004.
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The deduction is subject to a number of general
limitations. First, it applies only to cash repatriations in
excess of the taxpayer's average repatriation level over three
of the five most recent taxable years ending on or before June
30, 2003, determined by disregarding the highest-repatriation
year and the lowest-repatriation year among such five years
(the ``base-period average''). If the taxpayer has fewer than
five such years, then all taxable years ending on or before
June 30, 2003 are included in the base period.\549\
Repatriation levels are determined by reference to base-period
tax returns as filed, including any amended returns that were
filed on or before June 30, 2003. U.S. shareholders that file a
consolidated tax return are treated as one U.S. shareholder for
all purposes of this dividends-received deduction provision.
Thus, all such shareholders are aggregated in determining the
base-period average (as are all controlled foreign
corporations). In addition to cash dividends, dividends of
property, deemed repatriations under section 956, and
distributions of earnings previously taxed under subpart F are
included in the base-period average.
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\549\ A corporation that was spun off from another corporation
during the five-year period is treated for this purpose as having been
in existence for the same period that such other corporation has been
in existence. The pre-spin-off dividend history of the two corporations
is generally allocated between them on the basis of their interests in
the dividend-paying controlled foreign corporations immediately after
the spin-off. In other cases involving companies entering and exiting
corporate groups, rules similar to those of Code section 41(f)(3)(A)
and (B) apply.
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Second, the amount of dividends eligible for the deduction
is limited to the greatest of: (1) $500 million; (2) the amount
of earnings shown as permanently invested outside the United
States on the taxpayer's ``applicable financial statement''
(generally, the most recent audited financial statement which
is certified on or before June 30, 2003);\550\ or (3) in the
case of an applicable financial statement that does not show a
specific amount of such earnings, but that does show a specific
amount of tax liability attributable to such earnings, the
amount of such earnings determined by grossing up the tax
liability at a 35-percent rate. If there is no applicable
financial statement, or if such statement does not show a
specific earnings or tax liability amount, then the $500
million limit applies. This $500 million amount is divided
among corporations that are members of a controlled group,
using a 50-percent standard of common control. The two
financial statement amounts described above are divided among
the U.S. shareholders that are included on such statements.
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\550\ This rule refers to elements of Accounting Principles Board
Opinion 23 (``APB 23''), which provides an exception to the general
rule of comprehensive recognition of deferred taxes for temporary book-
tax differences. The exception is for temporary differences related to
undistributed earnings of foreign subsidiaries and foreign corporate
joint ventures that meet the indefinite reversal criterion in APB 23.
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In the case of a U.S. shareholder that is required to file
a financial statement with the Securities and Exchange
Commission (or is included in such a statement filed by another
person), the applicable financial statement is the most recent
audited annual statement that was so filed and certified on or
before June 30, 2003. For purposes of this rule, a restatement
of a previously filed and certified financial statement that
occurs after June 30, 2003 does not alter the statement's
status as having been filed and certified on or before June 30,
2003. In addition, the term ``applicable financial statement''
includes the notes that form an integral part of the financial
statement, but other materials, including work papers or
materials that may be filed for some purposes with a financial
statement but that do not form an integral part of such
statement, may not be relied upon for purposes of producing an
earnings or tax number under the provision. For example, if a
note that is an integral part of an applicable financial
statement states that the U.S. shareholder has not provided for
deferred taxes on $1 billion of undistributed earnings of
foreign subsidiaries because such earnings are intended to be
reinvested permanently (or indefinitely) abroad, the U.S.
shareholder's limit under Code section 965(b)(1) is $1 billion.
If an applicable financial statement does not show a specific
earnings or tax amount described in Code section 965(b)(1)(B)
or (C), a taxpayer cannot rely on underlying work papers or
other materials that are not a part of the financial statement
to derive such an amount. If an applicable financial statement
states that an earnings or tax amount is indeterminate (or that
determination of a specific amount of earnings or taxes is not
feasible), then the earnings or tax amount so described is
treated as being zero.\551\
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\551\ A technical correction may be necessary so that the statute
reflects the intent described in this paragraph. See section 2(a)(7)(C)
of H.R. 5395 and S. 3019, the ``Tax Technical Corrections Act of
2004,'' introduced November 19, 2004.
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Third, in order to qualify for the deduction, dividends
must be described in a domestic reinvestment plan approved by
the taxpayer's senior management and board of directors. This
plan must provide for the reinvestment of the repatriated
dividends in the United States, including as a source for the
funding of worker hiring and training, infrastructure, research
and development, capital investments, and the financial
stabilization of the corporation for the purposes of job
retention or creation. This list of permitted uses is not
exclusive. The reinvestment plan cannot, however, designate
repatriated funds for use as payment for executive
compensation. Dividends with respect to which the deduction is
not being claimed are not required to be included in any
domestic reinvestment plan.
Under Code section 965(d), no foreign tax credit (or
deduction) is allowed for foreign taxes attributable to the
deductible portion of any dividend.\552\ For this purpose, the
taxpayer may specifically identify which dividends are treated
as carrying the deduction and which dividends are not.\553\ In
other words, the taxpayer is allowed to choose which of its
dividends are treated as meeting the base-period repatriation
level (and thus carry foreign tax credits, to the extent
otherwise allowable), and which of its dividends are treated as
comprising the excess eligible for the deduction (and thus
entail proportional disallowance of any associated foreign tax
credits). The deduction itself will have the effect of
appropriately reducing the taxpayer's foreign tax credit
limitation.
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\552\ Foreign taxes that are not allowed as foreign tax credits by
reason of Code section 965(d) also do not give rise to income
inclusions under Code section 78. A technical correction may be
necessary so that the statute reflects this intent. See section
2(a)(7)(E) of H.R. 5395 and S. 3019, the ``Tax Technical Corrections
Act of 2004,'' introduced November 19, 2004.
\553\ In the absence of such a specification, a pro rata amount of
foreign tax credits will be disallowed with respect to every dividend
repatriated during the taxable year.
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Deductions are disallowed for expenses that are directly
allocable to the deductible portion of any dividend.\554\
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\554\ A technical correction may be necessary so that the statute
reflects this intent. See section 2(a)(7)(D) of H.R. 5395 and S. 3019,
the ``Tax Technical Corrections Act of 2004,'' introduced November 19,
2004.
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The income attributable to the nondeductible portion of a
qualifying dividend may not be offset by expenses, losses, or
deductions, and the tax attributable to such income generally
may not be offset by credits (other than foreign tax credits
and AMT credits).\555\ The only foreign tax credits that may be
used to reduce the tax on the nondeductible portion of a
dividend are credits for foreign taxes that are attributable to
the nondeductible portion of the dividend. Credits for other
foreign taxes cannot be used to reduce the tax on the
nondeductible portion of the dividend.\556\
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\555\ These expenses, losses, and deductions may, however, have the
effect of reducing other income of the taxpayer.
\556\ A technical correction may be necessary so that the statute
reflects this intent. See section 2(a)(7)(F) of H.R. 5395 and S. 3019,
the ``Tax Technical Corrections Act of 2004,'' introduced November 19,
2004.
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The tax on the income attributable to the nondeductible
portion of a qualifying dividend also cannot reduce the
alternative minimum tax that otherwise would be owed by the
taxpayer. However, the deduction available under this provision
is not treated as a preference item for purposes of computing
the AMT. Thus, the deduction is allowed in computing
alternative minimum taxable income notwithstanding the fact
that it may not be deductible in computing earnings and
profits. No deduction under sections 243 or 245 is allowed for
any dividend for which a deduction is allowed under the
provision.
Effective Date
The provision is effective only for a taxpayer's first
taxable year beginning on or after the date of enactment
(October 22, 2004) of the bill, or the taxpayer's last taxable
year beginning before such date, at the taxpayer's election.
The deduction available under the provision is not allowed for
dividends received in any taxable year beginning one year or
more after the date of enactment (October 22, 2004).
W. Delay in Effective Date of Final Regulations Governing Exclusion of
Income from International Operations of Ships and Aircraft (sec. 423 of
the Act and sec. 883 of the Code)
Present and Prior Law
Section 883 generally provides an exemption from gross
income for earnings of a foreign corporation derived from the
international operation of ships and aircraft if an equivalent
exemption from tax is granted by the applicable foreign country
to corporations organized in the United States.
The Treasury Department has issued regulations implementing
the rules of section 883 that are effective for taxable years
beginning 30 days or more after August 26, 2003. The
regulations provide, in general, that a foreign corporation
organized in a qualified foreign country and engaged in the
international operation of ships or aircraft shall exclude
qualified income from gross income for purposes of U.S. Federal
income taxation, provided that the corporation can satisfy
certain ownership and related documentation requirements. The
proposed rules explain when a foreign country is a qualified
foreign country and what income is considered to be qualified
income.
Explanation of Provision
The Act delays the effective date for the Treasury
regulations so that they apply to taxable years of foreign
corporations seeking qualified foreign corporation status
beginning after September 24, 2004.
Effective Date
The provision is effective after date of enactment (October
22, 2004).
X. Study of Earnings Stripping Provisions (sec. 424 of the Act and sec.
163(j) of the Code)
Present and Prior Law
The Code provides rules to limit the ability of U.S.
corporations to reduce the U.S. tax on their U.S.-source income
through certain earnings stripping transactions. These rules
limit the deductibility of interest paid to certain related
parties (``disqualified interest''), if the payor's debt-equity
ratio exceeds 1.5 to 1 and the payor's net interest expense
exceeds 50 percent of its ``adjusted taxable income''
(generally taxable income computed without regard to deductions
for net interest expense, net operating losses, and
depreciation, amortization, and depletion). Disqualified
interest for these purposes also may include interest paid to
unrelated parties in certain cases in which a related party
guarantees the debt.
Explanation of Provision
The Act requires the Treasury Department to conduct a study
of the earnings stripping rules, including a study of the
effectiveness of these rules in preventing the shifting of
income outside the United States, whether any deficiencies in
these rules have the effect of placing U.S.-based businesses at
a competitive disadvantage relative to foreign-based
businesses, the impact of earnings stripping activities on the
U.S. tax base, whether laws of foreign countries facilitate the
stripping of earnings out of the United States, and whether
changes to the earnings stripping rules would affect jobs in
the United States. This study is to include specific
recommendations for improving these rules and is to be
submitted to the Congress not later than June 30, 2005.
Effective Date
The provision is effective on the date of enactment
(October 22, 2004).
V. DEDUCTION OF STATE AND LOCAL GENERAL SALES TAXES
A. Deduction of State and Local General Sales Taxes (sec. 501 of the
Act and sec. 164 of the Code)
Present and Prior Law
For purposes of determining regular tax liability, an
itemized deduction is permitted for certain State and local
taxes paid, including individual income taxes, real property
taxes, and personal property taxes. The itemized deduction is
not permitted for purposes of determining a taxpayer's
alternative minimum taxable income. No itemized deduction is
permitted for State or local general sales taxes.
Reasons for Change
The Congress recognized that not all States rely on income
taxes as a primary source of revenue, and that allowing a
deduction for State and local income taxes, but not sales
taxes, created inequities across States and may also have
created biases in the types of taxes that States and localities
chose to impose. The Congress believed that the provision of an
itemized deduction for State and local general sales taxes in
lieu of the deduction for State and local income taxes would
provide more equitable Federal tax treatment across States, and
would cause the Federal tax laws to have a more neutral effect
on the types of taxes that State and local governments utilize.
Explanation of Provision
The Act provides that, at the election of the taxpayer, an
itemized deduction may be taken for State and local general
sales taxes in lieu of the itemized deduction provided under
present law for State and local income taxes. As is the case
for State and local income taxes, the itemized deduction for
State and local general sales taxes is not permitted for
purposes of determining a taxpayer's alternative minimum
taxable income.\557\ Taxpayers have two options with respect to
the determination of the sales tax deduction amount. Taxpayers
may deduct the total amount of general State and local sales
taxes paid by accumulating receipts showing general sales taxes
paid. Alternatively, taxpayers may use tables created by the
Secretary of the Treasury that show the allowable deduction.
The tables are based on average consumption by taxpayers on a
State-by-State basis taking into account filing status, number
of dependents, adjusted gross income and rates of State and
local general sales taxation. Taxpayers who use the tables
created by the Secretary may, in addition to the table amounts,
deduct eligible general sales taxes paid with respect to the
purchase of motor vehicles, boats and other items specified by
the Secretary. Sales taxes for items that may be added to the
tables are not reflected in the tables themselves.
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\557\ A technical correction may be necessary so that the statute
reflects this intent. See section 2(a)(8) of H.R. 5395 and S. 3019, the
``Tax Technical Corrections Act of 2004,'' introduced November 19,
2004.
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The term ``general sales tax'' means a tax imposed at one
rate with respect to the sale at retail of a broad range of
classes of items. However, in the case of items of food,
clothing, medical supplies, and motor vehicles, the fact that
the tax does not apply with respect to some or all of such
items is not taken into account in determining whether the tax
applies with respect to a broad range of classes of items, and
the fact that the rate of tax applicable with respect to some
or all of such items is lower than the general rate of tax is
not taken into account in determining whether the tax is
imposed at one rate. Except in the case of a lower rate of tax
applicable with respect to food, clothing, medical supplies, or
motor vehicles, no deduction is allowed for any general sales
tax imposed with respect to an item at a rate other than the
general rate of tax. However, in the case of motor vehicles, if
the rate of tax exceeds the general rate, such excess shall be
disregarded and the general rate is treated as the rate of tax.
A compensating use tax with respect to an item is treated
as a general sales tax, provided such tax is complementary to a
general sales tax and a deduction for sales taxes is allowable
with respect to items sold at retail in the taxing jurisdiction
that are similar to such item.
Effective Date
The provision is effective for taxable years beginning
after December 31, 2003, and prior to January 1, 2006.
VI. MISCELLANEOUS PROVISIONS
A. Brownfields Demonstration Program for Qualified Green Building and
Sustainable Design Projects (sec. 701 of the Act and secs. 142 and 146
of the Code)
Present and Prior Law
In general
Interest on debt 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. 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.'' The term ``private person'' includes the
Federal Government and all other individuals and entities other
than States or local governments.
Private activities eligible for financing with tax-exempt private
activity bonds
Present and prior law includes several exceptions
permitting States or local governments to act as conduits
providing tax-exempt financing for private activities. For
example, interest on bonds issued to benefit section 501(c)(3)
organizations is generally tax-exempt (``qualified 501(c)(3)
bonds''). Both capital expenditures and limited working capital
expenditures of section 501(c)(3) organizations may be financed
with qualified 501(c)(3) bonds.
In addition, States or local governments may issue tax-
exempt ``exempt-facility bonds'' to finance property for
certain private businesses.\558\ 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, hazardous waste disposal facilities, and
public educational facilities); privately owned and/or operated
low-income rental housing; \559\ 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-time farmers (``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'').
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\558\ Secs. 141(e) and 142(a).
\559\ Residential rental projects must satisfy low-income tenant
occupancy requirements for a minimum period of 15 years.
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Generally, tax-exempt private activity bonds are subject to
restrictions that do not apply to other bonds issued by State
or local governments. For example, most tax-exempt private
activity bonds are subject to annual volume limits on the
aggregate face amount of such bonds that may be issued.\560\
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\560\ Sec. 146.
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Explanation of Provision
In general
The Act creates a new category of exempt-facility bond, the
qualified green building and sustainable design project bond
(``qualified green bond''). A qualified green bond is defined
as any bond issued as part of an issue that finances a project
designated by the Secretary, after consultation with the
Administrator of the Environmental Protection Agency (the
``Administrator''), as a green building and sustainable design
project that meets the following eligibility requirements: (1)
at least 75 percent of the square footage of the commercial
buildings that are part of the project is registered for the
U.S. Green Building Council's LEED \561\ certification and is
reasonably expected (at the time of designation) to meet such
certification; (2) the project includes a brownfield site;
\562\ (3) the project receives at least $5 million in specific
State or local resources; and (4) the project includes at least
one million square feet of building or at least 20 acres of
land.
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\561\ The LEED (``Leadership in Energy and Environmental Design'')
Green Building Rating System is a voluntary, consensus-based national
standard for developing high-performance sustainable buildings.
Registration is the first step toward LEED certification. Actual
certification requires that the applicant project satisfy a number of
requirements. Commercial buildings, as defined by standard building
codes, are eligible for certification. Commercial occupancies include,
but are not limited to, offices, retail and service establishments,
institutional buildings (e.g., libraries, schools, museums, churches,
etc.), hotels, and residential buildings of four or more habitable
stories.
\562\ For this purpose, a brownfield site is defined by section
101(39) of the Comprehensive Environmental Response, Compensation, and
Liability Act of 1980 (42 U.S.C. 9601), including a site described in
subparagraph (D)(ii)(II)(aa) thereof (relating to a site that is
contaminated by petroleum or a petroleum product excluded from the
definition of ``hazardous substance'' under section 101).
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Under the Act, qualified green bonds are not subject to the
State bond volume limitations. Rather, there is a national
limitation of $2 billion of qualified green bonds that the
Secretary may allocate, in the aggregate, to qualified green
building and sustainable design projects. Qualified green bonds
may be currently refunded if certain conditions are met, but
cannot be advance refunded. The authority to issue qualified
green bonds terminates after September 30, 2009.
Application and designation process
The Act requires the submission of an application that
meets certain requirements before a project may be designated
for financing with qualified green bonds. In addition to the
eligibility requirements listed above, each project application
must demonstrate that the net benefit of the tax-exempt
financing provided will be allocated for (i) the purchase,
construction, integration or other use of energy efficiency,
renewable energy and sustainable design features of the
project, (ii) compliance with LEED certification standards,
and/or (iii) the purchase, remediation, foundation
construction, and preparation of the brownfield site. The
application also must demonstrate that the project is expected,
based on independent analysis, to provide the equivalent of at
least 1,500 full-time permanent employees (150 full-time
employees in rural States) when completed and the equivalent of
at least 1,000 construction employees (100 full-time employees
in rural States). In addition, each project application shall
contain a description of: (1) the amount of electric
consumption reduced as compared to conventional construction;
(2) the amount of sulfur dioxide daily emissions reduced
compared to coal generation; (3) the amount of gross installed
capacity of the project's solar photovoltaic capacity measured
in megawatts; and (4) the amount of the project's fuel cell
energy generation, measured in megawatts.
Under the Act, each project must be nominated by a State or
local government within 180 days of enactment of the Act and
such State or local government must provide written assurances
that the project will satisfy certain eligibility requirements.
Within 60 days after the end of the application period, the
Secretary, after consultation with the Administrator, will
designate the qualified green building and sustainable design
projects eligible for financing with qualified green bonds. At
least one of the projects must be in or within a ten-mile
radius of an empowerment zone (as defined under section 1391 of
the Code) and at least one project must be in a rural
State.\563\ No more than one project is permitted in a State. A
project shall not be designated for financing with qualified
green bonds if such project includes a stadium or arena for
professional sports exhibitions or games.
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\563\ The term ``rural State'' means any State that has (1) a
population of less than 4.5 million according to the 2000 census; (2) a
population density of less than 150 people per square mile according to
the 2000 census; and (3) increased in population by less than half the
rate of the national increase between the 1990 and 2000 censuses.
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The Act requires the Secretary, after consultation with the
Administrator, to ensure that the projects designated shall, in
the aggregate: (1) reduce electric consumption by more than 150
megawatts annually as compared to conventional construction;
(2) reduce daily sulfur dioxide emissions by at least 10 tons
compared to coal generation power; (3) expand by 75 percent the
domestic solar photovoltaic market in the United States
(measured in megawatts) as compared to the expansion of that
market from 2001 to 2002; and (4) use at least 25 megawatts of
fuel cell energy generation.
Each project must certify to the Secretary, no later than
30 days after the completion of the project, that the net
benefit of the tax-exempt financing was used for the purposes
described in the project application. In addition, no bond
proceeds can be used to provide any facility the principal
business of which is the sale of food or alcoholic beverages
for consumption on the premises.
Special rules
The Act requires each issuer to maintain, on behalf of each
project, an interest bearing reserve account equal to one
percent of the net proceeds of any qualified green bond issued
for such project. Not later than five years after the date of
issuance, the Secretary, after consultation with the
Administrator, shall determine whether the project financed
with the proceeds of qualified green bonds has substantially
complied with the requirements and goals described in the
project application. If the Secretary, after such consultation,
certifies that the project has substantially complied with the
requirements and goals, amounts in the reserve account,
including all interest, shall be released to the project. If
the Secretary determines that the project has not substantially
complied with such requirements and goals, amounts in the
reserve account, including all interest, shall be paid to the
United States Treasury.
Effective Date
The provision is effective for bonds issued after December
31, 2004, and before October 1, 2009.
B. Exclusion of Gain or Loss on Sale or Exchange of Certain Brownfield
Sites from Unrelated Business Taxable Income (sec. 702 of the Act and
secs. 512 and 514 of the Code)
Present and Prior Law
In general, an organization that is otherwise exempt from
Federal income tax is taxed on income from a trade or business
regularly carried on that is not substantially related to the
organization's exempt purposes. Gains or losses from the sale,
exchange, or other disposition of property, other than stock in
trade, inventory, or property held primarily for sale to
customers in the ordinary course of a trade or business,
generally are excluded from unrelated business taxable income.
Gains or losses are treated as unrelated business taxable
income, however, if derived from ``debt-financed property.''
Debt-financed property generally means any property that is
held to produce income and with respect to which there is
acquisition indebtedness at any time during the taxable year.
In general, income of a tax-exempt organization that is
produced by debt-financed property is treated as unrelated
business income in proportion to the acquisition indebtedness
on the income-producing property. Acquisition indebtedness
generally means the amount of unpaid indebtedness incurred by
an organization to acquire or improve the property and
indebtedness that would not have been incurred but for the
acquisition or improvement of the property. Acquisition
indebtedness does not include: (1) certain indebtedness
incurred in the performance or exercise of a purpose or
function constituting the basis of the organization's
exemption; (2) obligations to pay certain types of annuities;
(3) an obligation, to the extent it is insured by the Federal
Housing Administration, to finance the purchase,
rehabilitation, or construction of housing for low and moderate
income persons; or (4) indebtedness incurred by certain
qualified organizations to acquire or improve real property.
Special rules apply in the case of an exempt organization
that owns a partnership interest in a partnership that holds
debt-financed property. An exempt organization's share of
partnership income that is derived from debt-financed property
generally is taxed as debt-financed income unless an exception
provides otherwise.
Explanation of Provision
In general
The Act provides an exclusion from unrelated business
taxable income for the gain or loss from the qualified sale,
exchange, or other disposition of a qualifying brownfield
property by an eligible taxpayer. The exclusion from unrelated
business taxable income generally is available to an exempt
organization that acquires, remediates, and disposes of the
qualifying brownfield property. In addition, the Act provides
an exception from the debt-financed property rules for such
properties.
In order to qualify for the exclusions from unrelated
business income and the debt-financed property rules, the
eligible taxpayer is required to: (a) acquire from an unrelated
person real property that constitutes a qualifying brownfield
property; (b) pay or incur a minimum level of eligible
remediation expenditures with respect to the property; and (c)
transfer the remediated site to an unrelated person in a
transaction that constitutes a sale, exchange, or other
disposition for purposes of Federal income tax law.\564\
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\564\ Under the Act, a person is related to another person if (1)
such person bears a relationship to such other person that is described
in section 267(b) (determined without regard to paragraph (9)), or
section 707(b)(1), determined by substituting 25 percent for 50 percent
each place it appears therein; or (2) if such other person is a
nonprofit organization, if such person controls directly or indirectly
more than 25 percent of the governing body of such organization.
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Qualifying brownfield properties
Under the Act, the exclusion from unrelated business
taxable income applies only to real property that constitutes a
qualifying brownfield property. A qualifying brownfield
property means real property that is certified, before the
taxpayer incurs any eligible remediation expenditures (other
than to obtain a Phase I environmental site assessment), by an
appropriate State agency (within the meaning of section
198(c)(4)) in the State in which the property is located as a
brownfield site within the meaning of section 101(39) of the
Comprehensive Environmental Response, Compensation, and
Liability Act of 1980 (CERCLA) (as in effect on the date of
enactment of the provision). The Act requires that the
taxpayer's request for certification include a sworn statement
of the taxpayer and supporting documentation of the presence of
a hazardous substance, pollutant, or contaminant on the
property that is complicating the expansion, redevelopment, or
reuse of the property given the property's reasonably
anticipated future land uses or capacity for uses of the
property (including a Phase I environmental site assessment
and, if applicable, evidence of the property's presence on a
local, State, or Federal list of brownfields or contaminated
property) and other environmental assessments prepared or
obtained by the taxpayer.
Eligible taxpayer
An eligible taxpayer with respect to a qualifying
brownfield property is an organization exempt from tax under
section 501(a) that acquired such property from an unrelated
person and paid or incurred a minimum amount of eligible
remediation expenditures with respect to such property. The
exempt organization (or the qualifying partnership of which it
is a partner) is required to pay or incur eligible remediation
expenditures with respect to a qualifying brownfield property
in an amount that exceeds the greater of: (a) $550,000; or (b)
12 percent of the fair market value of the property at the time
such property is acquired by the taxpayer, determined as if the
property were not contaminated.
An eligible taxpayer does not include an organization that
is: (1) potentially liable under section 107 of CERCLA with
respect to the property; (2) affiliated with any other person
that is potentially liable thereunder through any direct or
indirect familial relationship or any contractual, corporate,
or financial relationship (other than a contractual, corporate,
or financial relationship that is created by the instruments by
which title to a qualifying brownfield property is conveyed or
financed by a contract of sale of goods or services); or (3)
the result of a reorganization of a business entity which was
so potentially liable.\565\
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\565\ In general, a person is potentially liable under section 107
of CERCLA if: (1) it is the owner and operator of a vessel or a
facility; (2) at the time of disposal of any hazardous substance it
owned or operated any facility at which such hazardous substances were
disposed of; (3) by contract, agreement, or otherwise it arranged for
disposal or treatment, or arranged with a transporter for transport for
disposal or treatment, of hazardous substances owned or possessed by
such person, by any other party or entity, at any facility or
incineration vessel owned or operated by another party or entity and
containing such hazardous substances; or (4) it accepts or accepted any
hazardous substances for transport to disposal or treatment facilities,
incineration vessels or sites selected by such person, from which there
is a release, or a threatened release which causes the incurrence of
response costs, of a hazardous substance. 42 U.S.C. sec. 9607(a)
(2004).
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Qualified sale, exchange, or other disposition
Under the Act, a sale, exchange, or other disposition of a
qualifying brownfield property shall be considered as qualified
if such property is transferred by the eligible taxpayer to an
unrelated person, and within one year of such transfer the
taxpayer has received a certification (a ``remediation
certification'') from the Environmental Protection Agency or an
appropriate State agency (within the meaning of section
198(c)(4)) in the State in which the property is located that,
as a result of the taxpayer's remediation actions, such
property would not be treated as a qualifying brownfield
property in the hands of the transferee. A taxpayer's request
for a remediation certification shall be made no later than the
date of the transfer and shall include a sworn statement by the
taxpayer certifying that: (1) remedial actions that comply with
all applicable or relevant and appropriate requirements
(consistent with section 121(d) of CERCLA) have been
substantially completed, such that there are no hazardous
substances, pollutants or contaminants that complicate the
expansion, redevelopment, or reuse of the property given the
property's reasonably anticipated future land uses or capacity
for uses of the property; (2) the reasonably anticipated future
land uses or capacity for uses of the property are more
economically productive or environmentally beneficial than the
uses of the property in existence on the date the property was
certified as a qualifying brownfield property;\566\ (3) a
remediation plan has been implemented to bring the property in
compliance with all applicable local, State, and Federal
environmental laws, regulations, and standards and to ensure
that remediation protects human health and the environment; (4)
the remediation plan, including any physical improvements
required to remediate the property, is either complete or
substantially complete, and if substantially complete,\567\
sufficient monitoring, funding, institutional controls, and
financial assurances have been put in place to ensure the
complete remediation of the site in accordance with the
remediation plan as soon as is reasonably practicable after the
disposition of the property by the taxpayer; and (5) public
notice and the opportunity for comment on the request for
certification (in the same form and manner as required for
public participation required under section 117(a) of CERCLA
(as in effect on the date of enactment of the provision)) was
completed before the date of such request. Public notice shall
include, at a minimum, publication in a major local newspaper
of general circulation.
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\566\ For this purpose, use of the property as a landfill or other
hazardous waste facility shall not be considered more economically
productive or environmentally beneficial.
\567\ For these purposes, substantial completion means any
necessary physical construction is complete, all immediate threats have
been eliminated, and all long-term threats are under control.
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A copy of each of the requests for certification that the
property was a brownfield site, and that it would no longer be
a qualifying brownfield property in the hands of the
transferee, shall be included in the tax return of the eligible
taxpayer (and, where applicable, of the qualifying partnership)
for the taxable year during which the transfer occurs.
Eligible remediation expenditures
Under the Act, eligible remediation expenditures means,
with respect to any qualifying brownfield property: (1)
expenditures that are paid or incurred by the taxpayer to an
unrelated person to obtain a Phase I environmental site
assessment of the property; (2) amounts paid or incurred by the
taxpayer after receipt of the certification that the property
is a qualifying brownfield property for goods and services
necessary to obtain the remediation certification; and (3)
expenditures to obtain remediation cost-cap or stop-loss
coverage, re-opener or regulatory action coverage, or similar
coverage under environmental insurance policies,\568\ or to
obtain financial guarantees required to manage the remediation
and monitoring of the property. Eligible remediation
expenditures include expenditures to: (1) manage, remove,
control, contain, abate, or otherwise remediate a hazardous
substance, pollutant, or contaminant on the property; (2)
obtain a Phase II environmental site assessment of the
property, including any expenditure to monitor, sample, study,
assess, or otherwise evaluate the release, threat of release,
or presence of a hazardous substance, pollutant, or contaminant
on the property; or (3) obtain environmental regulatory
certifications and approvals required to manage the remediation
and monitoring of the hazardous substance, pollutant, or
contaminant on the property. Eligible remediation expenditures
do not include: (1) any portion of the purchase price paid or
incurred by the eligible taxpayer to acquire the qualifying
brownfield property; (2) environmental insurance costs paid or
incurred to obtain legal defense coverage, owner/operator
liability coverage, lender liability coverage, professional
liability coverage, or similar types of coverage;\569\ (3) any
amount paid or incurred to the extent such amount is
reimbursed, funded or otherwise subsidized by: (a) grants
provided by the United States, a State, or a political
subdivision of a State for use in connection with the property;
(b) proceeds of an issue of State or local government
obligations used to provide financing for the property, the
interest of which is exempt from tax under section 103; or (c)
subsidized financing provided (directly or indirectly) under a
Federal, State, or local program in connection with the
property; or (4) any expenditure paid or incurred before the
date of enactment of the provision.\570\
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\568\ Cleanup cost-cap or stop-loss coverage is coverage that
places an upper limit on the costs of cleanup that the insured may have
to pay. Re-opener or regulatory action coverage is coverage for costs
associated with any future government actions that require further site
cleanup, including costs associated with the loss of use of site
improvements.
\569\ For this purpose, professional liability insurance is
coverage for errors and omissions by public and private parties dealing
with or managing contaminated land issues, and includes coverage under
policies referred to as owner-controlled insurance. Owner/operator
liability coverage is coverage for those parties that own the site or
conduct business or engage in cleanup operations on the site. Legal
defense coverage is coverage for lawsuits associated with liability
claims against the insured made by enforcement agencies or third
parties, including by private parties.
\570\ The Act authorizes the Secretary of the Treasury to issue
guidance regarding the treatment of government-provided funds for
purposes of determining eligible remediation expenditures.
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Qualified gain or loss
The Act generally excludes from unrelated business taxable
income the exempt organization's gain or loss from the sale,
exchange, or other disposition of a qualifying brownfield
property. Income, gain, or loss from other transfers does not
qualify under the provision.\571\ The amount of gain or loss
excluded from unrelated business taxable income is not limited
to or based upon the increase or decrease in value of the
property that is attributable to the taxpayer's expenditure of
eligible remediation expenditures. Further, the exclusion does
not apply to an amount treated as gain that is ordinary income
with respect to section 1245 or section 1250 property,
including any amount deducted as a section 198 expense that is
subject to the recapture rules of section 198(e), if the
taxpayer had deducted such amount in the computation of its
unrelated business taxable income.\572\
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\571\ For example, rent income from leasing the property does not
qualify under the proposal.
\572\ Depreciation or section 198 amounts that the taxpayer had not
used to determine its unrelated business taxable income are not treated
as gain that is ordinary income under sections 1245 or 1250 (secs.
1.1245-2(a)(8) and 1.1250-2(d)(6)), and are not recognized as gain or
ordinary income upon the sale, exchange, or disposition of the
property. Thus, an exempt organization would not be entitled to a
double benefit resulting from a section 198 expense deduction and the
proposed exclusion from gain with respect to any amounts it deducts
under section 198.
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Special rules for qualifying partnerships
In general
In the case of a tax-exempt organization that is a partner
of a qualifying partnership that acquires, remediates, and
disposes of a qualifying brownfield property, the Act applies
to the tax-exempt partner's distributive share of the
qualifying partnership's gain or loss from the disposition of
the property.\573\ A qualifying partnership is a partnership
that: (1) has a partnership agreement that satisfies the
requirements of section 514(c)(9)(B)(vi) at all times beginning
on the date of the first certification received by the
partnership that one of its properties is a qualifying
brownfield property; (2) satisfies the requirements of the
proposal if such requirements are applied to the partnership
(rather than to the eligible taxpayer that is a partner of the
partnership); and (3) is not an organization that would be
prevented from constituting an eligible taxpayer by reason of
it or an affiliate being potentially liable under CERCLA with
respect to the property.
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\573\ The Act's exclusions do not apply to a tax-exempt partner's
gain or loss from the tax-exempt partner's sale, exchange, or other
disposition of its partnership interest. Such transactions continue to
be governed by present-law.
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The exclusion is available to a tax-exempt organization
with respect to a particular property acquired, remediated, and
disposed of by a qualifying partnership only if the exempt
organization is a partner of the partnership at all times
during the period beginning on the date of the first
certification received by the partnership that one of its
properties is a qualifying brownfield property, and ending on
the date of the disposition of the property by the
partnership.\574\
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\574\ The Act subjects a tax-exempt partner to tax on gain
previously excluded by the partner (plus interest) if a property
subsequently becomes ineligible for exclusion under the qualifying
partnership's multiple-property election.
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Under the Act, the Secretary shall prescribe such
regulations as are necessary to prevent abuse of the
requirements of the provision, including abuse through the use
of special allocations of gains or losses, or changes in
ownership of partnership interests held by eligible taxpayers.
Certifications and multiple property elections
If the property is acquired and remediated by a qualifying
partnership of which the exempt organization is a partner, it
is intended that the certification as to status as a qualified
brownfield property and the remediation certification will be
obtained by the qualifying partnership, rather than by the tax-
exempt partner, and that both the eligible taxpayer and the
qualifying partnership will be required to make available such
copies of the certifications to the IRS. Any elections or
revocations regarding the application of the eligible
remediation expenditure rules to multiple properties (as
described below) acquired, remediated, and disposed of by a
qualifying partnership must be made by the partnership. A tax-
exempt partner is bound by an election made by the qualifying
partnership of which it is a partner.
Special rules for multiple properties
The eligible remediation expenditure determinations
generally are made on a property-by-property basis. An exempt
organization (or a qualifying partnership of which the exempt
organization is a partner) that acquires, remediates, and
disposes of multiple qualifying brownfield properties, however,
may elect to make the eligible remediation expenditure
determinations on a multiple-property basis. In the case of
such an election, the taxpayer satisfies the eligible
remediation expenditures test with respect to all qualifying
brownfield properties acquired during the election period if
the average of the eligible remediation expenditures for all
such properties exceeds the greater of: (a) $550,000; or (b) 12
percent of the average of the fair market value of the
properties, determined as of the dates they were acquired by
the taxpayer and as if they were not contaminated. If the
eligible taxpayer elects to make the eligible remediation
expenditure determination on a multiple property basis, then
the election shall apply to all qualifying sales, exchanges, or
other dispositions of qualifying brownfield properties the
acquisition and transfer of which occur during the period for
which the election remains in effect.\575\
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\575\ If the taxpayer fails to satisfy the averaging test for the
properties subject to the election, then the taxpayer may not apply the
exclusion on a separate property basis with respect to any of such
properties.
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An acquiring taxpayer makes a multiple-property election
with its timely filed tax return (including extensions) for the
first taxable year for which it intends to have the election
apply. A timely filed election is effective as of the first day
of the taxable year of the return in which the election is
included or a later day in such taxable year selected by the
taxpayer. An election remains effective until the earliest of a
date selected by the taxpayer, the date which is eight years
after the effective date of the election, the effective date of
a revocation of the election, or, in the case of a partnership,
the date of the termination of the partnership.
A taxpayer may revoke a multiple-property election by
filing a statement of revocation with a timely filed tax return
(including extensions). A revocation is effective as of the
first day of the taxable year of the return in which the
revocation is included or a later day in such taxable year
selected by the eligible taxpayer or qualifying partnership.
Once a taxpayer revokes the election, the taxpayer is
ineligible to make another multiple-property election with
respect to any qualifying brownfield property subject to the
revoked election.\576\
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\576\ The Act subjects a taxpayer to tax on gain previously
excluded (plus interest) in the event a site subsequently becomes
ineligible for gain exclusion under the multiple-property election.
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Debt-financed property
The Act provides that debt-financed property, as defined by
section 514(b), does not include any property the gain or loss
from the sale, exchange, or other disposition of which is
excluded by reason of the provisions of the proposal that
exclude such gain or loss from computing the gross income of
any unrelated trade or business of the taxpayer. Thus, gain or
loss from the sale, exchange, or other disposition of a
qualifying brownfield property that otherwise satisfies the
requirements of the provision is not taxed as unrelated
business taxable income merely because the taxpayer incurred
debt to acquire or improve the site.
Termination date
The Act provides for a termination date of December 31,
2009, by applying to gain or loss on the sale, exchange, or
other disposition of property that is acquired by the eligible
taxpayer or qualifying partnership during the period beginning
January 1, 2005, and ending December 31, 2009. Property
acquired during the five-year acquisition period need not be
disposed of by the termination date in order to qualify for the
exclusion. For purposes of the multiple property election, gain
or loss on property acquired after December 31, 2009, is not
eligible for the exclusion from unrelated business taxable
income, although properties acquired after the termination date
(but during the election period) are included for purposes of
determining average eligible remediation expenditures.
Effective Date
The provision applies to gain or loss on property that is
acquired after December 31, 2004, subject to the December 31,
2009, termination date provision.
C. Civil Rights Tax Relief (sec. 703 of the Act and sec. 62 of the
Code)
Present and Prior Law
Under present and prior law, gross income generally does
not include the amount of any damages (other than punitive
damages) received (whether by suit or agreement and whether as
lump sums or as periodic payments) by individuals on account of
personal physical injuries (including death) or physical
sickness.\577\ Expenses relating to recovering such damages are
generally not deductible.\578\
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\577\ Sec. 104(a)(2).
\578\ Sec. 265(a)(1).
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Other damages are generally included in gross income. The
related expenses to recover the damages, including attorneys'
fees, are generally deductible as expenses for the production
of income,\579\ subject to the two-percent floor on itemized
deductions.\580\ Thus, such expenses are deductible only to the
extent the taxpayer's total miscellaneous itemized deductions
exceed two percent of adjusted gross income. Any amount
allowable as a deduction is subject to reduction under the
overall limitation of itemized deductions if the taxpayer's
adjusted gross income exceeds a threshold amount.\581\ For
purposes of the alternative minimum tax, no deduction is
allowed for any miscellaneous itemized deduction.
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\579\ Sec. 212.
\580\ Sec. 67.
\581\ Sec. 68.
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In some cases, claimants will engage an attorney to
represent them on a contingent fee basis. That is, if the
claimant recovers damages, a prearranged percentage of the
damages will be paid to the attorney; if no damages are
recovered, the attorney is not paid a fee. The proper tax
treatment of contingent fee arrangements with attorneys has
been litigated in recent years. Some courts \582\ have held
that the entire amount of damages is income and that the
claimant is entitled to a miscellaneous itemized deduction
subject to both the two-percent floor as an expense for the
production of income for the portion paid to the attorney and
to the overall limitation on itemized deductions. Other courts
have held that the portion of the recovery that is paid
directly to the attorney is not income to the claimant, holding
that the claimant has no claim of right to that portion of the
recovery.\583\
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\582\ Kenseth v. Commissioner, 114 T.C. 399 (2000), aff'd 259 F.3d
881 (7th Cir. 2001); Coady v. Commissioner, 213 F.3d 1187 (9th Cir.
2000); Benci-Woodward v. Commissioner, 219 F.3d 941 (9th Cir. 2000);
Baylin v. United States, 43 F.3d 1451 (Fed. Cir. 1995).
Subsequent to the October 22, 2004, enactment of the American Jobs
Creation Act of 2004 (``AJCA''), the Supreme Court held that the
contingent attorney fees portion of a taxpayer's settlement proceeds is
an anticipatory assignment of income that is taxable income to the
taxpayer. See Commissioner v. Banks and Commissioner v. Banaitis, 125
S.Ct. 826 (2005).
\583\ Cotnam v. Commissioner, 263 F.2d 119 (5th Cir. 1959); Estate
of Arthur Clarks v. United States, 202 F.3d 854 (6th Cir. 2000);
Srivastava v. Commissioner, 220 F.3d 353 (5th Cir. 2000). In some of
these cases, such as Cotnam, State law has been an important
consideration in determining that the claimant has no claim of right to
the recovery.
As noted above, subsequent to the October 22, 2004, enactment of
the AJCA, the Supreme Court held that the contingent attorney fees
portion of a taxpayer's settlement proceeds is an anticipatory
assignment of income that is taxable income to the taxpayer. See Banks
and Banaitis, 125 S.Ct. 826.
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Explanation of Provision
The Act provides an above-the-line deduction for attorneys'
fees and costs paid by, or on behalf of, the taxpayer in
connection with any action involving a claim of unlawful
discrimination, certain claims against the Federal Government,
or a private cause of action under the Medicare Secondary Payer
statute. The amount that may be deducted above-the-line may not
exceed the amount includible in the taxpayer's gross income for
the taxable year on account of a judgment or settlement
(whether by suit or agreement and whether as lump sum or
periodic payments) resulting from such claim.
Under the Act, ``unlawful discrimination'' means an act
that is unlawful under certain provisions of any of the
following: the Civil Rights Act of 1991; the Congressional
Accountability Act of 1995; the National Labor Relations Act;
the Fair Labor Standards Act of 1938; the Age Discrimination in
Employment Act of 1967; the Rehabilitation Act of 1973; the
Employee Retirement Income Security Act of 1974; the Education
Amendments of 1972; the Employee Polygraph Protection Act of
1988; the Worker Adjustment and Retraining Notification Act;
the Family and Medical Leave Act of 1993; chapter 43 of Title
38 of the United States Code; the Revised Statutes; the Civil
Rights Act of 1964; the Fair Housing Act; the Americans with
Disabilities Act of 1990; any provision of Federal law
(popularly known as whistleblower protection provisions)
prohibiting the discharge of an employee, discrimination
against an employee, or any other form of retaliation or
reprisal against an employee for asserting rights or taking
other actions permitted under Federal law; or any provision of
Federal, State or local law, or common law claims permitted
under Federal, State, or local law providing for the
enforcement of civil rights or regulating any aspect of the
employment relationship, including claims for wages,
compensation, or benefits, or prohibiting the discharge of an
employee, discrimination against an employee, or any other form
of retaliation or reprisal against an employee for asserting
rights or taking other actions permitted by law.
Effective Date
The provision applies to fees and costs paid after the date
of enactment (October 22, 2004) with respect to any judgment or
settlement occurring after such date.
D. Seven-Year Recovery Period for Certain Track Facilities (sec. 704 of
the Act and sec. 168 of the Code)
Present and Prior Law
A taxpayer generally must capitalize the cost of property
used in a trade or business and recover such cost over time
through annual deductions for depreciation or amortization.
Tangible property generally is depreciated under the modified
accelerated cost recovery system (``MACRS''), which determines
depreciation by applying specific recovery periods, placed-in-
service conventions, and depreciation methods to the cost of
various types of depreciable property (sec. 168). The cost of
nonresidential real property is recovered using the straight-
line method of depreciation and a recovery period of 39 years.
Nonresidential real property is subject to the mid-month
placed-in-service convention. Under the mid-month convention,
the depreciation allowance for the first year property is
placed in service is based on the number of months the property
was in service, and property placed in service at any time
during a month is treated as having been placed in service in
the middle of the month. Land improvements (such as roads and
fences) are recovered over 15 years. An exception exists for
the theme and amusement park industry, whose assets are
assigned a recovery period of seven years.
Explanation of Provision
The Act provides a statutory seven-year recovery period for
permanent motorsports racetrack complexes. For this purpose,
motorsports racetrack complexes include land improvements and
support facilities but do not include transportation equipment,
warehouses, administrative buildings, hotels, or motels.
Effective Date
The provision is effective for property placed in service
after the date of enactment (October 22, 2004) and before
January 1, 2008. The Act also excludes racetrack facilities
placed in service after the date of enactment (October 22,
2004) from the definition of theme and amusement facilities
classified under Asset Class 80.0. The Congress does not intend
for this provision to create any inference as to the treatment
of property placed in service on or before the date of
enactment (October 22, 2004). Accordingly, the Congress does
not intend for the provision to affect the interpretation of
the scope of Asset Class 80.0 for assets placed in service
prior to the date of enactment (October 22, 2004). The Congress
strongly urges the Secretary to resolve expeditiously any
taxpayer disputes with respect to the scope of Class 80.0.
E. Distributions to Shareholders From Policyholders Surplus Account of
Life Insurance Companies (sec. 705 of the Act and sec. 815 of the Code)
Present and Prior Law
Under the law in effect from 1959 through 1983, a life
insurance company was subject to a three-phase taxable income
computation under Federal tax law. Under the three-phase
system, a company was taxed on the lesser of its gain from
operations or its taxable investment income (Phase I) and, if
its gain from operations exceeded its taxable investment
income, 50 percent of such excess (Phase II). Federal income
tax on the other 50 percent of the gain from operations was
deferred, and was accounted for as part of a policyholder's
surplus account and, subject to certain limitations, taxed only
when distributed to stockholders or upon corporate dissolution
(Phase III). To determine whether amounts had been distributed,
a company maintained a shareholders surplus account, which
generally included the company's previously taxed income that
would be available for distribution to shareholders.
Distributions to shareholders were treated as being first out
of the shareholders surplus account, then out of the
policyholders surplus account, and finally out of other
accounts.
The Deficit Reduction Act of 1984 included provisions that,
for 1984 and later years, eliminated further deferral of tax on
amounts (described above) that previously would have been
deferred under the three-phase system. Although for taxable
years after 1983, life insurance companies may not enlarge
their policyholders surplus account, the companies are not
taxed on previously deferred amounts unless the amounts are
treated as distributed to shareholders or subtracted from the
policyholders surplus account (sec. 815).
Any direct or indirect distribution to shareholders from an
existing policyholders surplus account of a stock life
insurance company is subject to tax at the corporate rate in
the taxable year of the distribution. Present law (like prior
law) provides that any distribution to shareholders is treated
as made (1) first out of the shareholders surplus account, to
the extent thereof, (2) then out of the policyholders surplus
account, to the extent thereof, and (3) finally, out of other
accounts.
Explanation of Provision
The Act suspends for a stock life insurance company's
taxable years beginning after December 31, 2004, and before
January 1, 2007, the application of the rules imposing income
tax on distributions to shareholders from the policyholders
surplus account of a life insurance company (sec. 815). The Act
also reverses the order in which distributions reduce the
various accounts, so that distributions are treated as first
made out of the policyholders surplus account, to the extent
thereof, and then out of the shareholders surplus account, and
lastly out of other accounts.
Effective Date
The provision is effective for taxable years beginning
after December 31, 2004.
F. Treat Certain Alaska Pipeline Property as Seven-Year Property (sec.
706 of the Act and sec. 168 of the Code)
Present and Prior Law
The applicable recovery period for assets placed in service
under the Modified Accelerated Cost Recovery System is based on
the ``class life of the property.'' The class lives of assets
placed in service after 1986 are generally set forth in Revenue
Procedure 87-56.\584\ Asset class 46.0, describing assets used
in the private, commercial, and contract carrying of petroleum,
gas and other products by means of pipes and conveyors, are
assigned a class life of 22 years and a recovery period of 15
years.
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\584\ 1987-2 C.B. 674 (as clarified and modified by Rev. Proc. 88-
22, 1988-1 C.B. 785).
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Reasons for Change \585\
The Congress recognized that, on our present course, the
nation will be ever more reliant on foreign governments, which
do not always have America's interest at heart, for oil and
natural gas. The Congress recognized that even with
conservation efforts and alternative sources of energy our
nation's long-term security depends on reducing our reliance on
foreign energy sources. In light of this, the Congress believed
it is appropriate to reduce the recovery period, and thus the
cost of capital, for investment in natural gas pipeline systems
in Alaska that meet certain requirements.
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\585\ See S. 1149, the ``Energy Tax Incentives Act of 2003,'' which
was reported by the Committee on Finance on May 23, 2003 (S. Rep. No.
108-54).
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Explanation of Provision
The Act establishes a statutory seven-year recovery period
and a class life of 22 years for any Alaska natural gas
pipeline. The term ``Alaska natural gas pipeline'' is defined
as any natural gas pipeline system (including the pipe, trunk
lines, related equipment, and appurtenances used to carry
natural gas, but not any gas processing plant) located in the
State of Alaska that has a capacity of more than 500 billion
Btu of natural gas per day and is placed in service after
December 31, 2013. A taxpayer who places an otherwise
qualifying system in service before January 1, 2014 may elect
to treat the system as placed in service on January 1, 2014,
thus qualifying for the seven-year recovery period.
Effective Date
The provision is effective for property placed in service
after December 31, 2004.
G. Enhanced Oil Recovery Credit for Certain Gas Processing Facilities
(sec. 707 of the Act and sec. 43 of the Code)
Present and Prior Law
The taxpayer may claim a credit equal to 15 percent of
enhanced oil recovery costs. Qualified enhanced oil recovery
costs include costs of depreciable tangible property that is
part of an enhanced oil recovery project, intangible drilling
and development costs with respect to an enhanced oil recovery
project, and tertiary injectant expenses incurred with respect
to an enhanced oil recovery project. The credit is phased out
when oil prices exceed a threshold amount.
Explanation of Provision
The Act provides that expenses in connection with the
construction of any qualifying natural gas processing plant
capable of processing two trillion British thermal units of
Alaskan natural gas into a natural gas pipeline system on a
daily basis are qualified enhanced oil recovery costs eligible
for the enhanced oil recovery credit. A qualifying natural gas
processing plant also must produce carbon dioxide for re-
injection into a producing oil or gas field.
Effective Date
The provision is effective for costs paid or incurred in
taxable years beginning after December 31, 2004.
H. Method of Accounting for Naval Shipbuilders (sec. 708 of the Act)
Present and Prior Law
Generally, taxpayers must use the percentage-of-completion
method to determine taxable income from long-term
contracts.\586\ Under sec. 10203(b)(2)(B) of the Revenue Act of
1987,\587\ an exception exists for certain ship construction
contracts, which may be accounted for using the 40/60
percentage-of-completion/capitalized cost method (``PCCM'').
Under the 40/60 PCCM, 60 percent of a taxpayer's long-term
contract income is exempt from the requirement to use the
percentage-of-completion method while 40 percent remains
subject to the requirement. The exempt 60 percent of long-term
contract income must be reported by consistently using the
taxpayer's exempt contract method. Permissible exempt contract
methods include the percentage-of-completion method, the
exempt-contract percentage-of-completion method, and the
completed contract method.\588\
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\586\ Sec. 460(a).
\587\ Pub. Law No. 100-203 (1987).
\588\ Treas. Reg. sec. 1.460-4(c)(1).
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Explanation of Provision
The Act provides that qualified naval ship contracts may be
accounted for using the 40/60 PCCM during the five taxable year
period beginning with the taxable year in which construction
commences.\589\ The cumulative reduction in tax resulting from
the provision over the five-year period is recaptured and
included in the taxpayer's tax liability in the sixth year.
Qualified naval ship contracts are defined as any contract or
portion thereof that is for the construction in the United
States of one ship or submarine for the Federal Government if
the taxpayer reasonably expects the acceptance date will occur
no later than nine years after the construction commencement
date.\590\ The Act specifies that the construction commencement
date is the date on which the physical fabrication of any
section or component of the ship or submarine begins in the
taxpayer's shipyard.
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\589\ A technical correction may be necessary so that the statute
reflect this intent.
\590\ For example, if a taxpayer enters into a contract to
construct three ships for the Federal government, and the taxpayer
reasonably expects the acceptance date with respect to each ship will
occur no later than nine years after the construction commencement date
of such ship, then the taxpayer is treted as having entered into three
separate qualified naval ship contracts. If the taxpayer meets the
reasonable expectation standard with respect to only two of the three
ships, then the taxpayer is treated as having entered into two separate
qualified naval ship contracts, and the portion of the overall contract
relating to the third ship is not treated as a qualified naval ship
contract.
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The Congress intended that section 481 not apply to any
change of accounting method required by this provision.\591\
Thus, a taxpayer who used a method other than the 40/60 PCCM in
taxable years prior to the taxable year in which construction
commences is not entitled to a section 481 adjustment when the
taxpayer begins using the 40/60 PCCM. Likewise, upon reverting
back to that prior method in the fifth year after the year in
which construction commences, no section 481 adjustment is
required because the recapture rule accomplishes a similar
purpose.
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\591\ A technical correction may be necessary so that the statute
reflects this intent.
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Effective Date
The provision is effective for contracts with respect to
which the construction commencement date occurs after date of
enactment (October 22, 2004).
I. Minimum Cost Requirement for Excess Pension Asset Transfers (sec.
709 of the Act and sec. 420 of the Code)
Present and Prior Law
Defined benefit plan assets generally may not revert to an
employer prior to termination of the plan and satisfaction of
all plan liabilities. In addition, a reversion may occur only
if the plan so provides. A reversion prior to plan termination
may constitute a prohibited transaction and may result in plan
disqualification. Any assets that revert to the employer upon
plan termination are includible in the gross income of the
employer and subject to an excise tax. The excise tax rate is
20 percent if the employer maintains a replacement plan or
makes certain benefit increases in connection with the
termination; if not, the excise tax rate is 50 percent. Upon
plan termination, the accrued benefits of all plan participants
are required to be 100-percent vested.
A pension plan may provide medical benefits to retired
employees through a separate account that is part of such plan.
A qualified transfer of excess assets of a defined benefit plan
to such a separate account within the plan may be made in order
to fund retiree health benefits.\592\ A qualified transfer does
not result in plan disqualification, is not a prohibited
transaction, and is not treated as a reversion. Thus,
transferred assets are not includible in the gross income of
the employer and are not subject to the excise tax on
reversions. No more than one qualified transfer may be made in
any taxable year. No qualified transfer may be made after
December 31, 2013.
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\592\ Sec. 420.
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Excess assets generally means the excess, if any, of the
value of the plan's assets \593\ over the greater of (1) the
accrued liability under the plan (including normal cost) or (2)
125 percent of the plan's current liability.\594\ In addition,
excess assets transferred in a qualified transfer may not
exceed the amount reasonably estimated to be the amount that
the employer will pay out of such account during the taxable
year of the transfer for qualified current retiree health
liabilities. No deduction is allowed to the employer for (1) a
qualified transfer or (2) the payment of qualified current
retiree health liabilities out of transferred funds (and any
income thereon).
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\593\ The value of plan assets for this purpose is the lesser of
fair market value or acturarial value.
\594\ In the case of plan years beginning before January 1, 2004,
excess assets generally means the excess, if any, of the value of the
plan's assets over the greater of (1) the lesser of (a) the accrued
liability under the plan (including normal cost) or (b) 170 percent of
the plan's current liability (for 2003), or (2) 125 percent of the
plan's current liability. The current liability full funding limit was
repealed for years beginning after 2003. Under the general sunset
provision of EGTRRA, the limit is reinstated for years after 2010.
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Transferred assets (and any income thereon) must be used to
pay qualified current retiree health liabilities for the
taxable year of the transfer. Transferred amounts generally
must benefit pension plan participants, other than key
employees, who are entitled upon retirement to receive retiree
medical benefits through the separate account. Retiree health
benefits of key employees may not be paid out of transferred
assets.
Amounts not used to pay qualified current retiree health
liabilities for the taxable year of the transfer are to be
returned to the general assets of the plan. These amounts are
not includible in the gross income of the employer, but are
treated as an employer reversion and are subject to a 20-
percent excise tax.
In order for a transfer to be qualified, accrued retirement
benefits under the pension plan generally must be 100-percent
vested as if the plan terminated immediately before the
transfer (or in the case of a participant who separated in the
one-year period ending on the date of the transfer, immediately
before the separation).
In order for a transfer to be qualified, the transfer must
meet the minimum cost requirement. To satisfy the minimum cost
requirement, an employer generally must maintain retiree health
benefits at the same level for the taxable year of the transfer
and the following four years (referred to as the cost maintance
period). The applicable employer cost during the cost
maintenance period cannot be less than the higher of the
applicable employer costs for each of the two taxable years
preceding the taxable year of the transfer. The applicable
employer cost is generally determined by dividing the current
retiree health liabilities by the number of individuals
provided coverage for applicable health benefits during the
year. The Secretary is directed to prescribe regulations as may
be necessary to prevent an employer who significantly reduces
retiree health coverage during the period from being treated as
satisfying the minimum cost requirement.
Under Treasury regulations,\595\ the minimum cost
requirement is not satisfied if the employer significantly
reduces retiree health coverage during the cost maintenance
period. Under the regulations, an employer significantly
reduces retiree health coverage for a year (beginning after
2001) during the cost maintenance period if either (1) the
employer-initiated reduction percentage for that taxable year
exceeds 10 percent, or (2) the sum of the employer-initiated
reduction percentages for that taxable year and all prior
taxable years during the cost maintenance period exceeds 20
percent.\596\ The employer-initiated reduction percentage is
the fraction, expressed as a percentage, of the number of
individuals receiving coverage for applicable health benefits
as of the day before the first day of the taxable year over the
total number of such individuals whose coverage for applicable
health benefits ended during the taxable year by reason of
employer action.\597\ Thus, under prior law, reductions in
retiree health coverage would not cause a violation of section
420 only if the reduction was accomplished through a change in
the number of individuals covered.
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\595\ Treas. Reg. sec. 1.420-1(a).
\596\ Treas. Reg. sec. 1.420-1(b)(1).
\597\ Treas. Reg. sec. 1.420.
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Reasons for Change \598\
The Congress believed that it was appropriate to provide
greater flexibility in complying with the minimum cost
requirement. The Congress believed that the requirement should
not be violated if the reduction in health cost is not more
than the allowable reduction in retiree health coverage.
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\598\ See S. 2424, the ``National Employee Savings and Trust Equity
Guarantee Act,'' which was reported by the Senate Committee on Finance
on May 14, 2004 (S. Rep. No. 108-266).
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Explanation of Provision
The Act provides that an eligible employer does not fail
the minimum cost requirement if, in lieu of any reduction of
health coverage permitted by Treasury regulations, the employer
reduces applicable employer cost by an amount not in excess of
the reduction in costs which would have occurred if the
employer had made the maximum permissible reduction in retiree
health coverage under such regulations. An employer is an
eligible employer if, for the preceding taxable year, the
qualified current retiree health liabilities of the employer
were at least five percent of gross receipts.
In applying such regulations to any subsequent taxable
year, any reduction in applicable employer cost under the
proposal is treated as if it were an equivalent reduction in
retiree health coverage.
Effective Date
The provision is effective for taxable years ending after
the date of enactment (October 22, 2004).
J. Credit for Electricity Produced from Certain Sources (sec. 710 of
the Act and sec. 45 of the Code)
Present and Prior Law
An income tax credit is allowed for the production of
electricity from either qualified wind energy, qualified
``closed-loop'' biomass, or qualified poultry waste facilities
(sec. 45). The amount of the credit is 1.5 cents per kilowatt-
hour (indexed for inflation) of electricity produced. The
amount of the credit is 1.8 cents per kilowatt-hour for 2004.
The credit is reduced for grants, tax-exempt bonds, subsidized
energy financing, and other credits.
The credit applies to electricity produced by a wind energy
facility placed in service after December 31, 1993, and before
January 1, 2006, to electricity produced by a closed-loop
biomass facility placed in service after December 31, 1992, and
before January 1, 2006, and to a poultry waste facility placed
in service after December 31, 1999, and before January 1, 2006.
The credit is allowable for production during the 10-year
period after a facility is originally placed in service. In
order to claim the credit, a taxpayer must own the facility and
sell the electricity produced by the facility to an unrelated
party. In the case of a poultry waste facility, the taxpayer
may claim the credit as a lessee/operator of a facility owned
by a governmental unit.
Reasons for Change \599\
Based on the success of the section 45 credit in the
development of wind power as an alternative source of
electricity generation, the Congress believed the country will
benefit from the expansion of the production credit to certain
other ``environmentally friendly'' sources of electricity
generation such as open-loop biomass, including agricultural
livestock waste nutrients, geothermal power, solar power, small
irrigation systems, landfill gas, and trash combustion. While
not all of these additional facilities are pollution free, they
do address environmental concerns related to waste disposal
and, in the case of landfill gas, mitigate the release of
methane gas into the atmosphere. In addition, these potential
power sources further diversify the nation's energy supply.
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\599\ H.R. 4520, which was reported by the House Committee on Ways
and Means on June 16, 2004 (H.R. Rep. No. 108-548) and passed the House
of Representatives on June 17, 2004, provided for an extension of the
placed in service date for certain qualified facilities, as explained
in Part Fifteen, above, but did not contain provisions for the
expansion of qualifying facilities. However, the conference agreement
for H.R. 6, the ``Energy Policy Act of 2003'' (H.R. Rep. No. 108-375),
contained provisions nearly identifical to S. 1637, the ``Jumpstart Our
Business Strength (JOBS) Act'' (S. Rep. No. 108-192), as passed by the
Senate on May 11, 2004.
These reasons for change were included for similar provisions
included in H.R. 1531, the ``Energy Tax Policy Act of 2003,'' which was
reported by the House Committee on Ways and Means on April 9, 2003
(H.R. Rep. No. 108-67) and S. 1149, the ``Energy Tax Incentive Act of
2003,'' which was reported by the Senate Committee on Finance on May 2,
2003 (S. Rep. No. 108-54). The two bills were conferenced to produce
H.R. 6. The conference agreement for H.R. 6 provided tax benefits for
``refined coal'' as part of modifications to seciton 29 of the Code.
The American Jobs Creation Act provided similar tax benefits as part of
the expansion of section 45.
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The Congress also believed it is appropriate to include in
qualifying facilities those facilities that co-fire closed-loop
biomass fuels with coal, with other biomass, or with coal and
other biomass.
The Congress also recognized that the credit for production
of synthetic fuels from coal, provided by section 29 of the
Code, has been interpreted to include fuels that are merely
chemical changes to coal that do not necessarily enhance the
value or environmental performance of the feedstock coal.
Therefore, the Congress believed it is appropriate to provide a
tax credit only to fuels produced from coal that achieve
significant environmental and value-added improvements.
Lastly, the Congress believed that certain pre-existing
facilities should qualify for the section 45 production credit,
albeit at a reduced rate. These facilities previously received
explicit subsidies, or implicit subsidies provided through rate
regulation. In a deregulated electricity market, these
facilities, and the environmental benefits they yield, may be
uneconomic without additional economic incentive. The Congress
believed the benefits provided by such existing facilities
warrant their inclusion in the section 45 production credit.
Explanation of Provision
In general
The Act makes substantial modifications to sec. 45,
primarily in defining additional qualified facilities eligible
for the production tax credit.
Modification of placed in service date for existing facilities
The Act modifies the placed in service date with respect to
qualifying closed-loop biomass facilities modified to use
closed-loop biomass to co-fire with coal, to co-fire with other
biomass, or to co-fire with coal and other biomass, but only if
the modification is approved under the Biomass Power for Rural
Development Programs or is part of a pilot project of the
Commodity Credit Corporation. In the case of such a facility, a
qualified facility must be originally placed in service and
modified to co-fire the closed-loop biomass at any time before
January 1, 2006. For such a facility, the 10-year credit period
begins no earlier than October 22, 2004.
Additional qualifying resource and facilities
The Act also defines five new qualifying resources for the
production of electricity: open-loop biomass (including
agricultural livestock waste nutrients), geothermal energy,
solar energy, small irrigation power, and municipal solid
waste. Two different qualifying facilities use municipal solid
waste as a qualifying resource: landfill gas facilities and
trash combustion facilities. In addition, the Act defines
refined coal as a qualifying resource.
Open-loop biomass (including agricultural livestock waste
nutrients) facility
An open-loop biomass facility is a facility using open-loop
biomass (including agricultural livestock waste nutrients) to
produce electricity. Open-loop biomass is defined as any solid,
nonhazardous, cellulosic waste material or any nonhazardous
lignin waste material \600\ which is segregated from other
waste materials and which is derived from eligible forest-
related resources, solid wood waste materials, or agricultural
sources. Eligible forest-related resources are mill residues,
other than spent chemicals from pulp manufacturing,
precommercial thinnings, slash, and brush. Solid wood waste
materials include waste pallets, crates, dunnage, manufacturing
and construction wood wastes (other than pressure-treated,
chemically-treated, or painted wood wastes), and landscape or
right-of-way tree trimmings. Agricultural sources include
orchard tree crops, vineyard, grain, legumes, sugar, and other
crop by-products or residues. However, qualifying open-loop
biomass does not include municipal solid waste (garbage), gas
derived from biodegradation of solid waste, or paper that is
commonly recycled. In addition, open-loop biomass does not
include closed-loop biomass or any biomass burned in
conjunction with fossil fuel (cofiring) beyond such fossil fuel
required for start up and flame stabilization.
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\600\ A technical correction may be necessary so that the statute
reflects this intent.
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Agricultural livestock waste nutrients are defined as
agricultural livestock manure and litter, including bedding
material for the disposition of manure. The installed capacity
of a qualified agricultural livestock waste nutrient facility
must be at least 150 kilowatts.
To be a qualified facility, an open-loop biomass facility
must be placed in service after October 22, 2004 and before
January 1, 2006, in the case of facility using agricultural
livestock waste nutrients and must be placed in service at any
time prior to January 1, 2006 in the case of a facility using
other open-loop biomass.
Geothermal facility
A geothermal facility is a facility that uses geothermal
energy to produce electricity. Geothermal energy is energy
derived from a geothermal deposit which is a geothermal
reservoir consisting of natural heat which is stored in rocks
or in an aqueous liquid or vapor (whether or not under
pressure). To be a qualified facility, a geothermal facility
must be placed in service after the date of enactment (October
22, 2004) and before January 1, 2006. A qualifying geothermal
energy facility may not have claimed any credit under sec. 48
of the Code.\601\
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\601\ If a geothermal facility claims credit for any year under
section 45 of the Code, the facility is precluded from claiming any
investment credit under section 48 of the Code in the future.
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Solar facility
A solar facility is a facility that uses solar energy to
produce electricity. To be a qualified facility, a solar
facility must be placed in service after the date of enactment
(October 22, 2004) and before January 1, 2006. A qualifying
solar energy facility may not have claimed any credit under
sec. 48 of the Code.\602\
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\602\ If a solar facility claims credit for any year under section
45 of the Code, the facility is precluded from claiming any investment
credit under section 48 of the Code in the future.
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Small irrigation facility
A small irrigation power facility is a facility that
generates electric power through an irrigation system canal or
ditch without any dam or impoundment of water. The installed
capacity of a qualified facility must be at least 150 kilowatts
and less than five megawatts. To be a qualified facility, a
small irrigation facility must be originally placed in service
after the date of enactment and before January 1, 2006.
Landfill gas facility
A landfill gas facility is a facility that uses landfill
gas to produce electricity. Landfill gas is defined as methane
gas derived from the biodegradation of municipal solid waste.
To be a qualified facility, a landfill gas facility must be
placed in service after October 22, 2004 and before January 1,
2006.
Trash combustion facility
Trash combustion facilities are facilities that burn
municipal solid waste (garbage) to produce steam to drive a
turbine for the production of electricity. To be a qualified
facility, a trash combustion facility must be placed in service
after October 22, 2004 and before January 1, 2006.
Refined coal facility
A refined coal facility is a facility that produces refined
coal. Refined coal is a qualifying liquid, gaseous, or solid
synthetic fuel produced from coal (including lignite) or high-
carbon fly ash, including such fuel used as a feedstock. A
qualifying fuel is a fuel that when burned emits 20 percent
less nitrogen oxides and either SO2 or mercury than
the burning of feedstock coal or comparable coal predominantly
available in the marketplace as of January 1, 2003, and if the
fuel sells at prices at least 50 percent greater than the
prices of the feedstock coal or comparable coal. In addition,
to be qualified refined coal the fuel must be sold by the
taxpayer with the reasonable expectation that it will be used
for the primary purpose of producing steam. A qualifying
refined coal facility is a facility producing refined coal that
is placed in service after October 22, 2004, and before January
1, 2009.
Credit period and credit rates
In general, the Act provides that taxpayers may claim the
credit at a rate of 1.5 cents per kilowatt-hour (indexed for
inflation and 1.8 cents per kilowatt-hour for 2004) for 10
years of production commencing on the date the facility is
placed in service.
In the case of open-loop biomass (including agricultural
livestock waste nutrients) facilities, geothermal energy
facilities, solar energy facilities, small irrigation power
facilities, landfill gas facilities, and trash combustion
facilities the 10-year credit period is reduced to five years
commencing on the date the facility is placed in service. In
general, for facilities placed in service prior to January 1,
2005, the credit period commences on January 1, 2005.\603\ In
the case of closed-loop biomass facilities modified to co-fire
with coal, to co-fire with other biomass, or to co-fire with
coal and other biomass, the credit period shall begin no
earlier than October 22, 2004.
In the case of open-loop biomass (including agricultural
livestock waste nutrients) facilities, small irrigation power
facilities, landfill gas facilities, and trash combustion
facilities, the otherwise allowable credit amount is reduced by
one half.
An alternative credit applies for the production of refined
coal. A qualified refined coal facility may claim credit at a
rate of $4.375 per ton (indexed for inflation after 1992 \604\)
of refined coal sold to an unrelated person. As is the case for
facilities that produce electricity, the credit a taxpayer may
claim for the production of refined coal is phased out as the
market price of refined coal exceeds certain threshold levels.
The threshold is defined by reference to the price of feedstock
fuel used to produce refined coal. Thus if a producer of
refined coal uses Powder River Basin coal as a feedstock, the
threshold price is determined by reference to prices of Powder
River Basin coal. If the producer uses Appalachian coal, the
threshold price is determined by reference to prices of
Appalachian coal.
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\603\ A technical correction may be necessary so that the statute
reflects this intent.
\604\ This amount would have equaled $5.350 per ton for 2004.
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Credit claimants, treatment of other subsidies, and other provisions
The Act provides that a lessee or operator may claim the
credit in lieu of the owner of the qualifying facility in the
case of qualifying open-loop biomass facilities originally
placed in service on or before the date of enactment and in the
case of closed-loop biomass facilities modified to co-fire with
coal, to co-fire with other biomass, or to co-fire with coal
and other biomass.
In addition, for all qualifying facilities, other than
closed-loop biomass facilities modified to co-fire with coal,
to co-fire with other biomass, or to co-fire with coal and
other biomass, the Act provides that any reduction in credit by
reason of grants, tax-exempt bonds, subsidized energy
financing, and other credits cannot exceed 50 percent. In the
case of closed-loop biomass facilities modified to co-fire with
coal, to co-fire with other biomass, or to co-fire with coal
and other biomass, there is no reduction in credit by reason of
grants, tax-exempt bonds, subsidized energy financing, and
other credits.
The amendments made by the Act do not apply with respect to
any poultry waste facility placed in service prior to January
1, 2005. Such facilities placed in service after December 31,
2004 generally may qualify for credit as animal livestock waste
nutrient facilities.
The Act provides that no facility is a qualifying landfill
gas facility for purposes of section 45 if the facility
produces electricity from gas derived from the biodegradation
of municipal solid waste if such gas is produced at a facility
for which a credit under section 29 of the Code is allowed in
the current year or was allowed in any prior taxable year.\605\
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\605\ A technical correction may be necessary so that the statute
reflects this intent.
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The Act provides that a taxpayer's tentative minimum tax is
treated as being zero for purposes of determining the tax
liability limitation with respect to the section 45 credit for
electricity produced from a facility (placed in service after
October 22, 2004) during the first four years of production
beginning on the date the facility is placed in service.
Effective Date
The provision is effective for electricity produced and
sold from qualifying facilities after October 22, 2004 in
taxable years ending after the date of enactment (October 22,
2004). With respect to open-loop biomass facilities placed in
service prior to January 1, 2005, the provisions are effective
for electricity produced and sold after December 31, 2004.
K. Allow Certain Business Energy Credits Against the Alternative
Minimum Tax (sec. 711 of the Act and sec. 38 of the Code)
Present and Prior Law
Under prior law, generally, business tax credits may not
exceed the excess of the taxpayer's income tax liability over
the tentative minimum tax (or, if greater, 25 percent of the
regular tax liability). Credits in excess of the limitation may
be carried back one year and carried forward for up to 20
years.
The tentative minimum tax is an amount equal to specified
rates of tax imposed on the excess of the alternative minimum
taxable income over an exemption amount. To the extent the
tentative minimum tax exceeds the regular tax, a taxpayer is
subject to the alternative minimum tax.
Reasons for Change \606\
The alternative minimum tax limits the intended incentive
effects of tax credits for some taxpayers. The Congress
believed that the incentive effects of business energy credits
should be available to taxpayers regardless of their
alternative minimum tax status. Accordingly, the Act provides
that certain business energy credits can be utilized by
offsetting both the regular tax and the alternative minimum
tax.
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\606\ See H. R. 1531, the ``Energy Tax Policy Act of 2003, which
was reported by the House Committee on Ways and Means on April 9, 2003
(H.R. Rep. No. 108-67).
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Explanation of Provision
The Act treats the tentative minimum tax as being zero for
purposes of determining the tax liability limitation with
respect to: (1) for taxable years beginning after December 31,
2004, the alcohol fuels credit determined under section 40; and
(2) the section 45 credit for electricity produced from a
facility (placed in service after the date of enactment) during
the first four years of production beginning on the date the
facility is placed in service.
Effective Date
The provision is effective for taxable years ending after
the date of enactment (October 22, 2004).
VII. REVENUE PROVISIONS
A. Provisions to Reduce Tax Avoidance Through Individual and Corporate
Expatriation
1. Tax treatment of expatriated entities and their foreign parents
(sec. 801 of the Act and new sec. 7874 of the Code)
Present and Prior Law
Determination of corporate residence
The U.S. tax treatment of a multinational corporate group
depends significantly on whether the parent corporation of the
group is domestic or foreign. For purposes of U.S. tax law, a
corporation is treated as domestic if it is incorporated under
the law of the United States or of any State. Other
corporations (i.e., those incorporated under the laws of
foreign countries) are treated as foreign.
U.S. taxation of domestic corporations
The United States employs a ``worldwide'' tax system, under
which domestic corporations generally are taxed on all income,
whether derived in the United States or abroad. In order to
mitigate the double taxation that may arise from taxing the
foreign-source income of a domestic corporation, a foreign tax
credit for income taxes paid to foreign countries is provided
to reduce or eliminate the U.S. tax owed on such income,
subject to certain limitations.
Income earned by a domestic parent corporation from foreign
operations conducted by foreign corporate subsidiaries
generally is subject to U.S. tax when the income is distributed
as a dividend to the domestic corporation. Until such
repatriation, the U.S. tax on such income generally is
deferred, and U.S. tax is imposed on such income when
repatriated. However, certain anti-deferral regimes may cause
the domestic parent corporation to be taxed on a current basis
in the United States with respect to certain categories of
passive or highly mobile income earned by its foreign
subsidiaries, regardless of whether the income has been
distributed as a dividend to the domestic parent corporation.
The main anti-deferral regimes in this context are the
controlled foreign corporation rules of subpart F (secs. 951-
964) and the passive foreign investment company rules (secs.
1291-1298). A foreign tax credit is generally available to
offset, in whole or in part, the U.S. tax owed on this foreign-
source income, whether repatriated as an actual dividend or
included under one of the anti-deferral regimes.
U.S. taxation of foreign corporations
The United States taxes foreign corporations only on income
that has a sufficient nexus to the United States. Thus, a
foreign corporation is generally subject to U.S. tax only on
income that is ``effectively connected'' with the conduct of a
trade or business in the United States. Such ``effectively
connected income'' generally is taxed in the same manner and at
the same rates as the income of a U.S. corporation. An
applicable tax treaty may limit the imposition of U.S. tax on
business operations of a foreign corporation to cases in which
the business is conducted through a ``permanent establishment''
in the United States.
In addition, foreign corporations generally are subject to
a gross-basis U.S. tax at a flat 30-percent rate on the receipt
of interest, dividends, rents, royalties, and certain similar
types of income derived from U.S. sources, subject to certain
exceptions. The tax generally is collected by means of
withholding by the person making the payment. This tax may be
reduced or eliminated under an applicable tax treaty.
U.S. tax treatment of inversion transactions
A U.S. corporation may reincorporate in a foreign
jurisdiction and thereby replace the U.S. parent corporation of
a multinational corporate group with a foreign parent
corporation. These transactions are commonly referred to as
inversion transactions. Inversion transactions may take many
different forms, including stock inversions, asset inversions,
and various combinations of and variations on the two. Most of
the known transactions to date have been stock inversions. In
one example of a stock inversion, a U.S. corporation forms a
foreign corporation, which in turn forms a domestic merger
subsidiary. The domestic merger subsidiary then merges into the
U.S. corporation, with the U.S. corporation surviving, now as a
subsidiary of the new foreign corporation. The U.S.
corporation's shareholders receive shares of the foreign
corporation and are treated as having exchanged their U.S.
corporation shares for the foreign corporation shares. An asset
inversion reaches a similar result, but through a direct merger
of the top-tier U.S. corporation into a new foreign
corporation, among other possible forms. An inversion
transaction may be accompanied or followed by further
restructuring of the corporate group. For example, in the case
of a stock inversion, in order to remove income from foreign
operations from the U.S. taxing jurisdiction, the U.S.
corporation may transfer some or all of its foreign
subsidiaries directly to the new foreign parent corporation or
other related foreign corporations.
In addition to removing foreign operations from the U.S.
taxing jurisdiction, the corporate group may derive further
advantage from the inverted structure by reducing U.S. tax on
U.S.-source
income through various earnings stripping or other
transactions. This may include earnings stripping through
payment by a U.S. corporation of deductible amounts such as
interest, royalties, rents, or management service fees to the
new foreign parent or other foreign affiliates. In this
respect, the post-inversion structure enables the group to
employ the same tax-reduction strategies that are available to
other multinational corporate groups with foreign parents and
U.S. subsidiaries, subject to the same limitations (e.g., secs.
163(j) and 482).
Inversion transactions may give rise to immediate U.S. tax
consequences at the shareholder and/or the corporate level,
depending on the type of inversion. In stock inversions, the
U.S. shareholders generally recognize gain (but not loss) under
section 367(a), based on the difference between the fair market
value of the foreign corporation shares received and the
adjusted basis of the domestic corporation stock exchanged. To
the extent that a corporation's share value has declined, and/
or it has many foreign or tax-exempt shareholders, the impact
of this section 367(a) ``toll charge'' is reduced. The transfer
of foreign subsidiaries or other assets to the foreign parent
corporation also may give rise to U.S. tax consequences at the
corporate level (e.g., gain recognition and earnings and
profits inclusions under secs. 1001, 311(b), 304, 367, 1248 or
other provisions). The tax on any income recognized as a result
of these restructurings may be reduced or eliminated through
the use of net operating losses, foreign tax credits, and other
tax attributes.
In asset inversions, the U.S. corporation generally
recognizes gain (but not loss) under section 367(a) as though
it had sold all of its assets, but the shareholders generally
do not recognize gain or loss, assuming the transaction meets
the requirements of a reorganization under section 368.
Reasons for Change
The Congress believed that inversion transactions resulting
in a minimal presence in a foreign country of incorporation
were a means of avoiding U.S. tax and should be curtailed. In
particular, these transactions permit corporations and other
entities to continue to conduct business in the same manner as
they did prior to the inversion, but with the result that the
inverted entity avoids U.S. tax on foreign operations and may
engage in earnings-stripping techniques to avoid U.S. tax on
domestic operations. The Congress believed that corporate
inversion transactions were a symptom of larger problems with
our current system for taxing U.S.-based global businesses and
were also indicative of the unfair advantages that our tax laws
conveyed to foreign ownership.
The Act addressed the underlying problems with the U.S.
system of taxing U.S.-based global businesses, and this
provision removes the incentives for entering into inversion
transactions. The Congress believed that certain inversion
transactions have little or no non-tax effect or purpose and
should be disregarded for U.S. tax purposes. The Congress
believed that other inversion transactions may have sufficient
non-tax effect and purpose to be respected, but warrant that
any applicable corporate-level ``toll charges'' for
establishing the inverted structure not be offset by tax
attributes such as net operating losses or foreign tax credits.
Explanation of Provision
In general
The Act defines two different types of corporate inversion
transactions and establishes a different set of consequences
for each type. Certain partnership transactions also are
covered.
Transactions involving at least 80 percent identity of stock ownership
The first type of inversion is a transaction in which,
pursuant to a plan \607\ or a series of related transactions:
(1) a U.S. corporation becomes a subsidiary of a foreign-
incorporated entity or otherwise transfers substantially all of
its properties to such an entity in a transaction completed
after March 4, 2003; (2) the former shareholders of the U.S.
corporation hold (by reason of holding stock in the U.S.
corporation) 80 percent or more (by vote or value) of the stock
of the foreign-incorporated entity after the transaction; and
(3) the foreign-incorporated entity, considered together with
all companies connected to it by a chain of greater than 50
percent ownership (i.e., the ``expanded affiliated group''),
does not have substantial business activities in the entity's
country of incorporation, compared to the total worldwide
business activities of the expanded affiliated group. The Act
denies the intended tax benefits of this type of inversion by
deeming the top-tier foreign corporation to be a domestic
corporation for all purposes of the Code.\608\
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\607\ Acquisitions with respect to a domestic corporation or
partnership are deemed to be ``pursuant to a plan'' if they occur
within the four-year period beginning on the date which is two years
before the ownership threshold under the provision is met with respect
to such corporation or partnership.
\608\ Since the top-tier foreign corporation is treated for all
purposes of the Code as domestic, the shareholder-level ``toll charge''
of sec. 367(a) does not apply to these inversion transactions.
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In determining whether a transaction meets the definition
of an inversion under the provision, stock held by members of
the expanded affiliated group that includes the foreign
incorporated entity is disregarded. For example, if the former
top-tier U.S. corporation receives stock of the foreign
incorporated entity (e.g., so-called ``hook'' stock), that
stock would not be considered in determining whether the
transaction meets the definition. Similarly, if a U.S. parent
corporation converts an existing wholly owned U.S. subsidiary
into a new wholly owned controlled foreign corporation, all
stock of the new foreign corporation would be disregarded, with
the result that the transaction would not meet the definition
of an inversion under the provision. Stock sold in a public
offering related to the transaction also is disregarded for
these purposes.
Transfers of properties or liabilities as part of a plan a
principal purpose of which is to avoid the purposes of the
provision are disregarded. In addition, the Treasury Secretary
is to provide regulations to carry out the Act, including
regulations to prevent the avoidance of the purposes of the
provision, including avoidance through the use of related
persons, pass-through or other noncorporate entities, or other
intermediaries, and through transactions designed to qualify or
disqualify a person as a related person or a member of an
expanded affiliated group. Similarly, the Treasury Secretary is
granted authority to treat certain non-stock instruments as
stock, and certain stock as not stock, where necessary to carry
out the purposes of the provision.
Transactions involving at least 60 percent but less than 80 percent
identity of stock ownership
The second type of inversion is a transaction that would
meet the definition of an inversion transaction described
above, except that the 80-percent ownership threshold is not
met. In such a case, if at least a 60-percent ownership
threshold is met, then a second set of rules applies to the
inversion. Under these rules, the inversion transaction is
respected (i.e., the foreign corporation is treated as
foreign), but any applicable corporate-level ``toll charges''
for establishing the inverted structure are not offset by tax
attributes such as net operating losses or foreign tax credits.
Specifically, any applicable corporate-level income or gain
required to be recognized under sections 304, 311(b), 367,
1001, 1248, or any other provision with respect to the transfer
of controlled foreign corporation stock or the transfer or
license of other assets by a U.S. corporation as part of the
inversion transaction or after such transaction to a related
foreign person is taxable, without offset by any tax attributes
(e.g., net operating losses or foreign tax credits). This rule
does not apply to certain transfers of inventory and similar
property. These measures generally apply for a 10-year period
following the inversion transaction.
Under the Act, inversion transactions include certain
partnership transactions. Specifically, the provision applies
to transactions in which a foreign-incorporated entity acquires
substantially all of the properties constituting a trade or
business of a domestic partnership, if after the acquisition at
least 60 percent of the stock of the entity is held by former
partners of the partnership (by reason of holding their
partnership interests), provided that the other terms of the
basic definition are met. For purposes of applying this test,
all partnerships that are under common control within the
meaning of section 482 are treated as one partnership, except
as provided otherwise in regulations. In addition, the modified
``toll charge'' proposals apply at the partner level.
A transaction otherwise meeting the definition of an
inversion transaction is not treated as an inversion
transaction if, on or before March 4, 2003, the foreign-
incorporated entity had acquired directly or indirectly more
than half of the properties held directly or indirectly by the
domestic corporation, or more than half of the properties
constituting the partnership trade or business, as the case may
be.
Effective Date
The provision applies to taxable years ending after March
4, 2003.
2. Excise tax on stock compensation of insiders in expatriated
corporations (sec. 802 of the Act and secs. 162(m), 275(a), and
new sec. 4985 of the Code)
Present and Prior Law
The income taxation of a nonstatutory \609\ compensatory
stock option is determined under the rules that apply to
property transferred in connection with the performance of
services.\610\ If a nonstatutory stock option does not have a
readily ascertainable fair market value at the time of grant,
which is generally the case unless the option is actively
traded on an established market, no amount is included in the
gross income of the recipient with respect to the option until
the recipient exercises the option or disposes of the option in
an arm's length transaction.\611\ Upon exercise of such an
option, the excess of the fair market value of the stock
purchased over the option price is generally included in the
recipient's gross income as ordinary income in such taxable
year.\612\
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\609\ Nonstatutory stock options refer to stock options other than
incentive stock options and employee stock purchase plans, the taxation
of which is determined under sections 421-424.
\610\ Sec. 83.
\611\ If an individual receives a grant of a nonstatutory option
that has a readily ascertainable fair market value at the time the
option is granted, the excess of the fair market value of the option
over the amount paid for the option is included in the recipient's
gross income as ordinary income in the first taxable year in which the
option is either transferable or not subject to a substantial risk of
forfeiture.
\612\ Under section 83, such amount is includable in gross income
in the first taxable year in which the rights to the stock are
transferable or are not subject to substantial risk of forfeiture.
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The tax treatment of other forms of stock-based
compensation (e.g., restricted stock and stock appreciation
rights) is also determined under section 83. The excess of the
fair market value over the amount paid (if any) for such
property is generally includable in gross income in the first
taxable year in which the rights to the property are
transferable or are not subject to substantial risk of
forfeiture.
Shareholders are generally required to recognize gain upon
stock inversion transactions. An inversion transaction is
generally not a taxable event for holders of stock options and
other stock-based compensation.
Reasons for Change
The Congress believed that certain inversion transactions
are a means of avoiding U.S. tax and should be curtailed. The
Congress was concerned that, while shareholders are generally
required to recognize gain upon stock inversion transactions,
executives holding stock options and certain stock-based
compensation are not taxed upon such transactions. Since such
executives are often instrumental in deciding whether to engage
in inversion transactions, the Congress believed that, upon
certain inversion transactions, it was appropriate to impose an
excise tax on certain executives holding stock options and
stock-based compensation. Because shareholders are taxed at the
capital gains rate upon inversion transactions, the Congress
believed that it was appropriate to impose the excise tax at an
equivalent rate.
Explanation of Provision
In general
Under the Act, specified holders of stock options and other
stock-based compensation are subject to an excise tax upon
certain inversion transactions. The Act imposes an excise tax
on the value of specified stock compensation held (directly or
indirectly) by or for the benefit of a disqualified individual,
or a member of such individual's family, at any time during the
12-month period beginning six months before the corporation's
expatriation date. Specified stock compensation is treated as
held for the benefit of a disqualified individual if such
compensation is held by an entity, e.g., a partnership or
trust, in which the individual, or a member of the individual's
family, has an ownership interest. The excise tax is imposed at
a rate equal to the maximum rate of tax on the adjusted net
capital gain of an individual (i.e., the rate of the excise tax
would be 15 percent for 2005 through 2008 and 20 percent for
taxable years beginning after December 31, 2008).
Disqualified individuals
A disqualified individual is any individual who, with
respect to a corporation, is, at any time during the 12-month
period beginning on the date which is six months before the
expatriation date, subject to the requirements of section 16(a)
of the Securities and Exchange Act of 1934 with respect to the
corporation, or any member of the corporation's expanded
affiliated group,\613\ or would be subject to such requirements
if the corporation (or member) were an issuer of equity
securities referred to in section 16(a). Disqualified
individuals generally include officers (as defined by section
16(a)),\614\ directors, and 10-percent-or-greater owners of
private and publicly-held corporations.
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\613\ An expanded affiliated group is an affiliated group (under
section 1504) except that such group is determined without regard to
the exceptions for certain corporations and is determined applying a
greater than 50 percent threshold, in lieu of the 80-percent test.
\614\ An officer is defined as the president, principal financial
officer, principal accounting officer (or, if there is no such
accounting officer, the controller), any vice-president in charge of a
principal business unit, division or function (such as sales,
administration or finance), any other officer who performs a policy-
making function, or any other person who performs similar policy-making
functions.
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Application of excise tax
The excise tax is imposed on a disqualified individual of
an expatriated corporation (as defined in the bill) only if
gain (if any) is recognized in whole or part by any shareholder
by reason of a corporate inversion transaction as previously
defined in the bill.
Specified stock compensation
Specified stock compensation subject to the excise tax
includes any payment \615\ (or right to payment) granted by the
expatriated corporation (or any member of the corporation's
expanded affiliated group) to any person in connection with the
performance of services by a disqualified individual for such
corporation (or member of the corporation's expanded affiliated
group) if the value of the payment or right is based on, or
determined by reference to, the value or change in value of
stock of such corporation (or any member of the corporation's
expanded affiliated group). In determining whether such
compensation exists and valuing such compensation, all
restrictions, other than a non-lapse restriction, are ignored.
Thus, the excise tax applies, and the value subject to the tax
is determined, without regard to whether the specified stock
compensation is subject to a substantial risk of forfeiture or
is exercisable at the time of the inversion transaction.
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\615\ Under the Act, any transfer of property is treated as a
payment and any right to a transfer of property is treated as a right
to a payment.
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Specified stock compensation includes compensatory stock
and restricted stock grants, compensatory stock options, and
other forms of stock-based compensation, including stock
appreciation rights, phantom stock, and phantom stock options.
Specified stock compensation also includes nonqualified
deferred compensation that is treated as though it were
invested in stock or stock options of the expatriating
corporation (or member). For example, the Act applies to a
disqualified individual's nonqualified deferred compensation if
company stock is one of the actual or deemed investment options
under the nonqualified deferred compensation plan.
Specified stock compensation includes a compensation
arrangement that gives the disqualified individual an economic
stake substantially similar to that of a corporate shareholder.
A payment directly tied to the value of the stock is specified
stock compensation. The excise tax does not apply if a payment
is simply triggered by a target value of the corporation's
stock or where a payment depends on a performance measure other
than the value of the corporation's stock. Similarly, the tax
does not apply if the amount of the payment is not directly
measured by the value of the stock or an increase in the value
of the stock. For example, an arrangement under which a
disqualified individual would be paid a cash bonus equal to
$10,000 for every $1 increase in the share price of the
corporation's stock is subject to the Act because the direct
connection between the compensation amount and the value of the
corporation's stock gives the disqualified individual an
economic stake substantially similar to that of a shareholder.
By contrast, an arrangement under which a disqualified
individual would be paid a cash bonus of $500,000 if the
corporation's stock increased in value by 25 percent over two
years or $1,000,000 if the stock increased by 33 percent over
two years is not specified stock compensation, even though the
amount of the bonus generally is keyed to an increase in the
value of the stock.
The excise tax applies to any specified stock compensation
previously granted to a disqualified individual but cancelled
or cashed-out within the six-month period ending with the
expatriation date, and to any specified stock compensation
awarded in the six-month period beginning with the expatriation
date. As a result, for example, if a corporation cancels
outstanding options three months before the inversion
transaction and then reissues comparable options three months
after the transaction, the tax applies both to the cancelled
options and the newly granted options. It is intended that the
Secretary issue guidance to avoid double counting with respect
to specified stock compensation that is cancelled and then
regranted during the applicable 12-month period.
Specified stock compensation subject to the tax does not
include a statutory stock option or any payment or right from a
qualified retirement plan or annuity, tax-sheltered annuity,
simplified employee pension, or SIMPLE. In addition, under the
Act, the excise tax does not apply to any stock option that is
exercised during the six-month period before the expatriation
date or to any stock acquired pursuant to such exercise, if
income is recognized under section 83 on or before the
expatriation date with respect to the stock acquired pursuant
to such exercise. The excise tax also does not apply to any
specified stock compensation that is exercised, sold,
exchanged, distributed, cashed out, or otherwise paid during
such period in a transaction in which income, gain, or loss is
recognized in full.
Determination of amount subject to tax
For specified stock compensation held on the expatriation
date, the amount of the tax is determined based on the value of
the compensation on such date. The tax imposed on specified
stock compensation cancelled during the six-month period before
the expatriation date is determined based on the value of the
compensation on the day before such cancellation, while
specified stock compensation granted after the expatriation
date is valued on the date granted. Under the Act, the
cancellation of a non-lapse restriction is treated as a grant.
The value of the specified stock compensation on which the
excise tax is imposed is the fair value in the case of stock
options (including warrants or other similar rights to acquire
stock) and stock appreciation rights and the fair market value
for all other forms of compensation. For purposes of the tax,
the fair value of an option (or a warrant or other similar
right to acquire stock) or a stock appreciation right is
determined using an appropriate option-pricing model, as
specified or permitted by the Secretary, that takes into
account: (1) the stock price at the valuation date; (2) the
exercise price under the option; (3) the remaining term of the
option; (4) the volatility of the underlying stock and the
expected dividends on it; and (5) the risk-free interest rate
over the remaining term of the option. Options that have no
intrinsic value (or ``spread'') because the exercise price
under the option equals or exceeds the fair market value of the
stock at valuation nevertheless have a fair value and are
subject to tax under the Act. The value of other forms of
compensation, such as phantom stock or restricted stock, is the
fair market value of the stock as of the date of the
expatriation transaction. The value of any deferred
compensation that can be valued by reference to stock is the
amount that the disqualified individual would receive if the
plan were to distribute all such deferred compensation in a
single sum on the date of the expatriation transaction (or the
date of cancellation or grant, if applicable). It is expected
that the Secretary issue guidance on valuation of specified
stock compensation, including guidance similar to the guidance
issued under section 280G, except that the guidance would not
permit the use of a term other than the full remaining term and
would be modified as necessary or appropriate to carry out the
purposes of the Act. Pending the issuance of guidance, it is
intended that taxpayers can rely on the guidance issued under
section 280G (except that the full remaining term must be used
and recalculation is not permitted).
Other rules
The excise tax also applies to any payment by the
expatriated corporation or any member of the expanded
affiliated group made to an individual, directly or indirectly,
in respect of the tax. Whether a payment is made in respect of
the tax is determined under all of the facts and circumstances.
Any payment made to keep the individual in the same after-tax
position that the individual would have been in had the tax not
applied is a payment made in respect of the tax. This includes
direct payments of the tax and payments to reimburse the
individual for payment of the tax. It is expected that the
Secretary issue guidance on determining when a payment is made
in respect of the tax and that such guidance include certain
factors that give rise to a rebuttable presumption that a
payment is made in respect of the tax, including a rebuttable
presumption that if the payment is contingent on the inversion
transaction, it is made in respect to the tax. Any payment made
in respect of the tax is includible in the income of the
individual, but is not deductible by the corporation.
To the extent that a disqualified individual is also a
covered employee under section 162(m), the $1,000,000 limit on
the deduction allowed for employee remuneration for such
employee is reduced by the amount of any payment (including
reimbursements) made in respect of the tax under the Act. As
discussed above, this includes direct payments of the tax and
payments to reimburse the individual for payment of the tax.
The payment of the excise tax has no effect on the
subsequent tax treatment of any specified stock compensation.
Thus, the payment of the tax has no effect on the individual's
basis in any specified stock compensation and no effect on the
tax treatment for the individual at the time of exercise of an
option or payment of any specified stock compensation, or at
the time of any lapse or forfeiture of such specified stock
compensation. The payment of the tax is not deductible and has
no effect on any deduction that might be allowed at the time of
any future exercise or payment.
Under the Act, the Secretary is authorized to issue
regulations as may be necessary or appropriate to carry out the
purposes of the Act.
Effective Date
The provision is effective as of March 4, 2003, except that
periods before March 4, 2003, are not taken into account in
applying the excise tax to specified stock compensation held or
cancelled during the six-month period before the expatriation
date.
3. Reinsurance of U.S. risks in foreign jurisdictions (sec. 803 of the
Act and sec. 845(a) of the Code)
Present and Prior Law
In the case of a reinsurance agreement between two or more
related persons, present and prior law provides the Treasury
Secretary with authority to allocate among the parties or
recharacterize income (whether investment income, premium or
otherwise), deductions, assets, reserves, credits and any other
items related to the reinsurance agreement, or make any other
adjustment, in order to reflect the proper source and character
of the items for each party.\616\ For this purpose, related
persons are defined as in section 482. Thus, persons are
related if they are organizations, trades or businesses
(whether or not incorporated, whether or not organized in the
United States, and whether or not affiliated) that are owned or
controlled directly or indirectly by the same interests. The
provision may apply to a contract even if one of the related
parties is not a domestic company.\617\ In addition, the
provision also permits such allocation, recharacterization, or
other adjustments in a case in which one of the parties to a
reinsurance agreement is, with respect to any contract covered
by the agreement, in effect an agent of another party to the
agreement, or a conduit between related persons.
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\616\ Sec. 845(a).
\617\ See S. Rep. No. 97-494, 97th Cong., 2d Sess., 337 (1982)
(describing provisions relating to the repeal of modified coinsurance
provisions).
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Reason for Change
The Congress was concerned that reinsurance transactions
were being used to allocate income, deductions, or other items
inappropriately among U.S. and foreign related persons. The
Congress was concerned that foreign related party reinsurance
arrangements may be a technique for eroding the U.S. tax base.
The Congress believed that the provision permitting the
Treasury Secretary to allocate or recharacterize items related
to a reinsurance agreement should be applied to prevent
misallocation, improper characterization, or to make any other
adjustment in the case of such reinsurance transactions between
U.S. and foreign related persons (or agents or conduits). The
Congress also wished to clarify that, in applying the authority
with respect to reinsurance agreements, the amount, source or
character of the items may be allocated, recharacterized or
adjusted.
Explanation of Provision
The Act clarifies the rules of section 845, relating to
authority for the Treasury Secretary to allocate items among
the parties to a reinsurance agreement, recharacterize items,
or make any other adjustment, in order to reflect the proper
source and character of the items for each party. The Act
authorizes such allocation, recharacterization, or other
adjustment, in order to reflect the proper source, character or
amount of the item. It is intended that this authority \618\ be
exercised in a manner similar to the authority under section
482 for the Treasury Secretary to make adjustments between
related parties. It is intended that this authority be applied
in situations in which the related persons (or agents or
conduits) are engaged in cross-border transactions that require
allocation, recharacterization, or other adjustments in order
to reflect the proper source, character or amount of the item
or items. No inference is intended that present and prior law
does not provide this authority with respect to reinsurance
agreements.
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\618\ The authority to allocate, recharacterize or make other
adjustments was granted in connection with the repeal of provisions
relating to modified coinsurance transactions.
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No regulations have been issued under section 845(a). It is
expected that the Treasury Secretary will issue regulations
under section 845(a) to address effectively the allocation of
income (whether investment income, premium or otherwise) and
other items, the recharacterization of such items, or any other
adjustment necessary to reflect the proper amount, source or
character of the item.
Effective Date
The provision is effective for any risk reinsured after the
date of enactment (October 22, 2004).
4. Revision of tax rules on expatriation of individuals (sec. 804 of
the Act and secs. 877, 2107, 2501 and 6039G of the Code)
Present and Prior Law
In general
U.S. citizens and residents generally are subject to U.S
income taxation on their worldwide income. The U.S. tax may be
reduced or offset by a credit allowed for foreign income taxes
paid with respect to foreign source income. Nonresident aliens
are taxed at a flat rate of 30 percent (or a lower treaty rate)
on certain types of passive income derived from U.S. sources,
and at regular graduated rates on net profits derived from a
U.S. trade or business. The estates of nonresident aliens
generally are subject to estate tax on U.S.-situated property
(e.g., real estate and tangible property located within the
United States and stock in a U.S. corporation). Nonresident
aliens generally are subject to gift tax on transfers by gift
of U.S.-situated property (e.g., real estate and tangible
property located within the United States, but excluding
intangibles, such as stock, regardless of where they are
located).
Income tax rules with respect to expatriates
For the 10 taxable years after an individual relinquishes
his or her U.S. citizenship or terminates his or her U.S.
residency \619\ with a principal purpose of avoiding U.S.
taxes, the individual is subject to an alternative method of
income taxation than that generally applicable to nonresident
aliens (the ``alternative tax regime''). Generally, the
individual is subject to income tax only on U.S.-source income
\620\ at the rates applicable to U.S. citizens for the 10-year
period.
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\619\ Under prior law, an individual's U.S. residency is considered
terminated for U.S. Federal tax purposes when the individual ceases to
be a lawful permanent resident under the immigration law (or is treated
as a resident of another country under a tax treaty and does not waive
the benefits of such treaty).
\620\ For this purpose, however, U.S.-source income has a broader
scope than it does typically in the Code.
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An individual who relinquishes citizenship or terminates
residency is treated as having done so with a principal purpose
of tax avoidance and is generally subject to the alternative
tax regime if: (1) the individual's average annual U.S. Federal
income tax liability for the five taxable years preceding
citizenship relinquishment or residency termination exceeds
$100,000; or (2) the individual's net worth on the date of
citizenship relinquishment or residency termination equals or
exceeds $500,000. These amounts are adjusted annually for
inflation.\621\ Certain categories of individuals (e.g., dual
residents) may avoid being deemed to have a tax avoidance
purpose for relinquishing citizenship or terminating residency
by submitting a ruling request to the IRS regarding whether the
individual relinquished citizenship or terminated residency
principally for tax reasons. Anti-abuse rules are provided to
prevent the circumvention of the alternative tax regime.
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\621\ The income tax liability and net worth thresholds under
section 877(a)(2) for 2004 are $124,000 and $622,000, respectively. See
Rev. Proc. 2003-85, 2003-49 I.R.B. 1184.
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Estate tax rules with respect to expatriates
Special estate tax rules apply to individuals who
relinquish their citizenship or long-term residency within the
10 years prior to the date of death, unless he or she did not
have a tax avoidance purpose (as determined under the test
above). Under these special rules, certain closely-held foreign
stock owned by the former citizen or former long-term resident
is includible in his or her gross estate to the extent that the
foreign corporation owns U.S.-situated assets.
Gift tax rules with respect to expatriates
Special gift tax rules apply to individuals who relinquish
their citizenship or long-term residency within the 10 years
prior to the date of death, unless he or she did not have a tax
avoidance purpose (as determined under the rules above). The
individual is subject to gift tax on gifts of U.S.-situated
intangibles made during the 10 years following citizenship
relinquishment or residency termination.
Information reporting
Under present and prior law, U.S. citizens who relinquish
citizenship and long-term residents who terminate residency
generally are required to provide information about their
assets held at the time of expatriation. However, this
information is only required once.
Reasons for Change
The Congress believed there were several difficulties in
administering the prior-law alternative tax regime. One such
difficulty was that the IRS was required to determine the
subjective intent of taxpayers who relinquished citizenship or
terminate residency. The prior-law presumption of a tax-
avoidance purpose in cases in which objective income tax
liability or net worth thresholds were exceeded mitigates this
problem to some extent. However, the prior-law rules still
required the IRS to make subjective determinations of intent in
cases involving taxpayers who fell below these thresholds, as
well as for certain taxpayers who exceeded these thresholds but
were nevertheless allowed to seek a ruling from the IRS to the
effect that they did not have a principal purpose of tax
avoidance. The Congress believed that the replacement of the
subjective determination of tax avoidance as a principal
purpose for citizenship relinquishment or residency termination
with objective rules result in easier administration of the tax
regime for individuals who relinquish their citizenship or
terminate residency.
Similarly, prior-law information-reporting and return-
filing provisions did not provide the IRS with the information
necessary to administer the alternative tax regime. Although
individuals were required to file tax information statements
upon the relinquishment of their citizenship or termination of
their residency, difficulties were encountered in enforcing the
requirement. The Congress believed that the tax benefits of
citizenship relinquishment or residency termination should be
denied an individual until he or she provides the information
necessary for the IRS to enforce the alternative tax regime.
The Congress also believed an annual report requirement and a
penalty for the failure to comply with such requirement are
needed to provide the IRS with sufficient information to
monitor the compliance of former U.S. citizens and long-term
residents.
Individuals who relinquish citizenship or terminate
residency for tax reasons often do not want to fully sever
their ties with the United States; they hope to retain some of
the benefits of citizenship or residency without being subject
to the U.S. tax system as a U.S. citizen or resident. Under
prior law, these individuals generally could continue to spend
significant amounts of time in the United States following
citizenship relinquishment or residency termination--
approximately four months every year--without being treated as
a U.S. resident. The Congress believed that provisions in the
Act that impose full U.S. taxation if the individual is present
in the United States for more than 30 days in a calendar year
substantially reduce the incentives to relinquish citizenship
or terminate residency for individuals who desire to maintain
significant ties to the United States.
With respect to the estate and gift tax rules, the Congress
was concerned that prior-law did not adequately address
opportunities for the avoidance of tax on the value of assets
held by a foreign corporation whose stock the individual
transfers. Thus, the provision imposes gift tax under the
alternative tax regime in the case of gifts of certain stock of
a closely held foreign corporation.
Explanation of Provision
In general
The Act provides: (1) objective standards for determining
whether former citizens or former long-term residents are
subject to the alternative tax regime; (2) tax-based (instead
of immigration-based) rules for determining when an individual
is no longer a U.S. citizen or long-term resident for U.S.
Federal tax purposes; (3) the imposition of full U.S. taxation
for individuals who are subject to the alternative tax regime
and who return to the United States for extended periods; (4)
imposition of U.S. gift tax on gifts of stock of certain
closely-held foreign corporations that hold U.S.-situated
property; and (5) an annual return-filing requirement for
individuals who are subject to the alternative tax regime, for
each of the 10 years following citizenship relinquishment or
residency termination.\622\
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\622\ These provisions reflect recommendations contained in Joint
Committee on Taxation, Review of the Present Law Tax and Immigration
Treatment of Relinquishment of Citizenship and Termination of Long-Term
Residency, (JCS-2-03), February 2003.
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Objective rules for the alternative tax regime
The Act replaces the subjective determination of tax
avoidance as a principal purpose for citizenship relinquishment
or residency termination under present law with objective
rules. Under the Act, a former citizen or former long-term
resident would be subject to the alternative tax regime for a
10-year period following citizenship relinquishment or
residency termination, unless the former citizen or former
long-term resident: (1) establishes that his or her average
annual net income tax liability for the five preceding years
does not exceed $124,000 (adjusted for inflation after 2004)
and his or her net worth does not exceed $2 million, or
alternatively satisfies limited, objective exceptions for dual
citizens and minors who have had no substantial contact with
the United States; and (2) certifies under penalties of perjury
that he or she has complied with all U.S. Federal tax
obligations for the preceding five years and provides such
evidence of compliance as the Secretary of the Treasury may
require.
The monetary thresholds under the Act replace the present-
law inquiry into the taxpayer's intent. In addition, the Act
eliminates the present-law process of IRS ruling requests.
If a former citizen exceeds the monetary thresholds, that
person is excluded from the alternative tax regime if he or she
falls within the exceptions for certain dual citizens and
minors (provided that the requirement of certification and
proof of compliance with Federal tax obligations is met). These
exceptions provide relief to individuals who have never had
substantial connections with the United States, as measured by
certain objective criteria, and eliminate IRS inquiries as to
the subjective intent of such taxpayers.
In order to be excepted from the application of the
alternative tax regime under the Act, whether by reason of
falling below the net worth and income tax liability thresholds
or qualifying for the dual-citizen or minor exceptions, the
former citizen or former long-term resident also is required to
certify, under penalties of perjury, that he or she has
complied with all U.S. Federal tax obligations for the five
years preceding the relinquishment of citizenship or
termination of residency and to provide such documentation as
the Secretary of the Treasury may require evidencing such
compliance (e.g., tax returns, proof of tax payments). Until
such time, the individual remains subject to the alternative
tax regime. It is intended that the IRS will continue to verify
that the information submitted was accurate, and it is intended
that the IRS will randomly audit such persons to assess
compliance.
Termination of U.S. citizenship or long-term resident status for U.S.
Federal income tax purposes
Under the Act, an individual continues to be treated as a
U.S. citizen or long-term \623\ resident for U.S. Federal tax
purposes, including for purposes of section 7701(b)(10), until
the individual: (1) gives notice of an expatriating act or
termination of residency (with the requisite intent to
relinquish citizenship or terminate residency) to the Secretary
of State or the Secretary of Homeland Security, respectively;
and (2) provides a statement in accordance with section 6039G
(if such a statement is otherwise required under section
6039G).\624\ This rule applies to all individuals losing U.S.
citizenship or terminating long-term resident status, even if
they are not subject to the alternative tax regime.
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\623\ A technical correction may be necessary so that the statute
reflects this intent.
\624\ A technical correction may be necessary so that the statute
reflects this intent.
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Sanction for individuals subject to the individual tax regime who
return to the United States for extended periods
The alternative tax regime does not apply to any individual
for any taxable year during the 10-year period following
citizenship relinquishment or residency termination if such
individual is present in the United States for more than 30
days in the calendar year ending in such taxable year. Such
individual is treated as a U.S. citizen or resident for such
taxable year and therefore is taxed on his or her worldwide
income.
Similarly, if an individual subject to the alternative tax
regime is present in the United States for more than 30 days in
any calendar year ending during the 10-year period following
citizenship relinquishment or residency termination, and the
individual dies during that year, he or she is treated as a
U.S. resident, and the individual's worldwide estate is subject
to U.S. estate tax. Likewise, if an individual subject to the
alternative tax regime is present in the United States for more
than 30 days in any year during the 10-year period following
citizenship relinquishment or residency termination, the
individual is subject to U.S. gift tax on any transfer of his
or her worldwide assets by gift during that taxable year.
For purposes of these rules, an individual is treated as
present in the United States on any day if such individual is
physically present in the United States at any time during that
day. The present-law exceptions from being treated as present
in the United States for residency purposes \625\ generally do
not apply for this purpose. However, for individuals with
certain ties to countries other than the United States \626\
and individuals with minimal prior physical presence in the
United States,\627\ a day of physical presence in the United
States is disregarded if the individual is performing services
in the United States on such day for an unrelated employer
(within the meaning of sections 267 and 707(b)), who meets the
requirements the Secretary of the Treasury may prescribe in
regulations. No more than 30 days may be disregarded during any
calendar year under this rule.
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\625\ Secs. 7701(b)(3)(D), 7701(b)(5) and 7701(b)(7)(B)-(D).
\626\ An individual has such a relationship to a foreign country if
the individual becomes a citizen or resident of the country in which
(1) the individual becomes fully liable for income tax or (2) the
individual was born, such individual's spouse was born, or either of
the individual's parents was born.
\627\ An individual has a minimal prior physical presence in the
United States if the individual was physically present for no more than
30 days during each year in the ten-year period ending on the date of
loss of United States citizenship or termination of residency. However,
an individual is not treated as being present in the United States on a
day if (1) the individual is a teacher or trainee, a student, a
professional athlete in certain circumstances, or a foreign government-
related individual or (2) the individual remained in the United States
because of a medical condition that arose while the individual was in
the United States. Sec. 7701(b)(3)(D). A technical correction may be
necessary so that the statute reflects this intent.
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Imposition of gift tax with respect to stock of certain closely held
foreign corporations
Gifts of stock of certain closely-held foreign corporations
by a former citizen or former long-term resident who is subject
to the alternative tax regime are subject to gift tax under
this Act, if the gift is made within the 10-year period after
citizenship relinquishment or residency termination. The gift
tax rule applies if: (1) the former citizen or former long-term
resident, before making the gift, directly or indirectly owns
10 percent or more of the total combined voting power of all
classes of stock entitled to vote of the foreign corporation;
and (2) directly or indirectly, is considered to own more than
50 percent of (a) the total combined voting power of all
classes of stock entitled to vote in the foreign corporation,
or (b) the total value of the stock of such corporation. If
this stock ownership test is met, then taxable gifts of the
former citizen or former long-term resident include that
proportion of the fair market value of the foreign stock
transferred by the individual, at the time of the gift, which
the fair market value of any assets owned by such foreign
corporation and situated in the United States (at the time of
the gift) bears to the total fair market value of all assets
owned by such foreign corporation (at the time of the gift).
This gift tax rule applies to a former citizen or former
long-term resident who is subject to the alternative tax regime
and who owns stock in a foreign corporation at the time of the
gift, regardless of how such stock was acquired (e.g., whether
issued originally to the donor, purchased, or received as a
gift or bequest).
Annual return
The Act requires former citizens and former long-term
residents to file an annual return for each year following
citizenship relinquishment or residency termination in which
they are subject to the alternative tax regime. The annual
return is required even if no U.S. Federal income tax is due.
The annual return requires certain information, including
information on the permanent home of the individual, the
individual's country of residence, the number of days the
individual was present in the United States for the year, and
detailed information about the individual's income and assets
that are subject to the alternative tax regime. This
requirement includes information relating to foreign stock
potentially subject to the special estate tax rule of section
2107(b) and the gift tax rules of this Act.
If the individual fails to file the statement in a timely
manner or fails correctly to include all the required
information, the individual is required to pay a penalty of
$5,000. The $5,000 penalty does not apply if it is shown that
the failure is due to reasonable cause and not to willful
neglect.
Effective Date
The provision applies to individuals who relinquish
citizenship or terminate long-term residency after June 3,
2004.
5. Reporting of taxable mergers and acquisitions (sec. 805 of the Act
and new sec. 6043A of the Code)
Present and Prior Law
Under section 6045 and the regulations thereunder, brokers
(defined to include stock transfer agents) are required to make
information returns and to provide corresponding payee
statements as to sales made on behalf of their customers,
subject to the penalty provisions of sections 6721-6724. Under
the regulations issued under section 6045, this requirement
generally does not apply with respect to taxable transactions
other than exchanges for cash (e.g., stock inversion
transactions taxable to shareholders by reason of section
367(a)).\628\
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\628\ Recently issued temporary regulations under section 6043
(relating to information reporting with respect to liquidations,
recapitalizations, and changes in control) impose information reporting
requirements with respect to certain taxable inversion transactions,
and proposed regulations would expand these requirements more generally
to taxable transactions occurring after the proposed regulations are
finalized.
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Reasons for Change
The Congress believed that administration of the tax laws
would be improved by greater information reporting with respect
to taxable non-cash transactions, and that the Treasury
Secretary's authority to require such enhanced reporting should
be made explicit in the Code.
Explanation of Provision
Under the Act, if gain or loss is recognized in whole or in
part by shareholders of a corporation by reason of a second
corporation's acquisition of the stock or assets of the first
corporation, then the acquiring corporation (or the acquired
corporation, if so prescribed by the Treasury Secretary) is
required to make a return containing:
1. A description of the transaction;
2. The name and address of each shareholder of the acquired
corporation that recognizes gain as a result of the transaction
(or would recognize gain, if there was a built-in gain on the
shareholder's shares);
3. The amount of money and the value of stock or other
consideration paid to each shareholder described above; and
4. Such other information as the Treasury Secretary may
prescribe.
Alternatively, a stock transfer agent who records transfers
of stock in such transaction may make the return described
above in lieu of the second corporation.
In addition, every person required to make a return
described above is required to furnish to each shareholder (or
the shareholder's nominee \629\) whose name is required to be
set forth in such return a written statement showing:
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\629\ In the case of a nominee, the nominee must furnish the
information to the shareholder in the manner prescribed by the Treasury
Secretary.
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1. The name, address, and phone number of the information
contact of the person required to make such return;
2. The information required to be shown on that return; and
3. Such other information as the Treasury Secretary may
prescribe.
This written statement is required to be furnished to the
shareholder on or before January 31 of the year following the
calendar year during which the transaction occurred.
The present-law penalties for failure to comply with
information reporting requirements are extended to failures to
comply with the requirements set forth under the Act.
Effective Date
The provision is effective for acquisitions after the date
of enactment (October 22, 2004).
6. Studies (sec. 806 of the Act)
Present and Prior Law
Due to the variation in tax rates and tax systems among
countries, a multinational enterprise, whether U.S.-based or
foreign-based, may have an incentive to shift income,
deductions, or tax credits in order to arrive at a reduced
overall tax burden. Such a shifting of items could be
accomplished by establishing artificial, non-arm's-length
prices for transactions between group members.
Under section 482, the Treasury Secretary is authorized to
reallocate income, deductions, or credits between or among two
or more organizations, trades, or businesses under common
control if he determines that such a reallocation is necessary
to prevent tax evasion or to clearly reflect income. Treasury
regulations adopt the arm's-length standard as the standard for
determining whether such reallocations are appropriate. Thus,
the regulations provide rules to identify the respective
amounts of taxable income of the related parties that would
have resulted if the parties had been uncontrolled parties
dealing at arm's length. Transactions involving intangible
property and certain services may present particular challenges
to the administration of the arm's-length standard, because the
nature of these transactions may make it difficult or
impossible to compare them with third-party transactions.
In addition to the statutory rules governing the taxation
of foreign income of U.S. persons and U.S. income of foreign
persons, bilateral income tax treaties limit the amount of
income tax that may be imposed by one treaty partner on
residents of the other treaty partner. For example, treaties
often reduce or eliminate withholding taxes imposed by a treaty
country on certain types of income (e.g., dividends, interest
and royalties) paid to residents of the other treaty country.
Treaties also contain provisions governing the creditability of
taxes imposed by the treaty country in which income was earned
in computing the amount of tax owed to the other country by its
residents with respect to such income. Treaties further provide
procedures under which inconsistent positions taken by the
treaty countries with respect to a single item of income or
deduction may be mutually resolved by the two countries.
Explanation of Provision
The Act requires the Treasury Secretary to conduct and
submit to the Congress three studies. The first study will
examine the effectiveness of the transfer pricing rules of
section 482, with an emphasis on transactions involving
intangible property. The second study will examine income tax
treaties to which the United States is a party, with a view
toward identifying any inappropriate reductions in withholding
tax or opportunities for abuse that may exist. The third study
will examine the impact of the provisions of this Act on
inversion transactions.
Effective Date
The tax treaty study required under the provision is due no
later than June 30, 2005. The transfer pricing study required
under the provision is due no later than June 30, 2005. The
inversions study required under the provision is due no later
than December 31, 2006.
B. Provisions Relating to Tax Shelters
1. Penalty for failure to disclose reportable transactions (sec. 811 of
the Act and new sec. 6707A of the Code)
Present and Prior Law
Regulations under section 6011 require a taxpayer to
disclose with its tax return certain information with respect
to each ``reportable transaction'' in which the taxpayer
participates.\630\
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\630\ On February 27, 2003, the Treasury Department and the IRS
released final regulations regarding the disclosure of reportable
transactions. In general, the regulations are effective for
transactions entered into on or after February 28, 2003.
The discussion of present and prior law refers to the final
regulations. The rules that apply with respect to transactions entered
into on or before February 28, 2003, are contained in Treas. Reg. sec.
1.6011-4T in effect on the date the transaction was entered into.
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There are six categories of reportable transactions. The
first category is any transaction that is the same as (or
substantially similar to) \631\ a transaction that is specified
by the Treasury Department as a tax avoidance transaction whose
tax benefits are subject to disallowance (referred to as a
``listed transaction'').\632\
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\631\ The regulations clarify that the term ``substantially
similar'' includes any transaction that is expected to obtain the same
or similar types of tax consequences and that is either factually
similar or based on the same or similar tax strategy. Further, the term
must be broadly construed in favor of disclosure. Treas. Reg. sec.
1.6011-4(c)(4).
\632\ Treas. Reg. sec. 1.6011-4(b)(2).
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The second category is any transaction that is offered
under conditions of confidentiality. In general, a transaction
is considered to be offered to a taxpayer under conditions of
confidentiality if the advisor who is paid a minimum fee places
a limitation on disclosure by the taxpayer of the tax treatment
or tax structure of the transaction and the limitation on
disclosure protects the confidentiality of that advisor's tax
strategies (irrespective of whether terms are legally
binding).\633\
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\633\ Treas. Reg. sec. 1.6011-4(b)(3).
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The third category of reportable transactions is any
transaction for which (1) the taxpayer has the right to a full
or partial refund of fees if the intended tax consequences from
the transaction are not sustained or, (2) the fees are
contingent on the intended tax consequences from the
transaction being sustained.\634\
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\634\ Treas. Reg. sec. 1.6011-4(b)(4). Rev. Proc. 2004-65, 2004-50
I.R.B. 965, exempts certain types of transactions from this reportable
transaction category.
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The fourth category of reportable transactions relates to
any transaction resulting in a taxpayer claiming a loss (under
section 165) of at least (1) $10 million in any single year or
$20 million in any combination of years by a corporate taxpayer
or a partnership with only corporate partners; (2) $2 million
in any single year or $4 million in any combination of years by
all other partnerships, S corporations, trusts, and
individuals; or (3) $50,000 in any single year for individuals
or trusts if the loss arises with respect to foreign currency
transaction losses.\635\
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\635\ Treas. Reg. sec. 1.6011-4(b)(5). Rev. Proc. 2004-66, 2004-50
I.R.B. 966, modifying and superseding Rev. Proc. 2003-24, 2003-11
I.R.B. 599, exempts certain types of losses from this reportable
transaction category.
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The fifth category of reportable transactions refers to any
transaction done by certain taxpayers \636\ in which the tax
treatment of the transaction differs (or is expected to differ)
by more than $10 million from its treatment for book purposes
(using generally accepted accounting principles) in any
year.\637\
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\636\ The significant book-tax category applies only to taxpayers
that are reporting companies under the Securities Exchange Act of 1934
or business entities that have $250 million or more in gross assets.
Rev. Proc. 2004-45, 2004-31 I.R.B. 140, provides alternative disclosure
procedures for certain taxpayers with respect to this reportable
transaction category.
\637\ Treas. Reg. sec. 1.6011-4(b)(6). Rev. Proc. 2004-67, 2004-50
I.R.B. 967, modifying and superseding Rev. Proc. 2003-25, 2003-11
I.R.B. 601, exempts certain types of transactions from this reportable
transaction category.
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The final category of reportable transactions is any
transaction that results in a tax credit exceeding $250,000
(including a foreign tax credit) if the taxpayer holds the
underlying asset for less than 45 days.\638\
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\638\ Treas. Reg. sec. 1.6011-4(b)(7). Rev. Proc. 2004-68, 2004-50
I.R.B. 969, modifying and superseding 2003-11 I.R.B. 601, exempts
certain types of transactions from this reportable transaction
category.
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Under prior law, there was no specific penalty for failing
to disclose a reportable transaction; however, such a failure
could jeopardize a taxpayer's ability to claim that any income
tax understatement attributable to such undisclosed transaction
is due to reasonable cause, and that the taxpayer acted in good
faith.\639\
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\639\ Section 6664(c) provides that a taxpayer can avoid the
imposition of a section 6662 accuracy-related penalty in cases where
the taxpayer can demonstrate that there was reasonable cause for the
underpayment and that the taxpayer acted in good faith. Regulations
under sections 6662 and 6664 provide that a taxpayer's failure to
disclose a reportable transaction is a strong indication that the
taxpayer failed to act in good faith, which would bar relief under
section 6664(c). Treas. Reg. sec. 1.6664-4(d).
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Reasons for Change
The Congress believed that the best way to combat tax
shelters is to be aware of them. The Treasury Department, using
the tools available, issued regulations requiring disclosure of
certain transactions and requiring organizers and promoters of
tax-engineered transactions to maintain customer lists and make
these lists available to the IRS. Nevertheless, the Congress
believed that legislation was needed to provide the Treasury
Department with additional tools to assist its efforts to
curtail abusive transactions. Moreover, the Congress believed
that a penalty for failing to make the required disclosures,
when the imposition of such penalty is not dependent on the tax
treatment of the underlying transaction ultimately being
sustained, would provide an additional incentive for taxpayers
to satisfy their reporting obligations under the new disclosure
provisions.
Explanation of Provision
In general
The Act creates a new penalty for any person who fails to
include with any return or statement any required information
with respect to a reportable transaction. The new penalty
applies without regard to whether the transaction ultimately
results in an understatement of tax, and applies in addition to
any accuracy-related penalty that may be imposed.
Transactions to be disclosed
The Act does not define the terms ``listed transaction''
\640\ or ``reportable transaction,'' nor does it explain the
type of information that must be disclosed in order to avoid
the imposition of a penalty. Rather, the Act authorizes the
Treasury Department to define a ``listed transaction'' and a
``reportable transaction'' under section 6011.
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\640\ The Act provides that, except as provided in regulations, a
listed transaction means a reportable transaction, which is the same
as, or substantially similar to, a transaction specifically identified
by the Secretary as a tax avoidance transaction for purposes of section
6011. For this purpose, it is expected that the definition of
``substantially similar'' will be the definition used in Treas. Reg.
sec. 1.6011-4(c)(4). However, the Secretary may modify this definition
(as well as the definitions of ``listed transaction'' and ``reportable
transactions'') as appropriate.
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Penalty rate
The penalty for failing to disclose a reportable
transaction is $10,000 in the case of a natural person and
$50,000 in any other case. The amount is increased to $100,000
and $200,000, respectively, if the failure is with respect to a
listed transaction. The penalty cannot be waived with respect
to a listed transaction. As to reportable transactions, the IRS
Commissioner or his delegate can rescind (or abate) the penalty
only if rescinding the penalty would promote compliance with
the tax laws and effective tax administration.\641\ The
decision to rescind a penalty must be accompanied by a record
describing the facts and reasons for the action and the amount
rescinded. There will be no taxpayer right to judicially appeal
a refusal to rescind a penalty.\642\ The IRS also is required
to submit an annual report to Congress summarizing the
application of the disclosure penalties and providing a
description of each penalty rescinded under this provision and
the reasons for the rescission.
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\641\ In determining whether to rescind (or abate) the penalty for
failing to disclose a reportable transaction on the grounds that doing
so would promote compliance with the tax laws and effective tax
administration, it is intended that the IRS Commissioner take into
account whether: (1) the person on whom the penalty is imposed has a
history of complying with the tax laws; (2) the violation is due to an
unintentional mistake of fact; and (3) imposing the penalty would be
against equity and good conscience.
\642\ This does not limit the ability of a taxpayer to challenge
whether a penalty is appropriate (e.g., a taxpayer may litigate the
issue of whether a transaction is a reportable transaction (and thus
subject to the penalty if not disclosed) or not a reportable
transaction (and thus not subject to the penalty)).
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In addition, the Act provides that a public entity that is
required to pay a penalty for failing to disclose a listed
transaction (or is subject to an understatement penalty
attributable to a non-disclosed listed transaction or a non-
disclosed reportable avoidance transaction) must disclose the
imposition of the penalty in reports to the Securities and
Exchange Commission for such period as the Secretary shall
specify. This requirement applies without regard to whether the
taxpayer determines the amount of the penalty to be material to
the reports in which the penalty must appear, and treats any
failure to disclose a transaction in such reports as a failure
to disclose a listed transaction. A taxpayer must disclose a
penalty in reports to the Securities and Exchange Commission
once the taxpayer has exhausted its administrative and judicial
remedies with respect to the penalty (or if earlier, when
paid). However, the taxpayer is only required to report the
penalty one time. The Act further provides that this
requirement also applies to a public entity that is subject to
a gross valuation misstatement penalty under section 6662(h)
attributable to a non-disclosed listed transaction or non-
disclosed reportable avoidance transaction.
Effective Date
The provision is effective for returns and statements the
due date for which is after the date of enactment (October 22,
2004).\643\
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\643\ It is intended that the provision be effective for returns
and statements the original or extended due date for which is after the
date of enactment, as well as delinquent returns and statements the
original or extended due date for which is before the date of enactment
but that are filed after the date of enactment. A technical correction
may be necessary so that the statute reflects this intent.
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2. Modifications to the accuracy-related penalties for listed
transactions and reportable transactions having a significant
tax avoidance purpose (sec. 812 of the Act and new sec. 6662A
of the Code)
Present and Prior Law
A 20-percent accuracy-related penalty applies to the
portion of any underpayment that is attributable to: (1)
negligence; (2) any substantial understatement of income tax;
(3) any substantial valuation misstatement; (4) any substantial
overstatement of pension liabilities; or (5) any substantial
estate or gift tax valuation understatement.\644\ The amount of
any understatement generally is reduced by any portion
attributable to an item if: (1) the treatment of the item is or
was supported by substantial authority, or (2) facts relevant
to the tax treatment of the item were adequately disclosed and
there was a reasonable basis for its tax treatment.\645\
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\644\ Sec. 6662(a) and (b). As amended by section 819 of the Act, a
``substantial understatement'' for non-corporate taxpayers exists if
the amount of the understatement for the taxable year exceeds the
greater of 10 percent of the correct tax or $5,000 ($10,000 in the case
of most corporations), while a substantial understatement for corporate
taxpayers exists if the amount of the understatement for the taxable
year exceeds the lesser of 10 percent of the correct tax (or, if
greater, $10,000) or $10 million. Sec. 6662(d)(1).
\645\ Sec. 6662(d)(2)(B).
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Special rules apply with respect to tax shelters.\646\ For
understatements by non-corporate taxpayers attributable to tax
shelters, prior law provided that the accuracy-related penalty
could be avoided only if the taxpayer established that, in
addition to having substantial authority for the position, the
taxpayer reasonably believed that the treatment claimed was
more likely than not the proper treatment of the item. Under
present and prior law, this reduction in the penalty is
unavailable to corporate tax shelters.
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\646\ Sec. 6662(d)(2)(C).
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The understatement penalty generally is abated (even with
respect to tax shelters) in cases in which the taxpayer can
demonstrate that there was ``reasonable cause'' for the
underpayment and that the taxpayer acted in good faith.\647\
The relevant regulations provide that reasonable cause exists
where the taxpayer ``reasonably relies in good faith on an
opinion based on a professional tax advisor's analysis of the
pertinent facts and authorities [that] . . . unambiguously
concludes that there is a greater than 50-percent likelihood
that the tax treatment of the item will be upheld if
challenged'' by the IRS.\648\
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\647\ Sec. 6664(c).
\648\ Treas. Reg. sec. 1.6662-4(g)(4)(i)(B); Treas. Reg. sec.
1.6664-4(c).
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Reasons for Change
Disclosure is vital to combating abusive tax avoidance
transactions, and the shelter initiatives undertaken by the
Treasury Department emphasize combating abusive tax avoidance
transactions by requiring increased disclosure of such
transactions by all parties involved. Therefore, the Congress
believed that taxpayers should be subject to a strict liability
penalty on an understatement of tax that is attributable to
non-disclosed listed transactions or non-disclosed reportable
transactions that have a significant purpose of tax avoidance.
Furthermore, in order to deter taxpayers from entering into tax
avoidance transactions, the Congress believe that a more
meaningful (but not a strict liability) accuracy-related
penalty should apply to such transactions even when disclosed.
Explanation of Provision
In general
In general
The Act augments the present-law accuracy related penalty
with a new accuracy-related penalty that applies to listed
transactions and reportable transactions with a significant tax
avoidance purpose (hereinafter referred to as a ``reportable
avoidance transaction'').\649\ The penalty rate and defenses
available to avoid the penalty vary depending on whether the
transaction was adequately disclosed.
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\649\ The terms ``reportable transaction'' and ``listed
transaction'' have the same meanings as used for purposes of the
penalty under new section 6707A for failing to disclose reportable
transactions.
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Disclosed transactions
In general, a 20-percent accuracy-related penalty is
imposed on any understatement attributable to an adequately
disclosed listed transaction or reportable avoidance
transaction. The only exception to the penalty is if the
taxpayer satisfies a more stringent reasonable cause and good
faith exception (hereinafter referred to as the ``strengthened
reasonable cause exception''), which is described below. The
strengthened reasonable cause exception is available only if
the relevant facts affecting the tax treatment are adequately
disclosed, there is or was substantial authority for the
claimed tax treatment, and the taxpayer reasonably believed
that the claimed tax treatment was more likely than not the
proper treatment.
Undisclosed transactions
If the taxpayer does not adequately disclose the
transaction, the strengthened reasonable cause exception is not
available (i.e., a strict-liability penalty applies), and the
taxpayer is subject to an increased penalty equal to 30 percent
of the understatement.
Determination of the understatement amount
The penalty is applied to the amount of any understatement
attributable to the listed or reportable avoidance transaction
without regard to other items on the tax return. For purposes
of this provision, the amount of the understatement is
determined as the sum of (1) the product of the highest
corporate or individual tax rate (as appropriate) and the
increase in taxable income resulting from the difference
between the taxpayer's treatment of the item and the proper
treatment of the item (without regard to other items on the tax
return),\650\ and (2) the amount of any decrease in the
aggregate amount of credits which results from a difference
between the taxpayer's treatment of an item and the proper tax
treatment of such item.
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\650\ For this purpose, any reduction in the excess of deductions
allowed for the taxable year over gross income for such year, and any
reduction in the amount of capital losses which would (without regard
to section 1211) be allowed for such year, shall be treated as an
increase in taxable income.
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Except as provided in regulations, a taxpayer's treatment
of an item shall not take into account any amendment or
supplement to a return if the amendment or supplement is filed
after the earlier of when the taxpayer is first contacted
regarding an examination of the return or such other date as
specified by the Secretary.
Strengthened reasonable cause exception
In general
A penalty is not imposed under the Act with respect to any
portion of an understatement if it shown that there was
reasonable cause for such portion and the taxpayer acted in
good faith. Such a showing requires (1) adequate disclosure of
the facts affecting the transaction in accordance with the
regulations under section 6011,\651\ (2) that there is or was
substantial authority for such treatment, and (3) that the
taxpayer reasonably believed that such treatment was more
likely than not the proper treatment. For this purpose, a
taxpayer will be treated as having a reasonable belief with
respect to the tax treatment of an item only if such belief (1)
is based on the facts and law that exist at the time the tax
return (that includes the item) is filed, and (2) relates
solely to the taxpayer's chances of success on the merits and
does not take into account the possibility that (a) a return
will not be audited, (b) the treatment will not be raised on
audit, or (c) the treatment will be resolved through settlement
if raised.
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\651\ See the previous discussion regarding the penalty under new
section 6707A for failing to disclose a reportable transaction.
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A taxpayer may (but is not required to) rely on an opinion
of a tax advisor in establishing its reasonable belief with
respect to the tax treatment of the item. However, a taxpayer
may not rely on an opinion of a tax advisor for this purpose if
the opinion (1) is provided by a ``disqualified tax advisor,''
or (2) is a ``disqualified opinion.''
Disqualified tax advisor
A disqualified tax advisor is any advisor who (1) is a
material advisor \652\ and who participates in the
organization, management, promotion or sale of the transaction
or is related (within the meaning of section 267(b) or
707(b)(1)) to any person who so participates, (2) is
compensated directly or indirectly \653\ by a material advisor
with respect to the transaction, (3) has a fee arrangement with
respect to the transaction that is contingent on all or part of
the intended tax benefits from the transaction being sustained,
or (4) as determined under regulations prescribed by the
Secretary, has a disqualifying financial interest with respect
to the transaction.
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\652\ Under the Act, the term ``material advisor'' (defined below
in connection with the new information filing requirements for material
advisors) means any person who provides any material aid, assistance,
or advice with respect to organizing, managing, promoting, selling,
implementing, insuring, or carrying out any reportable transaction, and
who derives gross income in excess of $50,000 in the case of a
reportable transaction substantially all of the tax benefits from which
are provided to natural persons ($250,000 in any other case).
\653\ This situation could arise, for example, when an advisor has
an arrangement or understanding (oral or written) with an organizer,
manager, or promoter of a reportable transaction that such party will
recommend or refer potential participants to the advisor for an opinion
regarding the tax treatment of the transaction.
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Organization, management, promotion or sale of a
transaction.--A material advisor is considered as participating
in the ``organization'' of a transaction if the advisor
performs acts relating to the development of the transaction.
This may include, for example, preparing documents (1)
establishing a structure used in connection with the
transaction (such as a partnership agreement), (2) describing
the transaction (such as an offering memorandum or other
statement describing the transaction), or (3) relating to the
registration of the transaction with any Federal, State or
local government body.\654\ Participation in the ``management''
of a transaction means involvement in the decision-making
process regarding any business activity with respect to the
transaction. Participation in the ``promotion or sale'' of a
transaction means involvement in the marketing or solicitation
of the transaction to others. Thus, an advisor who provides
information about the transaction to a potential participant is
involved in the promotion or sale of a transaction, as is any
advisor who recommends the transaction to a potential
participant.
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\654\ An advisor should not be treated as participating in the
organization of a transaction if the advisor's only involvement with
respect to the organization of the transaction is the rendering of an
opinion regarding the tax consequences of such transaction. However,
such an advisor may be a ``disqualified tax advisor'' with respect to
the transaction if the advisor participates in the management,
promotion or sale of the transaction (or if the advisor is compensated
by a material advisor, has a fee arrangement that is contingent on the
tax benefits of the transaction, or as determined by the Secretary, has
a disqualifying financial interest with respect to the transaction).
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Disqualified opinion
An opinion may not be relied upon if the opinion: (1) is
based on unreasonable factual or legal assumptions (including
assumptions as to future events); (2) unreasonably relies upon
representations, statements, finding or agreements of the
taxpayer or any other person; (3) does not identify and
consider all relevant facts; or (4) fails to meet any other
requirement prescribed by the Secretary.
Coordination with other penalties
Any portion of an underpayment upon which a penalty is
imposed under the Act is not subject to the penalties under
section 6662 for substantial understatements of income tax or,
in general, substantial valuation misstatements.\655\ However,
the understatement to which such portion is attributable is
included for purposes of determining whether an understatement
(as defined in sec. 6662(d)(2)) is a substantial understatement
(as defined under section 6662(d)(1)) subject to the penalty
under section 6662 for substantial understatements of income
tax.
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\655\ With regard to the section 6662 penalties for underpayments
attributable to negligence, substantial overstatement of pension
liabilities or substantial estate or gift tax valuation
understatements, a technical correction may be necessary to more
clearly reflect the intent that such penalties are not to be imposed
upon the portion of any underpayment upon which a penalty is imposed
under the Act.
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Any portion of an underpayment attributable to a
substantial valuation misstatement upon which a penalty under
section 6662 is imposed is not subject to the penalty under the
Act if the penalty amount is increased under section 6662(h)
because the substantial valuation misstatement is determined to
be a gross valuation misstatement.
The penalty imposed under the Act shall not apply to any
portion of an underpayment to which a fraud penalty is applied
under section 6663.
Effective Date
The provision is effective for taxable years ending after
the date of enactment (October 22, 2004).\656\
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\656\ It is not intended that the provision relating to
disqualified opinions apply generally on a retroactive basis.
Therefore, a technical correction may be necessary to clarify that this
provision does not apply to opinions provided to taxpayers before the
date of enactment with respect to transactions that were entered into
before the date of enactment and at least a portion of the tax
consequences of which were reported on a return or statement that was
filed before the date of enactment.
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3. Tax shelter exception to confidentiality privileges relating to
taxpayer communications (sec. 813 of the Act and sec. 7525 of
the Code)
Present and Prior Law
In general, a common law privilege of confidentiality
exists for communications between an attorney and client with
respect to the legal advice the attorney gives the client. The
Code provides that, with respect to tax advice, the same common
law protections of confidentiality that apply to a
communication between a taxpayer and an attorney also apply to
a communication between a taxpayer and a federally authorized
tax practitioner to the extent the communication would be
considered a privileged communication if it were between a
taxpayer and an attorney. This rule is inapplicable to
communications regarding corporate tax shelters.
Reasons for Change
The Congress believed that the rule previously applicable
only to corporate tax shelters should be applied to all tax
shelters, regardless of whether or not the participant is a
corporation.
Explanation of Provision
The Act modifies the rule relating to corporate tax
shelters by making it applicable to all tax shelters, whether
entered into by corporations, individuals, partnerships, tax-
exempt entities, or any other entity. Accordingly,
communications with respect to tax shelters are not subject to
the confidentiality provision of the Code that otherwise
applies to a communication between a taxpayer and a federally
authorized tax practitioner.
Effective Date
The provision is effective with respect to communications
made on or after the date of enactment (October 22, 2004).
4. Statute of limitations for unreported listed transactions (sec. 814
of the Act and sec. 6501 of the Code)
Present and Prior Law
In general, the Code requires that taxes be assessed within
three years \657\ after the date a return is filed.\658\ If
there has been a substantial omission of items of gross income
that totals more than 25 percent of the amount of gross income
shown on the return, the period during which an assessment must
be made is extended to six years.\659\ If an assessment is not
made within the required time periods, the tax generally cannot
be assessed or collected at any future time. Tax may be
assessed at any time if the taxpayer files a false or
fraudulent return with the intent to evade tax or if the
taxpayer does not file a tax return at all.\660\
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\657\ Sec. 6501(a).
\658\ For this purpose, a return that is filed before the date on
which it is due is considered to be filed on the required due date
(sec. 6501(b)(1)).
\659\ Sec. 6501(e).
\660\ Sec. 6501(c).
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Reasons for Change
The Congress observed that some taxpayers and their
advisors have been employing dilatory tactics and failing to
cooperate with the IRS in an attempt to avoid liability through
the expiration of the statute of limitations. The Congress
accordingly believed that it was appropriate to extend the
statute of limitations for unreported listed transactions,
which will encourage taxpayers to provide the required
disclosure and will afford the IRS additional time to discover
the transaction if the taxpayer does not disclose it.
Explanation of Provision
The Act extends the statute of limitations with respect to
a listed transaction if a taxpayer fails to include on any
return or statement for any taxable year any information with
respect to a listed transaction \661\ which is required to be
included (under section 6011) with such return or statement.
The statute of limitations with respect to such a transaction
will not expire before the date which is one year after the
earlier of: (1) the date on which the Secretary is furnished
the information so required; or (2) the date that a material
advisor (as defined in 6111) satisfies the list maintenance
requirements (as defined by section 6112) with respect to a
request by the Secretary.\662\ For example, if a taxpayer
engaged in a transaction in 2005 that becomes a listed
transaction in 2007 and the taxpayer fails to disclose such
transaction in the manner required by Treasury regulations,
then the transaction is subject to the extended statute of
limitations.\663\
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\661\ The term ``listed transaction'' has the same meaning as
described in a previous provision regarding the penalty for failure to
disclose reportable transactions.
\662\ It is intended that the term ``material advisor'' for this
purpose includes either a material advisor as defined in section
6111(b)(1) or, in the case of material aid, assistance, or advice
rendered on or before the date of enactment, a material advisor as
defined in Treasury regulations under section 6112. See Treas. Reg.
sec. 301.6112-1(c)(2). It also is intended that the date on which a
material advisor satisfies the list maintenance requirements for this
purpose applies to both (1) material advisors with respect to
reportable transactions under present-law section 6112, (2) and
organizers and sellers of potentially abusive tax shelters under prior-
law section 6112. Technical corrections may be necessary so that the
statute reflects this intent.
\663\ If the Treasury Department lists a transaction in a year
subsequent to the year in which a taxpayer entered into such
transaction and the taxpayer's tax return for the year the transaction
was entered into is closed by the statute of limitations prior to the
date the transaction became a listed transaction, this provision does
not re-open the statute of limitations with respect to such transaction
for such year. However, if the purported tax benefits of the
transaction are recognized over multiple tax years, the provision's
extension of the statute of limitations shall apply to such tax
benefits in any subsequent tax year in which the statute of limitations
had not closed prior to the date the transaction became a listed
transaction.
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Effective Date
The provision is effective for taxable years with respect
to which the period for assessing a deficiency did not expire
before the date of enactment (October 22, 2004).
5. Disclosure of reportable transactions by material advisors (secs.
815 and 816 of the Act and secs. 6111 and 6707 of the Code)
Present and Prior Law
Registration of tax shelter arrangements
Under prior law, an organizer of a tax shelter was required
to register the shelter with the Secretary not later than the
day on which the shelter was first offered for sale.\664\ A
``tax shelter'' was defined as any investment with respect to
which the tax shelter ratio \665\ for any investor as of the
close of any of the first five years ending after the
investment was offered for sale may be greater than two to one
and which was: (1) required to be registered under Federal or
State securities laws; (2) sold pursuant to an exemption from
registration requiring the filing of a notice with a Federal or
State securities agency; or (3) a substantial investment
(greater than $250,000 and involving at least five
investors).\666\
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\664\ Sec. 6111(a).
\665\ The tax shelter ratio was, with respect to any year, the
ratio that the aggregate amount of the deductions and 350 percent of
the credits, which were represented to be potentially allowable to any
investor, bears to the investment base (money plus basis of assets
contributed) as of the close of the tax year.
\666\ Sec. 6111(c).
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Other promoted arrangements were treated as tax shelters
for purposes of the prior-law registration requirement if: (1)
a significant purpose of the arrangement was the avoidance or
evasion of Federal income tax by a corporate participant; (2)
the arrangement was offered under conditions of
confidentiality; and (3) the promoter may receive fees in
excess of $100,000 in the aggregate.\667\
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\667\ Sec. 6111(d).
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In general, a transaction had a ``significant purpose of
avoiding or evading Federal income tax'' under prior law if the
transaction: (1) was the same as or substantially similar to a
``listed transaction,'' \668\ or (2) was structured to produce
tax benefits that constituted an important part of the intended
results of the arrangement and the promoter reasonably expected
to present the arrangement to more than one taxpayer.\669\
Certain exceptions were provided with respect to the second
category of transactions.\670\
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\668\ Treas. Reg. sec. 301.6111-2(b)(2).
\669\ Treas. Reg. sec. 301.6111-2(b)(3).
\670\ Treas. Reg. sec. 301.6111-2(b)(4).
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An arrangement was treated as offered under conditions of
confidentiality if: (1) an offeree had an understanding or
agreement to limit the disclosure of the transaction or any
significant tax features of the transaction; or (2) the
promoter knew, or had reason to know, that the offeree's use or
disclosure of information relating to the transaction was
limited in any other manner.\671\
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\671\ The regulations provide that the determination of whether an
arrangement is offered under conditions of confidentiality is based on
all the facts and circumstances surrounding the offer. If an offeree's
disclosure of the structure or tax aspects of the transaction is
limited in any way by an express or implied understanding or agreement
with or for the benefit of a tax shelter promoter, an offer is
considered made under conditions of confidentiality, whether or not
such understanding or agreement is legally binding. Treas. Reg. sec.
301.6111-2(c)(1).
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Failure to register tax shelter
Under prior law, the penalty for failing to timely register
a tax shelter (or for filing false or incomplete information
with respect to the tax shelter registration) generally was the
greater of one percent of the aggregate amount invested in the
shelter or $500.\672\ However, if the tax shelter involved an
arrangement offered to a corporation under conditions of
confidentiality, the penalty was the greater of $10,000 or 50
percent of the fees payable to any promoter with respect to
offerings prior to the date of late registration. Intentional
disregard of the requirement to register increased the penalty
to 75 percent of the applicable fees.
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\672\ Sec. 6707.
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Prior-law section 6707 also imposed (1) a $100 penalty on
the promoter for each failure to furnish the investor with the
required tax shelter identification number, and (2) a $250
penalty on the investor for each failure to include the tax
shelter identification number on a return.
Reasons for Change
The Congress understood that the prior-law promoter
registration rules were not proving particularly helpful,
primarily because the rules were not appropriate for the kinds
of abusive transactions now prevalent, and because the
limitations regarding confidential corporate arrangements had
proven easy to circumvent.
The Congress believed that providing a single, clear
definition regarding the types of transactions that must be
disclosed by taxpayers and material advisors, coupled with more
meaningful penalties for failing to disclose such transactions,
are necessary tools if the effort to curb the use of abusive
tax avoidance transactions is to be effective.
Explanation of Provision \673\
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\673\ Notice 2004-80, 2004-50 I.R.B. 963, Notice 2005-17, 2005-8
I.R.B. 1, and Notice 2005-22, 2005-12 IRB 756 provide interim guidance
concerning the application of this provision.
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Disclosure of reportable transactions by material advisors
The Act repeals the present law rules with respect to
registration of tax shelters. Instead, the Act requires each
material advisor with respect to any reportable transaction
(including any listed transaction) \674\ to timely file an
information return with the Secretary (in such form and manner
as the Secretary may prescribe). The return must be filed on
such date as specified by the Secretary.
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\674\ The terms ``reportable transaction'' and ``listed
transaction'' have the same meaning as previously described in
connection with the taxpayer-related provisions.
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The information return will include: (1) information
identifying and describing the transaction; (2) information
describing any potential tax benefits expected to result from
the transaction; and (3) such other information as the
Secretary may prescribe. It is expected that the Secretary may
seek from the material advisor the same type of information
that the Secretary may request from a taxpayer in connection
with a reportable transaction.\675\
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\675\ See the previous discussion regarding the disclosure
requirements under new section 6707A.
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A ``material advisor'' means any person: (1) who provides
material aid, assistance, or advice with respect to organizing,
managing, promoting, selling, implementing, insuring, or
carrying out any reportable transaction; and (2) who directly
or indirectly derives gross income for such aid, assistance or
advice in excess of $250,000 ($50,000 in the case of a
reportable transaction substantially all of the tax benefits
from which are provided to natural persons) or such other
amount as may be prescribed by the Secretary.
The Secretary may prescribe regulations which provide (1)
that only one material advisor has to file an information
return in cases in which two or more material advisors would
otherwise be required to file information returns with respect
to a particular reportable transaction, (2) exemptions from the
requirements of this section, and (3) other rules as may be
necessary or appropriate to carry out the purposes of this
section (including, for example, rules regarding the
aggregation of fees in appropriate circumstances).
Penalty for failing to furnish information regarding reportable
transactions
The Act repeals the present-law penalty for failure to
register tax shelters. Instead, the Act imposes a penalty on
any material advisor who fails to file an information return,
or who files a false or incomplete information return, with
respect to a reportable transaction (including a listed
transaction).\676\ The amount of the penalty is $50,000. If the
penalty is with respect to a listed transaction, the amount of
the penalty is increased to the greater of (1) $200,000, or (2)
50 percent of the gross income of such person with respect to
aid, assistance, or advice which is provided with respect to
the transaction before the date the information return that
includes the transaction is filed. Intentional disregard by a
material advisor of the requirement to disclose a listed
transaction increases the penalty to 75 percent of the gross
income.
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\676\ The terms ``reportable transaction'' and ``listed
transaction'' have the same meaning as previously described in
connection with the taxpayer-related provisions.
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The penalty cannot be waived with respect to a listed
transaction. As to reportable transactions, the penalty can be
rescinded (or abated) only in exceptional circumstances.\677\
All or part of the penalty may be rescinded only if rescinding
the penalty would promote compliance with the tax laws and
effective tax administration. The decision to rescind a penalty
must be accompanied by a record describing the facts and
reasons for the action and the amount rescinded. There will be
no right to judicially appeal a refusal to rescind a penalty.
The IRS also is required to submit an annual report to Congress
summarizing the application of the disclosure penalties and
providing a description of each penalty rescinded under this
provision and the reasons for the rescission.
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\677\ The Secretary's present-law authority to postpone certain
tax-related deadlines because of Presidentially-declared disasters
(sec. 7508A) will also encompass the authority to postpone the
reporting deadlines established by the provision.
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Effective Date
The provision requiring disclosure of reportable
transactions by material advisors applies to transactions with
respect to which material aid, assistance or advice is provided
after the date of enactment (October 22, 2004).
The provision imposing a penalty for failing to disclose
reportable transactions applies to returns the due date for
which is after the date of enactment (October 22, 2004).
6. Investor lists and modification of penalty for failure to maintain
investor lists (secs. 815 and 817 of the Act and secs. 6112 and
6708 of the Code)
Present and Prior Law
Investor lists
Under prior law, any organizer or seller of a potentially
abusive tax shelter was required to maintain a list identifying
each person who was sold an interest in any such tax shelter
with respect to which registration was required under section
6111 (even though the particular party may not have been
subject to confidentiality restrictions).\678\ Recently issued
regulations under section 6112 contain rules regarding the list
maintenance requirements.\679\ In general, the regulations
apply to transactions that are potentially abusive tax shelters
entered into, or acquired after, February 28, 2003.\680\
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\678\ Sec. 6112.
\679\ Treas. Reg. sec. 301.6112-1.
\680\ A special rule applies the list maintenance requirements to
transactions entered into after February 28, 2000 if the transaction
becomes a listed transaction (as defined in Treas. Reg. 1.6011-4) after
February 28, 2003.
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The regulations provide that a person is an organizer or
seller of a potentially abusive tax shelter if the person is a
material advisor with respect to that transaction.\681\ A
material advisor is defined as any person who is required to
register the transaction under section 6111, or expects to
receive a minimum fee of (1) $250,000 for a transaction that is
a potentially abusive tax shelter if all participants are
corporations, or (2) $50,000 for any other transaction that is
a potentially abusive tax shelter.\682\ For listed transactions
(as defined in the regulations under section 6011), the minimum
fees are reduced to $25,000 and $10,000, respectively.
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\681\ Treas. Reg. sec. 301.6112-1(c)(1).
\682\ Treas. Reg. sec. 301.6112-1(c)(2) and (3).
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A potentially abusive tax shelter is any transaction that
(1) is required to be registered under section 6111, (2) is a
listed transaction (as defined under the regulations under
section 6011), or (3) any transaction that a potential material
advisor, at the time the transaction is entered into, knows is
or reasonably expects will become a reportable transaction (as
defined under the new regulations under section 6011).\683\
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\683\ Treas. Reg. sec. 301.6112-1(b).
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Under prior law, the Secretary was required to prescribe
regulations which provide that, in cases in which two or more
persons are required to maintain the same list, only one person
would be required to maintain the list.\684\
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\684\ Sec. 6112(c)(2).
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Penalty for failing to maintain investor lists
Under prior law, the penalty for failing to maintain the
list required under prior law section 6112 was $50 for each
name omitted from the list (with a maximum penalty of $100,000
per year).\685\
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\685\ Sec. 6708.
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Reasons for Change
The Congress had been advised that the prior-law penalties
for failure to maintain customer lists were not meaningful and
that promoters often have refused to provide requested
information to the IRS. The Congress believed that requiring
material advisors to maintain a list of advisees with respect
to each reportable transaction, coupled with more meaningful
penalties for failing to maintain an investor list, are
important tools in the ongoing efforts to curb the use of
abusive tax avoidance transactions.
Explanation of Provision \686\
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\686\ Notice 2004-80, 2004-50 I.R.B. 963, provides interim guidance
concerning the application of this provision.
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Investor lists
Each material advisor \687\ with respect to a reportable
transaction (including a listed transaction) \688\ is required
to maintain a list that (1) identifies each person with respect
to whom the advisor acted as a material advisor with respect to
the reportable transaction, and (2) contains other information
as may be required by the Secretary. In addition, the Act
authorizes (but does not require) the Secretary to prescribe
regulations which provide that, in cases in which two or more
persons are required to maintain the same list, only one person
would be required to maintain the list.
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\687\ The term ``material advisor'' has the same meaning as when
used in connection with the requirement to file an information return
under section 6111, as amended by the Act.
\688\ The terms ``reportable transaction'' and ``listed
transaction'' have the same meaning as previously described in
connection with the taxpayer-related provisions.
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Penalty for failing to maintain investor lists
The Act modifies the penalty for failing to maintain the
required list by making it a time-sensitive penalty.\689\ Thus,
a material advisor who is required to maintain an investor list
and who fails to make the list available upon written request
by the Secretary within 20 business days after the request will
be subject to a $10,000 per day penalty. The penalty applies to
a person who fails to maintain a list, maintains an incomplete
list, or has in fact maintained a list but does not make the
list available to the Secretary. The penalty can be waived if
the failure to make the list available is due to reasonable
cause.\690\
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\689\ It is intended that the modified penalty for failing to
comply with the list maintenance requirements applies to both (1)
material advisors with respect to reportable transactions under
present-law section 6112, (2) and organizers and sellers of potentially
abusive tax shelters under prior-law section 6112. A technical
correction may be necessary so that the statute reflects this intent.
\690\ In no event will failure to maintain a list be considered
reasonable cause for failing to make a list available to the Secretary.
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Effective Date
The provision requiring a material advisor to maintain an
investor list applies to transactions with respect to which
material aid, assistance or advice is provided after the date
of enactment (October 22, 2004). The provision imposing a
penalty for failing to maintain investor lists applies to
requests made after the date of enactment (October 22, 2004).
7. Penalty on promoters of tax shelters (sec. 818 of the Act and sec.
6700 of the Code)
Present and Prior Law
A penalty is imposed on any person who organizes, assists
in the organization of, or participates in the sale of any
interest in, a partnership or other entity, any investment plan
or arrangement, or any other plan or arrangement, if in
connection with such activity the person makes or furnishes a
qualifying false or fraudulent statement or a gross valuation
overstatement.\691\ A qualified false or fraudulent statement
is any statement with respect to the allowability of any
deduction or credit, the excludability of any income, or the
securing of any other tax benefit by reason of holding an
interest in the entity or participating in the plan or
arrangement which the person knows or has reason to know is
false or fraudulent as to any material matter. A ``gross
valuation overstatement'' means any statement as to the value
of any property or services if the stated value exceeds 200
percent of the correct valuation, and the value is directly
related to the amount of any allowable income tax deduction or
credit.
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\691\ Sec. 6700.
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Under present and prior law, the amount of the penalty is
$1,000 (or, if the person establishes that it is less, 100
percent of the gross income derived or to be derived by the
person from such activity). A penalty attributable to a gross
valuation misstatement can be waived on a showing that there
was a reasonable basis for the valuation and it was made in
good faith.
Reasons for Change
The Congress believed that the present-law $1,000 penalty
for tax shelter promoters was insufficient to deter tax shelter
activities. The Congress believed that the increased penalties
for tax shelter promoters are meaningful and will help deter
the promotion of tax shelters.
Explanation of Provision
The Act modifies the penalty amount to equal 50 percent of
the gross income derived by the person from the activity for
which the new penalty is imposed. The new penalty rate applies
to any activity that involves a statement regarding the tax
benefits of participating in a plan or arrangement if the
person knows or has reason to know that such statement is false
or fraudulent as to any material matter. The enhanced penalty
does not apply to a gross valuation overstatement.
Effective Date
The provision is effective for activities occurring after
the date of enactment (October 22, 2004).
8. Modifications of substantial understatement penalty for
nonreportable transactions (sec. 819 of the Act and sec. 6662
of the Code)
Present and Prior Law
An accuracy-related penalty equal to 20 percent applies to
any substantial understatement of tax. Under prior law, a
``substantial understatement'' for both corporate and
noncorporate taxpayers existed if the correct income tax
liability for a taxable year exceeded that reported by the
taxpayer by the greater of 10 percent of the correct tax or
$5,000 ($10,000 in the case of most corporations).\692\
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\692\ Sec. 6662(a) and (d)(1)(A).
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The amount of any understatement generally is reduced by
any portion attributable to an item if (1) the treatment of the
item is or was supported by substantial authority, or (2) facts
relevant to the tax treatment of the item were adequately
disclosed and there was a reasonable basis for its tax
treatment.\693\ Under prior law, the Secretary was required to
prescribe (and revise at least annually) a list of positions
for which the Secretary believes there is not substantial
authority and which affect a significant number of taxpayers.
Such list was required to be published in the Federal Register.
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\693\ Sec. 6662(d)(2)(B).
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Reasons for Change
The Congress believed that the prior-law definition of
substantial understatement allowed large corporate taxpayers to
avoid the accuracy-related penalty on questionable transactions
of a significant size. The Congress believed that an
understatement of more than $10 million is substantial in and
of itself, regardless of the proportion it represents of the
taxpayer's total tax liability.
Explanation of Provision
The Act modifies the definition of ``substantial'' for
corporate taxpayers. Under the Act, a corporate taxpayer has a
substantial understatement if the amount of the understatement
for the taxable year exceeds the lesser of (1) 10 percent of
the tax required to be shown on the return for the taxable year
(or, if greater, $10,000), or (2) $10 million.
The Act also modifies the requirement of the Secretary to
prescribe a list of positions that do not have substantial
authority, and authorizes (but does not require) the Secretary
to publish such list in either the Federal Register or the
Internal Revenue Bulletin. The Act also authorizes (but does
not require) the Secretary to publish (in either the Federal
Register or Internal Revenue Bulletin) a list of positions that
do not have a realistic possibility of being sustained on the
merits for purposes of the income tax return preparer penalty
under section 6694.
Effective Date
The provision is effective for taxable years beginning
after date of enactment (October 22, 2004).
9. Modification of actions to enjoin certain conduct related to tax
shelters and reportable transactions (sec. 820 of the Act and
sec. 7408 of the Code)
Present and Prior Law
The Code authorizes civil actions to enjoin any person from
promoting abusive tax shelters or aiding or abetting the
understatement of tax liability.\694\
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\694\ Sec. 7408.
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Reasons for Change
The Congress believed that expanding the authority to
obtain injunctions against promoters and material advisors that
(1) fail to file an information return with respect to a
reportable transaction or (2) fail to maintain, or to timely
furnish upon written request by the Secretary, a list of
investors with respect to reportable transactions would
discourage tax shelter activity and encourage compliance with
the tax shelter disclosure requirements.
The Congress similarly believed that expanding the
authority to obtain injunctions against violations of the rules
under Circular 230 would encourage compliance with such rules.
Explanation of Provision
The Act expands this rule so that injunctions may also be
sought with respect to the requirements relating to the
reporting of reportable transactions \695\ and the keeping of
lists of investors by material advisors.\696\ Thus, under the
Act, an injunction may be sought against a material advisor to
enjoin the advisor from (1) failing to file an information
return with respect to a reportable transaction, or (2) failing
to maintain, or to timely furnish upon written request by the
Secretary, a list of investors with respect to each reportable
transaction.
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\695\ Sec. 6707, as amended by other provisions of the Act.
\696\ Sec. 6708, as amended by other provisions of the Act.
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The Act further expands this rule to permit injunctions to
be sought with respect to violations of any of the rules under
Circular 230, which regulates the practice of representatives
of persons before the Department of the Treasury.
Effective Date
The provision is effective on the day after the date of
enactment (October 22, 2004).
10. Penalty on failure to report interests in foreign financial
accounts (sec. 821 of the Act and sec. 5321 of Title 31, United
States Code)
Present and Prior Law
The Secretary must require citizens, residents, or persons
doing business in the United States to keep records and file
reports when that person makes a transaction or maintains an
account with a foreign financial entity.\697\ In general,
individuals must fulfill this requirement by answering
questions regarding foreign accounts or foreign trusts that are
contained in Part III of Schedule B of the IRS Form 1040.
Taxpayers who answer ``yes'' in response to the question
regarding foreign accounts must then file Treasury Department
Form TD F 90-22.1. This form must be filed with the Department
of the Treasury, and not as part of the tax return that is
filed with the IRS.
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\697\ 31 U.S.C. sec. 5314.
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The Secretary may impose a civil penalty on any person who
willfully violates this reporting requirement. Under prior law,
the civil penalty was the amount of the transaction or the
value of the account at the time of the violation, up to a
maximum of $100,000; the minimum amount of the penalty was
$25,000.\698\ In addition, any person who willfully violates
this reporting requirement is subject to a criminal penalty.
The criminal penalty is a fine of not more than $250,000 or
imprisonment for not more than five years (or both); if the
violation is part of a pattern of illegal activity, the maximum
amount of the fine is increased to $500,000 and the maximum
length of imprisonment is increased to 10 years.\699\
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\698\ 31 U.S.C. sec. 5321(a)(5).
\699\ 31 U.S.C. sec. 5322.
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On April 26, 2002, the Secretary submitted to the Congress
a report on these reporting requirements.\700\ This report,
which was statutorily required,\701\ studies methods for
improving compliance with these reporting requirements. It
makes several administrative recommendations, but no
legislative recommendations. A further report was required to
be submitted by the Secretary to the Congress by October 26,
2002.
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\700\ A Report to Congress in Accordance with Sec. 361(b) of the
Uniting and Strengthening America by Providing Appropriate Tools
Required to Intercept and Obstruct Terrorism Act of 2001, April 26,
2002.
\701\ Sec. 361(b) of the USA PATRIOT Act of 2001 (Pub. L. No. 107-
56).
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Reasons for Change
The Congress understood that the number of individuals
using offshore bank accounts to engage in abusive tax scams has
grown significantly in recent years. For one scheme alone, the
IRS estimates that there may be hundreds of thousands of
taxpayers with offshore bank accounts attempting to conceal
income from the IRS. The Congress was concerned about this
activity and believed that improving compliance with this
reporting requirement is vitally important to sound tax
administration, to combating terrorism, and to preventing the
use of abusive tax schemes and scams. The Congress believed
that increasing the prior-law penalty for willful noncompliance
with this requirement and imposing a new civil penalty that
applies without regard to willfulness in such noncompliance
will improve the reporting of foreign financial accounts.
Explanation of Provision
The Act adds an additional civil penalty that may be
imposed on any person who violates this reporting requirement
(without regard to willfulness). This new civil penalty is up
to $10,000. This penalty may be waived if any income from the
account was properly reported on the person's income tax return
and there was reasonable cause for the failure to report.
In addition, the Act increases the prior-law penalty for
willful behavior to the greater of $100,000 or 50 percent of
the amount of the transaction or account.
Effective Date
The provision is effective with respect to failures to
report occurring on or after the date of enactment (October 22,
2004).
11. Regulation of individuals practicing before the Department of the
Treasury (sec. 822 of the Act and sec. 330 of Title 31, United
States Code)
Present and Prior Law
The Secretary is authorized to regulate the practice of
representatives of persons before the Department of the
Treasury.\702\ The Secretary also is authorized to suspend or
disbar from practice before the Department a representative who
is incompetent, who is disreputable, who violates the rules
regulating practice before the Department, or who (with intent
to defraud) willfully and knowingly misleads or threatens the
person being represented (or a person who may be represented).
The rules promulgated by the Secretary pursuant to this
provision are contained in Circular 230.\703\
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\702\ 31 U.S.C. sec. 330.
\703\ On December 20, 2004, the Treasury Department and the IRS
published proposed and final regulations amending Circular 230. 69 Fed.
Reg. 75887; T.D. 9165, 69 Fed. Reg. 75839. The final regulations do not
reflect amendments made by the Act, although the preamble to the final
regulations states that the Treasury Department and the IRS expect to
propose additional regulations implementing the provisions of the Act.
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Reasons for Change
The Congress believed that it was critical that the
Secretary have the authority to censure tax advisors as well as
to impose monetary sanctions against tax advisors because of
the important role of tax advisors in our tax system. Use of
these sanctions is expected to curb the participation of tax
advisors in both tax shelter activity and any other activity
that is contrary to Circular 230 standards.
Explanation of Provision
The Act makes two modifications to expand the sanctions
that the Secretary may impose pursuant to these statutory
provisions. First, the Act expressly permits censure as a
sanction. Second, the Act permits the imposition of a monetary
penalty as a sanction. If the representative is acting on
behalf of an employer or other entity, the Secretary may impose
a monetary penalty on the employer or other entity if it knew,
or reasonably should have known, of the conduct. This monetary
penalty on the employer or other entity may be imposed in
addition to any monetary penalty imposed directly on the
representative. These monetary penalties are not to exceed the
gross income derived (or to be derived) from the conduct giving
rise to the penalty. These monetary penalties may be in
addition to, or in lieu of, any suspension, disbarment, or
censure of such individual.
The Act also confirms the authority of the Secretary to
impose standards applicable to written advice with respect to
an entity, transaction, plan, or arrangement that is of a type
that the Secretary determines as having a potential for tax
avoidance or evasion.
Effective Date
The modifications to expand the sanctions that the
Secretary may impose are effective for actions taken after the
date of enactment (October 22, 2004).
12. Treatment of stripped bonds to apply to stripped interests in bond
and preferred stock funds (sec. 831 of the Act and secs. 305
and 1286 of the Code)
Present and Prior Law
Assignment of income in general
In general, an ``income stripping'' transaction involves a
transaction in which the right to receive future income from
income-producing property is separated from the property
itself. In such transactions, it may be possible to generate
artificial losses from the disposition of certain property or
to defer the recognition of taxable income associated with such
property.
Common law has developed a rule (referred to as the
``assignment of income'' doctrine) whereby if the right to
receive income is transferred without an accompanying transfer
of the underlying property, the transfer is not respected. A
leading judicial decision relating to the assignment of income
doctrine involved a case in which a taxpayer made a gift of
detachable interest coupons before their due date while
retaining the bearer bond. The U.S. Supreme Court ruled that
the donor was taxable on the entire amount of interest when
paid to the donee on the grounds that the transferor had
``assigned'' to the donee the right to receive the income.\704\
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\704\ Helvering v. Horst, 311 U.S. 112 (1940).
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In addition to general common law assignment of income
principles, specific statutory rules have been enacted to
address certain specific types of stripping transactions, such
as transactions involving stripped bonds and stripped preferred
stock (which are discussed below).\705\ Under prior law,
however, there were no specific statutory rules that addressed
stripping transactions with respect to common stock or other
equity interests (other than preferred stock).\706\
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\705\ Depending on the facts, the IRS also could determine that a
variety of other Code-based and common law-based authorities could
apply to income stripping transactions, including: (1) sections 269,
382, 446(b), 482, 701, or 704 and the regulations thereunder; (2)
authorities that recharacterize certain assignments or accelerations of
future payments as financings; (3) business purpose, economic
substance, and sham transaction doctrines; (4) the step transaction
doctrine; and (5) the substance-over-form doctrine. See Notice 95-53,
1995-2 C.B. 334 (accounting for lease strips and other stripping
transactions).
\706\ However, in Estate of Stranahan v. Commissioner, 472 F.2d 867
(6th Cir. 1973), the court held that where a taxpayer sold a carved-out
interest of stock dividends, with no personal obligation to produce the
income, the transaction was treated as a sale of an income interest.
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Stripped bonds
Special rules are provided with respect to the purchaser
and ``stripper'' of stripped bonds.\707\ A ``stripped bond'' is
defined as a debt instrument in which there has been a
separation in ownership between the underlying debt instrument
and any interest coupon that has not yet become payable.\708\
In general, upon the disposition of either the stripped bond or
the detached interest coupons, the retained portion and the
portion that is disposed of each is treated as a new bond that
is purchased at a discount and is payable at a fixed amount on
a future date. Accordingly, section 1286 treats both the
stripped bond and the detached interest coupons as individual
bonds that are newly issued with original issue discount
(``OID'') on the date of disposition. Consequently, section
1286 effectively subjects the stripped bond and the detached
interest coupons to the general OID periodic income inclusion
rules.
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\707\ Sec. 1286.
\708\ Sec. 1286(e).
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A taxpayer who purchases a stripped bond or one or more
stripped coupons is treated as holding a new bond that is
issued on the purchase date with OID in an amount that is equal
to the excess of the stated redemption price at maturity (or in
the case of a coupon, the amount payable on the due date) over
the ratable share of the purchase price of the stripped bond or
coupon, determined on the basis of the respective fair market
values of the stripped bond and coupons on the purchase
date.\709\ The OID on the stripped bond or coupon is includible
in gross income under the general OID periodic income inclusion
rules.
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\709\ Sec. 1286(a).
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A taxpayer who strips a bond and disposes of either the
stripped bond or one or more stripped coupons must allocate the
taxpayer's basis, immediately before the disposition, in the
bond (with the coupons attached) between the retained and
disposed items.\710\ Special rules apply to require that
interest or market discount accrued on the bond prior to such
disposition must be included in the taxpayer's gross income (to
the extent that it had not been previously included in income)
at the time the stripping occurs, and the taxpayer increases
the basis in the bond by the amount of such accrued interest or
market discount. The adjusted basis (as increased by any
accrued interest or market discount) is then allocated between
the stripped bond and the stripped interest coupons in relation
to their respective fair market values. Amounts realized from
the sale of stripped coupons or bonds constitute income to the
taxpayer only to the extent such amounts exceed the basis
allocated to the stripped coupons or bond. With respect to
retained items (either the detached coupons or stripped bond),
to the extent that the price payable on maturity, or on the due
date of the coupons, exceeds the portion of the taxpayer's
basis allocable to such retained items, the difference is
treated as OID that is required to be included under the
general OID periodic income inclusion rules.\711\
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\710\ Sec. 1286(b). Similar rules apply in the case of any person
whose basis in any bond or coupon is determined by reference to the
basis in the hands of a person who strips the bond.
\711\ Special rules are provided with respect to stripping
transactions involving tax-exempt obligations that treat OID (computed
under the stripping rules) in excess of OID computed on the basis of
the bond's coupon rate (or higher rate if originally issued at a
discount) as income from a non-tax-exempt debt instrument (sec.
1286(d)).
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Stripped preferred stock
``Stripped preferred stock'' is defined as preferred stock
in which there has been a separation in ownership between such
stock and any dividend on such stock that has not become
payable.\712\ A taxpayer who purchases stripped preferred stock
is required to include in gross income, as ordinary income, the
amounts that would have been includible if the stripped
preferred stock were a bond issued on the purchase date with
OID equal to the excess of the redemption price of the stock
over the purchase price.\713\ This treatment is extended to any
taxpayer whose basis in the stock is determined by reference to
the basis in the hands of the purchaser. A taxpayer who strips
and disposes the future dividends is treated as having
purchased the stripped preferred stock on the date of such
disposition for a purchase price equal to the taxpayer's
adjusted basis in the stripped preferred stock.\714\
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\712\ Sec. 305(e)(5).
\713\ Sec. 305(e)(1).
\714\ Sec. 305(e)(3).
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Reasons for Change
The Congress was concerned that taxpayers are entering into
tax avoidance transactions to generate artificial losses, or
defer the recognition of ordinary income and convert such
income into capital gains, by selling or purchasing stripped
interests that are not subject to the present-law rules
relating to stripped bonds and preferred stock but that
represent interests in bonds or preferred stock. Therefore, the
Congress believed that it is appropriate to provide Treasury
with regulatory authority to apply such rules to interests that
do not constitute bonds or preferred stock but nevertheless
derive their economic value and characteristics exclusively
from underlying bonds or preferred stock.
Explanation of Provision
The Act authorizes the Treasury Department to promulgate
regulations that, in appropriate cases, apply rules that are
similar to the present-law rules for stripped bonds and
stripped preferred stock to direct or indirect interests in an
entity or account substantially all of the assets of which
consist of bonds (as defined in section 1286(e)(1)), preferred
stock (as defined in section 305(e)(5)(B)), or any combination
thereof. The Act applies only to cases in which the present-law
rules for stripped bonds and stripped preferred stock do not
already apply to such interests.
For example, such Treasury regulations could apply to a
transaction in which a person effectively strips future
dividends from shares in a money market mutual fund (and
disposes of either the stripped shares or stripped future
dividends) by contributing the shares (with the future
dividends) to a custodial account through which another person
purchases rights to either the stripped shares or the stripped
future dividends. However, it is intended that Treasury
regulations issued under the Act would not apply to certain
transactions involving direct or indirect interests in an
entity or account substantially all the assets of which consist
of tax-exempt obligations (as defined in section 1275(a)(3)),
such as a tax-exempt bond partnership described in Rev. Proc.
2002-68,\715\ modifying and superseding Rev. Proc. 2002-
16.\716\
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\715\ 2002-43 I.R.B. 753.
\716\ 2002-9 I.R.B. 572.
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No inference is intended as to the treatment under the
rules for stripped bonds and stripped preferred stock, or under
any other provisions or doctrines of law, of interests in an
entity or account substantially all of the assets of which
consist of bonds, preferred stock, or any combination thereof.
The Treasury regulations, when issued, would be applied
prospectively, except in cases to prevent abuse.
Effective Date
The provision is effective for purchases and dispositions
occurring after the date of enactment (October 22, 2004).
13. Minimum holding period for foreign tax credit with respect to
withholding taxes on income other than dividends (sec. 832 of the Act
and sec. 901 of the Code)
Present and Prior Law
In general, U.S. persons may credit foreign taxes against
U.S. tax on foreign-source income. The amount of foreign tax
credits that may be claimed in a year is subject to a
limitation that prevents taxpayers from using foreign tax
credits to offset U.S. tax on U.S.-source income. Separate
limitations are applied to specific categories of income.
As a consequence of the foreign tax credit limitations of
the Code, certain taxpayers are unable to utilize their
creditable foreign taxes to reduce their U.S. tax liability.
U.S. taxpayers that are tax-exempt receive no U.S. tax benefit
for foreign taxes paid on income that they receive.
The Code denies a U.S. shareholder the foreign tax credits
normally available with respect to a dividend from a
corporation or a regulated investment company (``RIC'') if the
shareholder has not held the stock for more than 15 days
(within a 30-day testing period) in the case of common stock or
more than 45 days (within a 90-day testing period) in the case
of preferred stock (sec. 901(k)). The disallowance applies both
to foreign tax credits for foreign withholding taxes that are
paid on the dividend where the dividend-paying stock is held
for less than these holding periods, and to indirect foreign
tax credits for taxes paid by a lower-tier foreign corporation
or a RIC where any of the required stock in the chain of
ownership is held for less than these holding periods. Periods
during which a taxpayer is protected from risk of loss (e.g.,
by purchasing a put option or entering into a short sale with
respect to the stock) generally are not counted toward the
holding period requirement. In the case of a bona fide contract
to sell stock, a special rule applies for purposes of indirect
foreign tax credits. The disallowance does not apply to foreign
tax credits with respect to certain dividends received by
active dealers in securities. If a taxpayer is denied foreign
tax credits because the applicable holding period is not
satisfied, the taxpayer is entitled to a deduction for the
foreign taxes for which the credit is disallowed.
Reasons for Change
The Congress believed that the holding period requirement
for claiming foreign tax credits with respect to dividends is
too narrow in scope and, in general, should be extended to
apply to items of income or gain other than dividends, such as
interest.
Explanation of Provision
The Act expands the disallowance of foreign tax credits to
include credits for gross-basis foreign withholding taxes with
respect to any item of income or gain from property if the
taxpayer who receives the income or gain has not held the
property for more than 15 days (within a 31-day testing
period), exclusive of periods during which the taxpayer is
protected from risk of loss. The Act does not apply to foreign
tax credits that are subject to the disallowance with respect
to dividends. The Act also does not apply to certain income or
gain that is received with respect to property held by active
dealers.\717\ Rules similar to the disallowance for foreign tax
credits with respect to dividends apply to foreign tax credits
that are subject to the Act. In addition, the Act authorizes
the Treasury Department to issue regulations providing that the
provision does not apply in appropriate cases.
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\717\ It is intended that the exception for certain withholding
taxes paid by registered or licensed brokers and dealers on income and
gain from securities also apply to gain from the sale of stock. A
technical correction may be necessary so that the statute reflects this
intent.
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It is intended that the Secretary will prescribe
regulations to adapt the holding period and hedging rules of
section 901(k) to property other than stock. It is anticipated
that such regulations will provide that credits are not
disallowed merely because a taxpayer eliminates its risk of
loss from interest rate or currency fluctuations. In addition,
it is intended that such regulations might permit other hedging
activities, such as hedging of credit risk, provided that the
taxpayer does not hedge most of its risk of loss with respect
to the property unless there has been a meaningful and
unanticipated change in circumstances.
Effective Date
The provision is effective for amounts that are paid or
accrued more than 30 days after the date of enactment (October
22, 2004).
14. Treatment of partnership loss transfers and partnership basis
adjustments (sec. 833 of the Act and secs. 704, 734, 743, and
754 of the Code)
Present and Prior Law
Contributions of property
If a partner contributes property to a partnership,
generally no gain or loss is recognized to the contributing
partner at the time of contribution.\718\ The partnership takes
the property at an adjusted basis equal to the contributing
partner's adjusted basis in the property.\719\ The contributing
partner increases its basis in its partnership interest by the
adjusted basis of the contributed property.\720\ Any items of
partnership income, gain, loss and deduction with respect to
the contributed property are allocated among the partners to
take into account any built-in gain or loss at the time of the
contribution.\721\ This rule is intended to prevent the
transfer of built-in gain or loss from the contributing partner
to the other partners by generally allocating items to the
noncontributing partners based on the value of their
contributions and by allocating to the contributing partner the
remainder of each item.\722\
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\718\ Sec. 721.
\719\ Sec. 723.
\720\ Sec. 722.
\721\ Sec. 704(c)(1)(A).
\722\ If there is an insufficient amount of an item to allocate to
the noncontributing partners, Treasury regulations allow for curative
or remedial allocations to remedy this insufficiency. Treas. Reg. sec.
1.704-3(c) and (d).
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If the contributing partner transfers its partnership
interest, the built-in gain or loss will be allocated to the
transferee partner as it would have been allocated to the
contributing partner.\723\ If the contributing partner's
interest is liquidated, there is no specific guidance
preventing the allocation of the built-in loss to the remaining
partners. Thus, it appears that losses can be ``transferred''
to other partners where the contributing partner no longer
remains a partner.
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\723\ Treas. Reg. sec. 1.704-3(a)(7).
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Transfers of partnership interests
A partnership does not adjust the basis of partnership
property following the transfer of a partnership interest
unless the partnership has made a one-time election under
section 754 to make basis adjustments.\724\ If an election is
in effect, adjustments are made with respect to the transferee
partner to account for the difference between the transferee
partner's proportionate share of the adjusted basis of the
partnership property and the transferee's basis in its
partnership interest.\725\ These adjustments are intended to
adjust the basis of partnership property to approximate the
result of a direct purchase of the property by the transferee
partner. Under these rules, if a partner purchases an interest
in a partnership with an existing built-in loss and no election
under section 754 is in effect, the transferee partner may be
allocated a share of the loss when the partnership disposes of
the property (or depreciates the property).
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\724\ Sec. 743(a).
\725\ Sec. 743(b).
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Distributions of partnership property
With certain exceptions, partners may receive distributions
of partnership property without recognition of gain or loss by
either the partner or the partnership.\726\ In the case of a
distribution in liquidation of a partner's interest, the basis
of the property distributed in the liquidation is equal to the
partner's adjusted basis in its partnership interest (reduced
by any money distributed in the transaction).\727\ In a
distribution other than in liquidation of a partner's interest,
the distributee partner's basis in the distributed property is
equal to the partnership's adjusted basis in the property
immediately before the distribution, but not to exceed the
partner's adjusted basis in the partnership interest (reduced
by any money distributed in the same transaction).\728\
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\726\ Sec. 731(a) and (b).
\727\ Sec. 732(b).
\728\ Sec. 732(a).
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The determination of the basis of individual properties
distributed by a partnership is dependent on the adjusted basis
of the properties in the hands of the partnership.\729\ If a
partnership interest is transferred to a partner and the
partnership has not elected to adjust the basis of partnership
property, a special basis rule provides for the determination
of the transferee partner's basis of properties that are later
distributed by the partnership.\730\ Under this rule, in
determining the basis of property distributed by a partnership
within 2 years following the transfer of the partnership
interest, the transferee may elect to determine its basis as if
the partnership had adjusted the basis of the distributed
property under section 743(b) on the transfer. The special
basis rule also applies to distributed property if, at the time
of the transfer, the fair market value of partnership property
other than money exceeds 110 percent of the partnership's basis
in such property and a liquidation of the partnership interest
immediately after the transfer would have resulted in a shift
of basis to property subject to an allowance of depreciation,
depletion or amortization.\731\
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\729\ Sec. 732(a)(1) and (c).
\730\ Sec. 732(d).
\731\ Treas. Reg. sec. 1.732-1(d)(4).
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Adjustments to the basis of the partnership's undistributed
properties are not required unless the partnership has made the
election under section 754 to make basis adjustments.\732\ If
an election is in effect under section 754, adjustments are
made by a partnership to increase or decrease the remaining
partnership assets to reflect any increase or decrease in the
adjusted basis of the distributed properties in the hands of
the distributee partner (or gain or loss recognized by the
distributee partner).\733\ To the extent the adjusted basis of
the distributed properties increases (or loss is recognized)
the partnership's adjusted basis in its properties is decreased
by a like amount; likewise, to the extent the adjusted basis of
the distributed properties decreases (or gain is recognized),
the partnership's adjusted basis in its properties is increased
by a like amount. Under these rules, a partnership with no
election in effect under section 754 may distribute property
with an adjusted basis lower than the distributee partner's
proportionate share of the adjusted basis of all partnership
property and leave the remaining partners with a smaller net
built-in gain or a larger net built-in loss than before the
distribution.
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\732\ Sec. 734(a).
\733\ Sec. 734(b).
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Reasons for Change
The Congress believed that the partnership rules allowed
for the inappropriate transfer of losses among partners. This
has allowed partnerships to be created and used to aid tax-
shelter transactions. The Act limits the ability to transfer
losses among partners, while preserving the simplification
aspects of the current partnership rules for transactions
involving smaller amounts. The Congress was made aware that
certain types of investment partnerships would incur
administrative difficulties in making partnership-level basis
adjustments in the event of a transfer of a partnership
interest, as evidenced by the present practice of a number of
investment partnerships not to elect partnership basis
adjustments even when the adjustments would be upward
adjustments to the basis of partnership property. Accordingly,
the Act provides a partner-level loss limitation as an
alternative to the partnership basis adjustments otherwise
required under the Act in the case of transfers of interests in
certain investment partnerships that are engaged in investment
activities rather than in any trade or business activity.
Explanation of Provision
Contributions of property
Under the Act, a built-in loss may be taken into account
only by the contributing partner and not by other partners.
Except as provided in regulations, in determining the amount of
items allocated to partners other than the contributing
partner, the basis of the contributed property is treated as
the fair market value at the time of contribution. Thus, if the
contributing partner's partnership interest is transferred or
liquidated, the partnership's adjusted basis in the property is
based on its fair market value at the time of contribution, and
the built-in loss is eliminated.\734\
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\734\ It is intended that a corporation succeeding to attributes of
the contributing corporate partner under section 381 shall be treated
in the same manner as the contributing partner.
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Transfers of partnership interests
The Act provides generally that the basis adjustment rules
under section 743 are mandatory in the case of the transfer of
a partnership interest with respect to which there is a
substantial built-in loss (rather than being elective as under
prior law). For this purpose, a substantial built-in loss
exists if the partnership's adjusted basis in its property
exceeds by more than $250,000 the fair market value of the
partnership property.
Thus, for example, assume that partner A sells his 25-
percent partnership interest to B for its fair market value of
$1 million. Also assume that, immediately after the transfer,
the fair market value of partnership assets is $4 million and
the partnership's adjusted basis in the partnership assets is
$4.3 million. Under the bill, section 743(b) applies, so that
an adjustment is required to the adjusted basis of the
partnership assets with respect to B. As a result, B would
recognize no gain or loss if the partnership immediately sold
all its assets for their fair market value.
The Act provides that an electing investment partnership is
not treated as having a substantial built-in loss, and thus is
not required to make basis adjustments to partnership property,
in the case of a transfer of a partnership interest. In lieu of
the partnership basis adjustments, a partner-level loss
limitation rule applies. Under this rule, the transferee
partner's distributive share of losses (determined without
regard to gains) from the sale or exchange of partnership
property is not allowed, except to the extent it is established
that the partner's share of such losses exceeds the loss
recognized by the transferor partner. In the event of
successive transfers, the transferee partner's distributive
share of such losses is not allowed, except to the extent that
it is established that such losses exceed the loss recognized
by the transferor (or any prior transferor to the extent not
fully offset by a prior disallowance under this rule). Losses
disallowed under this rule do not decrease the transferee
partner's basis in its partnership interest. Thus, on
subsequent disposition of its partnership interest, the
partner's gain is reduced (or loss increased) because the basis
of the partnership interest has not been reduced by such
losses. The Act is applied without regard to any termination of
a partnership under section 708(b)(1)(B). In the case of a
basis reduction to property distributed to the transferee
partner in a nonliquidating distribution, the amount of the
transferor's loss taken into account under this rule is reduced
by the amount of the basis reduction.
For this purpose, an electing investment partnership means
a partnership that satisfies the following requirements: (1) it
makes an election under the provision that is irrevocable
except with the consent of the Secretary; (2) it would be an
investment company under section 3(a)(1)(A) of the Investment
Company Act of 1940 \735\ but for an exemption under paragraph
(1) or (7) of section 3(c) of that Act; (3) it has never been
engaged in a trade or business; (4) substantially all of its
assets are held for investment; (5) at least 95 percent of the
assets contributed to it consist of money; (6) no assets
contributed to it had an adjusted basis in excess of fair
market value at the time of contribution; (7) all partnership
interests are issued by the partnership pursuant to a private
offering prior to the date that is 24 months after the date of
the first capital contribution to the partnership (the Congress
intends that ``dry'' closings in which partnership interests
are issued without the contribution of capital not start the
running of the 24-month period); (8) the partnership agreement
has substantive restrictions on each partner's ability to cause
a redemption of the partner's interest; and (9) the partnership
agreement provides for a term that is not in excess of 15
years.
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\735\ Section 3(a)(1)(A) of the Investment Company Act of 1940
provides, ``when used in this title, `investment company' means any
issuer which is or holds itself out as being engaged primarily, or
proposes to engage primarily, in the business of investing,
reinvesting, or trading in securities.''
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It is intended that in applying the requirement (with
respect to electing investment partnerships) that the
partnership agreement have substantive restrictions on each
partner's ability to cause a redemption, the following are
illustrative examples of substantive restrictions (i.e.,
redemption is permitted under the partnership agreement only if
the following would result absent the redemption): A violation
of Federal or State law (such as ERISA or the Bank Holding
Company Act); and imposition of a Federal excise tax on, or a
change in the Federal tax-exempt status of, a tax-exempt
partner.
The Congress understands that electing investment
partnerships will generally include venture capital funds,
buyout funds, and funds of funds. These funds are formed to
raise capital from investors pursuant to a private offering and
to make investments during the limited term of the partnership
with the intention of holding the investments for capital
appreciation.
The Act requires an electing investment partnership to
furnish to any transferee partner the information necessary to
enable the partner to compute the amount of losses disallowed
under this rule. With respect to this requirement, it is
expected that in some cases the transferor of the partnership
interest will furnish information relating to the amount of its
loss to the transferee partner. It is intended that the
requirement that the electing investment partnership furnish
necessary information to the transferee partner be administered
by the Treasury Secretary in a manner that (to the greatest
extent feasible) minimizes the need for the partnership to
furnish information to the transferee partner that the
transferee partner has obtained from the transferor.
Distributions of partnership property
The Act provides that a basis adjustment under section
734(b) is required in the case of a distribution with respect
to which there is a substantial basis reduction. A substantial
basis reduction means a downward adjustment of more than
$250,000 that would be made to the basis of partnership assets
if a section 754 election were in effect.
Thus, for example, assume that A and B each contributed
$2.5 million to a newly formed partnership and C contributed $5
million, and that the partnership purchased LMN stock for $3
million and XYZ stock for $7 million. Assume that the value of
each stock declined to $1 million. Assume LMN stock is
distributed to C in liquidation of its partnership interest.
Under prior law, the basis of LMN stock in C's hands is $5
million. Under prior law, C would recognize a loss of $4
million if the LMN stock were sold for $1 million.
Under the Act, there is a substantial basis adjustment
because the $2 million increase in the adjusted basis of LMN
stock (described in section 734(b)(2)(B)) is greater than
$250,000. Thus, the partnership is required to decrease the
basis of XYZ stock (under section 734(b)(2)) by $2 million (the
amount by which the basis of LMN stock was increased), leaving
a basis of $5 million. If the XYZ stock were then sold by the
partnership for $1 million, A and B would each recognize a loss
of $2 million.
Other rules
The Act adds an exception for securitization partnerships
to the rules requiring partnership basis adjustments in the
case of transfers of partnership interests and distributions of
property to a partner. The exceptions provide that a
securitization partnership is not treated as having a
substantial built-in loss in the case of a transfer of a
partnership interest, or as having a substantial basis
reduction in the case of a partnership distribution, and thus
is not required to make basis adjustments to partnership
property. Partnership basis adjustments remain elective for
such a partnership. Unlike in the case of an electing
investment partnership, the partner-level loss limitation rule
does not apply in the case of a securitization partnership. For
this purpose, a securitization partnership is any partnership
the sole business activity of which is to issue securities that
provide for a fixed principal (or similar) amount and that are
primarily serviced by the cash flows of a discrete pool (either
fixed or revolving) of receivables or other financial assets
that by their terms convert into cash in a finite period, but
only if the sponsor of the pool reasonably believes that the
receivables and other financial assets comprising the pool are
not acquired so as to be disposed of. It is intended that rules
similar to those applicable to sponsors of REMICs apply in
determining whether the sponsor's belief is reasonable.\736\ It
is not intended that the rules requiring partnership basis
adjustments on transfers or distributions be avoided through
dispositions of pool assets.
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\736\ See Treas. Reg. sec. 1.860G-2(a)(3), providing that a
sponsor's belief is not reasonable if the sponsor actually knows or has
reason to know that the requirement is not met, or if the requirement
is later discovered not to have been met.
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It is intended that an electing investment partnership or
securitization partnership that subsequently fails to meet the
definition of an electing investment partnership or of a
securitization partnership will be subject to the partnership
basis adjustment rules of the provision with respect to the
first transfer of a partnership interest (and, in the case of a
securitization partnership, the first distribution) that occurs
after the partnership ceases to meet the applicable definition
and to each subsequent transfer (and distribution, in the case
of a securitization partnership).
It is not intended that the rules of the provision be
avoided through the use of tiered partnerships.
It is not intended that the provision relating to
contributions of built-in loss property limit the ability of
master-feeder structures to apply an aggregate method for
making allocations under section 704(c) to the extent the
aggregate method is permitted under prior law.\737\
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\737\ See. Rev. Proc. 2001-36, 2001-1 C.B. 1326. Definitional
requirements of a master-feeder structure include that there is a
portfolio of assets that is treated as a partnership for Federal tax
purposes and that is registered as an investment company under the
Investment Company Act of 1940, each partner of which is a feeder fund
that is a regulated investment company (RIC) for Federal tax purposes,
or is an investment advisor, principal underwriter, or manager of the
portfolio. The Congress believes that these restrictions (and other
applicable restrictions) serve to limit potential avoidance of the
section 704(c) provision through use of the aggregate method in the
case of master-feeder structures.
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Effective Date
The provision applies to contributions, distributions and
transfers (as the case may be) after the date of enactment
(October 22, 2004).
In the case of an electing investment partnership in
existence on June 4, 2004, the requirement that the partnership
agreement have substantive restrictions on redemptions does not
apply, and the requirement that the partnership agreement
provide for a term not exceeding 15 years is modified to permit
a term not exceeding 20 years.
15. No reduction of basis under section 734 in stock held by
partnership in corporate partner (sec. 834 of the Act and sec.
755 of the Code)
Present and Prior Law
In general
Generally, a partner and the partnership do not recognize
gain or loss on a contribution of property to the
partnership.\738\ Similarly, a partner and the partnership
generally do not recognize gain or loss on the distribution of
partnership property.\739\ This includes current distributions
and distributions in liquidation of a partner's interest.
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\738\ Sec. 721(a).
\739\ Sec. 731(a) and (b).
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Basis of property distributed in liquidation
The basis of property distributed in liquidation of a
partner's interest is equal to the partner's tax basis in its
partnership interest (reduced by any money distributed in the
same transaction).\740\ Thus, the partnership's tax basis in
the distributed property is adjusted (increased or decreased)
to reflect the partner's tax basis in the partnership interest.
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\740\ Sec. 732(b).
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Election to adjust basis of partnership property
When a partnership distributes partnership property, the
basis of partnership property generally is not adjusted to
reflect the effects of the distribution or transfer. However,
the partnership is permitted to make an election (referred to
as a 754 election) to adjust the basis of partnership property
in the case of a distribution of partnership property.\741\ The
effect of the 754 election is that the partnership adjusts the
basis of its remaining property to reflect any change in basis
of the distributed property in the hands of the distributee
partner resulting from the distribution transaction. Such a
change could be a basis increase due to gain recognition, or a
basis decrease due to the partner's adjusted basis in its
partnership interest exceeding the adjusted basis of the
property received. If the 754 election is made, it applies to
the taxable year with respect to which such election was filed
and all subsequent taxable years.
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\741\ Sec. 754.
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In the case of a distribution of partnership property to a
partner with respect to which the 754 election is in effect,
the partnership increases the basis of partnership property by
(1) any gain recognized by the distributee partner and (2) the
excess of the adjusted basis of the distributed property to the
partnership immediately before its distribution over the basis
of the property to the distributee partner, and decreases the
basis of partnership property by (1) any loss recognized by the
distributee partner and (2) the excess of the basis of the
property to the distributee partner over the adjusted basis of
the distributed property to the partnership immediately before
the distribution.
The allocation of the increase or decrease in basis of
partnership property is made in a manner that has the effect of
reducing the difference between the fair market value and the
adjusted basis of partnership properties.\742\ In addition, the
allocation rules require that any increase or decrease in basis
be allocated to partnership property of a like character to the
property distributed. For this purpose, the two categories of
assets are (1) capital assets and depreciable and real property
used in the trade or business held for more than one year, and
(2) any other property.\743\
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\742\ Sec. 755(a).
\743\ Sec. 755(b).
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Reasons for Change
The Joint Committee on Taxation staff's investigative
report of Enron Corporation \744\ revealed that certain
transactions were being undertaken that purported to use the
interaction of the partnership basis adjustment rules and the
rules protecting a corporation from recognizing gain on its
stock to obtain unintended tax results. These transactions
generally purported to increase the tax basis of depreciable
assets and to decrease, by a corresponding amount, the tax
basis of the stock of a partner. Because the tax rules protect
a corporation from gain on the sale of its stock (including
through a partnership), the transactions enable taxpayers to
duplicate tax deductions at no economic cost. The provision
precludes the ability to reduce the basis of corporate stock of
a partner (or related party) in certain transactions.
---------------------------------------------------------------------------
\744\ See Joint Committee on Taxation, Report of Investigation of
Enron Corporation and Related Entities Regarding Federal Tax and
Compensation Issues, and Policy Recommendations (JCS-3-03), February
2003.
---------------------------------------------------------------------------
Explanation of Provision
The Act provides that in applying the basis allocation
rules to a distribution in liquidation of a partner's interest,
a partnership is precluded from decreasing the basis of
corporate stock of a partner or a related person. Any decrease
in basis that, absent the provision, would have been allocated
to the stock is allocated to other partnership assets. If the
decrease in basis exceeds the basis of the other partnership
assets, then gain is recognized by the partnership in the
amount of the excess.
Effective Date
The provision applies to distributions after the date of
enactment (October 22, 2004).
16. Repeal of special rules for FASITs (sec. 835 of the Act and secs.
860H through 860L of the Code)
Present and Prior Law
Financial asset securitization investment trusts
In general
In 1996 Congress created a new type of statutory entity
called a ``financial asset securitization investment trust''
(``FASIT'') that facilitates the securitization of debt
obligations such as credit card receivables, home equity loans,
and auto loans.\745\ A FASIT generally was not taxable; the
FASIT's taxable income or net loss flowed through to the owner
of the FASIT.
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\745\ Sections 860H through 860L.
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The ownership interest of a FASIT generally was required to
be entirely held by a single domestic C corporation. In
addition, a FASIT generally could hold only qualified debt
obligations, and certain other specified assets, and was
subject to certain restrictions on its activities. An entity
that qualified as a FASIT could issue one or more classes of
instruments that met certain specified requirements and treat
those instruments as debt for Federal income tax purposes.
Instruments issued by a FASIT bearing yields to maturity over
five percentage points above the yield to maturity on specified
United States government obligations (i.e., ``high-yield
interests'') were required to be held, directly or indirectly,
only by domestic C corporations that are not exempt from income
tax.
Qualification as a FASIT
To qualify as a FASIT, an entity was required to: (1) make
an election to be treated as a FASIT for the year of the
election and all subsequent years; \746\ (2) have assets
substantially all of which (including assets that the FASIT was
treated as owning because they support regular interests) were
specified types called ``permitted assets;'' (3) have non-
ownership interests be certain specified types of debt
instruments called ``regular interests''; (4) have a single
ownership interest which was held by an ``eligible holder'';
and (5) not qualify as a regulated investment company
(``RIC''). Any entity, including a corporation, partnership, or
trust could be treated as a FASIT. In addition, a segregated
pool of assets could qualify as a FASIT.
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\746\ Once an election to be a FASIT was made, the election applied
from the date specified in the election and all subsequent years until
the entity ceased to be a FASIT. If an election to be a FASIT was made
after the initial year of an entity, all of the assets in the entity at
the time of the FASIT election were deemed contributed to the FASIT at
that time and, accordingly, any gain (but not loss) on such assets
would be recognized at that time.
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An entity ceased to qualify as a FASIT if the entity's
owner ceased being an eligible corporation. Loss of FASIT
status was treated as if all of the regular interests of the
FASIT were retired and then reissued without the application of
the rule that deems regular interests of a FASIT to be debt.
Permitted assets
For an entity or arrangement to qualify as a FASIT,
substantially all of its assets were required to consist of the
following ``permitted assets'': (1) cash and cash equivalents;
(2) certain permitted debt instruments; (3) certain foreclosure
property; (4) certain instruments or contracts that represent a
hedge or guarantee of debt held or issued by the FASIT; (5)
contract rights to acquire permitted debt instruments or
hedges; and (6) a regular interest in another FASIT. Permitted
assets could be acquired at any time by a FASIT, including any
time after its formation.
``Regular interests'' of a FASIT
``Regular interests'' of a FASIT were treated as debt for
Federal income tax purposes, regardless of whether instruments
with similar terms issued by non-FASITs might be characterized
as equity under general tax principles. To be treated as a
``regular interest'', an instrument was required to have fixed
terms and was required to: (1) unconditionally entitle the
holder to receive a specified principal amount; (2) pay
interest that was based on (a) fixed rates, or (b) except as
provided by regulations issued by the Treasury Secretary,
variable rates permitted with respect to REMIC interests under
section 860G(a)(1)(B)(i); (3) have a term to maturity of no
more than 30 years, except as permitted by Treasury
regulations; (4) be issued to the public with a premium of not
more than 25 percent of its stated principal amount; and (5)
have a yield to maturity determined on the date of issue of
less than five percentage points above the applicable Federal
rate (``AFR'') for the calendar month in which the instrument
was issued.
Permitted ownership holder
A permitted holder of the ownership interest in a FASIT
generally was a non-exempt (i.e., taxable) domestic C
corporation, other than a corporation that qualified as a RIC,
REIT, REMIC, or cooperative.
Transfers to FASITs
In general, gain (but not loss) was recognized immediately
by the owner of the FASIT upon the transfer of assets to a
FASIT. Where property was acquired by a FASIT from someone
other than the FASIT's owner (or a person related to the
FASIT's owner), the property was treated as being first
acquired by the FASIT's owner for the FASIT's cost in acquiring
the asset from the non-owner and then transferred by the owner
to the FASIT.
Valuation rules.--In general, except in the case of debt
instruments, the value of FASIT assets was their fair market
value. Similarly, in the case of debt instruments that are
traded on an established securities market, the market price
was used for purposes of determining the amount of gain
realized upon contribution of such assets to a FASIT. However,
in the case of debt instruments which are not traded on an
established securities market, special valuation rules applied
for purposes of computing gain on the transfer of such debt
instruments to a FASIT. Under these rules, the value of such
debt instruments was the sum of the present values of the
reasonably expected cash flows from such obligations discounted
over the weighted average life of such assets. The discount
rate was 120 percent of the AFR, compounded semiannually, or
such other rate that the Treasury Secretary shall prescribe by
regulations.
Taxation of a FASIT
A FASIT generally was not subject to tax. Instead, all of
the FASIT's assets and liabilities were treated as assets and
liabilities of the FASIT's owner and any income, gain,
deduction or loss of the FASIT was allocable directly to its
owner. Accordingly, income tax rules applicable to a FASIT
(e.g., related party rules, sec. 871(h), sec. 165(g)(2)) were
to be applied in the same manner as they applied to the FASIT's
owner. The taxable income of a FASIT was calculated using an
accrual method of accounting. The constant yield method and
principles that apply for purposes of determining original
issue discount (``OID'') accrual on debt obligations whose
principal is subject to acceleration applied to all debt
obligations held by a FASIT to calculate the FASIT's interest
and discount income and premium deductions or adjustments.
Taxation of holders of FASIT regular interests
In general, a holder of a regular interest was taxed in the
same manner as a holder of any other debt instrument, except
that the regular interest holder was required to account for
income relating to the interest on an accrual method of
accounting, regardless of the method of accounting otherwise
used by the holder.
Taxation of holders of FASIT ownership interests
Because all of the assets and liabilities of a FASIT were
treated as assets and liabilities of the holder of a FASIT
ownership interest, the ownership interest holder took into
account all of the FASIT's income, gain, deduction, or loss in
computing its taxable income or net loss for the taxable year.
The character of the income to the holder of an ownership
interest was the same as its character to the FASIT, except
tax-exempt interest was included in the income of the holder as
ordinary income.
Although the recognition of losses on assets contributed to
the FASIT was not allowed upon contribution of the assets, such
losses were allowed to the FASIT owner upon their disposition
by the FASIT. Furthermore, the holder of a FASIT ownership
interest was not permitted to offset taxable income from the
FASIT ownership interest (including gain or loss from the sale
of the ownership interest in the FASIT) with other losses of
the holder. In addition, any net operating loss carryover of
the FASIT owner was computed by disregarding any income arising
by reason of a disallowed loss. Where the holder of a FASIT
ownership interest was a member of a consolidated group, this
rule applied to the consolidated group of corporations of which
the holder was a member as if the group were a single taxpayer.
Real estate mortgage investment conduits
In general, a real estate mortgage investment conduit
(``REMIC'') is a self-liquidating entity that holds a fixed
pool of mortgages and issues multiple classes of investor
interests. A REMIC is not treated as a separate taxable entity.
Rather, the income of the REMIC is allocated to, and taken into
account by, the holders of the interests in the REMIC under
detailed rules.\747\ In order to qualify as a REMIC,
substantially all of the assets of the entity must consist of
qualified mortgages and permitted investments as of the close
of the third month beginning after the startup day of the
entity. A ``qualified mortgage'' generally includes any
obligation which is principally secured by an interest in real
property, and which is either transferred to the REMIC on the
startup day of the REMIC in exchange for regular or residual
interests in the REMIC or purchased by the REMIC within three
months after the startup day pursuant to a fixed-price contract
in effect on the startup day. A ``permitted investment''
generally includes any intangible property that is held for
investment and is part of a reasonably required reserve to
provide for full payment of certain expenses of the REMIC or
amounts due on regular interests.
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\747\ See secs. 860A-860G.
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All of the interests in the REMIC must consist of one or
more classes of regular interests and a single class of
residual interests. A ``regular interest'' is an interest in a
REMIC that is issued with a fixed term, designated as a regular
interest, and unconditionally entitles the holder to receive a
specified principal amount (or other similar amount) with
interest payments that are either based on a fixed rate (or, to
the extent provided in regulations, a variable rate) or consist
of a specified portion of the interest payments on qualified
mortgages that does not vary during the period such interest is
outstanding. In general, a ``residual interest'' is any
interest in the REMIC other than a regular interest, and which
is so designated by the REMIC, provided that there is only one
class of such interest and that all distributions (if any) with
respect to such interests are pro rata. Holders of residual
REMIC interests are subject to tax on the portion of the income
of the REMIC that is not allocated to the regular interest
holders.
Reasons for Change
The Joint Committee on Taxation staff's investigative
report of Enron Corporation \748\ described two structured tax-
motivated transactions--Projects Apache and Renegade--that
Enron undertook in which the use of a FASIT was a key component
in the structure of the transactions. The Congress was aware
that FASITs were not being used widely in the manner envisioned
by the Congress and, consequently, the FASIT rules had not
served the purpose for which they originally were intended.
Moreover, the Joint Committee staff's report and other
information indicated that FASITs were particularly prone to
abuse and likely were being used primarily to facilitate tax
avoidance transactions.\749\ Therefore, the Congress believed
that the potential for abuse that was inherent in FASITs far
outweighed any beneficial purpose that the FASIT rules may have
served. Accordingly, the Congress believed that these rules
should be repealed, with appropriate transition relief for
existing FASITs and appropriate modifications to the REMIC
rules to permit the use of REMICs by taxpayers that have relied
upon FASITs to securitize certain obligations secured by
interests in real property.
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\748\ See Joint Committee on Taxation, Report of Investigation of
Enron Corporation and Related Entities Regarding Federal Tax and
Compensation Issues, and Policy Recommendations (JCS-3-03), February
2003.
\749\ For example, the Congress was aware that FASITs also had been
used to facilitate the issuance of certain tax-advantaged cross-border
hybrid instruments that were treated as indebtedness in the United
States but equity in the foreign country of the holder of the
instruments. The Congress did not intend such use of FASITs when it
enacted the FASIT rules.
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Explanation of Provision
The Act repeals the special rules for FASITs. The Act
provides a transition period for existing FASITs, pursuant to
which the repeal of the FASIT rules generally does not apply to
any FASIT in existence on the date of enactment to the extent
that regular interests issued by the FASIT prior to such date
continue to remain outstanding in accordance with their
original terms.
For purposes of the REMIC rules, the Act also modifies the
definitions of REMIC regular interests, qualified mortgages,
and permitted investments so that certain types of real estate
loans and loan pools can be transferred to, or purchased by, a
REMIC. Specifically, the Act modifies the definition of a REMIC
``regular interest'' to provide that an interest in a REMIC
does not fail to qualify as a regular interest solely because
the specified principal amount of such interest or the amount
of interest accrued on such interest could be reduced as a
result of the nonoccurrence of one or more contingent payments
with respect to one or more reverse mortgages loans, as defined
below, that are held by the REMIC, provided that on the startup
day for the REMIC, the REMIC sponsor reasonably believes that
all principal and interest due under the interest will be paid
at or prior to the liquidation of the REMIC. For this purpose,
a reasonable belief concerning ultimate payment of all amounts
due under an interest is presumed to exist if, as of the
startup day, the interest receives an investment grade rating
from at least one nationally recognized statistical rating
agency.
In addition, the Act makes three modifications to the
definition of a ``qualified mortgage.'' First, the Act modifies
the definition to include an obligation principally secured by
real property which represents an increase in the principal
amount under the original terms of an obligation, provided such
increase: (1) is attributable to an advance made to the obligor
pursuant to the original terms of the obligation; (2) occurs
after the REMIC startup day; and (3) is purchased by the REMIC
pursuant to a fixed price contract in effect on the startup
day. Second, the Act modifies the definition to generally
include reverse mortgage loans and the periodic advances made
to obligors on such loans. For this purpose, a ``reverse
mortgage loan'' is defined as a loan that: (1) is secured by an
interest in real property; (2) provides for one or more
advances of principal to the obligor (each such advance giving
rise to a ``balance increase''), provided such advances are
principally secured by an interest in the same real property as
that which secures the loan; (3) may provide for a contingent
payment at maturity based upon the value or appreciation in
value of the real property securing the loan; (4) provides for
an amount due at maturity that cannot exceed the value, or a
specified fraction of the value, of the real property securing
the loan; (5) provides that all payments under the loan are due
only upon the maturity of the loan; and (6) matures after a
fixed term or at the time the obligor ceases to use as a
personal residence the real property securing the loan. Third,
the Act modifies the definition to provide that, if more than
50 percent of the obligations transferred to, or purchased by,
the REMIC are: (1) originated by the United States or any State
(or any political subdivision, agency, or instrumentality of
the United States or any State); and (2) principally secured by
an interest in real property, then each obligation transferred
to, or purchased by, the REMIC shall be treated as principally
secured by an interest in real property.\750\
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\750\ It is intended that, if more than 50 percent of the
obligations transferred to, or purchased by, a REMIC are originated by
a Government entity and are principally secured by an interest in real
property, then each obligation originated by a Government entity and
transferred to, or purchased by, the REMIC is treated as principally
secured by an interest in real property. Thus, it is intended that this
rule align with the ``principally secured'' standard that generally is
provided by the definition of a qualified mortgage, and that the
treatment of obligations as principally secured by an interest in real
property under this rule does not extend to obligations that are not
originated by a Government entity. Technical corrections may be
necessary to reflect this intent.
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In addition, the Act modifies the present-law definition of
a ``permitted investment'' to include intangible investment
property held as part of a reasonably required reserve to
provide a source of funds for the purchase of obligations
described above as part of the modified definition of a
``qualified mortgage.''
Effective Date
Except as provided by the transition period for existing
FASITs, the provision is effective January 1, 2005.
17. Limitation on transfer and importation of built-in losses (sec. 836
of the Act and secs. 362 and 334 of the Code)
Present and Prior Law
Generally, no gain or loss is recognized when one or more
persons transfer property to a corporation in exchange for
stock and immediately after the exchange such person or persons
control the corporation.\751\ Under present and prior law, the
transferor's basis in the stock of the controlled corporation
generally is the same as the basis of the property contributed
to the controlled corporation, increased by the amount of any
gain (or dividend) recognized by the transferor on the
exchange, and reduced by the amount of any money or property
received, and by the amount of any loss recognized by the
transferor.\752\
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\751\ Sec. 351.
\752\ Sec. 358.
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Under present and prior law, the basis of property received
by a corporation, whether from domestic or foreign transferors,
in a tax-free incorporation, reorganization, or liquidation of
a subsidiary corporation generally is the same as the adjusted
basis in the hands of the transferor, adjusted for gain or loss
recognized by the transferor.\753\
---------------------------------------------------------------------------
\753\ Secs. 334(b) and 362(a) and (b).
---------------------------------------------------------------------------
Reasons for Change
The Joint Committee on Taxation staff's investigative
report of Enron Corporation \754\ and other information
revealed that taxpayers are engaging in various tax motivated
transactions to duplicate a single economic loss and,
subsequently, are deducting such loss more than once. Congress
has previously taken actions to limit the ability of taxpayers
to engage in specific transactions that purport to duplicate a
single economic loss. However, new schemes that purport to
duplicate losses have continued to proliferate. In furtherance
of the overall tax policy objective of accurately measuring
taxable income, the Congress believed that a single economic
loss should not be deducted more than once. Thus, the Congress
believed that it generally is appropriate to limit a
corporation's basis in property acquired in a tax-free transfer
to the fair market value of such property. In addition, the
Congress believed that it is appropriate to prevent the
importation of economic losses into the U.S. tax system if such
losses arose before the assets became subject to the U.S. tax
system.
---------------------------------------------------------------------------
\754\ See Joint Committee on Taxation, Report of Investigation of
Enron Corporation and Related Entities Regarding Federal Tax and
Compensation Issues, and Policy Recommendations (JCS-3-03), February
2003.
---------------------------------------------------------------------------
Explanation of Provision
Importation of built-in losses
The Act provides that if property with a net built-in loss
is transferred in a tax-free organization or reorganization,
the basis of certain property so transferred is adjusted to its
fair market value in the hands of the transferee. The property
that receives a fair market value adjusted basis under this
rule is property with respect to which any gain or loss would
not be subject to U.S. income tax in the hands of the
transferor immediately before the transfer but would be subject
to U.S. income tax in the hands of the transferee immediately
after the transfer. A similar rule applies in the case of the
tax-free liquidation by a domestic corporation of its foreign
subsidiary.\755\
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\755\ As is the case with non-liquidation transactions to which
this provision applies, it is intended that the adjustment to the basis
of property that is transferred in a liquidation to which this
provision applies occurs only with respect to property the gain or loss
on which would not have U.S. income tax consequences in the hands of
the transferor immediately before the transfer but would have U.S.
income tax consequences in the hands of the transferee immediately
after the transfer. A technical correction may be necessary so that the
statute reflects this intent.
---------------------------------------------------------------------------
Under the Act, transferred property has a net built-in loss
if the aggregate adjusted basis of property received by a
transferee corporation exceeds the fair market value of the
property. Thus, for example, if in a tax-free incorporation
some properties are received by a corporation from U.S. persons
subject to tax, and some properties are received from foreign
persons not subject to U.S. tax, the Act adjusts the basis of
each property received from the foreign persons to its fair
market value at the time of the transfer. In the case of a
transfer by a partnership (either domestic or foreign), the Act
applies as if the properties had been transferred by each of
the partners in proportion to their interests in the
partnership.
Limitation on transfer of built-in losses in section 351 transactions
Separately, the Act also provides that if the aggregate
adjusted basis of property contributed by a transferor to a
corporation in a tax-free incorporation exceeds the aggregate
fair market value of the transferred property, the transferee's
aggregate basis of the transferred property generally is
limited to the aggregate fair market value of the property.
Under the Act, any required basis reduction is allocated among
the transferred properties in proportion to their respective
built-in losses immediately before the transaction.
In lieu of limiting the basis of the transferred property
in a transaction to which this provision applies, the Act
permits the transferor and transferee to jointly elect to limit
the basis in the stock received by the transferor to the
aggregate fair market value of the transferred property. Such
election shall be included with the tax returns of the
transferor and transferee for the taxable year in which the
transaction occurs and, once made, shall be irrevocable.
Effective Date
The provision applies to transactions and liquidations
after the date of enactment (October 22, 2004).
18. Clarification of banking business for purposes of determining
investment of earnings in U.S. property (sec. 837 of the Act
and sec. 956 of the Code)
Present and Prior Law
In general, the subpart F rules \756\ require the U.S. 10-
percent shareholders of a controlled foreign corporation to
include in income currently their pro rata shares of certain
income of the controlled foreign corporation (referred to as
``subpart F income''), whether or not such earnings are
distributed currently to the shareholders. In addition, the
U.S. 10-percent shareholders of a controlled foreign
corporation are subject to U.S. tax currently on their pro rata
shares of the controlled foreign corporation's earnings to the
extent invested by the controlled foreign corporation in
certain U.S. property.\757\
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\756\ Secs. 951-964.
\757\ Sec. 951(a)(1)(B).
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A shareholder's current income inclusion with respect to a
controlled foreign corporation's investment in U.S. property
for a taxable year is based on the controlled foreign
corporation's average investment in U.S. property for such
year. For this purpose, the U.S. property held (directly or
indirectly) by the controlled foreign corporation must be
measured as of the close of each quarter in the taxable
year.\758\ The amount taken into account with respect to any
property is the property's adjusted basis as determined for
purposes of reporting the controlled foreign corporation's
earnings and profits, reduced by any liability to which the
property is subject. The amount determined for current
inclusion is the shareholder's pro rata share of an amount
equal to the lesser of: (1) the controlled foreign
corporation's average investment in U.S. property as of the end
of each quarter of such taxable year, to the extent that such
investment exceeds the foreign corporation's earnings and
profits that were previously taxed on that basis; or (2) the
controlled foreign corporation's current or accumulated
earnings and profits (but not including a deficit), reduced by
distributions during the year and by earnings that have been
taxed previously as earnings invested in U.S. property.\759\ An
income inclusion is required only to the extent that the amount
so calculated exceeds the amount of the controlled foreign
corporation's earnings that have been previously taxed as
subpart F income.\760\
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\758\ Sec. 956(a).
\759\ Secs. 956 and 959.
\760\ Secs. 951(a)(1)(B) and 959.
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For purposes of section 956, U.S. property generally is
defined to include tangible property located in the United
States, stock of a U.S. corporation, an obligation of a U.S.
person, and certain intangible assets including a patent or
copyright, an invention, model or design, a secret formula or
process or similar property right which is acquired or
developed by the controlled foreign corporation for use in the
United States.\761\
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\761\ Sec. 956(c)(1).
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Specified exceptions from the definition of U.S. property
are provided for: (1) obligations of the United States or
money; (2) certain export property; (3) certain trade or
business obligations; (4) aircraft, railroad rolling stock,
vessels, motor vehicles or containers used in transportation in
foreign commerce and used predominantly outside of the United
States; (5) certain insurance company reserves and unearned
premiums related to insurance of foreign risks; (6) stock or
debt of certain unrelated U.S. corporations; (7) moveable
property (other than a vessel or aircraft) used for the purpose
of exploring, developing, or certain other activities in
connection with the ocean waters of the U.S. Continental Shelf;
(8) an amount of assets equal to the controlled foreign
corporation's accumulated earnings and profits attributable to
income effectively connected with a U.S. trade or business; (9)
property (to the extent provided in regulations) held by a
foreign sales corporation and related to its export activities;
(10) certain deposits or receipts of collateral or margin by a
securities or commodities dealer, if such deposit is made or
received on commercial terms in the ordinary course of the
dealer's business as a securities or commodities dealer; and
(11) certain repurchase and reverse repurchase agreement
transactions entered into by or with a dealer in securities or
commodities in the ordinary course of its business as a
securities or commodities dealer.\762\ Under prior law, an
additional exception from the definition of U.S. property was
provided for deposits with persons carrying on the banking
business.
---------------------------------------------------------------------------
\762\ Sec. 956(c)(2).
---------------------------------------------------------------------------
With regard to the exception for deposits with persons
carrying on the banking business, the U.S. Court of Appeals for
the Sixth Circuit in The Limited, Inc. v. Commissioner \763\
concluded that a U.S. subsidiary of a U.S. shareholder was
``carrying on the banking business'' even though its operations
were limited to the administration of the private label credit
card program of the U.S. shareholder. Therefore, the court held
that a controlled foreign corporation of the U.S. shareholder
could make deposits with the subsidiary (e.g., through the
purchase of certificates of deposit) under this exception, and
avoid taxation of the deposits under section 956 as an
investment in U.S. property.
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\763\ 286 F.3d 324 (6th Cir. 2002), rev'g 113 T.C. 169 (1999).
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that further guidance was necessary
under the U.S. property investment provisions of subpart F with
regard to the treatment of deposits with persons carrying on
the banking business. In particular, the Congress believed that
the transaction at issue in The Limited case was not
contemplated or intended by Congress when it excepted from the
definition of U.S. property deposits with persons carrying on
the banking business. Therefore, the Congress believed that it
was appropriate and necessary to clarify the scope of this
exception so that it applies only to deposits with regulated
banking businesses and their affiliates.
Explanation of Provision
The Act provides that the exception from the definition of
U.S. property under section 956 for deposits with persons
carrying on the banking business is limited to deposits with:
(1) any bank (as defined by section 2(c) of the Bank Holding
Company Act of 1956 (12 U.S.C. 1841(c), without regard to
paragraphs (C) and (G) of paragraph (2) of such section); or
(2) any other corporation with respect to which a bank holding
company (as defined by section 2(a) of such Act) or financial
holding company (as defined by section 2(p) of such Act) owns
directly or indirectly more than 80 percent by vote or value of
the stock of such corporation.
No inference is intended as to the meaning of the phrase
``carrying on the banking business'' under prior law.
Effective Date
The provision is effective on the date of enactment
(October 22, 2004).
19. Denial of deduction for interest on underpayments attributable to
nondisclosed reportable transactions (sec. 838 of the Act and
sec. 163 of the Code)
Present and Prior Law
In general, corporations may deduct interest paid or
accrued within a taxable year on indebtedness.\764\ Interest on
indebtedness to the Federal government attributable to an
underpayment of tax generally may be deducted pursuant to this
provision.
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\764\ Sec. 163(a).
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Reasons for Change
The Congress believed that it was inappropriate for
corporations to deduct interest paid to the Government with
respect to certain tax shelter transactions.
Explanation of Provision
The Act disallows any deduction for interest paid or
accrued within a taxable year on any portion of an underpayment
of tax that is attributable to an understatement arising from
an undisclosed listed transaction or from an undisclosed
reportable avoidance transaction (other than a listed
transaction).\765\
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\765\ The definitions of these transactions are the same as those
previously described in connection with the provision elsewhere in this
Act to modify the accuracy-related penalty for listed and certain
reportable transactions.
---------------------------------------------------------------------------
Effective Date
The provision is effective for underpayments attributable
to transactions entered into in taxable years beginning after
the date of enactment (October 22, 2004).
20. Clarification of rules for payment of estimated tax for certain
deemed asset sales (sec. 839 of the Act and sec. 338 of the
Code)
Present and Prior Law
In certain circumstances, taxpayers can make an election
under section 338(h)(10) to treat a qualifying purchase of 80
percent of the stock of a target corporation by a corporation
from a corporation that is a member of an affiliated group (or
a qualifying purchase of 80 percent of the stock of an S
corporation by a corporation from S corporation shareholders)
as a sale of the assets of the target corporation, rather than
as a stock sale. The election must be made jointly by the buyer
and seller of the stock and is due by the 15th day of the ninth
month beginning after the month in which the acquisition date
occurs. An agreement for the purchase and sale of stock often
may contain an agreement of the parties to make a section
338(h)(10) election.
Section 338(a) also permits a unilateral election by a
buyer corporation to treat a qualified stock purchase of a
corporation as a deemed asset acquisition, whether or not the
seller of the stock is a corporation (or an S corporation is
the target). In such a case, the seller or sellers recognize
gain or loss on the stock sale (including any estimated taxes
with respect to the stock sale), and the target corporation
recognizes gain or loss on the deemed asset sale.
Section 338(h)(13) provides that, for purposes of section
6655 (relating to additions to tax for failure by a corporation
to pay estimated income tax), tax attributable to a deemed
asset sale under section 338(a)(1) shall not be taken into
account.
Reasons for Change
The Congress was concerned that some taxpayers might
inappropriately be taking the position that estimated tax and
the penalty (computed in the amount of an interest charge)
under section 6655 applies neither to the stock sale nor to the
asset sale in the case of a section 338(h)(10) election. The
Congress believed that estimated tax should not be avoided
merely because an election may be made under section
338(h)(10). Furthermore, the Congress understood that parties
typically negotiate a sale with an understanding as to whether
or not an election under section 338(h)(10) will be made. In
the event there is a contingency in this regard, the parties
may provide for adjustments to the price to reflect the effect
of the election.
Explanation of Provision
The Act clarifies section 338(h)(13) to provide that the
exception for estimated tax purposes with respect to tax
attributable to a deemed asset sale does not apply with respect
to a qualified stock purchase for which an election is made
under section 338(h)(10).
Under the Act if a transaction eligible for the election
under section 338(h)(10) occurs, estimated tax would be
determined based on the stock sale unless and until there is an
agreement of the parties to make a section 338(h)(10) election.
If at the time of the sale there is an agreement of the
parties to make a section 338(h)(10) election, then estimated
tax is computed based on an asset sale, computed from the date
of the sale.
If the agreement to make a section 338(h)(10) election is
concluded after the stock sale, such that the original
computation was based on a stock sale, estimated tax is
recomputed based on the asset sale election.
No inference is intended as to prior law.
Effective Date
The provision is effective for qualified stock purchase
transactions that occur after the date of enactment (October
22, 2004).
21. Exclusion of like-kind exchange property from nonrecognition
treatment on the sale or exchange of a principal residence
(sec. 840 of the Act)
Present and Prior Law
A taxpayer may 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. Under prior law, there were no
special rules relating to the sale or exchange of a principal
residence that was acquired in a like-kind exchange within the
prior five years.
Reasons for Change
The Congress believed that the present-law exclusion of
gain allowable upon the sale or exchange of principal
residences serves an important role in encouraging home
ownership. The Congress did not believe that this exclusion was
appropriate for properties that were recently acquired in like-
kind exchanges. Under the like-kind exchange rules, a taxpayer
that exchanges property that was held for productive use or
investment for like-kind property may acquire the replacement
property on a tax-free basis. Because the replacement property
generally has a low carry-over tax basis, the taxpayer will
have taxable gain upon the sale or exchange of the replacement
property. However, when the taxpayer converts the replacement
property into the taxpayer's principal residence, the taxpayer
may shelter some or all of this gain from income taxation. The
Congress believed that this proposal balances the concerns
associated with these provisions to reduce this tax shelter
concern without unduly limiting the exclusion on sales or
exchanges of principal residences.
Explanation of Provision
The Act provides that the exclusion for gain on the sale or
exchange of a principal residence does not apply if the
principal residence was acquired in a like-kind exchange in
which any gain was not recognized within the prior five years.
Effective Date
The provision is effective for sales or exchanges of
principal residences after the date of enactment (October 22,
2004).
22. Prevention of mismatching of interest and original issue discount
deductions and income inclusions in transactions with related
foreign persons (sec. 841 of the Act and secs. 163 and 267 of
the Code)
Present and Prior Law
Income earned by a foreign corporation from its foreign
operations generally is subject to U.S. tax only when such
income is distributed to any U.S. person that holds stock in
such corporation. Accordingly, a U.S. person that conducts
foreign operations through a foreign corporation generally is
subject to U.S. tax on the income from such operations when the
income is repatriated to the United States through a dividend
distribution to the U.S. person. The income is reported on the
U.S. person's tax return for the year the distribution is
received, and the United States imposes tax on such income at
that time. However, certain anti-deferral regimes may cause the
U.S. person to be taxed on a current basis in the United States
with respect to certain categories of passive or highly mobile
income earned by the foreign corporations in which the U.S.
person holds stock. The main anti-deferral regimes have been
the controlled foreign corporation rules of subpart F (secs.
951-964), the passive foreign investment company rules (secs.
1291-1298), and the prior-law foreign personal holding company
rules (secs. 551-558).
As a general rule, there is allowed as a deduction all
interest paid or accrued within the taxable year with respect
to indebtedness, including the aggregate daily portions of
original issue discount (``OID'') of the issuer for the days
during such taxable year.\766\ However, if a debt instrument is
held by a related foreign person, any portion of such OID is
not allowable as a deduction to the payor of such instrument
until paid (``related-foreign-person rule''). This related-
foreign-person rule does not apply to the extent that the OID
is effectively connected with the conduct by such foreign
related person of a trade or business within the United States
(unless such OID is exempt from taxation or is subject to a
reduced rate of taxation under a treaty obligation).\767\
Treasury regulations further modified the related-foreign-
person rule by providing that in the case of a debt owed to a
foreign personal holding company (``FPHC''), controlled foreign
corporation (``CFC'') or passive foreign investment company
(``PFIC''), a deduction was allowed for OID as of the day on
which the amount was includible in the income of the FPHC, CFC
or PFIC, respectively.\768\
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\766\ Sec. 163(e)(1).
\767\ Sec. 163(e)(3).
\768\ Treas. Reg. sec. 1.163-12(b)(3). In the case of a PFIC, the
regulations further require that the person owing the amount at issue
have in effect a qualified electing fund election pursuant to section
1295 with respect to the PFIC.
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In the case of unpaid stated interest and expenses of
related persons, where, by reason of a payee's method of
accounting, an amount is not includible in the payee's gross
income until it is paid but the unpaid amounts are deductible
currently by the payor, the amount generally is allowable as a
deduction when such amount is includible in the gross income of
the payee.\769\ With respect to stated interest and other
expenses owed to related foreign corporations, Treasury
regulations provide a general rule that requires a taxpayer to
use the cash method of accounting with respect to the deduction
of amounts owed to such related foreign persons (with an
exception for income of a related foreign person that is
effectively connected with the conduct of a U.S. trade or
business and that is not exempt from taxation or subject to a
reduced rate of taxation under a treaty obligation).\770\ As in
the case of OID, the Treasury regulations additionally provided
that in the case of stated interest owed to a FPHC, CFC, or
PFIC, a deduction was allowed as of the day on which the amount
was includible in the income of the FPHC, CFC or PFIC.\771\
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\769\ Sec. 267(a)(2).
\770\ Treas. Reg. sec. 1.267(a)-3(b)(1), -3(c).
\771\ Treas. Reg. sec. 1.267(a)-3(c)(4).
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Reasons for Change
The special rules in the Treasury regulations for FPHCs,
CFCs and PFICs were exceptions to the general rule that OID and
unpaid interest owed to a related foreign person are deductible
when paid (i.e., under the cash method). These special rules
were deemed appropriate in the case of FPHCs, CFCs and PFICs
because it was thought that there would be little material
distortion in matching of income and deductions with respect to
amounts owed to a related foreign corporation that is required
to determine its taxable income and earnings and profits for
U.S. tax purposes pursuant to the FPHC, subpart F or PFIC
provisions. The Congress believed that this premise failed to
take into account the situation where amounts owed to the
related foreign corporation were included in the income of the
related foreign corporation but were not currently included in
the income of the related foreign corporation's U.S.
shareholder. Consequently, under the Treasury regulations, both
the U.S. payors and U.S.-owned foreign payors were able to
accrue deductions for amounts owed to related FPHCs, CFCs or
PFICs without the U.S. owners of such related entities taking
into account for U.S. tax purposes a corresponding amount of
income. These deductions could be used to reduce U.S. income
or, in the case of a U.S.-owned foreign payor, to reduce
earnings and profits which could reduce a CFC's income that
would be currently taxable to its U.S. shareholders under
subpart F.
Explanation of Provision
The Act provides that deductions for amounts accrued but
unpaid (whether by U.S. or foreign persons) to related FPHCs,
CFCs, or PFICs are allowable only to the extent that the
amounts accrued by the payor are, for U.S. tax purposes,
currently includible in the income of the direct or indirect
U.S. owners of the related foreign corporation under the
relevant inclusion rules.\772\ Deductions that have accrued but
are not allowable under this provision are allowed when the
amounts are paid.
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\772\ Section 413 of the Act repeals the foreign personal holding
company regime, effective for taxable years of foreign corporations
beginning after December 31, 2004, and taxable years of U.S.
shareholders with or within which such taxable years of foreign
corporations end.
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For purposes of determining the amount of the deduction
allowable, the extent that an amount attributable to OID or an
item is includible in the income of a U.S. person is determined
without regard to (1) properly allocable deductions of the
related foreign corporation, and (2) qualified deficits of the
related foreign corporation under section 952(c)(1)(B).
Properly allocable deductions of the related foreign
corporation are those expenses, losses, and other deductible
amounts of the related foreign corporation that are properly
allocated or apportioned, under the principles of section
954(b)(5), to the relevant income item of the related foreign
corporation.
The following examples illustrate the operation of the Act.
Assume the following facts. A U.S. parent corporation owns 60
percent of the stock of a CFC. An unrelated foreign corporation
owns the remaining 40 percent interest in the CFC. The U.S.
parent accrues an expense item of 100 to the CFC. The parent
would be entitled to a current deduction of 100 for the accrued
amount, before taking into account the Act. The item
constitutes gross foreign base company income in the hands of
the CFC. The item is the only gross income item of the CFC that
has the potential to result in the CFC having subpart F income,
and has not been paid by the end of the taxable year of the
parent. The CFC has deductions of 60 that are properly
allocated or apportioned to the 100 of gross foreign base
company income under the principles of section 954(b)(5),
resulting in 40 (100-60) of net foreign base company income.
The CFC has earnings and profits for its taxable year in excess
of 40, and has 40 of subpart F income. Under these facts, the
U.S. parent is allowed a current deduction of 60 (100 60%).
If, in the example above, the CFC has deductions of 100 (or
more) properly allocated or apportioned to the sole item of 100
of gross foreign base company income under the principles of
section 954(b)(5), and has no other income or deductions, the
same deduction is allowed to the U.S. parent. Under these
circumstances, the parent is allowed a deduction of 60, whether
the CFC has positive earnings and profits for its taxable year
or has a deficit in earnings and profits for such year.
If the CFC's item of net foreign base company income is
positive, and the earnings and profits limitation of section
952(c)(1)(A) reduces what would otherwise be a U.S.
shareholder's pro rata share of the CFC's subpart F income,
then the deduction will also be reduced under the provision.
For example, assume the facts in the first example above, in
which the CFC has deductions of 60 that are properly allocated
or apportioned to the item of 100 of gross foreign base company
income under the principles of section 954(b)(5), resulting in
40 of net foreign base company income. Further assume that, due
solely to other losses, the CFC's earnings and profits for its
taxable year are 10 instead of 40. In that case, the CFC's
subpart F income is limited to 10, and only six is includible
in the gross income of the U.S. parent as its pro rata share of
subpart F income. Under the Act, the U.S. parent is allowed a
current deduction in that case of 42 ((10+60) 60%). If, as a
result of such other losses, the CFC has no earnings and
profits for its taxable year or has a deficit in earnings and
profits for such year, the U.S. parent is instead allowed a
current deduction of 36 ((0+60) 60%).
The Act grants the Secretary regulatory authority to exempt
transactions from these rules, including any transactions
entered into by the payor in the ordinary course of a trade or
business in which the payor is predominantly engaged, and (in
the case of items other than OID) in which the payment of the
accrued amounts occurs shortly after its accrual.
Effective Date
The provision is effective for payments accrued on or after
the date of enactment (October 22, 2004).
23. Deposits made to suspend the running of interest on potential
underpayments (sec. 842 of the Act and new sec. 6603 of the
Code)
Present and Prior Law
Generally, interest on underpayments and overpayments
continues to accrue during the period that a taxpayer and the
IRS dispute a liability. The accrual of interest on an
underpayment is suspended if the IRS fails to notify an
individual taxpayer in a timely manner, but interest will begin
to accrue once the taxpayer is properly notified. No similar
suspension is available for other taxpayers.
A taxpayer that wants to limit its exposure to underpayment
interest has a limited number of options. The taxpayer can
continue to dispute the amount owed and risk paying a
significant amount of interest. If the taxpayer continues to
dispute the amount and ultimately loses, the taxpayer will be
required to pay interest on the underpayment from the original
due date of the return until the date of payment.
In order to avoid the accrual of underpayment interest, the
taxpayer may choose to pay the disputed amount and immediately
file a claim for refund. Payment of the disputed amount will
prevent further interest from accruing if the taxpayer loses
(since there is no longer any underpayment) and the taxpayer
will earn interest on the resultant overpayment if the taxpayer
wins. However, the taxpayer will generally lose access to the
Tax Court if it follows this alternative. Amounts paid
generally cannot be recovered by the taxpayer on demand, but
must await final determination of the taxpayer's liability.
Even if an overpayment is ultimately determined, overpaid
amounts may not be refunded if they are eligible to be offset
against other liabilities of the taxpayer.
The taxpayer may also make a deposit in the nature of a
cash bond. The procedures for making a deposit in the nature of
a cash bond are provided in Rev. Proc. 84-58.\773\
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\773\ 1984-2 C.B. 501.
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A deposit in the nature of a cash bond will stop the
running of interest on an amount of underpayment equal to the
deposit, but the deposit does not itself earn interest. A
deposit in the nature of a cash bond is not a payment of tax
and is not subject to a claim for credit or refund. A deposit
in the nature of a cash bond may be made for all or part of the
disputed liability and generally may be recovered by the
taxpayer prior to a final determination. However, a deposit in
the nature of a cash bond need not be refunded to the extent
the Secretary determines that the assessment or collection of
the tax determined would be in jeopardy, or that the deposit
should be applied against another liability of the taxpayer in
the same manner as an overpayment of tax. If the taxpayer
recovers the deposit prior to final determination and a
deficiency is later determined, the taxpayer will not receive
credit for the period in which the funds were held as a
deposit. The taxable year to which the deposit in the nature of
a cash bond relates must be designated, but the taxpayer may
request that the deposit be applied to a different year under
certain circumstances.
Reasons for Change
The Congress believed that taxpayers should be able to
limit their underpayment interest exposure in a tax dispute. An
improved deposit system will help taxpayers better manage their
exposure to underpayment interest without requiring them to
surrender access to their funds or requiring them to make a
potentially indefinite-term investment in a non-interest
bearing account. The Congress believed that an improved deposit
system that allows for the payment of interest on amounts that
are not ultimately needed to offset tax liability when the
taxpayer's position is upheld, as well as allowing for the
offset of tax liability when the taxpayer's position fails,
will provide an effective way for taxpayers to manage their
exposure to underpayment interest. However, the Congress
believed that such an improved deposit system should be
reserved for the issues that are known to both parties, either
through IRS examination or voluntary taxpayer disclosure.
Explanation of Provision
In general
The Act allows a taxpayer to deposit cash with the IRS that
may subsequently be used to pay an underpayment of income,
gift, estate, generation-skipping, or certain excise taxes.
Interest will not be charged on the portion of the underpayment
that is deposited for the period that the amount is on deposit.
Generally, deposited amounts that have not been used to pay a
tax may be withdrawn at any time if the taxpayer so requests in
writing. The withdrawn amounts will earn interest at the
applicable Federal rate to the extent they are attributable to
a disputable tax.
The Secretary may issue rules relating to the making, use,
and return of the deposits.
Use of a deposit to offset underpayments of tax
Any amount on deposit may be used to pay an underpayment of
tax that is ultimately assessed. If an underpayment is paid in
this manner, the taxpayer will not be charged underpayment
interest on the portion of the underpayment that is so paid for
the period the funds were on deposit.
For example, assume a calendar year individual taxpayer
deposits $20,000 on May 15, 2005, with respect to a disputable
item on its 2004 income tax return. On April 15, 2007, an
examination of the taxpayer's year 2004 income tax return is
completed, and the taxpayer and the IRS agree that the taxable
year 2004 taxes were underpaid by $25,000. The $20,000 on
deposit is used to pay $20,000 of the underpayment, and the
taxpayer also pays the remaining $5,000. In this case, the
taxpayer will owe underpayment interest from April 15, 2005
(the original due date of the return) to the date of payment
(April 15, 2007) only with respect to the $5,000 of the
underpayment that is not paid by the deposit. The taxpayer will
owe underpayment interest on the remaining $20,000 of the
underpayment only from April 15, 2005, to May 15, 2005, the
date the $20,000 was deposited.
Withdrawal of amounts
A taxpayer may request the withdrawal of any amount on
deposit at any time. The Secretary must comply with the
withdrawal request unless the amount has already been used to
pay tax or the Secretary properly determines that collection of
tax is in jeopardy. Interest will be paid on deposited amounts
that are withdrawn at a rate equal to the short-term applicable
Federal rate for the period from the date of deposit to a date
not more than 30 days preceding the date of the check paying
the withdrawal. Interest is not payable to the extent the
deposit was not attributable to a disputable tax.
For example, assume a calendar year individual taxpayer
receives a 30-day letter showing a deficiency of $20,000 for
taxable year 2004 and deposits $20,000 on May 15, 2006. On
April 15, 2007, an administrative appeal is completed, and the
taxpayer and the IRS agree that the 2004 taxes were underpaid
by $15,000. $15,000 of the deposit is used to pay the
underpayment. In this case, the taxpayer will owe underpayment
interest from April 15, 2005 (the original due date of the
return) to May 15, 2006, the date the $20,000 was deposited.
Simultaneously with the use of the $15,000 to offset the
underpayment, the taxpayer requests the return of the remaining
amount of the deposit (after reduction for the underpayment
interest owed by the taxpayer from April 15, 2005, to May 15,
2006). This amount must be returned to the taxpayer with
interest determined at the applicable Federal short-term rate
from the May 15, 2006, to a date not more than 30 days
preceding the date of the check repaying the deposit to the
taxpayer.
Limitation on amounts for which interest may be allowed
Interest on a deposit that is returned to a taxpayer shall
be allowed for any period only to the extent attributable to a
disputable item for that period. A disputable item is any item
for which the taxpayer (1) has a reasonable basis for the
treatment used on its return and (2) reasonably believes that
the Secretary also has a reasonable basis for disallowing the
taxpayer's treatment of such item.
All items included in a 30-day letter issued to a taxpayer
are deemed disputable for this purpose. Thus, once a 30-day
letter has been issued, the disputable amount cannot be less
than the amount of the proposed deficiency shown in the 30-day
letter. A 30-day letter is the first letter of proposed
deficiency that allows the taxpayer an opportunity for
administrative review in the Internal Revenue Service Office of
Appeals.
Deposits are not payments of tax
A deposit is not a payment of tax prior to the time the
deposited amount is used to pay a tax. Similarly, withdrawal of
a deposit will not establish a period for which interest was
allowable at the short-term applicable Federal rate for the
purpose of establishing a net zero interest rate on a similar
amount of underpayment for the same period.
Effective Date
The provision is effective for deposits made after date of
enactment (October 22, 2004).
24. Authorize IRS to enter into installment agreements that provide for
partial payment (sec. 843 of the Act and sec. 6159 of the Code)
Present and Prior Law
The Code authorizes the IRS to enter into written
agreements with any taxpayer under which the taxpayer is
allowed to pay taxes owed, as well as interest and penalties,
in installment payments if the IRS determines that doing so
will facilitate collection of the amounts owed (sec. 6159). An
installment agreement does not reduce the amount of taxes,
interest, or penalties owed. Generally, during the period
installment payments are being made, other IRS enforcement
actions (such as levies or seizures) with respect to the taxes
included in that agreement are held in abeyance.
Prior to 1998, the IRS administratively entered into
installment agreements that provided for partial payment
(rather than full payment) of the total amount owed over the
period of the agreement. In that year, the IRS Chief Counsel
issued a memorandum concluding that partial payment installment
agreements were not permitted.
Reasons for Change
According to the Department of the Treasury, at the end of
fiscal year 2003, the IRS had not pursued 2.25 million cases
totaling more than $16.5 billion in delinquent taxes. The
Congress believed that clarifying that the IRS is authorized to
enter into installment agreements with taxpayers that do not
provide for full payment of the taxpayer's liability over the
life of the agreement will improve effective tax
administration.
The Congress recognized that some taxpayers are unable or
unwilling to enter into a realistic offer-in-compromise. The
Congress believed that these taxpayers should be encouraged to
make partial payments toward resolving their tax liability, and
that providing for partial payment installment agreements will
help facilitate this.
Explanation of Provision
The Act clarifies that the IRS is authorized to enter into
installment agreements with taxpayers which do not provide for
full payment of the taxpayer's liability over the life of the
agreement. The Act also requires the IRS to review partial
payment installment agreements at least every two years. The
primary purpose of this review is to determine whether the
financial condition of the taxpayer has significantly changed
so as to warrant an increase in the value of the payments being
made.
Effective Date
The provision is effective for installment agreements
entered into on or after the date of enactment (October 22,
2004).
25. Affirmation of consolidated return regulation authority (sec. 844
of the Act and sec. 1502 of the Code)
Present and Prior Law
An affiliated group of corporations may elect to file a
consolidated return in lieu of separate returns. A condition of
electing to file a consolidated return is that all corporations
that are members of the consolidated group must consent to all
the consolidated return regulations prescribed under section
1502 prior to the last day prescribed by law for filing such
return.\774\
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\774\ Sec. 1501.
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Section 1502 states:
The Secretary shall prescribe such regulations as he
may deem necessary in order that the tax liability of
any affiliated group of corporations making a
consolidated return and of each corporation in the
group, both during and after the period of affiliation,
may be returned, determined, computed, assessed,
collected, and adjusted, in such manner as clearly to
reflect the income-tax liability and the various
factors necessary for the determination of such
liability, and in order to prevent the avoidance of
such tax liability.\775\
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\775\ Sec. 1502.
Under this authority, the Treasury Department has issued
extensive consolidated return regulations.\776\
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\776\ Regulations issued under the authority of section 1502 are
considered to be ``legislative'' regulations rather than
``interpretative'' regulations, and as such are usually given greater
deference by courts in case of a taxpayer challenge to such a
regulation. See, S. Rep. No. 960, 70th Cong., 1st Sess. at 15 (1928),
describing the consolidated return regulations as ``legislative in
character''. The Supreme Court has stated that ``. . . legislative
regulations are given controlling weight unless they are arbitrary,
capricious, or manifestly contrary to the statute.'' Chevron, U.S.A.,
Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 844
(1984) (involving an environmental protection regulation). For examples
involving consolidated return regulations, see, e.g., Wolter
Construction Company v. Commissioner, 634 F.2d 1029 (6th Cir. 1980);
Garvey, Inc. v. United States, 1 Ct. Cl. 108 (1983), aff'd 726 F.2d
1569 (Fed. Cir. 1984), cert. denied, 469 U.S. 823 (1984). Compare,
e.g., Audrey J. Walton v. Commissioner, 115 T.C. 589 (2000), describing
different standards of review. The case did not involve a consolidated
return regulation.
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In the recent case of Rite Aid Corp. v. United States,\777\
the Federal Circuit Court of Appeals addressed the application
of a particular provision of certain consolidated return loss
disallowance regulations, and concluded that the provision was
invalid.\778\ The particular provision, known as the
``duplicated loss'' provision,\779\ would have denied a loss on
the sale of stock of a subsidiary by a parent corporation that
had filed a consolidated return with the subsidiary, to the
extent the subsidiary corporation had assets that had a built-
in loss, or had a net operating loss, that could be recognized
or used later.\780\
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\777\ 255 F.3d 1357 (Fed. Cir. 2001), reh'g denied, 2001 U.S. App.
LEXIS 23207 (Fed. Cir. Oct. 3, 2001).
\778\ Prior to this decision, there had been a few instances
involving prior laws in which certain consolidated return regulations
were held to be invalid. See, e.g., American Standard, Inc. v. United
States, 602 F.2d 256 (Ct. Cl. 1979), discussed in the text infra. See
also Union Carbide Corp. v. United States, 612 F.2d 558 (Ct. Cl. 1979),
and Allied Corporation v. United States, 685 F. 2d 396 (Ct. Cl. 1982),
all three cases involving the allocation of income and loss within a
consolidated group for purposes of computation of a deduction allowed
under prior law by the Code for Western Hemisphere Trading
Corporations. See also Joseph Weidenhoff v. Commissioner, 32 T.C. 1222,
1242-1244 (1959), involving the application of certain regulations to
the excess profits tax credit allowed under prior law, and concluding
that the Commissioner had applied a particular regulation in an
arbitrary manner inconsistent with the wording of the regulation and
inconsistent with even a consolidated group computation. Cf. Kanawha
Gas & Utilities Co. v. Commissioner, 214 F.2d 685 (1954), concluding
that the substance of a transaction was an acquisition of assets rather
than stock. Thus, a regulation governing basis of the assets of
consolidated subsidiaries did not apply to the case. See also General
Machinery Corporation v. Commissioner, 33 B.T.A. 1215 (1936); Lefcourt
Realty Corporation, 31 B.T.A. 978 (1935); Helvering v. Morgans, Inc.,
293 U.S. 121 (1934), interpreting the term ``taxable year.''
\779\ Treas. Reg. sec. 1.1502-20(c)(1)(iii).
\780\ Treasury Regulation section 1.1502-20, generally imposing
certain ``loss disallowance'' rules on the disposition of subsidiary
stock, contained other limitations besides the ``duplicated loss'' rule
that could limit the loss available to the group on a disposition of a
subsidiary's stock. Treasury Reg sec. 1.1502-20 as a whole was
promulgated in connection with regulations issued under section 337(d),
principally in connection with the so-called General Utilities repeal
of 1986 (referring to the case of General Utilities & Operating Company
v. Helvering, 296 U.S. 200 (1935)). Such repeal generally required a
liquidating corporation, or a corporation acquired in a stock
acquisition treated as a sale of assets, to pay corporate level tax on
the excess of the value of its assets over the basis. Treasury
regulation section 1.1502-20 principally reflected an attempt to
prevent corporations filing consolidated returns from offsetting income
with a loss on the sale of subsidiary stock. Such a loss could result
from the unique upward adjustment of a subsidiary's stock basis
required under the consolidated return regulations for subsidiary
income earned in consolidation, an adjustment intended to prevent
taxation of both the subsidiary and the parent on the same income or
gain. As one example, absent a denial of certain losses on a sale of
subsidiary stock, a consolidated group could obtain a loss deduction
with respect to subsidiary stock, the basis of which originally
reflected the subsidiary's value at the time of the purchase of the
stock, and that had then been adjusted upward on recognition of any
built-in income or gain of the subsidiary reflected in that value. The
regulations also contained the duplicated loss factor addressed by the
court in Rite Aid. The preamble to the regulations stated: ``it is not
administratively feasible to differentiate between loss attributable to
built-in gain and duplicated loss.'' T.D. 8364, 1991-2 C.B. 43, 46
(Sept. 13, 1991). The government also argued in the Rite Aid case that
duplicated loss was a separate concern of the regulations. 255 F.3d at
1360.
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The Federal Circuit Court opinion contained language
discussing the fact that the regulation produced a result
different than the result that would have obtained if the
corporations had filed separate returns rather than
consolidated returns.\781\
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\781\ For example, the court stated: ``The duplicated loss factor .
. . addresses a situation that arises from the sale of stock regardless
of whether corporations file separate or consolidated returns. With
I.R.C. secs. 382 and 383, Congress has addressed this situation by
limiting the subsidiary's potential future deduction, not the parent's
loss on the sale of stock under I.R.C. sec. 165.'' 255 F.3d 1357, 1360
(Fed. Cir. 2001).
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The Federal Circuit Court opinion cited a 1928 Senate
Finance Committee Report to legislation that authorized
consolidated return regulations, which stated that ``many
difficult and complicated problems, . . . have arisen in the
administration of the provisions permitting the filing of
consolidated returns'' and that the committee ``found it
necessary to delegate power to the commissioner to prescribe
regulations legislative in character covering them.'' \782\ The
Court's opinion also cited a previous decision of the Court of
Claims for the proposition, interpreting this legislative
history, that section 1502 grants the Secretary ``the power to
conform the applicable income tax law of the Code to the
special, myriad problems resulting from the filing of
consolidated income tax returns;'' but that section 1502 ``does
not authorize the Secretary to choose a method that imposes a
tax on income that would not otherwise be taxed.'' \783\
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\782\ S. Rep. No. 960, 70th Cong., 1st Sess. 15 (1928). Though not
quoted by the court in Rite Aid, the same Senate report also indicated
that one purpose of the consolidated return authority was to permit
treatment of the separate corporations as if they were a single unit,
stating ``The mere fact that by legal fiction several corporations
owned by the same shareholders are separate entities should not obscure
the fact that they are in reality one and the same business owned by
the same individuals and operated as a unit.'' S. Rep. No. 960, 70th
Cong., 1st Sess. 29 (1928).
\783\ American Standard, Inc. v. United States, 602 F.2d 256, 261
(Ct. Cl. 1979). That case did not involve the question of separate
returns as compared to a single return approach. It involved the
computation of a Western Hemisphere Trade Corporation (``WHTC'')
deduction under prior law (which deduction would have been computed as
a percentage of each WHTC's taxable income if the corporations had
filed separate returns), in a case where a consolidated group included
several WHTCs as well as other corporations. The question was how to
apportion income and losses of the admittedly consolidated WHTCs and
how to combine that computation with the rest of the group's
consolidated income or losses. The court noted that the new, changed
regulations approach varied from the approach taken to a similar
problem involving public utilities within a group and previously
allowed for WHTCs. The court objected that the allocation method
adopted by the regulation allowed non-WHTC losses to reduce WHTC
income. However, the court did not disallow a method that would net
WHTC income of one WHTC with losses of another WHTC, a result that
would not have occurred under separate returns. Nor did the court
expressly disallow a different fractional method that would net both
income and losses of the WHTCs with those of other corporations in the
consolidated group. The court also found that the regulation had been
adopted without proper notice.
---------------------------------------------------------------------------
The Federal Circuit Court construed these authorities and
applied them to invalidate Treas. Reg. Sec. 1.1502-
20(c)(1)(iii), stating that:
The loss realized on the sale of a former
subsidiary's assets after the consolidated group sells
the subsidiary's stock is not a problem resulting from
the filing of consolidated income tax returns. The
scenario also arises where a corporate shareholder
sells the stock of a non-consolidated subsidiary. The
corporate shareholder could realize a loss under I.R.C.
sec. 1001, and deduct the loss under I.R.C. sec. 165.
The subsidiary could then deduct any losses from a
later sale of assets. The duplicated loss factor,
therefore, addresses a situation that arises from the
sale of stock regardless of whether corporations file
separate or consolidated returns. With I.R.C. secs. 382
and 383, Congress has addressed this situation by
limiting the subsidiary's potential future deduction,
not the parent's loss on the sale of stock under I.R.C.
sec. 165.\784\
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\784\ Rite Aid, 255 F.3d at 1360.
The Treasury Department has announced that it will not
continue to litigate the validity of the duplicated loss
provision of the regulations, and has issued interim
regulations that permit taxpayers for all years to elect a
different treatment, though they may apply the provision for
the past if they wish.\785\
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\785\ See Temp. Treas. Reg. sec. 1.1502-20T(i)(2), Temp. Treas.
Reg. sec. 1.337(d)-2T, and Temp. Treas. Reg. sec. 1.1502-35T. The
Treasury Department has also indicated its intention to continue to
study all the issues that the original loss disallowance regulations
addressed (including issues of furthering single entity principles) and
possibly issue different regulations (not including the particular
approach of Treas. Reg. Sec. 1.1502-20(c)(1)(iii)) on the issues in the
future. See, e.g. Notice 2002-11, 2002-7 I.R.B. 526 (Feb. 19, 2002);
T.D. 8984, 67 F.R. 11034 (March 12, 2002); REG-102740-02, 67 F.R. 11070
(March 12, 2002); see also Notice 2002-18, 2002-12 I.R.B. 644 (March
25, 2002); REG-131478-02, 67 F.R. 65060 (October 18, 2002); T.D. 9048,
68 F.R. 12287 (March 14, 2003); and T.D. 9118, REG-153172-03 (March 17,
2004).
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Reasons for Change
The Congress was concerned that Treasury Department
resources might be unnecessarily devoted to defending
challenges to consolidated return regulations on the mere
assertion by a taxpayer that the result under the consolidated
return regulations is different than the result for separate
taxpayers. The consolidated return regulations offer many
benefits that are not available to separate taxpayers,
including generally rules that tax income received by the group
once and attempt to avoid a second tax on that same income when
stock of a subsidiary is sold.
Explanation of Provision
The Act confirms that, in exercising its authority under
section 1502 to issue consolidated return regulations, the
Treasury Department may provide rules treating corporations
filing consolidated returns differently from corporations
filing separate returns.
Thus, under the statutory authority of section 1502, the
Treasury Department is authorized to issue consolidated return
regulations utilizing either a single taxpayer or separate
taxpayer approach or a combination of the two approaches, as
Treasury deems necessary in order that the tax liability of any
affiliated group of corporations making a consolidated return,
and of each corporation in the group, both during and after the
period of affiliation, may be determined and adjusted in such
manner as clearly to reflect the income-tax liability and the
various factors necessary for the determination of such
liability, and in order to prevent avoidance of such liability.
Rite Aid is thus overruled to the extent it suggests that
the Secretary is required to identify a problem created from
the filing of consolidated returns in order to issue
regulations that change the application of a Code provision.
The Secretary may promulgate consolidated return regulations to
change the application of a tax code provision to members of a
consolidated group, provided that such regulations are
necessary to clearly reflect the income tax liability of the
group and each corporation in the group, both during and after
the period of affiliation.
The Act nevertheless allows the result of the Rite Aid case
to stand with respect to the type of factual situation
presented in the case. That is, the Act provides for the
override of the regulatory provision that took the approach of
denying a loss on a deconsolidating disposition of stock of a
consolidated subsidiary \786\ to the extent the subsidiary had
net operating losses or built in losses that could be used
later outside the group.\787\
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\786\ Treas. Reg. Sec. 1.1502-20(c)(1)(iii).
\787\ The Act is not intended to overrule the current Treasury
Department regulations, which allow taxpayers in certain circumstances
for the past to follow Treasury Regulations section 1.1502-
20(c)(1)(iii), if they choose to do so. Temp. Treas. Reg. sec. 1.1502-
20T(i)(2).
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Retaining the result in the Rite Aid case with respect to
the particular regulation section 1.1502-20(c)(1)(iii) as
applied to the factual situation of the case does not in any
way prevent or invalidate the various approaches Treasury has
announced it will apply or that it intends to consider in lieu
of the approach of that regulation, including, for example, the
denial of a loss on a stock sale if inside losses of a
subsidiary may also be used by the consolidated group, and the
possible requirement that inside attributes be adjusted when a
subsidiary leaves a group.\788\
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\788\ See, e.g., Notice 2002-11, 2002-7 I.R.B. 526 (February 19,
2002); Temp. Treas. Reg. sec. 1.337(d)-2T, (T.D. 8984, 67 F.R. 11034
(March 12, 2002) and T.D. 8998, 67 F.R. 37998 (May 31, 2002)); REG-
102740-02, 67 F.R. 11070 (March 12, 2002); see also Notice 2002-18,
2002-12 I.R.B. 644 (March 25, 2002); REG-131478-02, 67 F.R. 65060
(October 18, 2002); Temp. Reg. sec. 1.1502-35T (T.D. 9048, 68 F.R.
12287 (March 14, 2003)); and T.D. 9118, REG-153172-03 (March 17, 2004).
In exercising its authority under section 1502, the Secretary is also
authorized to prescribe rules that protect the purpose of General
Utilities repeal using presumptions and other simplifying conventions.
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Effective Date
The provision is effective for all years, whether beginning
before, on, or after the date of enactment (October 22, 2004).
No inference is intended that the results following from this
provision are not the same as the results under present law.
26. Expanded disallowance of deduction for interest on convertible debt
(sec. 845 of the Act and sec. 163 of the Code)
Present and Prior Law
Whether an instrument qualifies for tax purposes as debt or
equity is determined under all the facts and circumstances
based on principles developed in case law. If an instrument
qualifies as equity, the issuer generally does not receive a
deduction for dividends paid and the holder generally includes
such dividends in income (although individual holders generally
may pay tax on the income at capital gains rates, and corporate
holders generally may obtain a dividends-received deduction of
at least 70 percent of the amount of the dividend). If an
instrument qualifies as debt, the issuer may receive a
deduction for accrued interest and the holder generally
includes interest in income, subject to certain limitations.
Original issue discount (``OID'') on a debt instrument is
the excess of the stated redemption price at maturity over the
issue price of the instrument. An issuer of a debt instrument
with OID generally accrues and deducts the discount as interest
over the life of the instrument even though interest may not be
paid until the instrument matures. The holder of such a debt
instrument also generally includes the OID in income as it
accrues.
Under present and prior law, no deduction is allowed for
interest or OID on a debt instrument issued by a corporation
(or issued by a partnership to the extent of its corporate
partners) that is payable in equity of the issuer or a related
party (within the meaning of sections 267(b) and 707(b)),
including a debt instrument a substantial portion of which is
mandatorily convertible or convertible at the issuer's option
into equity of the issuer or a related party.\789\ In addition,
a debt instrument is treated as payable in equity if a
substantial portion of the principal or interest is required to
be determined, or may be determined at the option of the issuer
or related party, by reference to the value of equity of the
issuer or related party.\790\ A debt instrument also is treated
as payable in equity if it is part of an arrangement that is
designed to result in the payment of the debt instrument with
or by reference to such equity, such as in the case of certain
issuances of a forward contract in connection with the issuance
of debt, nonrecourse debt that is secured principally by such
equity, or certain debt instruments that are paid in, converted
to, or determined with reference to the value of equity if it
may be so required at the option of the holder or a related
party and there is a substantial certainty that option will be
exercised.\791\
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\789\ Sec. 163(l), enacted in the Taxpayer Relief Act of 1997, Pub.
L. No. 105-34, sec. 1005(a).
\790\ Sec. 163(l)(3)(B).
\791\ Sec. 163(l)(3)(C).
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Reasons for Change
The Joint Committee on Taxation staff's investigative
report on Enron Corporation \792\ described two structured
financing transactions that Enron undertook in 1995 and 1999
involving what the report referred to as ``investment unit
securities.'' In substance, these securities featured principal
repayment that was not unconditional in amount, as generally is
required in order for debt characterization to be respected for
tax purposes. Instead, principal on the securities was payable
upon maturity in stock of an Enron affiliate (or in cash
equivalent to the value of such stock).
---------------------------------------------------------------------------
\792\ See Joint Committee on Taxation, Report of Investigation of
Enron Corporation and Related Entities Regarding Federal Tax and
Compensation Issues, and Policy Recommendations (JCS-3-03), February
2003.
---------------------------------------------------------------------------
The Congress believed that the financing activities
undertaken by Enron in 1995 and 1999 using investment unit
securities cast doubt upon the tax policy rationale for
excluding stock ownership interests of 50 percent or less (by
virtue of the prior-law related party threshold) from the
application of the interest expense disallowance rules for
certain convertible equity-linked debt instruments. With regard
to the securities issued by Enron, the fact that Enron owned
more than 50 percent of the affiliate stock at the time of the
1995 issuance but owned less than 50 percent of such stock at
the time of the 1999 issuance (or shortly thereafter) had no
discernible bearing on the intent or economic consequences of
either transaction. In each instance, the transaction did not
involve a borrowing by Enron in substance for which an interest
deduction is appropriate. Rather, these transactions had the
purpose and effect of carrying out a monetization of the
affiliate stock. Nevertheless, the tax consequences of the 1995
issuance likely would have been different from those of the
1999 issuance if the prior-law rules had been in effect at the
time of both transactions, rather than only at the time of the
1999 transaction (to which the interest expense disallowance
rules did not apply because of the prior-law 50-percent related
party threshold). Therefore, the Congress believed that
eliminating the related party threshold for the application of
these rules would further the tax policy objective of similar
tax treatment of economically equivalent transactions. The
Congress further believed that disallowed interest under the
Act should increase the basis of the equity to which the equity
is linked in a manner similar to that contemplated under
currently proposed Treasury regulations.\793\
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\793\ Prop. Treas. Reg. sec. 1.263(g)-4.
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Explanation of Provision
The Act expands the disallowance of interest deductions on
certain convertible or equity-linked corporate debt that is
payable in, or by reference to the value of, equity. Under the
Act, the disallowance is expanded to include interest on
corporate debt that is payable in, or by reference to the value
of, any equity held by the issuer (or by any related party) in
any other person, without regard to whether such equity
represents more than a 50-percent ownership interest in such
person. However, the Act does not apply to debt that is issued
by an active dealer in securities (or by a related party) if
the debt is payable in, or by reference to the value of, equity
that is held by the securities dealer in its capacity as a
dealer in securities.
Effective Date
The provision applies to debt instruments that are issued
after October 3, 2004.
27. Reform of tax treatment of certain leasing arrangements and
limitation on deductions allocable to property used by
governments or other tax-exempt entities (secs. 847 through 849
of the Act and secs. 167 and 168 of the Code, and new sec. 470
of the Code)
Present and Prior Law
Overview of depreciation
A taxpayer is allowed to recover, through annual
depreciation deductions, the cost of certain property used in a
trade or business or for the production of income. The amount
of the depreciation deduction allowed with respect to tangible
property for a taxable year is determined under the modified
accelerated cost recovery system (``MACRS''). Under MACRS,
different types of property generally are assigned applicable
recovery periods and depreciation methods based on such
property's class life. The recovery periods applicable to most
tangible personal property (generally tangible property other
than residential rental property and nonresidential real
property) range from three to 25 years and are significantly
shorter than the property's class life, which is intended to
approximate the economic useful life of the property. In
addition, the depreciation methods generally applicable to
tangible personal property are the 200-percent and 150-percent
declining balance methods, switching to the straight-line
method for the taxable year in which the depreciation deduction
would be maximized.
Characterization of leases for tax purposes
In general, a taxpayer is treated as the tax owner and is
entitled to depreciate property leased to another party if the
taxpayer acquires and retains significant and genuine
attributes of a traditional owner of the property, including
the benefits and burdens of ownership. No single factor is
determinative of whether a lessor will be treated as the owner
of the property. Rather, the determination is based on all the
facts and circumstances surrounding the leasing transaction.
A sale-leaseback transaction is respected for Federal tax
purposes if ``there is a genuine multiple-party transaction
with economic substance which is compelled or encouraged by
business or regulatory realities, is imbued with tax-
independent considerations, and is not shaped solely by tax-
avoidance features that have meaningless labels attached.''
\794\
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\794\ Frank Lyon Co. v. United States, 435 U.S. 561, 583-84 (1978).
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Recovery period for tax-exempt use property
Under present and prior law, ``tax-exempt use property''
must be depreciated on a straight-line basis over a recovery
period equal to the longer of the property's class life or 125
percent of the lease term.\795\ For purposes of this rule,
``tax-exempt use property'' is tangible property that is leased
(other than under a short-term lease) to a tax-exempt
entity.\796\ For this purpose, the term ``tax-exempt entity''
includes Federal, State and local governmental units,
charities, and, foreign entities or persons.\797\
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\795\ Sec. 168(g)(3)(A). Under present law, section 168(g)(3)(C)
states that the recovery period of ``qualified technological
equipment'' is five years.
\796\ Sec. 168(h)(1).
\797\ Sec. 168(h)(2).
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In determining the length of the lease term for purposes of
the 125-percent calculation, several special rules apply. In
addition to the stated term of the lease, the lease term
includes options to renew the lease or other periods of time
during which the lessee could be obligated to make rent
payments or assume a risk of loss related to the leased
property.
Tax-exempt use property does not include property that is
used by a taxpayer to provide a service to a tax-exempt entity.
So long as the relationship between the parties is a bona fide
service contract, the taxpayer will be allowed to depreciate
the property used in satisfying the contract under normal MACRS
rules, rather than the rules applicable to tax-exempt use
property.\798\ In addition, property is not treated as tax-
exempt use property merely by reason of a short-term lease. In
general, a short-term lease means any lease the term of which
is less than three years and less than the greater of one year
or 30 percent of the property's class life.\799\
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\798\ Sec. 7701(e) provides that a service contract will not be
respected, and instead will be treated as a lease of property, if such
contract is properly treated as a lease taking into account all
relevant factors. The relevant factors include, among others, the
service recipient controls the property, the service recipient is in
physical possession of the property, the service provider does not bear
significant risk of diminished receipts or increased costs if there is
nonperformance, the property is not used to concurrently provide
services to other entities, and the contract price does not
substantially exceed the rental value of the property.
\799\ Sec. 168(h)(1)(C).
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Also, tax-exempt use property generally does not include
qualified technological equipment that meets the exception for
leases of high technology equipment to tax-exempt entities with
lease terms of five years or less.\800\ The recovery period for
qualified technological equipment that is treated as tax-exempt
use property, but is not subject to the high technology
equipment exception, is five years.\801\
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\800\ Sec. 168(h)(3). However, the exception does not apply if part
or all of the qualified technological equipment is financed by a tax-
exempt obligation, is sold by the tax-exempt entity (or related party)
and leased back to the tax-exempt entity (or related party), or the
tax-exempt entity is the United States or any agency or instrumentality
of the United States.
\801\ Sec. 168(g)(3)(C).
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The term ``qualified technological equipment'' is defined
as computers and related peripheral equipment, high technology
telephone station equipment installed on a customer's premises,
and high technology medical equipment.\802\ In addition, tax-
exempt use property does not include computer software because
it is intangible property.
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\802\ Sec. 168(i)(2).
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Reasons for Change
The special rules applicable to the depreciation of tax-
exempt use property were enacted to prevent tax-exempt entities
from using leasing arrangements to transfer the tax benefits of
accelerated depreciation on property they used to a taxable
entity. The Congress was concerned that some taxpayers were
attempting to circumvent this policy through the creative use
of service contracts with the tax-exempt entities.
More generally, the Congress believed that certain ongoing
leasing activity with tax-exempt entities and foreign
governments indicated that the prior-law tax rules were not
effective in curtailing the ability of a tax-exempt entity to
transfer certain tax benefits to a taxable entity. The Congress
was concerned about this activity and the continual development
of new structures that purported to minimize or neutralize the
effect of these rules. In addition, the Congress also was
concerned about the increasing use of certain leasing
structures involving property purported to be qualified
technological equipment. Although the Congress recognized that
leasing plays an important role in ensuring the availability of
capital to businesses, it believed that certain transactions of
which it recently had become aware did not serve this role.
These transactions resulted in little or no accumulation of
capital for financing or refinancing but, instead, essentially
involved an accommodation fee paid by a U.S. taxpayer to a tax
indifferent party.
In discussing the reasons for the enactment of rules in
1984 that were intended to limit the transfer of tax benefits
to taxable entities with respect to property used by tax-exempt
entities, Congress at the time stated that: (1) the Federal
budget was in no condition to sustain substantial and growing
revenue losses by making additional tax benefits (in excess of
tax exemption itself) available to tax-exempt entities through
leasing transactions; (2) there were concerns about possible
problems of accountability of governments to their citizens,
and of tax-exempt organizations to their clientele, if
substantial amounts of their property came under the control of
outside parties solely because the Federal tax system made
leasing more favorable than owning; (3) the tax system should
not encourage tax-exempt entities to dispose of assets they own
or to forego control over the assets they use; (4) there were
concerns about waste of Federal revenues because in some cases
a substantial portion of the tax savings was retained by
lawyers, investment bankers, lessors, and investors and, thus,
the Federal revenue loss became more of a gain to financial
entities than to tax-exempt entities; (5) providing aid to tax-
exempt entities through direct appropriations was more
efficient and appropriate than providing such aid through the
Code; and (6) popular confidence in the tax system must be
sustained by ensuring that the system generally is working
correctly and fairly.\803\
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\803\ See H.R. Rep. No. 98-432, Pt. 2, pp. 1140-1141 (1984) and S.
Prt. No. 98-169, Vol. I, pp. 125-127 (1984).
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The Congress believed that the reasons stated above for the
enactment in 1984 of the present-law rules are as important
today as they were in 1984. Unfortunately, the prior-law rules
did not adequately deter taxpayers from engaging in
transactions that attempted to circumvent the rules enacted in
1984. Therefore, the Congress believed that changes to prior
law were essential to ensure the attainment of the
aforementioned Congressional intentions, provided such changes
did not inhibit legitimate commercial leasing transactions that
involve a significant and genuine transfer of the benefits and
burdens of tax ownership between the taxpayer and the tax-
exempt lessee.
Explanation of Provision
Overview
The Act expands the prior-law definition of tax-exempt
entity for purposes of this provision, modifies the recovery
period of certain property leased to a tax-exempt entity,
alters the definition of lease term for all property leased to
a tax-exempt entity, expands the short-term lease exception for
qualified technological equipment, and establishes rules to
limit deductions associated with leases to tax-exempt entities
if the leases do not satisfy specified criteria.
Definition of tax-exempt entity
The Act expands the definition of tax-exempt entity for
purposes of this provision to include certain Indian tribal
governments in addition to Federal, State, local, and foreign
governmental units, charities, foreign entities or persons.
Modify the recovery period of certain property leased to a tax-exempt
entity
The Act modifies the recovery period for qualified
technological equipment, computer software and certain
intangibles leased to a tax-exempt entity to be the longer of
the property's assigned class life \804\ or 125 percent of the
lease term. This provision does not apply to short-term leases,
as defined under present and prior law with a modification
described below for short-term leases of qualified
technological equipment.
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\804\ In the case of computer software and intangible assets, this
rule is applied by substituting useful life and amortization period,
respectively, for class life.
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Modify definition of lease term
In determining the length of the lease term for purposes of
the 125-percent calculation, the Act provides that the lease
term includes all service contracts (whether or not treated as
a lease under section 7701(e)) and other similar arrangements
that follow a lease of property to a tax-exempt entity and that
are part of the same transaction (or series of transactions) as
the lease.\805\
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\805\ A service contract involving property that previously was
leased to the tax-exempt entity is not part of the same transaction as
the preceding leasing arrangement (and, thus, is not included in the
lease term of such arrangement) if the service contract was not
included in the terms and conditions, or contemplated at the inception,
of the preceding leasing arrangement.
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Under the Act, service contracts and other similar
arrangements include arrangements by which services are
provided using the property in exchange for fees that provide a
source of repayment of the capital investment in the
property.\806\
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\806\ For purposes of this provision, a service contract does not
include an arrangement for the provision of services if the leased
property or substantially similar property is not utilized to provide
such services. For example, if at the conclusion of a lease term, a
tax-exempt lessee purchases property from the taxpayer and enters into
an agreement pursuant to which the taxpayer maintains the property, the
maintenance agreement will not be included in the lease term for
purposes of the 125-percent computation.
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This requirement applies to all leases of property to a
tax-exempt entity.
Expand short-term lease exception for qualified technological equipment
For purposes of determining whether a lease of qualified
technological equipment to a tax-exempt entity satisfies the
five-year short-term lease exception for leases of qualified
technological equipment, the Act provides that the term of the
lease does not include an option or options of the lessee to
renew or extend the lease, provided the rents under the renewal
or extension are based upon fair market value determined at the
time of the renewal or extension. The aggregate period of such
renewals or extensions not included in the lease term under
this provision may not exceed 24 months. In addition, this
provision does not apply to any period following the failure of
a tax-exempt lessee to exercise a purchase option if the result
of such failure is that the lease renews automatically at fair
market value rents.
Limit deductions for certain leases of property to tax-exempt parties
The Act also provides that if a taxpayer leases property to
a tax-exempt entity, the taxpayer may not claim deductions for
a taxable year from the lease transaction in excess of the
taxpayer's gross income from the lease for that taxable year.
The deduction limitation provision does not apply to certain
transactions involving property with respect to which the low-
income housing credit or the rehabilitation credit is
allowable.
The deduction limitation provision applies to deductions or
losses related to a lease to a tax-exempt entity and the leased
property.\807\ Any disallowed deductions are carried forward
and treated as deductions related to the lease in the following
taxable year subject to the same limitations. Under rules
similar to those applicable to passive activity losses
(including the treatment of dispositions of property in which
less than all of the gain or loss from the disposition is
recognized),\808\ a taxpayer generally is permitted to deduct
previously disallowed deductions and losses when the taxpayer
completely disposes of its interest in the property.
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\807\ Deductions related to a lease of tax-exempt use property
include any depreciation or amortization expense, maintenance expense,
taxes or the cost of acquiring an interest in, or lease of, property.
In addition, this provision applies to interest that is properly
allocable to tax-exempt use property, including interest on any
borrowing by a related person, the proceeds of which were used to
acquire an interest in the property, whether or not the borrowing is
secured by the leased property or any other property.
\808\ See Sec. 469(g).
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A lease of property to a tax-exempt party is not subject to
the deduction limitations of this provision if the lease
satisfies all of the following requirements: \809\
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\809\ Even if a transaction satisfies each of the following
requirements, the taxpayer will be treated as the owner of the leased
property only if the taxpayer acquires and retains significant and
genuine attributes of an owner of the property under the present-law
tax rules, including the benefits and burdens of ownership.
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1. Tax-exempt lessee does not monetize its lease
obligations
In general, the tax-exempt lessee may not monetize its
lease obligations (including any purchase option) in an amount
that exceeds 20 percent of the taxpayer's adjusted basis \810\
in the leased property at the time the lease is entered
into.\811\ Specifically, a lease does not satisfy this
requirement if the tax-exempt lessee monetizes such excess
amount pursuant to an arrangement, set-aside, or expected set-
aside, that is to or for the benefit of the taxpayer or any
lender, or is to or for the benefit of the tax-exempt lessee,
in order to satisfy the lessee's obligations or options under
the lease. This determination shall be made at all times during
the lease term and shall include the amount of any interest or
other income or gain earned on any amount set aside or subject
to an arrangement described in this provision. For purposes of
determining whether amounts have been set aside or are expected
to be set aside, amounts are treated as set aside or expected
to be set aside only if a reasonable person would conclude that
the facts and circumstances indicate that such amounts are set
aside or expected to be set aside.\812\
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\810\ For purposes of this requirement, the adjusted basis of
property acquired by the taxpayer in a like-kind exchange or
involuntary conversion to which section 1031 or section 1033 applies is
equal to the lesser of (1) the fair market value of the property as of
the beginning of the lease term, or (2) the amount that would be the
taxpayer's adjusted basis if section 1031 or section 1033 did not apply
to such acquisition.
\811\ Arrangements to monetize lease obligations include defeasance
arrangements, loans by the tax-exempt entity (or an affiliate) to the
taxpayer (or an affiliate) or any lender, deposit agreements, letters
of credit collateralized with cash or cash equivalents, payment
undertaking agreements, prepaid rent (within the meaning of the
regulations under section 467), sinking fund arrangements, guaranteed
investment contracts, financial guaranty insurance, or any similar
arrangements.
\812\ It is anticipated under the Act that the customary and
budgeted funding by tax-exempt entities of current obligations under a
lease through unrestricted accounts or funds for general working
capital needs will not be considered arrangements, set-asides, or
expected set-asides under this requirement.
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The Secretary may provide by regulations that this
requirement is satisfied, even if a tax-exempt lessee monetizes
its lease obligations or options in an amount that exceeds 20
percent of the taxpayer's adjusted basis in the leased
property, in cases in which the creditworthiness of the tax-
exempt lessee would not otherwise satisfy the taxpayer's
customary underwriting standards. Such credit support would not
be permitted to exceed 50 percent of the taxpayer's adjusted
basis in the property. In addition, if the lease provides the
tax-exempt lessee an option to purchase the property for a
fixed purchase price (or for other than the fair market value
of the property determined at the time of exercise of the
option), such credit support at the time that such option may
be exercised would not be permitted to exceed 50 percent of the
purchase option price.
Certain lease arrangements that involve circular cash flows
or insulation of the taxpayer's equity investment from the risk
of loss fail this requirement without regard to the amount in
which the tax-exempt lessee monetizes its lease obligations or
options. Thus, a lease does not satisfy this requirement if the
tax-exempt lessee enters into an arrangement to monetize in any
amount its lease obligations or options if such arrangement
involves (1) a loan (other than an amount treated as a loan
under section 467 with respect to a section 467 rental
agreement) from the tax-exempt lessee to the taxpayer or a
lender, (2) a deposit that is received, a letter of credit that
is issued, or a payment undertaking agreement that is entered
into by a lender otherwise involved in the transaction, or (3)
in the case of a transaction that involves a lender, any credit
support made available to the taxpayer in which any such lender
does not have a claim that is senior to the taxpayer.
2. Taxpayer makes and maintains a substantial equity
investment in the leased property
The taxpayer must make and maintain a substantial equity
investment in the leased property. For this purpose, a taxpayer
generally does not make or maintain a substantial equity
investment unless (1) at the time the lease is entered into,
the taxpayer initially makes an unconditional at-risk equity
investment in the property of at least 20 percent of the
taxpayer's adjusted basis \813\ in the leased property at that
time,\814\ (2) the taxpayer maintains such equity investment
throughout the lease term, and (3) at all times during the
lease term, the fair market value of the property at the end of
the lease term is reasonably expected to be equal to at least
20 percent of such basis.\815\ For this purpose, the fair
market value of the property at the end of the lease term is
reduced to the extent that a person other than the taxpayer
bears a risk of loss in the value of the property.
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\813\ For purposes of this requirement, the adjusted basis of
property acquired by the taxpayer in a like-kind exchange or
involuntary conversion to which section 1031 or section 1033 applies is
equal to the lesser of (1) the fair market value of the property as of
the beginning of the lease term, or (2) the amount that would be the
taxpayer's adjusted basis if section 1031 or section 1033 did not apply
to such acquisition.
\814\ The taxpayer's at-risk equity investment shall include only
consideration paid, and personal liability incurred, by the taxpayer to
acquire the property. Cf. Rev. Proc. 2001-28, 2001-2 C.B. 1156.
\815\ Cf. Rev. Proc. 2001-28, sec. 4.01(2), 2001-1 C.B. 1156. The
fair market value of the property must be determined without regard to
inflation or deflation during the lease term and after subtracting the
cost of removing the property.
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This requirement does not apply to leases with lease terms
of five years or less.
3. Tax-exempt lessee does not bear more than a minimal risk
of loss
The tax-exempt lessee generally may not assume or retain
more than a minimal risk of loss, other than the obligation to
pay rent and insurance premiums, to maintain the property, or
other similar conventional obligations of a net lease.\816\ For
this purpose, a tax-exempt lessee assumes or retains more than
a minimal risk of loss if, as a result of obligations assumed
or retained by, on behalf of, or pursuant to an agreement with
the tax-exempt lessee, the taxpayer is protected from either
(1) any portion of the loss that would occur if the fair market
value of the leased property were 25 percent less than the
leased property's reasonably expected fair market value at the
time the lease is terminated, or (2) an aggregate loss that is
greater than 50 percent of the loss that would occur if the
fair market value of the leased property were zero at lease
termination.\817\ In addition, the Secretary may provide by
regulations that this requirement is not satisfied where the
tax-exempt lessee otherwise retains or assumes more than a
minimal risk of loss. Such regulations shall be prospective
only.
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\816\ Examples of arrangements by which a tax-exempt lessee might
assume or retain a risk of loss include put options, residual value
guarantees, residual value insurance, and service contracts. However,
leases do not fail to satisfy this requirement solely by reason of
lease provisions that require the tax-exempt lessee to pay a
contractually stipulated loss value to the taxpayer in the event of an
early termination due to a casualty loss, a material default by the
tax-exempt lessee (excluding the failure by the tax-exempt lessee to
enter into an arrangement described above), or other similar
extraordinary events that are not reasonably expected to occur at lease
inception.
\817\ For purposes of this requirement, residual value protection
provided to the taxpayer by a manufacturer or dealer of the leased
property is not treated as borne by the tax-exempt lessee if the
manufacturer or dealer provides such residual value protection to
customers in the ordinary course of its business.
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This requirement does not apply to leases with lease terms
of 5 years or less.
4. Lease of certain property does not include a fixed-price
purchase option of the tax-exempt lessee
The tax-exempt lessee may not have an option to purchase
the leased property for any stated purchase price other than
the fair market value of the property (as determined at the
time of exercise of the option). This requirement does not
apply to (1) property with a class life (as defined in section
168(i)(1)) of seven years or less, or (2) any fixed-wing
aircraft or vessels (i.e., ships).
Coordination with like-kind exchange and involuntary
conversion rules
Under the deduction limitation provision, neither the like-
kind exchange rules (sec. 1031) nor the involuntary conversion
rules (sec. 1033) apply if either (1) the exchanged or
converted property is tax-exempt use property subject to a
lease that was entered into prior to the effective date of the
provision and the lease would not have satisfied the
requirements of the provision had such requirements been in
effect when the lease was entered into, or (2) the replacement
property is tax-exempt use property subject to a lease that
does not meet the requirements of the provision.
Other rules
The deduction limitation provision continues to apply
throughout the lease term to property that initially was tax-
exempt use property, even if the property ceases to be tax-
exempt use property during the lease term.\818\ In addition,
the deduction limitation provision is applied before the
application of the passive activity loss rules under section
469.
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\818\ Conversely, however, a lease of property that is not tax-
exempt use property does not become subject to this provision solely by
reason of requisition or seizure by the Federal government in national
emergency circumstances.
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The deduction limitation provision does not alter the
treatment of any Qualified Motor Vehicle Operating Agreement
within the meaning of section 7701(h). In the case of any such
agreement, the second and third requirements provided by the
provision (relating to taxpayer equity investment and tax-
exempt lessee risk of loss, respectively) shall be applied
without regard to any terminal rental adjustment clause.
Effective Date
The provision generally is effective for leases \819\
entered into after March 12, 2004.\820\ However, the provision
does not apply to property located in the United States that is
subject to a lease with respect to which a formal application
(1) was submitted for approval to the Federal Transit
Administration (an agency of the Department of Transportation)
after June 30, 2003, and before March 13, 2004, (2) is approved
by the Federal Transit Administration before January 1, 2006,
and (3) includes a description and the fair market value of
such property.
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\819\ While the effective date of the provision refers specifically
to leases, it is intended that the deduction limitation provision
applies without regard to whether the tax-exempt use property is
treated as such by reason of a lease or otherwise (e.g., by virtue of
section 168(h)(6) because the property is owned by a partnership that
has a tax-exempt partner and provides for certain special allocations).
A technical correction, effective for transactions involving property
that is acquired after March 12, 2004, may be necessary to reflect this
intent. On March 10, 2005, the IRS issued Notice 2005-29, 2005-13
I.R.B. 796, which provides temporary transition relief from the Act to
partnerships and other pass-through entities that are treated as
holding tax-exempt use property by virtue of section 168(h)(6).
\820\ If a lease entered into on or before March 12, 2004, is
transferred in a transaction that does not materially alter the terms
of such lease, the Act shall not apply to the lease as a result of such
transfer.
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The provisions relating to intangible assets and Indian
tribal governments are effective for leases entered into after
October 3, 2004.
The provisions relating to coordination with the like-kind
exchange and involuntary conversion rules are effective with
respect to property that is exchanged or converted after the
date of enactment (October 22, 2004).
No inference is intended regarding the appropriate prior-
law tax treatment of transactions entered into prior to the
effective date of the Act. In addition, it is intended that the
Act shall not be construed as altering or supplanting the
present-law tax rules providing that a taxpayer is treated as
the owner of leased property only if the taxpayer acquires and
retains significant and genuine attributes of an owner of the
property, including the benefits and burdens of ownership. The
Act also is not intended to affect the scope of any other
present-law or prior-law tax rules or doctrines applicable to
purported leasing transactions.
C. Reduction of Fuel Tax Evasion
1. Exemption from certain excise taxes for mobile machinery vehicles
and modification of definition of off-highway vehicle (secs.
851 and 852 of the Act and secs. 4053, 4072, 4082, 4483, 6421,
and 7701 of the Code)
Present and Prior Law
The definition of a ``highway vehicle'' affects the
application of the retail tax on heavy vehicles, the heavy
vehicle use tax, the tax on tires, and fuel taxes.\821\ Section
4051 of the Code provides for a 12-percent retail sales tax on
tractors, heavy trucks with a gross vehicle weight (``GVW'')
over 33,000 pounds, and trailers with a GVW over 26,000 pounds.
Section 4071 provides for a tax on certain highway vehicle
tires.\822\ Section 4481 provides for an annual use tax on
heavy vehicles with a GVW of 55,000 pounds or more, with higher
rates of tax on heavier vehicles. All of these excise taxes are
paid into the Highway Trust Fund.
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\821\ Secs. 4051, 4071, 4481, 4041 and 4081.
\822\ This tax was modified by section 869 of the Act.
---------------------------------------------------------------------------
Federal excise taxes are also levied on the motor fuels
used in highway vehicles. Gasoline is subject to a tax of 18.4
cents per gallon, of which 18.3 cents per gallon is paid into
the Highway Trust Fund and 0.1 cent per gallon is paid into the
Leaking Underground Storage Tank (``LUST'') Trust Fund. Highway
diesel fuel is subject to a tax of 24.4 cents per gallon, of
which 24.3 cents per gallon is paid into the Highway Trust Fund
and 0.1 cent per gallon is paid into the LUST Trust Fund.
The Code does not define a ``highway vehicle.'' For
purposes of these taxes, Treasury regulations define a highway
vehicle as any self-propelled vehicle or trailer or semitrailer
designed to perform a function of transporting a load over the
public highway, whether or not also designed to perform other
functions. Excluded from the definition of highway vehicle are
(1) certain specially designed mobile machinery vehicles for
non-transportation functions (the ``mobile machinery
exception''); (2) certain vehicles specially designed for off-
highway transportation for which the special design
substantially limits or impairs the use of such vehicle to
transport loads over the highway (the ``off-highway
transportation vehicle'' exception); and (3) certain trailers
and semi-trailers specially designed to function only as an
enclosed stationary shelter for the performance of non-
transportation functions off the public highways.\823\
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\823\ See Treas. Reg. sec. 48.4061-1(d)).
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Under prior law, the mobile machinery exception applied if
three tests were met: (1) the vehicle consists of a chassis to
which jobsite machinery (unrelated to transportation) has been
permanently mounted; (2) the chassis has been specially
designed to serve only as a mobile carriage and mount for the
particular machinery; and (3) by reason of such special design,
the chassis could not, without substantial structural
modification, be used to transport a load other than the
particular machinery. An example of a mobile machinery vehicle
is a crane mounted on a truck chassis that meets the foregoing
factors.
On June 6, 2002, the Treasury Department put forth proposed
regulations that would eliminate the mobile machinery
exception.\824\ The other exceptions from the definition of
highway vehicle would continue to apply with some
modifications. Under the proposed regulations, the chassis of a
mobile machinery vehicle would be subject to the retail sales
tax on heavy vehicles unless the vehicle qualified under the
off-highway transportation vehicle exception. Also, under the
proposed regulations, mobile machinery vehicles may be subject
to the heavy vehicle use tax. In addition, the tax credits,
refunds, and exemptions from tax may not be available for the
fuel used in these vehicles.
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\824\ Prop. Treas. Reg. sec. 48.4051-1(a), 67 Fed. Reg. 38913,
38914-38915 (2002).
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The proposed regulations also would modify the off-highway
transportation vehicle exception.\825\ Under the proposed
regulations, a vehicle is not treated as a highway vehicle if
it is specially designed for the primary function of
transporting a particular type of load other than over the
public highway and because of this special design its
capability to transport a load over the public highway is
substantially limited or impaired. A vehicle's design is
determined solely on the basis of its physical characteristics.
In determining whether substantial limitation or impairment
exists, account may be taken of factors such as the size of the
vehicle, whether it is subject to the licensing, safety, and
other requirements applicable to highway vehicles, and whether
it can transport a load at a sustained speed of at least 25
miles per hour. Under the proposed regulation, it is not
material that a vehicle can transport a greater load off the
public highway than it is permitted to transport over the
public highway.
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\825\ Prop. Treas. Reg. sec. 48.4051-1(a)(2)(i).
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The proposed regulation provides an exception to the
definition of a highway vehicle for nontransportation trailers
and semitrailers.\826\ Under the proposed regulation, a trailer
or semitrailer is not treated as a highway vehicle if it is
specially designed to function only as an enclosed stationary
shelter for the carrying on of an off-highway function at an
off-highway site. For example, a trailer that is capable only
of functioning as an office for an off-highway construction
operation is not a highway vehicle.
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\826\ Prop. Treas. Reg. sec. 48.4051-1(a)(2)(ii).
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Reasons for Change
The Treasury Department delayed issuance of final
regulations regarding mobile machinery to allow Congressional
action on a statutory definition of mobile machinery vehicle.
The Highway Trust Fund is supported by taxes related to the use
of vehicles on the public highways. The Congress understood
that a mobile machinery exemption was created by Treasury
regulation because the Treasury Department believed that mobile
machinery used the public highways only incidentally to get
from one job site to another. However, it had come to the
attention of the Congress that certain vehicles are taking
advantage of the mobile machinery exemption even though they
spend a significant amount of time on public highways and,
therefore, cause wear and tear to such highways. Because the
mobile machinery exemption is based on incidental use of the
public highways, the Congress believed it was appropriate to
add a use-based test to the design-based test that exists under
current regulation. The Congress believed that a use-based test
was practical to administer only for purposes of the fuel
excise tax.
Explanation of Provision
The Act codifies the three-part mobile machinery exemption
for purposes of three taxes: the retail tax on heavy vehicles,
the heavy vehicle use tax, and the tax on tires. Thus, if a
vehicle can satisfy the three-part design test, it will not be
treated as a highway vehicle and will be exempt from these
taxes.
For purposes of the fuel excise tax, the three-part design
test is codified and a use test is added by the provision.
Specifically, in addition to the three-part design test, the
vehicle must not have traveled more than 7,500 miles over
public highways during the owner's taxable year. Refunds of
fuel taxes are permitted on an annual basis only. For purposes
of this rule, a person's taxable year is his taxable year for
income tax purposes. Vehicles owned by an organization
described in section 501(c), exempt from tax under section
501(a), need only satisfy the three-part design test to recover
taxes paid with respect to such vehicles.
The Act also adopts the definition of an off-highway
transportation vehicle and a nontransportation trailer and
semitrailer described in Proposed Treasury Regulation section
48.4051-1(a)(2).
For example, as provided in the proposed regulations,\827\
Vehicle C consists of a truck chassis on which an oversize body
designed to transport and apply liquid agricultural chemicals
on farms has been installed. It is capable of transporting a
load over the public highway. It is 132 inches in width, which
is considerably in excess of standard highway vehicle width.
For travel on uneven and soft terrain, it is equipped with
oversize wheels with high-flotation tires, and nonstandard
axles, brakes, and transmission. It has a special fuel and
carburetor air filtration system that enable it to perform
efficiently in an environment of dirt and dust. It is not able
to maintain a speed of 25 miles per hour for more than one mile
while fully loaded. Because Vehicle C is a self-propelled
vehicle capable of transporting a load over the public highway,
it would meet the general definition of a highway vehicle.
However, its considerable physical characteristics for
transporting its load other than over the public highway, when
compared with its physical characteristics for transporting the
load over the public highway, establish that it is specially
designed for the primary function of transporting its load
other than over the public highway. Further, the physical
characteristics for transporting its load other than over the
public highway substantially limit its capability to transport
a load over the public highway. Therefore, Vehicle C is an off-
highway vehicle and is not treated as a highway vehicle.
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\827\ Prop. Treas. Reg. sec. 48.4051-1(c), Example (3).
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Effective Date
The provisions are generally effective after the date of
enactment (October 22, 2004). As to the fuel taxes, the
provisions are effective for taxable years beginning after the
date of enactment.
2. Taxation of aviation-grade kerosene (sec. 853 of the Act and secs.
4041, 4081, 4082, 4083, 4091, 4092, 4093, 4101, and 6427 of the
Code)
Present and Prior Law
In general
Under prior law, aviation fuel was defined as kerosene and
any liquid (other than any product taxable under section 4081)
that is suitable for use as a fuel in an aircraft.\828\ Unlike
other fuels that generally are taxed upon removal from a
terminal rack,\829\ under prior law, aviation fuel was taxed
upon sale of the fuel by a producer or importer.\830\ Sales by
a registered producer to another registered producer were
exempt from tax, with the result that, as a practical matter,
aviation fuel was not taxed under prior law until the fuel was
used at the airport (or sold to an unregistered person). Use of
untaxed aviation fuel by a producer was treated as a taxable
sale.\831\ The producer or importer was liable for the tax. The
rate of tax on aviation fuel under present and prior law is
21.9 cents per gallon.\832\
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\828\ Sec. 4093(a). All references to sections 4091, 4092, and 4093
are to such sections as in effect prior to enactment of the Act, which
repealed such sections.
\829\ A rack is a mechanism capable of delivering taxable fuel into
a means of transport other than a pipeline or vessel. Treas. Reg. sec.
48.4081-1(b).
\830\ Sec. 4091(a)(1).
\831\ Sec. 4091(a)(2).
\832\ Sec. 4081(a)(2)(A)(iv); sec. 4091(b). This rate includes a
0.1 cent per gallon Leaking Underground Storage Tank (``LUST'') Trust
Fund tax. The LUST Trust Fund is set to expire after September 30,
2005, with the result that on October 1, 2005, the tax rate is
scheduled to be 21.8 cents per gallon.
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Under present and prior law, the tax on aviation fuel is
reported by filing Form 720--Quarterly Federal Excise Tax
Return. Generally, semi-monthly deposits are required using
Form 8109B--Federal Tax Deposit Coupon or by depositing the tax
by electronic funds transfer.
Partial exemptions
In general, under present and prior law aviation fuel sold
for use or used in commercial aviation is taxed at a reduced
rate of 4.4 cents per gallon.\833\ Commercial aviation means
any use of an aircraft in a business of transporting persons or
property for compensation or hire by air (unless the use is
allocable to any transportation exempt from certain excise
taxes).\834\
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\833\ Sec. 4081(a)(2)(C); sec. 4092(b). The 4.4-cent rate includes
0.1 cent per gallon that is attributable to the LUST Trust Fund
financing rate. A full exemption, discussed below, applies to aviation
fuel that is sold for use in commercial aviation as fuel supplies for
vessels or aircraft, which includes use by certain foreign air carriers
and for the international flights of domestic carriers.
\834\ Sec. 4083(b).
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Under prior law, in order to qualify for the 4.4-cents-per-
gallon rate, the person engaged in commercial aviation was
required to be registered with the Secretary \835\ and to
provide the seller with a written exemption certificate stating
the airline's name, address, taxpayer identification number,
registration number, and intended use of the fuel. A person
that was registered as a buyer of aviation fuel for use in
commercial aviation generally was assigned a registration
number with a ``Y'' suffix (a ``Y'' registrant), which entitled
the registrant to purchase aviation fuel at the 4.4-cents-per-
gallon rate.
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\835\ Notice 88-132, sec. III(D). See also, Form 637--Application
for Registration (For Certain Excise Tax Activities). A bond may be
required as a condition of registration.
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Large commercial airlines that also are producers of
aviation fuel qualify for registration numbers with an ``H''
suffix. Under prior law, as producers of aviation fuel, ``H''
registrants could buy aviation fuel tax free pursuant to a full
exemption that applied to sales of aviation fuel by a
registered producer to a registered producer. If the ``H''
registrant ultimately used such untaxed fuel in domestic
commercial aviation, the H registrant was liable for the
aviation fuel tax at the 4.4-cents-per-gallon rate.
Exemptions
Under prior law, aviation fuel sold by a producer or
importer for use by the buyer in a nontaxable use was exempt
from the excise tax on sales of aviation fuel.\836\ To qualify
for the exemption, the buyer had to provide the seller with a
written exemption certificate stating the buyer's name,
address, taxpayer identification number, registration number
(if applicable), and intended use of the fuel.
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\836\ Sec. 4092(a).
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Under present and prior law, nontaxable uses include: (1)
use other than as fuel in an aircraft (such as use in heating
oil); (2) use on a farm for farming purposes; (3) use in a
military aircraft owned by the United States or a foreign
country; (4) use in a domestic air carrier engaged in foreign
trade or trade between the United States and any of its
possessions; \837\ (5) use in a foreign air carrier engaged in
foreign trade or trade between the United States and any of its
possessions (but only if the foreign carrier's country of
registration provides similar privileges to United States
carriers); (6) exclusive use of a State or local government;
(7) sales for export, or shipment to a United States
possession; (8) exclusive use by a nonprofit educational
organization; (9) use by an aircraft museum exclusively for the
procurement, care, or exhibition of aircraft of the type used
for combat or transport in World War II; and (10) use as a fuel
in a helicopter or a fixed-wing aircraft for purposes of
providing transportation with respect to which certain
requirements are met.\838\
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\837\ ``Trade'' includes the transportation of persons or property
for hire. Treas. Reg. sec. 48.4221-4(b)(8).
\838\ Secs. 4041(f)(2), 4041(g), 4041(h), 4041(l), and 4092.
---------------------------------------------------------------------------
Under prior law, a producer that was registered with the
Secretary could sell aviation fuel tax free to another
registered producer.\839\ Producers included refiners,
blenders, wholesale distributors of aviation fuel, dealers
selling aviation fuel exclusively to producers of aviation
fuel, the actual producer of the aviation fuel, and with
respect to fuel purchased at a reduced rate, the purchaser of
such fuel.
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\839\ Sec. 4092(c).
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Refunds and credits
Under prior law, a claim for refund of taxed aviation fuel
held by a registered aviation fuel producer was allowed \840\
(without interest) if: (1) the aviation fuel tax was paid by an
importer or producer (the ``first producer'') and the tax was
not otherwise credited or refunded; (2) the aviation fuel was
acquired by a registered aviation fuel producer (the ``second
producer'') after the tax was paid; (3) the second producer
filed a timely refund claim with the proper information; and
(4) the first producer and any other person that owned the fuel
after its sale by the first producer and before its purchase by
the second producer met certain reporting requirements.\841\
Refund claims had to contain the volume and type of aviation
fuel, the date on which the second producer acquired the fuel,
the amount of tax that the first producer paid, a statement by
the claimant that the amount of tax was not collected nor
included in the sales price of the fuel by the claimant when
the fuel was sold to a subsequent purchaser, the name, address,
and employer identification number of the first producer, and a
copy of any required statement of a subsequent seller
(subsequent to the first producer but prior to the second
producer) that the second producer received. A claim for refund
was filed on Form 8849, Claim for Refund of Excise Taxes, and
could not be combined with any other refunds.\842\
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\840\ Sec. 4091(d).
\841\ Treas. Reg. sec. 48.4091-3(b).
\842\ Treas. Reg. sec. 48.4091-3(d)(1).
---------------------------------------------------------------------------
Under prior law, a payment was allowable to the ultimate
purchaser of taxed aviation fuel if the aviation fuel was used
in a nontaxable use. A claim for payment could be made on Form
8849 or on Form 720, Schedule C. A claim made on Form 720,
Schedule C, could be netted against the claimant's excise tax
liability. Claims for payment not so taken could be allowed as
income tax credits on Form 4136, Credit for Federal Tax Paid on
Fuels.
Reasons for Change
The Congress believed that the prior law rules for taxation
of aviation fuel created opportunities for widespread abuse and
evasion of fuels excise taxes. In general, aviation fuel was
taxed on its sale, whereas other fuel generally is taxed on its
removal from a refinery or terminal rack. Because the incidence
of tax on aviation fuel was sale and not removal, under prior
law, aviation fuel could be removed from a refinery or terminal
rack tax free if such fuel was intended for use in aviation
purposes. The Congress was aware that unscrupulous persons were
removing fuel tax free, purportedly for aviation use, but then
were selling the fuel for highway use, charging their customer
the full rate of tax that would be owed on highway fuel, and
keeping the amount of the tax.
In order to prevent such fraud, the Congress believed that
it was appropriate to conform the tax treatment of all taxable
fuels by shifting the incidence of taxation on aviation fuel
from the sale of aviation fuel to the removal of such fuel from
a refinery or terminal rack. In general, all removals of
aviation fuel are fully taxed at the time of removal, therefore
minimizing the cost to the government of the fraudulent
diversion of aviation fuel for non-aviation uses. If fuel is
later used for an aviation use to which a reduced rate of tax
applies, refunds are available. The Congress noted that when
the incidence of tax for other fuels (for example, gasoline or
diesel) was shifted to the rack, collection of the tax
increased significantly indicating that fraud had been
occurring.
The Act provides exceptions to the general rule in cases
where the opportunities for fraud are insignificant. For
example, if fuel is removed from an airport terminal directly
into the wing of a commercial aircraft by a hydrant system, it
is clear that the fuel will be used in commercial aviation and
that the reduced rate of tax for commercial aviation should
apply. In addition, if a terminal is located within a secure
airport and, except in exigent circumstances, does not fuel
highway vehicles, then the Congress believed it was appropriate
to permit certain airline refueling vehicles to transport fuel
from the terminal rack directly to the wing of an aircraft and
have the applicable rate of tax (reduced or otherwise) apply
upon removal from the refueling vehicle.
Explanation of Provision
The Act changes the incidence of taxation of aviation fuel
from the sale of aviation fuel to the removal of aviation fuel
from a refinery or terminal, or the entry into the United
States of aviation fuel. Sales of not previously taxed aviation
fuel to an unregistered person also are subject to tax.
Under the Act, the full rate of tax--21.9 cents per
gallon--is imposed upon removal of aviation fuel from a
refinery or terminal (or entry into the United States).
Aviation fuel may be removed at a reduced rate--either 4.4 or
zero cents per gallon--only if the aviation fuel is: (1)
removed directly into the wing of an aircraft (i) that is
registered with the Secretary as a buyer of aviation fuel for
use in commercial aviation (e.g., a ``Y'' registrant), (ii)
that is a foreign airline entitled to the present law exemption
for aviation fuel used in foreign trade, or (iii) for a tax-
exempt use; or (2) removed or entered as part of an exempt bulk
transfer.\843\ An exempt bulk transfer is a removal or entry of
aviation fuel transferred in bulk by pipeline or vessel to a
terminal or refinery if the person removing or entering the
aviation fuel, the operator of such pipeline or vessel, and the
operator of such terminal or refinery are registered with the
Secretary.
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\843\ See sec. 4081(a)(1)(B).
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Under a special rule, the Act treats certain refueler
trucks, tankers, and tank wagons as part of a terminal if
certain requirements are met. For the special rule to apply, a
qualifying truck, tanker, or tank wagon must be loaded with
aviation fuel from a terminal: (1) that is located within a
secured area of an airport, and (2) from which no vehicle
licensed for highway use is loaded with aviation fuel, except
in exigent circumstances identified by the Secretary in
regulations. The Act requires the Secretary to publish, by
December 15, 2004, and maintain a list of airports that include
a secured area in which a terminal is located.\844\ It is
intended that an exigent circumstance under which loading a
vehicle registered for highway use with fuel would not
disqualify a terminal under the special rule would include, for
example, the unloading of fuel from bulk storage tanks into
highway vehicles in order to repair the storage tanks.
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\844\ It is intended that the following airports, subject to
verification by the Secretary, be included on the Secretary's initial
list of airports that include a secured area in which a terminal is
located. The airports are listed by airport name, and the terminal with
respect to the airport is identified by terminal control number. In
maintaining the list of qualified airports, the Secretary has the
discretion to add or remove airports from the list. Ted Stevens
International Airport, T-91-AK-4520; William B. Hartsfield Atlanta
International Airport, T-58-GA-2512; William B. Hartsfield Atlanta
International Airport, T-58-GA-2513; William B. Hartsfield Atlanta
International Airport, T-58-GA-2536; Bradley International Airport, T-
06-CT-1271; Nashville Metropolitan Airport, T-62-TN-2222; Logan
International Airport, T-04-MA-1171; Baltimore/Washington International
Airport, T-52-MD-1569; Cleveland Hopkins International Airport, T-31-
OH-3109; Charlotte/Douglas International Airport, T-56-NC-2032;
Colorado Springs Airport, T-84-CO-4108; Cincinnati/Northern Kentucky
International Airport, T-61-KY-3277; Dallas Love Field Airport, T-75-
TX-2663; Ronald Reagan National Airport, T-54-VA-1686; Denver
International Airport, T-84-CO-4111; Dallas Fort Worth International
Airport, T-75-TX-2673; Wayne County Metropolitan Airport, T-38-MI-3018;
Newark Liberty International Airport, T-22-NJ-1532; Fort Lauderdale/
Hollywood International Airport; T-65-FL-2158; Piedmont Triad
International Airport, T-56-NC-2038; Honolulu International Airport, T-
91-HI-4570; Dulles International Airport, T-54-VA-1676; George Bush
Intercontinental Airport, T-76-TX-2818; Mid Continent Airport, T-43-KS-
3653; John F. Kennedy International Airport, T-11-NY-1334; McCarren
International Airport, T-86-NV-4355; Kansas City International Airport,
T-43-MO-3723; Orlando International Airport, T-59-FL-2111; Midway
Airport, T-36-IL-3376; Memphis International Airport, T-62-TN-2212;
General Mitchell International Airport, T-39-WI-3092; Minneapolis-St.
Paul International Airport, T-41-MN-3419; Minneapolis-St. Paul
International Airport, T-41-MN-3420; Minneapolis-St. Paul International
Airport, T-41-MN-3421; Louis Armstrong New Orleans International
Airport, T-72-LA-2356; Oakland International Airport, T-94-CA-4702;
Eppley Airfield, T-47-NE-3608; Ontario International Airport, T-33-CA-
4792; O'Hare International Airport, T-36-IL-3325; Portland
International Airport, T-91-OR-4450; Philadelphia International
Airport, T-23-PA-1770; Sky Harbor International Airport, T-86-AZ-4302;
Pittsburgh International Airport, T-23-PA-1766; Raleigh/Durham
International Airport, T-56-NC-2045; Reno Cannon International Airport,
T-86-NV-4352; San Diego International Airport, T-33-CA-4788; San
Antonio International Airport, pending; Seattle Tacoma International
Airport, T-91-WA-4425; San Francisco International Airport, T-94-CA-
4701; San Jose Municipal Airport, T-77-CA-4650; Salt Lake City
International Airport, T-84-UT-4207; John Wayne Airport/Orange County,
T-33-CA-4772; Lambert International Airport, T-43-MO-3722; Tampa/St.
Petersburg International Airport, T-59-FL-2110.
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In order to qualify for the special rule, a refueler truck,
tanker, or tank wagon must: (1) be loaded with aviation fuel
for delivery into aircraft at the airport where the terminal is
located; (2) have storage tanks, hose, and coupling equipment
designed and used for the purposes of fueling aircraft; (3) not
be registered for highway use; and (4) be operated by the
terminal operator (who operates the terminal rack from which
the fuel is unloaded) or by a person that makes a daily
accounting to such terminal operator of each delivery of fuel
from such truck, tanker, or tank wagon.\845\
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\845\ The Act requires that if such delivery of information is
provided to a terminal operator (or if a terminal operator collects
such information), the terminal operator must provide such information
to the Secretary.
---------------------------------------------------------------------------
The Act does not change the applicable rates of tax--21.9
cents per gallon for use in noncommercial aviation, 4.4 cents
per gallon for use in commercial aviation, and zero cents per
gallon for use by domestic airlines in an international flight,
by foreign airlines, or other nontaxable use. The Act imposes
liability for the tax on aviation fuel removed from a refinery
or terminal directly into the wing of an aircraft for use in
commercial aviation on the person receiving the fuel, in which
case, such person self-assesses the tax on a return. The Act
does not change the nontaxable uses of aviation fuel, or change
the persons or the qualifications of persons who are entitled
to purchase fuel at a reduced rate, except that a producer is
not permitted to purchase aviation fuel at a reduced rate by
reason of such person's status as a producer.
Under the Act, a refund is allowable to the ultimate vendor
of aviation fuel if such ultimate vendor purchases fuel tax
paid and subsequently sells the fuel to a person qualified to
purchase at a reduced rate and who waives the right to a
refund. In such a case, the Act permits an ultimate vendor to
net refund claims against any excise tax liability of the
ultimate vendor, in a manner similar to the present and prior
law treatment of ultimate purchaser payment claims.\846\
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\846\ For example, X is a commercial airline subsidiary of airline
Y. If Y sells fuel to X, X can waive its right to a refund to Y as the
ultimate vendor. Y would then be entitled to file for a refund or net
the refund against its excise tax liability.
---------------------------------------------------------------------------
As under prior law, if previously taxed aviation fuel is
used for a nontaxable use, the ultimate purchaser may claim a
refund for the tax previously paid. If previously taxed
aviation fuel is used for a taxable nonaircraft use, the fuel
is subject to the tax imposed on kerosene (24.4 cents per
gallon) and a refund of the previously paid aviation fuel tax
is allowed. Claims by the ultimate vendor or the purchaser that
are not taken as refund claims may be allowable as income tax
credits.
For example, for an airport that is not served by a
pipeline, aviation fuel generally is removed from a terminal
and transported to an airport storage facility for eventual use
at the airport. In such a case, the aviation fuel will be taxed
at 21.9 cents per gallon upon removal from the terminal. At the
airport, if the fuel is purchased from a vendor by a person
registered with the Secretary to use fuel in commercial
aviation, the purchaser may buy the fuel at a reduced rate
(generally, 4.4 cents per gallon for domestic flights and zero
cents per gallon for international flights) and waive the right
to a refund. The ultimate vendor generally may claim a refund
for the difference between 21.9 cents per gallon of tax paid
upon removal and the rate of tax paid to the vendor by the
purchaser. To obtain a zero rate upon purchase, a registered
domestic airline must certify to the vendor at the time of
purchase that the fuel is for use in an international flight;
otherwise, the airline must pay the 4.4 cents per gallon rate
and file a claim for refund to the Secretary if the fuel is
used for international aviation. If a zero rate is paid and the
fuel subsequently is used in domestic and not international
travel, the domestic airline is liable for tax at 4.4 cents per
gallon. A foreign airline eligible under present law to
purchase aviation fuel tax free would continue to purchase such
fuel tax free.
As another example, for an airport that is served by a
pipeline, aviation fuel generally is delivered to the wing of
an aircraft either by a refueling truck or by a ``hydrant''
that runs directly from the pipeline to the airplane wing. If a
refueling truck that is not licensed for highway use loads fuel
from a terminal located within the airport (and the other
requirements of the provision for such truck and terminal are
met), and delivers the fuel directly to the wing of an aircraft
for use in commercial aviation, the aviation fuel is taxed at
4.4 cents per gallon upon delivery to the wing and the person
receiving the fuel is liable for the tax, which such person
would be able to self-assess on a return.\847\ If fuel is
loaded into a refueling truck that does not meet the
requirements of the provision, then the fuel is treated as
removed from the terminal into the refueling truck and tax of
21.9 cents per gallon is paid on such removal. The ultimate
vendor is entitled to a refund of the difference between 21.9
cents per gallon paid on removal and the rate paid by a
commercial airline purchaser (assuming the purchaser waived the
refund right). If fuel is removed from a terminal directly to
the wing of an aircraft registered to use fuel in commercial
aviation by a hydrant or similar device, the person receiving
the aviation fuel is liable for a tax of 4.4 cents per gallon
(or zero in the case of an international flight or qualified
foreign airline) and may self-assess such tax on a return.
---------------------------------------------------------------------------
\847\ Alternatively, if the aviation fuel in the example is for use
in noncommercial aviation, the fuel is taxed at 21.9 cents per gallon
upon delivery into the wing. Self-assessment of the tax would not apply
in such case.
---------------------------------------------------------------------------
Under the Act, a floor stocks tax applies to aviation fuel
held by a person (if title for such fuel has passed to such
person) on January 1, 2005. The tax is equal to the amount of
tax that would have been imposed before January 1, 2005, if the
provision was in effect at all times before such date, reduced
by (1) the tax imposed by section 4091, as in effect on the day
before such date and, (2) in the case of kerosene held
exclusively for the holder's own use, the amount which such
holder would reasonably expect under the provision to be paid
as a refund for a nontaxable use with respect to the kerosene.
The tax does not apply to kerosene held in the fuel tank of an
aircraft on January 1, 2005. The Secretary shall determine the
time and manner for payment of the tax, including the
nonapplication of the tax on de minimis amounts of aviation
fuel. Under the provision, 0.1 cents per gallon of such tax is
transferred to the LUST Trust Fund. The remainder is
transferred to the Airport and Airway Trust Fund.
The Congress expects the Secretary to delay the due date of
the excise tax return with respect to aviation fuel for the
quarter beginning on January 1, 2005. It is intended that the
requirement of semi-monthly deposits of aviation fuel taxes
continue unchanged.
Effective Date
The provision is effective for aviation-grade kerosene
removed, entered, or sold after December 31, 2004.
3. Mechanical dye injection and related penalties (secs. 854, 855, and
856 of the Act and secs. 4082 and 6715 and new sec. 6715A of
the Code)
Present and Prior Law
Statutory rules
Gasoline, diesel fuel and kerosene are generally subject to
excise tax upon removal from a refinery or terminal, upon
importation into the United States, and upon sale to
unregistered persons unless there was a prior taxable removal
or importation of such fuels.\848\ However, a tax is not
imposed upon diesel fuel or kerosene if all of the following
are met: (1) the Secretary determines that the fuel is destined
for a nontaxable use, (2) the fuel is indelibly dyed in
accordance with regulations prescribed by the Secretary,\849\
and (3) the fuel meets marking requirements prescribed by the
Secretary.\850\ A nontaxable use is defined as (1) any use that
is exempt from the tax imposed by section 4041(a)(1) other than
by reason of a prior imposition of tax, (2) any use in a train,
or (3) certain uses in buses for public and school
transportation, as described in section 6427(b)(1) (after
application of section 6427(b)(3)).\851\
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\848\ Sec. 4081(a)(1)(A). If such fuel is used for a nontaxable
purpose, the purchaser is entitled to a refund of tax paid, or in some
cases, an income tax credit. See sec. 6427.
\849\ Dyeing is not a requirement, however, for certain fuels under
certain conditions, i.e., diesel fuel or kerosene exempted from dyeing
in certain States by the EPA under the Clean Air Act, aviation-grade
kerosene as determined under regulations prescribed by the Secretary,
kerosene received by pipeline or vessel and used by a registered
recipient to produce substances (other than gasoline, diesel fuel or
special fuels), kerosene removed or entered by a registrant to produce
such substances or for resale, and (under regulations) kerosene sold by
a registered distributor who sells kerosene exclusively to ultimate
vendors that resell it (1) from a pump that is not suitable for fueling
any diesel-powered highway vehicle or train, or (2) for blending with
heating oil to be used during periods of extreme or unseasonable cold.
Sec. 4082(c), (d).
\850\ Sec. 4082(a).
\851\ Sec. 4082(b).
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The Secretary is required to prescribe necessary
regulations relating to dyeing, including specifically the
labeling of retail diesel fuel and kerosene pumps.\852\
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\852\ Sec. 4082(e).
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A person who sells dyed fuel (or holds dyed fuel for sale)
for any use that such person knows (or has reason to know) is a
taxable use, or who willfully alters or attempts to alter the
dye in any dyed fuel, is subject to a penalty.\853\ The penalty
also applies to any person who uses dyed fuel for a taxable use
(or holds dyed fuel for such a use) and who knows (or has
reason to know) that the fuel is dyed.\854\ The penalty is the
greater of $1,000 per act or $10 per gallon of dyed fuel
involved. In determining the amount of the penalty, the $1,000
is increased by the product of $1,000 and the number of prior
penalties imposed upon such person (or a related person or
predecessor of such person or related person).\855\ The penalty
may be imposed jointly and severally on any business entity and
on each officer, employee, or agent of such entity who
willfully participated in any act giving rise to such
penalty.\856\ For purposes of the penalty, the term ``dyed
fuel'' means any dyed diesel fuel or kerosene, whether or not
the fuel was dyed pursuant to section 4082.\857\
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\853\ Sec. 6715(a).
\854\ Sec. 6715(a).
\855\ Sec. 6715(b).
\856\ Sec. 6715(d).
\857\ Sec. 6715(c)(1).
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Regulations
The Secretary has prescribed certain regulations under this
provision, including regulations that specify the allowable
types and concentration of dye, that the person claiming the
exemption must be a taxable fuel registrant, that the terminal
must be an approved terminal (in the case of a removal from a
terminal rack), and the contents of the notice to be posted on
diesel fuel and kerosene pumps.\858\ However, the regulations
do not prescribe the time or method of adding the dye to
taxable fuel.\859\ Diesel fuel is usually dyed at a terminal
rack by either manual dyeing or mechanical injection. The
regulations also provide that a terminal operator is jointly
and severally liable for unpaid tax if undyed diesel fuel or
kerosene is removed and the terminal operator provides any
person with documentation that such fuel is dyed.\860\
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\858\ Treas. Reg. secs. 48.4082-1,-2.
\859\ In March 2000, the IRS withdrew its Notice of Proposed
Rulemaking PS-6-95 (61 F.R. 10490 (1996)) relating to dye injection
systems. Announcement 2000-42, 2000-1 C.B. 949. The proposed regulation
established standards for mechanical dye injection equipment and
required terminal operators to report nonconforming dyeing to the IRS.
See also Treas. Reg. sec. 48.4082-1(c), (d).
\860\ Treas. Reg. sec. 48.4081-2(c).
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Reasons for Change
The Federal government, State governments, and various
segments of the petroleum industry have long been concerned
with the problem of diesel fuel tax evasion. To address this
problem, the Congress changed the law to require that untaxed
diesel fuel be indelibly dyed. The Congress remained concerned,
however, that tax could still be evaded through removals at a
terminal of undyed fuel that had been designated as dyed.
Manual dyeing was inherently difficult to monitor. It
occurred after diesel fuel had been withdrawn from a terminal
storage tank, generally required the work of several people,
was imprecise, and did not automatically create a reliable
record. The Congress believed that requiring that untaxed
diesel fuel be dyed only by mechanical injection will
significantly reduce the opportunities for diesel fuel tax
evasion.
The Congress further believed that security of such
mechanical dyeing systems will be enhanced by the establishment
of standards for making such systems tamper resistant, and by
the addition of new penalties for tampering with such
mechanical dyeing systems and for failing to maintain the
established security standards for such systems. In furtherance
of the enforcement of these penalties in the case of business
entities, it was appropriate to impose joint and several
liability for such penalties upon natural persons who willfully
participate in any act giving rise to these penalties and upon
the parent corporation of an affiliated group of which the
business entity is a member.
Explanation of Provision
With respect to terminals that offer dyed fuel, the Act
eliminates manual dyeing of fuel and requires dyeing by a
mechanical system. Not later than 180 days after the date of
enactment, the Secretary of the Treasury is to prescribe
regulations establishing standards for tamper resistant
mechanical injector dyeing. Such standards shall be reasonable,
cost-effective, and establish levels of security commensurate
with the applicable facility.
The Act adds an additional set of penalties for violation
of the new rules. A penalty, equal to the greater of $25,000 or
$10 for each gallon of fuel involved, applies to each act of
tampering with a mechanical dye injection system. The person
committing the act is also responsible for any unpaid tax on
removed undyed fuel. A penalty of $1,000 is imposed upon the
operator of a mechanical dye injection system for each failure
to maintain the security standards for such system.\861\ An
additional penalty of $1,000 is imposed upon such operator for
each day any such violation remains uncorrected after the first
day such violation has been or reasonably should have been
discovered. For purposes of the daily penalty, a violation may
be corrected by shutting down the portion of the system causing
the violation. If any of these penalties are imposed on any
business entity, each officer, employee, or agent of such
entity or other contracting party who willfully participated in
any act giving rise to such penalty is jointly and severally
liable with such entity for such penalty. If such business
entity is part of an affiliated group, the parent corporation
of such entity is jointly and severally liable with such entity
for the penalty.
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\861\ The operator remains liable under current Treas. Reg. sec.
48.4081-2(c) for any unpaid tax on removed undyed fuel.
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The Act also denies administrative appeal or review for
repeat offenders (persons found, after a chemical analysis of
the fuel, to be subject to more than two penalties after
October 22, 2004), except in the case of a claim regarding
fraud or mistake in the chemical analysis or error in the
mathematical calculation of the amount of penalty.
The Act also extends present-law penalties to any person
who knows that the strength or composition of any dye or
marking in any dyed fuel has been altered, chemically or
otherwise, and who sells (or holds for sale) such fuel for any
use that the person knows or has reason to know is a taxable
use of such fuel.
Effective Date
Penalties relating to mechanical dyeing systems are
effective 180 days after the required regulations are issued.
The Secretary must issue such regulations no later than 180
days after the date of enactment (October 22, 2004). The
prohibition on certain administrative review is effective for
penalties assessed after the date of enactment (October 22,
2004). The extension of present-law penalties is effective on
the date of enactment (October 22, 2004).
4. Terminate dyed diesel use by intercity buses (sec. 857 of the Act
and secs. 4082 and 6427 of the Code)
Present and Prior Law
A manufacturer's tax of 24.4 cents per gallon applies to
diesel fuel.\862\ Diesel fuel that is to be used for a
nontaxable purpose will not be taxed upon removal from the
terminal if it is dyed to indicate its nontaxable purpose.
Under prior law, use in an intercity bus was a nontaxable use
for purposes of the manufacturers tax on diesel fuel. However,
diesel fuel was subject to a retail backup tax. The retail tax
was 7.4 cents per gallon for intercity buses, but only applied
if no tax was imposed on the diesel under the manufacturers
tax. Thus, dyed diesel removed from the terminal was exempt
from the manufacturers tax but a tax of 7.3 cents per gallon
(plus 0.1 cents per gallon for LUST) was imposed on the
delivery of the dyed fuel into the fuel supply tank of the
intercity bus. The operator of the bus was liable for the tax.
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\862\ Sec. 4081.
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Under present and prior law, intercity bus operators may
buy fully taxed undyed diesel and seek a refund of the
difference between the 24.4-cents-per-gallon rate and the 7.4-
cents-per-gallon rate.
Explanation of Provision
The Act eliminates the ability of intercity buses to buy
dyed diesel and self-assess the 7.4 cents per gallon. Under the
Act, operators of such buses must buy clear fuel and seek a
refund of the difference between 24.4 and 7.4 cents per gallon
of tax on diesel fuel. The Act also permits ultimate vendors to
make such refund claims if the bus operator assigns its right
to claim a refund to the ultimate vendor. The Act permits
refund claimants to obtain interest if they file their refund
claims electronically and the Secretary does not pay such
claims within 20 days (45 days for paper claims).
Effective Date
The provision is effective for fuel sold after January 1,
2005.
5. Authority to inspect on-site records (sec. 858 of the Act and sec.
4083 of the Code)
Present and Prior Law \863\
The IRS is authorized to inspect any place where taxable
fuel \864\ is produced or stored (or may be stored). As part of
the inspection, the IRS is authorized to: (1) examine the
equipment used to determine the amount or composition of the
taxable fuel and the equipment used to store the fuel; and (2)
take and remove samples of taxable fuel.\865\ Places of
inspection include, but are not limited to, terminals, fuel
storage facilities, retail fuel facilities or any designated
inspection site.\866\
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\863\ Code references are those in effect immediately before the
enactment of the Act.
\864\ ``Taxable fuel'' means gasoline, diesel fuel, and kerosene.
Sec. 4083(a).
\865\ Sec. 4083(c)(1)(A).
\866\ Treas. Reg. sec. 48.4083-1(b).
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In conducting the inspection, the IRS may detain any
receptacle that contains or may contain any taxable fuel, or
detain any vehicle or train to inspect its fuel tanks and
storage tanks. The scope of the inspection includes the books
and records kept at the place of inspection to determine the
excise tax liability under section 4081.\867\
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\867\ Treas. Reg. sec. 48.4083-1(c)(1).
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Reasons for Change
The Congress believed it was appropriate to expand the
authority of the IRS to make on-site inspections of books and
records. The Congress believed that such expanded authority
will aid in the detection of fuel tax evasion and the
enforcement of Federal fuel taxes.
Explanation of Provision
The Act expands the scope of the inspection to include any
books, records, or shipping papers pertaining to taxable fuel
located in any authorized inspection location.
Effective Date
The provision is effective on the date of enactment
(October 22, 2004).
6. Assessable penalty for refusal of entry (sec. 859 of the Act and new
sec. 6717 of the Code)
Present and Prior Law \868\
The IRS is authorized to inspect any place where taxable
fuel is produced or stored (or may be stored). As part of the
inspection, the IRS is authorized to: (1) examine the equipment
used to determine the amount or composition of the taxable fuel
and the equipment used to store the fuel; and (2) take and
remove samples of taxable fuel.\869\ Places of inspection,
include, but are not limited to, terminals, fuel storage
facilities, retail fuel facilities or any designated inspection
site.\870\
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\868\ Code references are those in effect immediately before the
enactment of the Act.
\869\ Sec. 4083(c)(1)(A).
\870\ Treas. Reg. sec. 48.4083-1(b).
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In conducting the inspection, the IRS may detain any
receptacle that contains or may contain any taxable fuel, or
detain any vehicle or train to inspect its fuel tanks and
storage tanks. The scope of the inspection includes the books
and records kept to determine the excise tax liability under
section 4081.\871\ The IRS is authorized to establish
inspection sites. A designated inspection site includes any
State highway inspection station, weigh station, agricultural
inspection station, mobile station or other location designated
by the IRS.\872\
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\871\ Treas. Reg. sec. 48.4083-1(b)(2).
\872\ Sec. 4083(c); Treas. Reg. sec. 48.4083-1(b)(1).
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Any person that refuses to allow an inspection is subject
to a penalty in the amount of $1,000 for each refusal.\873\ The
IRS is not able to assess this penalty in the same manner as it
would a tax. It must first seek the assistance of the
Department of Justice to obtain a judgment. Assessable
penalties are payable upon notice and demand by the Secretary
and are assessed and collected in the same manner as
taxes.\874\
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\873\ Secs. 4083(c)(3) and 7342.
\874\ Sec. 6671.
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Explanation of Provision
In addition to the $1,000 non-assessable penalty under
present and prior law, the Act imposes an assessable penalty
with respect to the refusal of entry. The assessable penalty is
$1,000 for such refusal. The penalty will not apply if it is
shown that such failure is due to reasonable cause. If the
penalty is imposed on a business entity, the Act provides for
joint and several liability with respect to each officer,
employee, or agent of such entity or other contracting party
who willfully participated in the act giving rise to the
penalty. If the business entity is part of an affiliated group,
the parent corporation also will be jointly and severally
liable for the penalty.
Effective Date
The provision is effective on January 1, 2005.
7. Registration of pipeline or vessel operators required for exemption
of bulk transfers to registered terminals or refineries (sec.
860 of the Act and sec. 4081 of the Code)
Present and Prior Law
In general, under present and prior law, gasoline, diesel
fuel, and kerosene (``taxable fuel'') are taxed upon removal
from a refinery or a terminal.\875\ Tax also is imposed on the
entry into the United States of any taxable fuel for
consumption, use, or warehousing. The tax does not apply to any
removal or entry of a taxable fuel transferred in bulk (a
``bulk transfer'') to a terminal or refinery if both the person
removing or entering the taxable fuel and the operator of such
terminal or refinery are registered with the Secretary.\876\
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\875\ Sec. 4081(a)(1)(A).
\876\ Sec. 4081(a)(1)(B). The sale of a taxable fuel to an
unregistered person prior to a taxable removal or entry of the fuel is
subject to tax. Sec. 4081(a)(1)(A).
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Prior law did not require that the vessel or pipeline
operator that transfers fuel as part of a bulk transfer be
registered in order for the transfer to be exempt. For example,
under prior law if a registered refiner transferred fuel to an
unregistered vessel or pipeline operator who in turn
transferred fuel to a registered terminal operator, the
transfer was exempt despite the intermediate transfer to an
unregistered person.
In general, under present and prior law, the owner of the
fuel is liable for payment of tax with respect to bulk
transfers not received at an approved terminal or
refinery.\877\ The refiner is liable for payment of tax with
respect to certain taxable removals from the refinery.\878\
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\877\ Treas. Reg. sec. 48.4081-3(e)(2).
\878\ Treas. Reg. sec. 48.4081-3(b).
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Under present and prior law, disclosure of excise tax
registration information is permitted to the extent the
Secretary determines that such disclosure is needed for
effective excise tax administration.\879\
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\879\ Sec. 6103(k)(7).
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Reasons for Change
The Congress was concerned that unregistered pipeline and
vessel operators were receiving bulk transfers of taxable fuel,
and then diverting the fuel to retailers or end users without
the tax ever being paid. The Congress believed that requiring
that a pipeline or vessel operator be registered with the IRS
in order for a bulk transfer exemption to be valid, in
combination with other provisions that impose penalties
relating to registration, would help to ensure that transfers
of fuel in bulk are delivered as intended to approved
refineries and terminals and taxed appropriately.
Explanation of Provision
The Act requires that for a bulk transfer of a taxable fuel
to be exempt from tax, any pipeline or vessel operator that is
a party to the bulk transfer be registered with the Secretary.
Transfer to an unregistered party will subject the transfer to
tax.
Under the authority of section 6103(k)(7), the Secretary is
required to publish periodically a list of all registered
persons that are required to register.
Effective Date
The provision is effective on March 1, 2005, except that
the Secretary is required to publish the list of persons
required to register beginning on January 1, 2005.
8. Display of registration and penalties for failure to display
registration and to register (secs. 861 of the Act and secs.
4101, 7232, 7272 and new secs. 6718 and 6719 of the Code)
Present and Prior Law
Under present and prior law, blenders, enterers, pipeline
operators, position holders, refiners, terminal operators, and
vessel operators are required to register with the Secretary
with respect to fuels taxes imposed by sections 4041(a)(1) and
4081.\880\
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\880\ Sec. 4101; Treas. Reg. sec. 48.4101-1(a) and (c)(1).
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Under prior law, a non-assessable penalty for failure to
register was $50.\881\ Under prior law, a criminal penalty of
$5,000, or imprisonment of not more than five years, or both,
together with the costs of prosecution also applied to a
failure to register and to certain false statements made in
connection with a registration application.\882\
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\881\ Sec. 7272(a).
\882\ Sec. 7232.
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Reasons for Change
Registration with the Secretary is a critical component of
enabling the Secretary to regulate the movement and use of
taxable fuels and ensure that the appropriate excise taxes are
being collected. The Congress believed that prior law penalties
were not severe enough to ensure that persons that are required
to register in fact register. Accordingly, the Congress
believed it was appropriate to increase prior law penalties
significantly and to add a new assessable penalty for failure
to register. In addition, the Congress believed that persons
that do business with vessel operators should be able easily to
verify whether the vessel operator is registered. Thus, the
Congress required that vessel operators display proof of
registration on their vessels and imposed an attendant penalty
for failure to display such proof.
Explanation of Provision
The Act requires that every operator of a vessel who is
required to register with the Secretary display on each vessel
used by the operator to transport fuel, proof of registration
through an identification device prescribed by the Secretary. A
failure to display such proof of registration results in a
penalty of $500 per month per vessel. The amount of the penalty
is increased for multiple prior violations. No penalty is
imposed upon a showing by the taxpayer of reasonable cause.
The Act imposes a new assessable penalty for failure to
register of $10,000 for each initial failure, plus $1,000 per
day that the failure continues. No penalty is imposed upon a
showing by the taxpayer of reasonable cause. In addition, the
Act increases the non-assessable penalty for failure to
register from $50 to $10,000 and the criminal penalty for
failure to register from $5,000 to $10,000.
Effective Date
The provision requiring display of registration is
effective on January 1, 2005. The provision relating to
penalties is effective for penalties imposed after December 31,
2004.
9. Registration of persons within foreign trade zones (sec. 862 of the
Act and sec. 4101 of the Code)
Present and Prior Law
Under present and prior law, blenders, enterers, pipeline
operators, position holders, refiners, terminal operators, and
vessel operators are required to register with the Secretary
with respect to fuels taxes imposed by sections 4041(a)(1) and
4081.\883\
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\883\ Sec. 4101; Treas. Reg. sec. 48.4101-1(a) and (c)(1).
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Explanation of Provision
The Secretary shall require registration by any person that
operates a terminal or refinery within a foreign trade zone or
within a customs bonded storage facility, or holds an inventory
position with respect to a taxable fuel in such a terminal. It
is intended that the Secretary shall establish a date by which
persons required to register under the provision must be
registered.
Effective Date
The provision is effective on January 1, 2005.
10. Penalties for failure to report (sec. 863 of the Act and new sec.
6725 of the Code)
Present and Prior Law
Under present and prior law, a fuel information reporting
program, the Excise Summary Terminal Activity Reporting System
(``ExSTARS''), requires terminal operators and bulk transport
carriers to report monthly on the movement of any liquid
product into or out of an approved terminal.\884\ Terminal
operators file Form 720-TO--Terminal Operator Report, which
shows the monthly receipts and disbursements of all liquid
products to and from an approved terminal.\885\ Bulk transport
carriers (barges, vessels, and pipelines) that receive liquid
product from an approved terminal or deliver liquid product to
an approved terminal file Form 720-CS--Carrier Summary Report,
which details such receipts and disbursements. In general,
under prior law, the only penalty for failure to file a report
or a failure to furnish all of the required information in a
report was $50 per report.\886\
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\884\ Sec. 4010(d); Treas. Reg. sec. 48.4101-2. The reports are
required to be filed by the end of the month following the month to
which the report relates.
\885\ An approved terminal is a terminal that is operated by a
taxable fuel registrant that is a terminal operator. Treas. Reg. sec.
48.4081-1(b).
\886\ Sec. 6721(a).
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Reasons for Change
The Congress believed that the proper and timely reporting
of the disbursements of taxable fuels under the ExSTARs system
was essential to the Treasury Department's ability to monitor
and enforce the fuels excise taxes. Accordingly, the Congress
believed it was appropriate to provide for significant
penalties if required information is not provided accurately,
completely, and on a timely basis.
Explanation of Provision
The Act imposes a new assessable penalty for failure to
file a report required by the ExSTARS system or for filing a
report with incomplete or inaccurate information. The penalty
is $10,000 per failure with respect to each vessel or facility
(e.g., a terminal or other facility) for which information is
required to be furnished. No penalty is imposed upon a showing
by the taxpayer of reasonable cause.
Effective Date
The provision is effective for penalties imposed after
December 31, 2004.
11. Electronic filing of required information reports (sec. 864 of the
Act and sec. 4010 of the Code)
Present and Prior Law
Under present and prior law, a fuel information reporting
program, the Excise Summary Terminal Activity Reporting System
(``ExSTARS''), requires terminal operators and bulk transport
carriers to report monthly on the movement of any liquid
product into or out of an approved terminal.\887\ Terminal
operators file Form 720-TO--Terminal Operator Report, which
shows the monthly receipts and disbursements of all liquid
products to and from an approved terminal.\888\ Bulk transport
carriers (barges, vessels, and pipelines) that receive liquid
product from an approved terminal or deliver liquid product to
an approved terminal file Form 720-CS--Carrier Summary Report,
which details such receipts and disbursements.
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\887\ Sec. 4101(d); Treas. Reg. sec. 48.4101-2. The reports are
required to be filed by the end of the month following the month to
which the report relates.
\888\ An approved terminal is a terminal that is operated by a
taxable fuel registrant that is a terminal operator. Treas. Reg. sec.
48.4081-1(b).
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Explanation of Provision
The Act requires that any person who must report under the
ExSTARs systems and who has 25 or more reportable transactions
in a month to report in electronic format.
Effective Date
The provision is effective on January 1, 2006.
12. Taxable fuel refunds for certain ultimate vendors (sec. 865 of the
Act and secs. 6416 and 6427 of the Code)
Present and Prior Law
Under prior law, a wholesale distributor that sold gasoline
on which tax had been paid for an exempt purpose was treated as
the only person who paid the tax, and thereby was the proper
claimant for a credit or refund of the tax paid. Relevant
exempt purposes were gasoline: sold to a State or local
government for its exclusive use; sold to a nonprofit
educational organization for its exclusive use; used or sold
for use as supplies for vessels or aircraft; exported; or used
or sold for use in the production of special fuels. In the case
of undyed diesel fuel or kerosene used on a farm for farming
purposes or by a State or local government, a credit or payment
is allowable only to the ultimate, registered vendors
(``ultimate vendors'') of such fuels.
In general, refunds of such taxes were paid without
interest. However, in the case of refunds of tax due ultimate
vendors of diesel fuel or kerosene used on a farm for farming
purposes or by a State or local government, the Secretary is
required to pay interest on certain refunds. Under present and
prior law, the Secretary must pay interest on such refunds of
$200 or more ($100 or more in the case of kerosene) due to the
taxpayer arising from sales over any period of a week or more,
if the Secretary does not make payment within a prescribed
period. Under prior law, the prescribed period was 20 days.
Reasons for Change
The Congress observed that refund procedures for gasoline
differ from those for diesel fuel and kerosene. The Congress
believed that simplification of administration can be achieved
for both taxpayers and the IRS by providing a more uniform
refund procedure applicable to all taxed highway fuels. The
Congress further believed that compliance can be increased and
administration made less costly by increased use of electronic
filing.
Explanation of Provision
The Act provides that for sales of gasoline, on which tax
has been paid, to a State or local government or to a nonprofit
educational organization for its exclusive use, the refund
procedure conforms to the procedure in the case of diesel fuel
or kerosene. That is, the ultimate vendor (if registered) is
the only person entitled to claim the refund. The Act provides
that the special rules for refunds to ultimate vendors of
diesel fuel or kerosene used on a farm for farming purposes or
by a State or local government apply to claims made under this
provision. In addition, under the Act, interest is paid on such
refunds of $200 or more arising from sales over any period of a
week or more if the Secretary does not make payment within 45
days from the date of the filing of such claim. That period is
shortened to 20 days in the case of an electronic claim, except
that such shortened period does not apply unless the ultimate
vendor has certified to the Secretary for the most recent
quarter of the taxable year that all ultimate purchasers of the
vendor are certified and entitled to a refund as State or local
governments or nonprofit educational organizations purchasing
for their exclusive use.
Effective Date
The provision is effective on January 1, 2005.
13. Two party exchanges (sec. 866 of the Act and new sec. 4105 of the
Code)
Present and Prior Law
Most fuel is taxed when it is removed from a registered
terminal.\889\ The party liable for payment of this tax is the
``position holder.'' The position holder is the person
reflected on the records of the terminal operator as holding
the inventory position in the fuel.\890\
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\889\ A ``terminal'' is a storage and distribution facility that is
supplied by pipeline or vessel, and from which fuel may be removed at a
rack. A ``rack'' is a mechanism capable of delivering taxable fuel into
a means of transport other than a pipeline or vessel.
\890\ Such person has a contractual agreement with the terminal
operator to store and provide services with respect to the fuel. A
``terminal operator'' is any person who owns, operates, or otherwise
controls a terminal. A terminal operator can also be a position holder
if that person owns fuel in its terminal.
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It is common industry practice for oil companies to serve
customers of other oil companies under exchange agreements,
e.g., where Company A's terminal is more conveniently located
for wholesale or retail customers of Company B. In such cases,
the exchange agreement party (Company B in the example) owns
the fuel when the motor fuel is removed from the terminal and
sold to B's customer.
Reasons for Change
The Congress believed it was appropriate to recognize
industry practice under exchange agreements by relieving the
original position holder of tax liability for the removal of a
taxable fuel from a terminal if certain circumstances are met.
Explanation of Provision
The Act permits two registered parties to switch position
holder status in fuel within a registered terminal (thereby
relieving the person originally owning the fuel \891\ of tax
liability as the position holder) if all of the following
occur:
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\891\ In the provision, this person is referred to as the
``delivering person.''
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1. The transaction includes a transfer from the
original owner, i.e., the person who holds the original
inventory position for taxable fuel in the terminal as
reflected in the records of the terminal operator prior
to the transaction.
2. The exchange transaction occurs before or at the
same time as completion of removal across the rack from
the terminal by the receiving person or its customer.
3. The terminal operator in its books and records
treats the receiving person as the person that removes
the product across a terminal rack for purposes of
reporting the transaction to the Internal Revenue
Service.
4. The transaction is the subject of a written
contract.
Effective Date
The provision is effective on the date of enactment
(October 22, 2004).
14. Modification of the use tax on heavy highway vehicles (sec. 867 of
the Act and secs. 4481, 4483, and 6165 of the Code)
Present and Prior Law
An annual use tax is imposed on heavy highway vehicles, at
the rates below.\892\
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\892\ Sec. 4481.
Under 55,000 pounds....................... No tax
55,000-75,000 pounds...................... $100 plus $22 per 1,000
pounds over 55,000
Over 75,000 pounds........................ $550
The annual use tax is imposed for a taxable period of July
1 through June 30. Generally, the tax is paid by the person in
whose name the vehicle is registered. Under prior law, in
certain cases, taxpayers were allowed to pay the tax in
installments.\893\ State governments are required to receive
proof of payment of the use tax as a condition of vehicle
registration.
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\893\ Sec. 6156.
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Exemptions and reduced rates are provided for certain
``transit-type buses,'' trucks used for fewer than 5,000 miles
on public highways (7,500 miles for agricultural vehicles), and
logging trucks.\894\ Any highway motor vehicle that is issued a
base plate by Canada or Mexico and is operated on U.S. highways
is subject to the annual use tax whether or not the vehicles
are required to be registered in the United States. Under prior
law, the tax rate for Canadian and Mexican vehicles was 75
percent of the rate that would otherwise be imposed.\895\
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\894\ See generally, sec. 4483.
\895\ Sec. 4483(f): Treas. Reg. sec. 41.4483-7(a).
---------------------------------------------------------------------------
Reasons for Change
The Congress noted that in the case of taxpayers that elect
quarterly installment payments, the IRS had no procedure for
ensuring that installments subsequent to the first one actually
are paid. Thus, it was possible for taxpayers to receive State
registrations when only the first quarterly installment is paid
with the return. Similarly, it was possible for taxpayers
repeatedly to pay the first quarterly installment and continue
to receive State registrations because the IRS has no
computerized system for checking past compliance when it issues
certificates of payment for the current year. In the case of
taxpayers owning only one or a few vehicles, it was not cost
effective for the IRS to monitor and enforce compliance. Thus,
the Congress believed it was appropriate to eliminate the
ability of taxpayers to pay the use tax in installments. The
Congress also believed that Canadian and Mexican vehicles
operating on U.S. highways should be subject to the full amount
of use tax, as such vehicles contribute to the wear and tear on
U.S. highways.
Explanation of Provision
The Act eliminates the ability to pay the tax in
installments. It also eliminates the reduced rates for Canadian
and Mexican vehicles. The Act requires taxpayers with 25 or
more vehicles for any taxable period to file their returns
electronically. Finally, the Act permits proration of tax for
vehicles sold during the taxable period.
Effective Date
The provision is effective for taxable periods beginning
after the date of enactment (October 22, 2004).
15. Dedication of revenue from certain penalties to the Highway Trust
Fund (sec. 868 of the Act and sec. 9503 of the Code)
Prior Law
Prior law did not dedicate to the Highway Trust Fund any
penalties assessed and collected by the Secretary.
Reasons for Change
The Congress believed it was appropriate to dedicate to the
Highway Trust Fund penalties associated with the administration
and enforcement of taxes supporting the Highway Trust Fund.
Explanation of Provision
The Act dedicates to the Highway Trust Fund amounts
equivalent to the penalties paid under sections 6715 (relating
to dyed fuel sold for use or used in taxable use), 6715A
(penalty for tampering with or failing to maintain security
requirements for mechanical dye injection systems), 6717
(assessable penalty for refusal of entry), 6718 (penalty for
failing to display tax registration on vessels), 6719
(assessable penalty for failure to register), 6725 (penalty for
failing to report information required by the Secretary), 7232
(penalty for failing to register and false representations of
registration status), and 7272 (but only with regard to
penalties related to failure to register under section 4101).
Effective Date
The provision is effective for penalties assessed on or
after the date of enactment (October 22, 2004).
16. Simplification of tax on tires (sec. 869 of the Act and sec. 4071
of the Code)
Present and Prior Law
Under prior law, a graduated excise tax was imposed on the
sale by a manufacturer (or importer) of tires designed for use
on highway vehicles (sec. 4071). The tire tax rates were as
follows:
------------------------------------------------------------------------
Tire Weight Tax Rate
------------------------------------------------------------------------
Not more than 40 lbs...................... No tax
More than 40 lbs., but not more than 70 15 cents/lb. in excess of 40
lbs.. lbs.
More than 70 lbs., but not more than 90 $4.50 plus 30 cents/lb. in
lbs. excess of 70 lbs.
More than 90 lbs.......................... $10.50 plus 50 cents/lb. in
excess of 90 lbs.
------------------------------------------------------------------------
No tax is imposed on the recapping of a tire that
previously has been subject to tax. Tires of extruded tiring
with internal wire fastening also are exempt.
The tax expires after September 30, 2005.
Reasons for Change
Under prior law, the tire excise tax was based on the
weight of each tire. This forced tire manufacturers to weigh
sample batches of every type of tire made and collect the tax
based on that weight. This regime also made it difficult for
the IRS to measure and enforce compliance with the tax, as the
IRS likewise must weigh sample batches of tires to ensure
compliance. The Congress believed significant administrative
simplification for both tire manufacturers and the IRS would be
achieved if the tax were based on the weight carrying capacity
of the tire, rather than the weight of the tire, because the
Department of Transportation requires the load rating to be
stamped on the side of highway tires. Thus, both the
manufacturer and the IRS will know immediately whether a tire
is taxable and how much tax should be paid.
Explanation of Provision
The Act modifies the excise tax applicable to tires. The
Act replaces the present-law tax rates based on the weight of
the tire with a tax rate based on the load capacity of the
tire. In general, the tax is 9.45 cents for each 10 pounds of
tire load capacity in excess of 3,500 pounds. In the case of a
biasply tire, the tax rate is 4.725 cents for each 10 pounds of
tire load capacity in excess of 3,500 pounds. The Act also
imposes tax at a rate of is 4.725 cents for each 10 pounds of
tire load capacity in excess of 3,500 pounds on any super
single tire. The Act also exempts from tax any tire sold for
the exclusive use of the United States Department of Defense or
the United States Coast Guard.
The Act modifies the definition of tires for use on highway
vehicles to include any tire marked for highway use pursuant to
certain regulations promulgated by the Secretary of
Transportation. A super single tire is a single tire greater
than 13 inches in cross section width designed to replace two
tires in a dual fitment. The Act provides that a biasply tire
means a pneumatic tire on which the ply cords that extend to
the beads are laid at alternate angles substantially less than
90 degrees to the centerline of the tread. Tire load capacity
is the maximum load rating labeled on the tire pursuant to
regulations promulgated by the Secretary of Transportation.
Nothing in the Act is to be construed to have any effect on
subsection (d) of section 48.4701-1 of Title 26, Code of
Federal Regulations (relating to recapped and retreaded tires).
The Secretary is to prescribe regulations implementing the
amendment to section 4071 but that such regulations will not
affect subsection (d). No tax is to be imposed on the recapping
of a tire that previously has been subject to tax.
Effective Date
The provision is effective for sales in calendar years
beginning more than 30 days after the date of enactment
(October 22, 2004).
17. Taxation of transmix and diesel fuel blend stocks and Treasury
study on fuel tax compliance (secs. 870 and 871 of the Act and
sec. 4083 of the Code)
Present and Prior Law \896\
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\896\ All Code references are with respect to those in effect
immediately prior to the enactment of the Act.
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Definition of taxable fuels
A ``taxable fuel'' is gasoline, diesel fuel (including any
liquid, other than gasoline, which is suitable for use as a
fuel in a diesel-powered highway vehicle or train), and
kerosene.\897\
---------------------------------------------------------------------------
\897\ Sec. 4083(a).
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Under the regulations, ``gasoline'' includes all products
commonly or commercially known or sold as gasoline and suited
for use as a motor fuel, and that have an octane rating of 75
or more. Gasoline also includes, to the extent provided in
regulations, gasoline blendstocks and products commonly used as
additives in gasoline. The term ``gasoline blendstocks'' does
not include any product that cannot be blended into gasoline
without further processing or fractionation (``off-spec
gasoline'').\898\
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\898\ Treas. Reg. sec. 48.4081-1(c)(3)(ii). The term ``gasoline
blendstocks'' means alkylate; butane; catalytically cracked gasoline;
coker gasoline; ethyl tertiary butyl ether (ETBE); hexane;
hydrocrackate; isomerate; methyl tertiary butyl ether (MTBE); mixed
xylene (not including any separated isomer of xylene); natural
gasoline; pentane; pentane mixture; polymer gasoline; raffinate;
reformate; straight-run gasoline; straight-run naphtha; tertiary amyl
methyl ether (TAME); tertiary butyl alcohol (gasoline grade) (TBA);
thermally cracked gasoline; toluene; and transmix containing gasoline.
Treas. Reg. sec. 48.4081-1(c)(3)(i).
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Diesel fuel is any liquid (other than gasoline) that is
suitable for use as a fuel in a diesel-powered highway vehicle
or diesel-powered train.\899\ By regulation, diesel fuel does
not include kerosene, gasoline, No. 5 and No. 6 fuel oils (as
described in ASTM Specification D 396), or F-76 (Fuel Naval
Distillates MIL-F-16884), any liquid that contains less than
four percent normal paraffins, or any liquid that has a
distillation range of 125 degrees Fahrenheit or less, sulfur
content of 10 ppm or less, and minimum color of +27 Saybolt
(these are known as ``excluded liquids'').\900\
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\899\ Sec. 4083(a)(3).
\900\ Treas. Reg. sec. 48.4081-1(c)(2)(ii).
---------------------------------------------------------------------------
By regulation, kerosene is defined as the kerosene
described in ASTM Specification D 3699 (No. 1-K and No. 2-K),
ASTM Specification D 1655 (kerosene-type jet fuel), and
military specifications MIL-DTL-5624T (Grade JP-5) and MIL-DTL-
83133E (Grade JP-8). Kerosene does not include any liquid that
is an excluded liquid.\901\
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\901\ Treas. Reg. sec. 48.4081-1(b).
---------------------------------------------------------------------------
Taxable events and exemptions
In general
An excise tax is imposed upon (1) the removal of any
taxable fuel from a refinery or terminal, (2) the entry of any
taxable fuel into the United States, or (3) the sale of any
taxable fuel to any person who is not registered with the IRS
to receive untaxed fuel, unless there was a prior taxable
removal or entry.\902\ The tax does not apply to any removal or
entry of taxable fuel transferred in bulk to a terminal or
refinery if the person removing or entering the taxable fuel
and the operator of such terminal or refinery are registered
with the Secretary.\903\
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\902\ Sec. 4081(a)(1).
\903\ Sec. 4081(a)(1)(B).
---------------------------------------------------------------------------
Gasoline exemptions
If certain conditions are met, the removal, entry, or sale
of gasoline blendstocks is not taxable. Generally, the
exemption from tax applies if a gasoline blendstock is not used
to produce finished gasoline or is received at an approved
terminal or refinery. No tax is imposed on nonbulk removals
from a terminal or refinery, or nonbulk entries into the United
States or on any gasoline blendstocks if the person liable for
the tax is a gasoline registrant, has an unexpired notification
certificate, and knows of no false information in the
certificate. The sale of a gasoline blendstock that was not
subject to tax on nonbulk removal or entry is taxable unless
the seller has an unexpired certificate from the buyer and has
no reason to believe that any information in the certificate is
false. No tax is imposed on, or purchaser certification
required for, off-spec gasoline.
Diesel fuel and kerosene exemptions
Diesel fuel or kerosene that is to be used for a nontaxable
purpose will not be taxed upon removal from the terminal if it
is dyed to indicate its nontaxable purpose. Undyed aviation-
grade kerosene also is exempt from tax at the rack if it is
destined for use as a fuel in an aircraft. The tax does not
apply to diesel fuel asserted to be ``not suitable for use'' or
kerosene asserted to qualify as an excluded liquid.
Feedstock kerosene that a registered industrial user
receives by pipeline or vessel also is exempt from the dyeing
requirement. A kerosene feedstock user is defined as a person
that receives kerosene by bulk transfer for its own use in the
manufacture or production of any substance (other than
gasoline, diesel fuel or special fuels subject to tax). Thus,
for example, kerosene is used for a feedstock purpose when it
is used as an ingredient in the production of paint and is not
used for a feedstock purpose when it is used to power machinery
at a factory where paint is produced. The person receiving the
kerosene must be registered with the IRS and provide a
certificate noting that the kerosene will be used for a
feedstock purpose in order for the exemption to apply.
Information and tax return reporting
The IRS collects data under the ExSTARS reporting system
that tracks all removals across the terminal rack regardless of
whether or not the product is technically excluded from the
definition of gasoline, diesel or blendstocks. ExSTARS
reporting identifies the position holder at the time of
removal. Below the rack, no information is gathered for exempt
or excluded products or uses.
Taxpayers file quarterly excise tax returns showing only
net taxable gallons.\904\ Taxpayers do not account for gallons
they claim to be exempt on such returns. Although the return is
a quarterly return, the excise taxes are paid in semimonthly
deposits.\905\ If deposits are not made as required, a taxpayer
may be required to file returns on a monthly or semimonthly
basis instead of quarterly.\906\
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\904\ Treas. Reg. sec. 406011(a)-1(a); Form 720, Quarterly Federal
Excise Tax Return.
\905\ Treas. Reg. sec. 40.6302(c)-1(a).
\906\ Treas. Reg. sec. 40.6011(a)-1(b).
---------------------------------------------------------------------------
Explanation of Provision
The Act adds two additional categories to the definition of
diesel fuel. Under the Act, diesel fuel means: (1) any liquid
(other than gasoline) which is suitable for use as a fuel in a
diesel-powered highway vehicle, or a diesel-powered train; (2)
transmix; and (3) diesel fuel blend stocks as identified by the
Secretary. Transmix means a by-product of refined products
pipeline operations created by the mixing of different
specification products during pipeline transportation. Transmix
generally results when one fuel, such as diesel fuel, is placed
in a pipeline followed by another taxable fuel, such as
kerosene. The mixture created between the two fuels when it is
neither all diesel fuel nor all kerosene, is an example of a
transmix. Under the provision, all transmix is taxable as
diesel fuel, regardless of whether it contains gasoline.
Under the Act, it is intended that the re-refining of tax-
paid transmix into gasoline, diesel fuel or kerosene qualify as
a nontaxable off-highway business use of such transmix, for
purposes of the refund and payment provisions relating to
nontaxable uses of diesel fuel.
Not later than January 31, 2005, the Secretary shall submit
to the Committee on Finance of the Senate and the Committee on
Ways and Means of the House of Representatives a report
regarding fuel tax compliance, which shall include information,
and analysis as specified below, and recommendations to address
the issues identified.
The Secretary is to identify chemical products that should
be added to the list of blendstocks. The Secretary is to
identify those chemical products, as identified by lab analysis
of fuel samples taken by the IRS, that have been blended with
taxable fuel but are not currently treated as a blendstock. The
report should indicate, to the extent possible, any statistics
as to the frequency in which such chemical product has been
discovered, and whether the samples contained above-normal
concentrations of such chemical product. The report also shall
include a discussion of IRS findings regarding the addition of
waste products to taxable fuel and any recommendations to
address the taxation of such products. The report shall include
a discussion of IRS findings regarding sales of taxable fuel to
entities claiming exempt status as a State or local government.
Such discussion shall include the frequency of erroneous
certifications as to exempt status determined on audit. The
Secretary shall consult with representatives of State and local
governments in providing recommendations to address this issue,
including the feasibility of State maintained lists of their
exempt governmental entities.
Effective Date
The provision regarding the taxation of transmix and diesel
fuel blendstocks is effective for fuel removed, sold, or used
after December 31, 2004. The requirement for a Treasury study
is effective on the date of enactment (October 22, 2004).
D. Other Revenue Provisions
1. Permit private sector debt collection companies to collect tax debts
(sec. 881 of the Act and new sec. 6306 of the Code)
Present and Prior Law
In fiscal years 1996 and 1997, the Congress earmarked $13
million for IRS to test the use of private debt collection
companies. There were several constraints on this pilot
project. First, because both IRS and OMB considered the
collection of taxes to be an inherently governmental function,
only government employees were permitted to collect the
taxes.\907\ The private debt collection companies were utilized
to assist the IRS in locating and contacting taxpayers,
reminding them of their outstanding tax liability, and
suggesting payment options. If the taxpayer agreed at that
point to make a payment, the taxpayer was transferred from the
private debt collection company to the IRS. Second, the private
debt collection companies were paid a flat fee for services
rendered; the amount that was ultimately collected by the IRS
was not taken into account in the payment mechanism.
---------------------------------------------------------------------------
\907\ Sec. 7801(a).
---------------------------------------------------------------------------
The pilot program was discontinued because of disappointing
results. GAO reported \908\ that the IRS collected $3.1 million
attributable to the private debt collection company efforts;
expenses were also $3.1 million. In addition, there were lost
opportunity costs of $17 million to the IRS because collection
personnel were diverted from their usual collection
responsibilities to work on the pilot. The pilot program
results were disappointing because ``IRS' efforts to design and
implement the private debt collection pilot program were
hindered by limitations that affected the program's results.''
The limitations included the scope of work permitted to the
private debt collection companies, the number and type of cases
referred to the private debt collection companies, and the
ability of IRS' computer systems to identify, select, and
transmit collection cases to the private debt collectors.
---------------------------------------------------------------------------
\908\ GOA/GGD-97-129R Issues Affecting IRS' Collection Pilot (July
18, 1997).
---------------------------------------------------------------------------
The IRS has in the last several years expressed renewed
interest in the possible use of private debt collection
companies; for example, IRS recently revised its extensive
Request for Information concerning its possible use of private
debt collection companies.\909\ GAO recently reviewed IRS'
planning and preparation for the use of private debt collection
companies.\910\ GAO identified five broad factors critical to
the success of using private debt collection companies to
collect taxes. GAO concluded: ``If Congress does authorize PCA
\911\ use, IRS's planning and preparations to address the
critical success factors for PCA contracting provide greater
assurance that the PCA program is headed in the right direction
to meet its goals and achieve desired results. Nevertheless,
much work and many challenges remain in addressing the critical
success factors and helping to maximize the likelihood that a
PCA program would be successful.'' \912\
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\909\ TIRNO-03-H-0001 (February 14, 2003), at
www.procurement.irs.treas.gov. The basic request for information is 104
pages, and there are 16 additional attachments.
\910\ GAO-04-492 Tax Debt Collection: IRS Is Addressing Critical
Success Factors for Contracting Out but Will Need to Study the Best Use
of Resources (May 2004).
\911\ Private collection agencies.
\912\ Page 19 of the May 2004 GAO report.
---------------------------------------------------------------------------
In general, Federal agencies are permitted to enter into
contracts with private debt collection companies for collection
services to recover indebtedness owed to the United
States.\913\ That provision does not apply to the collection of
debts under the Internal Revenue Code.\914\
---------------------------------------------------------------------------
\913\ 31 U.S.C. sec. 3718.
\914\ 31 U.S.C. sec. 3718(f).
---------------------------------------------------------------------------
The President's fiscal year 2004 and 2005 budget proposals
proposed the use of private debt collection companies to
collect Federal tax debts.
Reasons for Change
The Congress believed that the use of private debt
collection agencies will help facilitate the collection of
taxes that are owed to the Government. The Congress also
believed that safeguards it has incorporated will protect
taxpayers' rights and privacy.
Explanation of Provision
The Act permits the IRS to use private debt collection
companies to locate and contact taxpayers owing outstanding tax
liabilities of any type \915\ and to arrange payment of those
taxes by the taxpayers. There must be an assessment pursuant to
section 6201 in order for there to be an outstanding tax
liability. An assessment is the formal recording of the
taxpayer's tax liability that fixes the amount payable. An
assessment must be made before the IRS is permitted to commence
enforcement actions to collect the amount payable. In general,
an assessment is made at the conclusion of all examination and
appeals processes within the IRS.\916\
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\915\ The Act generally applies to any type of tax imposed under
the Internal Revenue Code. It is anticipated that the focus in
implementing the provision will be: (a) taxpayers who have filed a
return showing a balance due but who have failed to pay that balance in
full; and (b) taxpayers who have been assessed additional tax by the
IRS and who have made several voluntary payments toward satisfying
their obligation but have not paid in full.
\916\ An amount of tax reported as due on the taxpayer's tax return
is considered to be self-assessed. If the IRS determines that the
assessment or collection of tax will be jeopardized by delay, it has
the authority to assess the amount immediately (sec. 6861), subject to
several procedural safeguards.
---------------------------------------------------------------------------
Several steps are involved in the deployment of private
debt collection companies. First, the private debt collection
company contacts the taxpayer by letter.\917\ If the taxpayer's
last known address is incorrect, the private debt collection
company searches for the correct address. Second, the private
debt collection company telephones the taxpayer to request full
payment.\918\ If the taxpayer cannot pay in full immediately,
the private debt collection company offers the taxpayer an
installment agreement providing for full payment of the taxes
over a period of as long as five years. If the taxpayer is
unable to pay the outstanding tax liability in full over a
five-year period, the private debt collection company obtains
financial information from the taxpayer and will provide this
information to the IRS for further processing and action by the
IRS.
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\917\ Several portions of the Act require that the IRS disclose
confidential taxpayer information to the private debt collection
company. Section 6103(n) permits disclosure of returns and return
information for ``the providing of other services . . . for purposes of
tax administration.'' Accordingly, no amendment to section 6103 is
necessary to implement the provision. It is intended, however, that the
IRS vigorously protect the privacy of confidential taxpayer information
by disclosing the least amount of information possible to contractors
consistent with the effective operation of the Act.
\918\ The private debt collection company is not permitted to
accept payment directly. Payments are required to be processed by IRS
employees.
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The Act specifies several procedural conditions under which
the provision would operate. First, provisions of the Fair Debt
Collection Practices Act apply to the private debt collection
company. Second, taxpayer protections that are statutorily
applicable to the IRS are also made statutorily applicable to
the private sector debt collection companies. In addition,
taxpayer protections that are statutorily applicable to IRS
employees are made statutorily applicable to employees of
private sector debt collection companies. Third, subcontractors
are prohibited from having contact with taxpayers, providing
quality assurance services, and composing debt collection
notices; any other service provided by a subcontractor must
receive prior approval from the IRS. In addition, it is
intended that the IRS require the private sector debt
collection companies to inform every taxpayer they contact of
the availability of assistance from the Taxpayer Advocate.
The Act creates a revolving fund from the amounts collected
by the private debt collection companies. The private debt
collection companies will be paid out of this fund. The Act
prohibits the payment of fees for all services in excess of 25
percent of the amount collected under a tax collection
contract.\919\
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\919\ It is assumed that there will be competitive bidding for
these contracts by private sector tax collection agencies and that
vigorous bidding will drive the overhead costs down.
---------------------------------------------------------------------------
The Act also provides that up to 25 percent of the amount
collected may be used for IRS collection enforcement
activities. The Act requires Treasury to provide a biennial
report to Congress. The Congress expected that, consistent with
best management practices and sound tax administration
principles, the Secretary will utilize this new debt collection
provision to the maximum extent feasible.
The Congress expected that activities conducted by any
person under a qualified tax collection contract will be in
compliance with the Fair Debt Collection Practices Act, as
required by new section 6306(e) of the Code. Accordingly, the
Congress anticipated that the Secretary will not impose
requirements that would violate this provision of the Code. The
Congress believed that this new debt collection provision will
protect both taxpayers' rights and the confidentiality of tax
information.
Effective Date
The provision is effective on the date of enactment
(October 22, 2004).
2. Modify charitable contribution rules for donations of patents and
other intellectual property (sec. 882 of the Act and secs. 170
and 6050L of the Code)
Present and Prior Law
In general, under present and prior law, a deduction is
permitted for charitable contributions, subject to certain
limitations that depend on the type of taxpayer, the property
contributed, and the donee organization.\920\ In the case of
non-cash contributions, the amount of the deduction generally
equals the fair market value of the contributed property on the
date of the contribution.
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\920\ Charitable deductions are provided for income, estate, and
gift tax purposes. Secs. 170, 2055, and 2522, respectively.
---------------------------------------------------------------------------
Under present and prior law, for certain contributions of
property, the taxpayer is required to reduce the deduction
amount by any gain, generally resulting in a deduction equal to
the taxpayer's basis. This rule applies to contributions of:
(1) property that, at the time of contribution, would not have
resulted in long-term capital gain if the property was sold by
the taxpayer on the contribution date; (2) tangible personal
property that is used by the donee in a manner unrelated to the
donee's exempt (or governmental) purpose; and (3) property to
or for the use of a private foundation (other than a foundation
defined in section 170(b)(1)(E)).
Charitable contributions of capital gain property generally
are deductible at fair market value. Capital gain property
means any capital asset or property used in the taxpayer's
trade or business the sale of which at its fair market value,
at the time of contribution, would have resulted in gain that
would have been long-term capital gain. Contributions of
capital gain property are subject to different percentage
limitations than other contributions of property. Under present
and prior law, certain copyrights are not considered capital
assets, in which case the charitable deduction for such
copyrights generally is limited to the taxpayer's basis.\921\
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\921\ See sec. 1221(a)(3), 1231(b)(1)(C).
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In general, a charitable contribution deduction is allowed
only for contributions of the donor's entire interest in the
contributed property, and not for contributions of a partial
interest.\922\ If a taxpayer sells property to a charitable
organization for less than the property's fair market value,
the amount of any charitable contribution deduction is
determined in accordance with the bargain sale rules.\923\ In
general, if a donor receives a benefit or quid pro quo in
return for a contribution, any charitable contribution
deduction is reduced by the amount of the benefit received. For
contributions of $250 or more, no charitable contribution
deduction is allowed unless the donee organization provides a
contemporaneous written acknowledgement of the contribution
that describes and provides a good faith estimate of the value
of any goods or services provided by the donee organization in
exchange for the contribution.\924\
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\922\ Sec. 170(f)(3).
\923\ Sec. 1011(b) and Treas. Reg. sec. 1.1011-2.
\924\ Sec. 170(f)(8).
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In general, taxpayers are required to obtain a qualified
appraisal for donated property with a value of $5,000 or more,
and to attach the appraisal to the tax return in certain cases.
Under Treasury regulations, a qualified appraisal means an
appraisal document that, among other things, (1) relates to an
appraisal that is made not earlier than 60 days prior to the
date of contribution of the appraised property and not later
than the due date (including extensions) of the return on which
a deduction is first claimed under section 170; \925\ (2) is
prepared, signed, and dated by a qualified appraiser; (3)
includes (a) a description of the property appraised; (b) the
fair market value of such property on the date of contribution
and the specific basis for the valuation; (c) a statement that
such appraisal was prepared for income tax purposes; (d) the
qualifications of the qualified appraiser; and (e) the
signature and taxpayer identification number (``TIN'') of such
appraiser; and (4) does not involve an appraisal fee that
violates certain prescribed rules.\926\
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\925\ In the case of a deduction first claimed or reported on an
amended return, the deadline is the date on which the amended return is
filed.
\926\ Treas. Reg. sec. 1.170A-13(c)(3).
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Reasons for Change
The Congress believed that the value of certain
intellectual property, such as patents, copyrights, trademarks,
trade names, trade secrets, know-how, software, similar
property, or applications or registrations of such property,
that is contributed to a charity often is highly speculative.
Some donated intellectual property may prove to be worthless,
or the initial promise of worth may be diminished by future
inventions, marketplace competition, or other factors. Although
in theory, such intellectual property may promise significant
monetary benefits, the benefits generally will not materialize
if the charity does not make the appropriate investments, have
the right personnel and equipment, or even have sufficient
sustained interest to exploit the intellectual property. The
Congress understood that valuation is made yet more difficult
in the charitable contribution context because the transferee
does not provide full, if any, consideration in exchange for
the transferred property pursuant to arm's length negotiations,
and there may not be a comparable sales market for such
property to use as a benchmark for valuations.
The Congress was concerned that taxpayers with intellectual
property were taking advantage of the inherent difficulties in
valuing such property and were preparing or obtaining erroneous
valuations. In such cases, the charity would receive an asset
of questionable value, while the taxpayer received a
significant tax benefit. The Congress believed that the
excessive charitable contribution deductions enabled by
inflated valuations were best addressed by ensuring that the
amount of the deduction for charitable contributions of such
property may not exceed the taxpayer's basis in the property.
The Congress noted that for other types of charitable
contributions for which valuation is especially problematic--
charitable contributions of property created by the personal
efforts of the taxpayer and charitable contributions to certain
private foundations--a basis deduction generally is the result
under present and prior law.
Although the Congress believed that a deduction of basis
was appropriate in this context, the Congress recognized that
some contributions of intellectual property may be proven to be
of economic benefit to the charity and that donors may need an
economic incentive to make such contributions. Accordingly, the
Congress believed that it was appropriate to permit donors of
intellectual property to receive certain additional charitable
contribution deductions in the future but only if the
contributed property generates qualified income for the
charitable organization.
Explanation of Provision
The Act provides that if a taxpayer contributes a patent or
other intellectual property (other than certain copyrights or
inventory) to a charitable organization, the taxpayer's initial
charitable deduction is limited to the lesser of the taxpayer's
basis in the contributed property or the fair market value of
the property. In addition, the taxpayer is permitted to deduct,
as a charitable deduction, certain additional amounts in the
year of contribution or in subsequent taxable years based on a
specified percentage of the qualified donee income received or
accrued by the charitable donee with respect to the contributed
property. For this purpose, ``qualified donee income'' includes
net income received or accrued by the donee that properly is
allocable to the intellectual property itself (as opposed to
the activity in which the intellectual property is used).
The amount of any additional charitable deduction is
calculated as a sliding-scale percentage of qualified donee
income received or accrued by the charitable donee that
properly is allocable to the contributed property to the
applicable taxable year of the donor, determined as follows:
------------------------------------------------------------------------
Deduction Permitted for Such
Taxable Year of Donor Taxable Year
------------------------------------------------------------------------
1st year ending on or 100 percent of qualified donee
after contribution. income
2nd year ending on or 100 percent of qualified donee
after contribution. income
3rd year ending on or 90 percent of qualified
after contribution. donee income
4th year ending on or 80 percent of qualified
after contribution. donee income
5th year ending on or 70 percent of qualified
after contribution. donee income
6th year ending on or 60 percent of qualified
after contribution. donee income
7th year ending on or 50 percent of qualified
after contribution. donee income
8th year ending on or 40 percent of qualified
after contribution. donee income
9th year ending on or 30 percent of qualified
after contribution. donee income
10th year ending on or after 20 percent of qualified
contribution. donee income
11th year ending on or after 10 percent of qualified
contribution. donee income
12th year ending on or after 10 percent of qualified
contribution. donee income
Taxable years thereafter............... No deduction permitted
------------------------------------------------------------------------
An additional charitable deduction is allowed only to the
extent that the aggregate of the amounts that are calculated
pursuant to the sliding-scale exceed the amount of the
deduction claimed upon the contribution of the patent or
intellectual property.
No charitable deduction is permitted with respect to any
revenues or income received or accrued by the charitable donee
after the expiration of the legal life of the patent or
intellectual property, or after the tenth anniversary of the
date the contribution was made by the donor.
The taxpayer is required to inform the donee at the time of
the contribution that the taxpayer intends to treat the
contribution as a contribution subject to the additional
charitable deduction provisions of the provision. In addition,
the taxpayer must obtain written substantiation from the donee
of the amount of any qualified donee income properly allocable
to the contributed property during the charity's taxable
year.\927\ The donee is required to file an annual information
return that reports the qualified donee income and other
specified information relating to the contribution. In
instances where the donor's taxable year differs from the
donee's taxable year, the donor bases its additional charitable
deduction on the qualified donee income of the charitable donee
properly allocable to the donee's taxable year that ends within
the donor's taxable year.
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\927\ The net income taken into account by the taxpayer may not
exceed the amount of qualified donee income reported by the donee to
the taxpayer and the IRS under the provision's substantiation and
reporting requirements.
---------------------------------------------------------------------------
Under the Act, additional charitable deductions are not
available for patents or other intellectual property
contributed to a private foundation (other than a private
operating foundation or certain other private foundations
described in section 170(b)(1)(E)).
Under the Act, the Secretary may prescribe regulations or
other guidance to carry out the purposes of the provision,
including providing for the determination of amounts to be
treated as qualified donee income in certain cases where the
donee uses the donated property to further its exempt
activities or functions, or as may be necessary or appropriate
to prevent the avoidance of the purposes of the Act.
Effective Date
The provision is effective for contributions made after
June 3, 2004.
3. Require increased reporting for noncash charitable contributions
(sec. 883 of the Act and sec. 170 of the Code)
Present and Prior Law
In general, under present and prior law, a deduction is
permitted for charitable contributions, subject to certain
limitations that depend on the type of taxpayer, the property
contributed, and the donee organization.\928\ In the case of
noncash contributions, the amount of the deduction generally
equals the fair market value of the contributed property on the
date of the contribution.
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\928\ Charitable deductions are provided for income, estate, and
gift tax purposes. Secs. 170, 2055, and 2522, respectively.
---------------------------------------------------------------------------
In general, under present and prior law, if the total
charitable deduction claimed for non-cash property exceeds
$500, the taxpayer must file IRS Form 8283 (Noncash Charitable
Contributions) with the IRS. Under present and prior law, C
corporations (other than personal service corporations and
closely-held corporations) are required to file Form 8283 only
if the deduction claimed exceeds $5,000.
In general, under present and prior law, certain taxpayers
are required to obtain a qualified appraisal for donated
property (other than money and publicly traded securities) with
a value of more than $5,000.\929\ Under prior law, corporations
(other than a closely-held corporation, a personal service
corporation, or an S corporation) were not required to obtain a
qualified appraisal. Under prior law, taxpayers were not
required to attach a qualified appraisal to the taxpayer's
return, except in the case of contributed art-work valued at
more than $20,000.
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\929\ Pub. L. No. 98-369, sec. 155(a)(1) through (6) (1984)
(providing that not later than December 31, 1984, the Secretary shall
prescribe regulations requiring an individual, a closely held
corporation, or a personal service corporation claiming a charitable
deduction for property (other than publicly traded securities) to
obtain a qualified appraisal of the property contributed and attach an
appraisal summary to the taxpayer's return if the claimed value of such
property (plus the claimed value of all similar items of property
donated to one or more donees) exceeds $5,000). Under Pub. L. No. 98-
369, a qualified appraisal means an appraisal prepared by a qualified
appraiser that includes, among other things, (1) a description of the
property appraised; (2) the fair market value of such property on the
date of contribution and the specific basis for the valuation; (3) a
statement that such appraisal was prepared for income tax purposes; (4)
the qualifications of the qualified appraiser; (5) the signature and
taxpayer identification number of such appraiser; and (6) such
additional information as the Secretary prescribes in such regulations.
---------------------------------------------------------------------------
Under Treasury regulations, a qualified appraisal means an
appraisal document that, among other things, (1) relates to an
appraisal that is made not earlier than 60 days prior to the
date of contribution of the appraised property and not later
than the due date (including extensions) of the return on which
a deduction is first claimed under section 170; \930\ (2) is
prepared, signed, and dated by a qualified appraiser; (3)
includes (a) a description of the property appraised; (b) the
fair market value of such property on the date of contribution
and the specific basis for the valuation; (c) a statement that
such appraisal was prepared for income tax purposes; (d) the
qualifications of the qualified appraiser; and (e) the
signature and taxpayer identification number of such appraiser;
and (4) does not involve an appraisal fee that violates certain
prescribed rules.\931\
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\930\ In the case of a deduction first claimed or reported on an
amended return, the deadline is the date on which the amended return is
filed.
\931\ Treas. Reg. sec. 1.170A-13(c)(3).
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Reasons for Change
Under present and prior law, an individual who contributes
property to a charity and claims a deduction in excess of
$5,000 must obtain a qualified appraisal, but, under prior law,
a C corporation (other than a closely-held corporation or a
personal services corporation) that donated property in excess
of $5,000 was not required to obtain such an appraisal. Prior
law did not require that appraisals, even for large gifts, be
attached to a taxpayer's return. The Congress believed that
requiring C corporations to obtain a qualified appraisal for
charitable contributions of certain property in excess of
$5,000, and requiring that appraisals be attached to a
taxpayer's return for large gifts, would reduce valuation
abuses.
Explanation of Provision
The Act requires increased donor reporting for certain
charitable contributions of property other than cash,
inventory, or publicly traded securities. The Act extends to
all C corporations the present and prior law requirement,
applicable to an individual, closely-held corporation, personal
service corporation, partnership, or S corporation, that the
donor must obtain a qualified appraisal of the property if the
amount of the deduction claimed exceeds $5,000. The Act also
provides that if the amount of the contribution of property
other than cash, inventory, or publicly traded securities
exceeds $500,000, then the donor (whether an individual,
partnership, or corporation) must attach the qualified
appraisal to the donor's tax return. For purposes of the dollar
thresholds under the provision, property and all similar items
of property donated to one or more donees are treated as one
property. Taxpayers contributing artwork valued at more than
$20,000 are still required to attach a copy of the qualified
appraisal to the taxpayer's return.
Appraisals are not required for charitable contributions of
certain vehicles that are sold by the donee organization
without a significant intervening use or material improvement
of the vehicle by such organization, and for which the
organization provides an acknowledgement to the donor
containing a certification that the vehicle was sold in an
arm's length transaction between unrelated parties, and
providing the gross sales proceeds from the sale, and a
statement that the donor's deductible amount may not exceed the
amount of such gross proceeds.
The Act provides that a donor that fails to substantiate a
charitable contribution of property, as required by the
Secretary, is denied a charitable contribution deduction. If
the donor is a partnership or S corporation, the deduction is
denied at the partner or shareholder level. The denial of the
deduction does not apply if it is shown that such failure is
due to reasonable cause and not to willful neglect.
The Act provides that the Secretary may prescribe such
regulations as may be necessary or appropriate to carry out the
purposes of the Act, including regulations that may provide
that some or all of the requirements of the Act do not apply in
appropriate cases.
Effective Date
The provision is effective for contributions made after
June 3, 2004.
4. Limit deduction for charitable contributions of vehicles (sec. 884
of the Act and new sec. 6720 and sec. 170 of the Code)
Present and Prior Law
In general, under present and prior law, a deduction is
permitted for charitable contributions, subject to certain
limitations that depend on the type of taxpayer, the property
contributed, and the donee organization.\932\ In the case of
non-cash contributions, the amount of the deduction generally
equals the fair market value of the contributed property on the
date of the contribution.
---------------------------------------------------------------------------
\932\ Charitable deductions are provided for income, estate, and
gift tax purposes. Secs. 170, 2055, and 2522, respectively.
---------------------------------------------------------------------------
Under present and prior law, for certain contributions of
property, the taxpayer is required to determine the deductible
amount by subtracting any gain from fair market value,
generally resulting in a deduction equal to the taxpayer's
basis. This rule applies to contributions of: (1) property
that, at the time of contribution, would not have resulted in
long-term capital gain if the property was sold by the taxpayer
on the contribution date; (2) tangible personal property that
is used by the donee in a manner unrelated to the donee's
exempt (or governmental) purpose; and (3) property to or for
the use of a private foundation (other than a foundation
defined in section 170(b)(1)(E)).
Under present and prior law, charitable contributions of
capital gain property generally are deductible at fair market
value. Capital gain property means any capital asset or
property used in the taxpayer's trade or business the sale of
which at its fair market value, at the time of contribution,
would have resulted in gain that would have been long-term
capital gain. Contributions of capital gain property are
subject to different percentage limitations than other
contributions of property.
Under prior law, a taxpayer who donated a used automobile
to a charitable donee generally deducted the fair market value
(rather than the taxpayer's basis) of the automobile. A
taxpayer who donated a used automobile generally was permitted
to use an established used car pricing guide to determine the
fair market value of the automobile, but only if the guide
listed a sales price for an automobile of the same make, model
and year, sold in the same area, and in the same condition as
the donated automobile. Similar rules applied to contributions
of other types of vehicles and property, such as boats.
Under present and prior law, charities are required to
provide donors with written substantiation of donations of $250
or more. Taxpayers are required to report non-cash
contributions totaling $500 or more and the method used for
determining fair market value.
In general, under present and prior law, taxpayers are
required to obtain a qualified appraisal for donated property
with a value of $5,000 or more, and to attach the appraisal to
the tax return in certain cases. Under Treasury regulations, a
qualified appraisal means an appraisal document that, among
other things, (1) relates to an appraisal that is made not
earlier than 60 days prior to the date of contribution of the
appraised property and not later than the due date (including
extensions) of the return on which a deduction is first claimed
under section 170; \933\ (2) is prepared, signed, and dated by
a qualified appraiser; (3) includes (a) a description of the
property appraised; (b) the fair market value of such property
on the date of contribution and the specific basis for the
valuation; (c) a statement that such appraisal was prepared for
income tax purposes; (d) the qualifications of the qualified
appraiser; and (e) the signature and taxpayer identification
number (``TIN'') of such appraiser; and (4) does not involve an
appraisal fee that violates certain prescribed rules.\934\
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\933\ In the case of a deduction first claimed or reported on an
amended return, the deadline is the date on which the amended return is
filed.
\934\ Treas. Reg. sec. 1.170A-13(c)(3).
---------------------------------------------------------------------------
Under present and prior law, appraisal fees paid by an
individual to determine the fair market value of donated
property are deductible as miscellaneous expenses subject to
the 2 percent of adjusted gross income limit.\935\
---------------------------------------------------------------------------
\935\ Rev. Rul. 67-461, 1967-2 C.B. 125.
---------------------------------------------------------------------------
Explanation of Provision
Under the Act, the amount of deduction for charitable
contributions of vehicles (generally including automobiles,
boats, and airplanes for which the claimed value exceeds $500
and excluding inventory property) depends upon the use of the
vehicle by the donee organization. If the donee organization
sells the vehicle without any significant intervening use or
material improvement of such vehicle by the organization, the
amount of the deduction shall not exceed the gross proceeds
received from the sale.
The Act imposes new substantiation requirements for
contributions of vehicles for which the claimed value exceeds
$500 (excluding inventory). A deduction is not allowed unless
the taxpayer substantiates the contribution by a
contemporaneous written acknowledgement by the donee. The
acknowledgement must contain the name and taxpayer
identification number of the donor and the vehicle
identification number (or similar number) of the vehicle. In
addition, if the donee sells the vehicle without performing a
significant intervening use or material improvement of such
vehicle, the acknowledgement must provide a certification that
the vehicle was sold in an arm's length transaction between
unrelated parties, and state the gross proceeds from the sale
and that the deductible amount may not exceed such gross
proceeds. In all other cases, the acknowledgement must contain
a certification of the intended use or material improvement of
the vehicle and the intended duration of such use, and a
certification that the vehicle will not be transferred in
exchange for money, other property, or services before
completion of such use or improvement. The donee must notify
the Secretary of the information contained in an
acknowledgement, in a time and manner provided by the
Secretary. An acknowledgement is considered contemporaneous if
provided within 30 days of sale of a vehicle that is not
significantly improved or materially used by the donee, or, in
all other cases, within 30 days of the contribution.
A penalty applies if a donee organization knowingly
furnishes a false or fraudulent acknowledgement, or knowingly
fails to furnish an acknowledgement in the manner, at the time,
and showing the required information. In the case of an
acknowledgement provided within 30 days of sale of a vehicle
which is not significantly used or materially improved by the
donee, the penalty is the greater of the gross proceeds from
the sale of the vehicle or the product of the highest rate of
tax specified in section 1 and the sales price stated on the
acknowledgement. For all other acknowledgements, the penalty is
the greater of $5,000 or the product of the highest rate of tax
specified in section 1 and the claimed value of the vehicle.
The Act provides that the Secretary shall prescribe such
regulations or other guidance as may be necessary to carry out
the purposes of the proposal. The Secretary may prescribe
regulations or other guidance that exempts sales of vehicles
that are in direct furtherance of the donee's charitable
purposes from the requirement that the donor may not deduct an
amount in excess of the gross proceeds from the sale, and the
requirement that the donee certify that the vehicle will not be
transferred in exchange for money, other property, or services
before completion of a significant use or material improvement
by the donee. It is intended that such guidance may be
appropriate, for example, if an organization directly furthers
its charitable purposes by selling automobiles to needy persons
at a price significantly below fair market value.
It is intended that in providing guidance on the provision,
the Secretary shall strictly construe the requirement of
significant use or material improvement. To meet the
significant use test, an organization must actually use the
vehicle to substantially further the organization's regularly
conducted activities and the use must be significant. A donee
will not be considered to significantly use a qualified vehicle
if, under the facts and circumstances, the use is incidental or
not intended at the time of the contribution. Whether a use is
significant also depends on the frequency and duration of use.
With respect to the material improvement test, it is intended
that a material improvement would include major repairs to a
vehicle, or other improvements to the vehicle that improve the
condition of the vehicle in a manner that significantly
increases the vehicle's value. Cleaning the vehicle, minor
repairs, and routine maintenance are not considered a material
improvement.
Example 1.--As part of its regularly conducted activities,
an organization delivers meals to needy individuals. The use
requirement would be met if the organization actually used a
donated qualified vehicle to deliver food to the needy. Use of
the vehicle to deliver meals substantially furthers a regularly
conducted activity of the organization. However, the use also
must be significant, which depends on the nature, extent, and
frequency of the use. If the organization used the vehicle only
once or a few times to deliver meals, the use would not be
considered significant. If the organization used the vehicle to
deliver meals every day for one year the use would be
considered significant. If the organization drove the vehicle
10,000 miles while delivering meals, such use likely would be
considered significant. However, use of a vehicle in such an
activity for one week or for several hundreds of miles
generally would not be considered a significant use.
Example 2.--An organization uses a donated qualified
vehicle to transport its volunteers. The use would not be
significant merely because a volunteer used the vehicle over a
brief period of time to drive to or from the organization's
premises. On the other hand, if at the time the organization
accepts the contribution of a qualified vehicle, the
organization intends to use the vehicle as a regular and
ongoing means of transport for volunteers of the organization,
and such vehicle is so used, then the significant use test
likely would be met.
Example 3.--The following example is a general illustration
of the Act. A taxpayer makes a charitable contribution of a
used automobile in good running condition and that needs no
immediate repairs to a charitable organization that operates an
elder care facility. The donee organization accepts the vehicle
and immediately provides the donor a written acknowledgment
containing the name and TIN of the donor, the vehicle
identification number, a certification that the donee intends
to retain the vehicle for a year or longer to transport the
facility's residents to community and social events and deliver
meals to the needy, and a certification that the vehicle will
not be transferred in exchange for money, other property, or
services before completion of such use by the organization. A
few days after receiving the vehicle, the donee organization
commences to use the vehicle three times a week to transport
some of its residents to various community events, and twice a
week to deliver food to needy individuals. The organization
continues to regularly use the vehicle for these purposes for
approximately one year and then sells the vehicle. Under the
Act, the donee's use of the vehicle constitutes a significant
intervening use prior to the sale by the organization, and the
donor's deduction is not limited to the gross proceeds received
by the organization.
Effective Date
The provision is effective for contributions made after
December 31, 2004.
5. Treatment of nonqualified deferred compensation plans (sec. 885 of
the Act secs. 6040 and 6051 and new sec. 409A of the Code)
Present and Prior Law
In general
Under present and prior law, the determination of when
amounts deferred under a nonqualified deferred compensation
arrangement are includible in the gross income of the
individual earning the compensation depends on the facts and
circumstances of the arrangement. A variety of tax principles
and Code provisions may be relevant in making this
determination, including the doctrine of constructive receipt,
the economic benefit doctrine,\936\ the provisions of section
83 relating generally to transfers of property in connection
with the performance of services, and provisions relating
specifically to nonexempt employee trusts (sec. 402(b)) and
nonqualified annuities (sec. 403(c)). Under prior law, the Code
did not include rules specifically governing nonqualified
deferred compensation.
---------------------------------------------------------------------------
\936\ See, e.g., Sproull v. Commissioner, 16 T.C. 244 (1951),
aff'd, per curiam, 194 F.2d 541 (6th Cir. 1952); Rev. Rul. 60-31, 1960-
1 C.B. 174.
---------------------------------------------------------------------------
In general, the time for income inclusion of nonqualified
deferred compensation depends on whether the arrangement is
unfunded or funded. If the arrangement is unfunded, then the
compensation is generally includible in income when it is
actually or constructively received. If the arrangement is
funded, then income is includible for the year in which the
individual's rights are transferable or not subject to a
substantial risk of forfeiture.
Nonqualified deferred compensation is generally subject to
social security and Medicare taxes when the compensation is
earned (i.e., when services are performed), unless the
nonqualified deferred compensation is subject to a substantial
risk of forfeiture. If nonqualified deferred compensation is
subject to a substantial risk of forfeiture, it is subject to
social security and Medicare tax when the risk of forfeiture is
removed (i.e., when the right to the nonqualified deferred
compensation vests). Amounts deferred under a nonaccount
balance plan that are not reasonably ascertainable are not
required to be taken into account as wages subject to social
security and Medicare taxes until the first date that such
amounts are reasonably ascertainable. Social security and
Medicare tax treatment is not affected by whether the
arrangement is funded or unfunded, which is relevant in
determining when amounts are includible in income (and subject
to income tax withholding).
In general, an arrangement is considered funded if there
has been a transfer of property under section 83. Under that
section, a transfer of property occurs when a person acquires a
beneficial ownership interest in such property. The term
``property'' is defined very broadly for purposes of section
83.\937\ Property includes real and personal property other
than money or an unfunded and unsecured promise to pay money in
the future. Property also includes a beneficial interest in
assets (including money) that are transferred or set aside from
claims of the creditors of the transferor; for example, in a
trust or escrow account. Accordingly, if, in connection with
the performance of services, vested contributions are made to a
trust on an individual's behalf and the trust assets may be
used solely to provide future payments to the individual, the
payment of the contributions to the trust constitutes a
transfer of property to the individual that is taxable under
section 83. On the other hand, deferred amounts are generally
not includible in income if nonqualified deferred compensation
is payable from general corporate funds that are subject to the
claims of general creditors, as such amounts are treated as
unfunded and unsecured promises to pay money or property in the
future.
---------------------------------------------------------------------------
\937\ Treas. Reg. sec. 1.83-3(e). This definition, in part,
reflects previous IRS rulings on nonqualified deferred compensation.
---------------------------------------------------------------------------
As discussed above, if the arrangement is unfunded, then
the compensation is generally includible in income when it is
actually or constructively received under section 451.\938\
Income is constructively received when it is credited to an
individual's account, set apart, or otherwise made available so
that it may be drawn on at any time. Income is not
constructively received if the taxpayer's control of its
receipt is subject to substantial limitations or restrictions.
A requirement to relinquish a valuable right in order to make
withdrawals is generally treated as a substantial limitation or
restriction.
---------------------------------------------------------------------------
\938\ Treas. Reg. secs. 1.451-1 and 1.451-2.
---------------------------------------------------------------------------
Rabbi trusts
Arrangements have developed in an effort to provide
employees with security for nonqualified deferred compensation,
while still allowing deferral of income inclusion. A ``rabbi
trust'' is a trust or other fund established by the employer to
hold assets from which nonqualified deferred compensation
payments will be made. The trust or fund is generally
irrevocable and does not permit the employer to use the assets
for purposes other than to provide nonqualified deferred
compensation, except that the terms of the trust or fund
provide that the assets are subject to the claims of the
employer's creditors in the case of insolvency or bankruptcy.
As discussed above, for purposes of section 83, property
includes a beneficial interest in assets set aside from the
claims of creditors, such as in a trust or fund, but does not
include an unfunded and unsecured promise to pay money in the
future. In the case of a rabbi trust, terms providing that the
assets are subject to the claims of creditors of the employer
in the case of insolvency or bankruptcy have been the basis for
the conclusion that the creation of a rabbi trust does not
cause the related nonqualified deferred compensation
arrangement to be funded for income tax purposes.\939\ As a
result, no amount is included in income by reason of the rabbi
trust; generally income inclusion occurs as payments are made
from the trust.
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\939\ This conclusion was first provided in a 1980 private ruling
issued by the IRS with respect to an arrangement covering a rabbi;
hence, the popular name ``rabbi trust.'' Priv. Ltr. Rul. 8113107 (Dec.
31, 1980).
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The IRS has issued guidance setting forth model rabbi trust
provisions.\940\ Revenue Procedure 92-64 provides a safe harbor
for taxpayers who adopt and maintain grantor trusts in
connection with unfunded deferred compensation arrangements.
The model trust language requires that the trust provide that
all assets of the trust are subject to the claims of the
general creditors of the company in the event of the company's
insolvency or bankruptcy.
---------------------------------------------------------------------------
\940\ Rev. Proc. 92-64, 1992-2 C.B. 422, modified in part by Notice
2000-56, 2000-2 C.B. 393.
---------------------------------------------------------------------------
Since the concept of rabbi trusts was developed,
arrangements have developed which attempt to protect the assets
from creditors despite the terms of the trust. Arrangements
also have developed which attempt to allow deferred amounts to
be available to individuals, while still purporting to meet the
safe harbor requirements set forth by the IRS.
Reasons for Change
The Congress was aware of the popular use of deferred
compensation arrangements by executives to defer current
taxation of substantial amounts of income. Many nonqualified
deferred compensation arrangements had developed which allowed
improper deferral of income. Executives often used arrangements
that allowed deferral of income, but also provided security of
future payment and control over amounts deferred. For example,
nonqualified deferred compensation arrangements often contained
provisions that allowed participants to receive distributions
upon request, subject to forfeiture of a minimal amount (i.e.,
a ``haircut'' provision).
The Congress was aware that since the concept of a rabbi
trust was developed, techniques had been used that attempted to
protect the assets from creditors despite the terms of the
trust. For example, the trust or fund would be located in a
foreign jurisdiction, making it difficult or impossible for
creditors to reach the assets.
While the general tax principles governing deferred
compensation were well established, the determination whether a
particular arrangement effectively allowed deferral of income
was generally made on a facts and circumstances basis. There
was limited specific guidance with respect to common deferral
arrangements. The Congress believed that it was appropriate to
provide specific rules regarding whether deferral of income
inclusion should be permitted.
The Congress believed that certain arrangements that allow
participants inappropriate levels of control or access to
amounts deferred should not result in deferral of income
inclusion. The Congress also believed that certain
arrangements, such as offshore trusts, which effectively
protect assets from creditors, should be treated as funded and
not result in deferral of income inclusion.\941\
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\941\ The staff of the Joint Committee on Taxation made
recommendations similar to the new provision in the report on their
investigation on Enron Corporation, which detailed how executives
deferred millions of dollars in Federal income taxes through
nonqualified deferred compensation arrangements. See Joint Committee on
Taxation, Report of Investigation of Enron Corporation and Related
Entities Regarding Federal Tax and Compensation Issues, and Policy
Recommendations (JCS-3-03), February 2003.
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Explanation of Provision
In general
Under the Act, all amounts deferred under a nonqualified
deferred compensation plan \942\ for all taxable years are
currently includible in gross income to the extent not subject
to a substantial risk of forfeiture \943\ and not previously
included in gross income, unless certain requirements are
satisfied.\944\ If the requirements of the Act are not
satisfied, in addition to current income inclusion, interest at
the underpayment rate plus one percentage point is imposed on
the underpayments that would have occurred had the compensation
been includible in income when first deferred, or if later,
when not subject to a substantial risk of forfeiture. The
amount required to be included in income is also subject to a
20-percent additional tax.\945\
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\942\ A plan includes an agreement or arrangement, including an
agreement or arrangement that includes one person. Amounts deferred
also include actual or notional earnings.
\943\ As under section 83, the rights of a person to compensation
are subject to a substantial risk of forfeiture if the person's rights
to such compensation are conditioned upon the performance of
substantial services by an individual.
\944\ It is inteded that Treasury regulations will provide guidance
regarding when an amount is deferred. It is intended that timing of an
election to defer is not determinative of when the deferral is made.
\945\ These consequences apply under the Act to amounts deferred
after the effective date of the provision. The additional tax and
interest are not treated as payments of regular tax for alternative
minimum tax purposes. A technical correction may be necessary so that
the statute reflects this intent. See section 2(a)(10)(A) of H.R. 5395
and S. 3019, the ``Tax Technical Corrections Act of 2004,'' introduced
November 19, 2004.
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Current income inclusion, interest, and the additional tax
apply only with respect to the participants with respect to
whom the requirements of the Act are not met. For example,
suppose a plan covering all executives of an employer
(including those subject to section 16(a) of the Securities and
Exchange Act of 1934) allows distributions to individuals
subject to section 16(a) upon a distribution event that is not
permitted under the Act. The individuals subject to section
16(a), rather than all participants of the plan, would be
required to include amounts deferred in income and would be
subject to interest and the 20-percent additional tax.
Permissible distributions
In general
Under the Act, distributions from a nonqualified deferred
compensation plan may be allowed only upon separation from
service (as determined by the Secretary), death, a specified
time (or pursuant to a fixed schedule), change in control of a
corporation (to the extent provided by the Secretary),
occurrence of an unforeseeable emergency, or if the participant
becomes disabled. A nonqualified deferred compensation plan may
not allow distributions other than upon the permissible
distribution events and, except as provided in regulations by
the Secretary, may not permit acceleration of a distribution.
Separation from service
In the case of a specified employee who separates from
service, distributions may not be made earlier than six months
after the date of the separation from service or upon death.
Specified employees are key employees \946\ of publicly-traded
corporations.
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\946\ Key employees are defined in section 416(i) and generally
include officers having annual compensation greater than $130,000
(adjusted for inflation and limited to 50 employees), five percent
owners, and one percent owners having annual compensation from the
employer greater than $150,000.
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Specified time
Amounts payable at a specified time or pursuant to a fixed
schedule must be specified under the plan at the time of
deferral. Amounts payable upon the occurrence of an event are
not treated as amounts payable at a specified time. For
example, amounts payable when an individual attains age 65 are
payable at a specified time, while amounts payable when an
individual's child begins college are payable upon the
occurrence of an event.
Change in control
Distributions upon a change in the ownership or effective
control of a corporation, or in the ownership of a substantial
portion of the assets of a corporation, may only be made to the
extent provided by the Secretary. It is intended that the
Secretary use a similar, but more restrictive, definition of
change in control as is used for purposes of the golden
parachute provisions of section 280G consistent with the
purposes of the Act. The Act requires the Secretary to issue
guidance defining change of control within 90 days after the
date of enactment.
Unforeseeable emergency
An unforeseeable emergency is defined as a severe financial
hardship to the participant: (1) resulting from an illness or
accident of the participant, the participant's spouse, or a
dependent (as defined in sec. 152(a)); (2) loss of the
participant's property due to casualty; or (3) other similar
extraordinary and unforeseeable circumstances arising as a
result of events beyond the control of the participant. The
amount of the distribution must be limited to the amount needed
to satisfy the emergency plus taxes reasonably anticipated as a
result of the distribution. Distributions may not be allowed to
the extent that the hardship may be relieved through
reimbursement or compensation by insurance or otherwise, or by
liquidation of the participant's assets (to the extent such
liquidation would not itself cause a severe financial
hardship).
Disability
A participant is considered disabled if he or she (1) is
unable to engage in any substantial gainful activity by reason
of any medically determinable physical or mental impairment
which can be expected to result in death or can be expected to
last for a continuous period of not less than 12 months; or (2)
is, by reason of any medically determinable physical or mental
impairment which can be expected to result in death or can be
expected to last for a continuous period of not less than 12
months, receiving income replacement benefits for a period of
not less than three months under an accident and health plan
covering employees of the participant's employer.
Prohibition on acceleration of distributions
As mentioned above, except as provided in regulations by
the Secretary, no accelerations of distributions may be
allowed. In general, changes in the form of distribution that
accelerate payments are subject to the rule prohibiting
acceleration of distributions. However, it is intended that the
rule against accelerations is not violated merely because a
plan provides a choice between cash and taxable property if the
timing and amount of income inclusion is the same regardless of
the medium of distribution. For example, the choice between a
fully taxable annuity contract and a lump-sum payment may be
permitted. It is also intended that the Secretary provide rules
under which the choice between different forms of actuarially
equivalent life annuity payments is permitted.
It is intended that the Secretary will provide other,
limited, exceptions to the prohibition on accelerated
distributions, such as when the accelerated distribution is
required for reasons beyond the control of the participant and
the distribution is not elective. For example, it is
anticipated that an exception could be provided if a
distribution is needed in order to comply with Federal conflict
of interest requirements or a court-approved settlement
incident to divorce. It is intended that Treasury regulations
provide that a plan would not violate the prohibition on
accelerations by providing that withholding of an employee's
share of employment taxes will be made from the employee's
interest in the nonqualified deferred compensation plan. It is
also intended that Treasury regulations provide that a plan
would not violate the prohibition on accelerations by providing
for a distribution to a participant to pay income taxes due
upon a vesting event subject to section 457(f), provided that
such amount is not more than an amount equal to the income tax
withholding that would have been remitted by the employer if
there had been a payment of wages equal to the income
includible by the participant under section 457(f). It is also
intended that Treasury regulations provide that a plan would
not violate the prohibition on accelerations by providing for
automatic distributions of minimal interests in a deferred
compensation plan upon permissible distribution events for
purposes of administrative convenience. For example, a plan
could provide that upon separation from service of a
participant, account balances less than $10,000 will be
automatically distributed (except in the case of specified
employees).
Requirements with respect to elections
The Act requires that a plan must provide that compensation
for services performed during a taxable year may be deferred at
the participant's election only if the election to defer is
made no later than the close of the preceding taxable year, or
at such other time as provided in Treasury regulations.\947\ In
the case of any performance-based compensation based on
services performed over a period of at least 12 months, such
election may be made no later than six months before the end of
the service period. It is not intended that the Act override
the constructive receipt doctrine, as constructive receipt
rules continue to apply. It is intended that the term
``performance-based compensation'' will be defined by the
Secretary to include compensation to the extent that an amount
is: (1) variable and contingent on the satisfaction of pre-
established organizational or individual performance criteria
and (2) not readily ascertainable at the time of the election.
For the purposes of the Act, it is intended that performance-
based compensation may be required to meet certain requirements
similar to those under section 162(m), but would not be
required to meet all requirements under that section. For
example, it is expected that the Secretary will provide that
performance criteria would be considered pre-established if it
is established in writing no later than 90 days after the
commencement of the service period, but the requirement of
determination by the compensation committee of the board of
directors would not be required. It is expected that the
Secretary will issue guidance providing coordination rules, as
appropriate, regarding the timing of elections in the case when
the fiscal year of the employer and the taxable year of the
individual are different. It is expected that Treasury
regulations will not permit any election to defer any bonus or
other compensation if the timing of such election would be
inconsistent with the purposes of the Act.
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\947\ Under the Act, in the first year that an employee becomes
eligible for participation in a nonqualified deferred compensation
plan, the election may be made within 30 days after the date that the
employee is initially eligible.
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The time and form of distributions must be specified at the
time of initial deferral. A plan could specify the time and
form of payments that are to be made as a result of a
distribution event (e.g., a plan could specify that payments
upon separation of service will be paid in lump sum within 30
days of separation from service) or could allow participants to
elect the time and form of payment at the time of the initial
deferral election. If a plan allows participants to elect the
time and form of payment, such election is subject to the rules
regarding initial deferral elections under the Act. It is
intended that multiple payout events are permissible. For
example, a participant could elect to receive 25 percent of
their account balance at age 50 and the remaining 75 percent at
age 60. A plan could also allow participants to elect different
forms of payment for different permissible distribution events.
For example, a participant could elect to receive a lump-sum
distribution upon disability, but an annuity at age 65.
Under the Act, a plan may allow changes in the time and
form of distributions subject to certain requirements. A
nonqualified deferred compensation plan may allow a subsequent
election to delay the timing or form of distributions only if:
(1) the plan requires that such election cannot be effective
for at least 12 months after the date on which the election is
made; (2) except in the case of elections relating to
distributions on account of death, disability or unforeseeable
emergency, the plan requires that the additional deferral with
respect to which such election is made is for a period of not
less than five years from the date such payment would otherwise
have been made \948\; and (3) the plan requires that an
election related to a distribution to be made upon a specified
time may not be made less than 12 months prior to the date of
the first scheduled payment. It is expected that in limited
cases, the Secretary will issue guidance, consistent with the
purposes of the Act, regarding to what extent elections to
change a stream of payments are permissible. The Secretary may
issue regulations regarding elections with respect to payments
under nonelective, supplemental retirement plans.
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\948\ A technical correction may be necessary so that the statute
reflects this intent. See section 2(a)(10)(B) of H.R. 5395 and S. 3019,
the ``Tax Technical Corrections Act of 2004,'' introduced November 19,
2004.
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Foreign trusts
Under the Act, in the case of assets set aside (directly or
indirectly) in a trust (or other arrangement determined by the
Secretary) for purposes of paying nonqualified deferred
compensation, such assets are treated as property transferred
in connection with the performance of services under section 83
(whether or not such assets are available to satisfy the claims
of general creditors) at the time set aside if such assets (or
trust or other arrangement) are located outside of the United
States or at the time transferred if such assets (or trust or
other arrangement) are subsequently transferred outside of the
United States. Any subsequent increases in the value of, or any
earnings with respect to, such assets are treated as additional
transfers of property. Interest at the underpayment rate plus
one percentage point is imposed on the underpayments that would
have occurred had the amounts set aside been includible in
income for the taxable year in which first deferred or, if
later, the first taxable year not subject to a substantial risk
of forfeiture. The amount required to be included in income is
also subject to an additional 20-percent tax.
It is expected that the Secretary will provide rules for
identifying the deferrals to which assets set aside are
attributable, for situations in which assets equal to less than
the full amount of deferrals are set aside. The Act does not
apply to assets located in a foreign jurisdiction if
substantially all of the services to which the nonqualified
deferred compensation relates are performed in such foreign
jurisdiction. The Act is specifically intended to apply to
foreign trusts and arrangements that effectively shield from
the claims of general creditors any assets intended to satisfy
nonqualified deferred compensation arrangements. The Secretary
has authority to exempt arrangements from the Act if the
arrangements do not result in an improper deferral of U.S. tax
and will not result in assets being effectively beyond the
reach of creditors.
Triggers upon financial health
Under the Act, a transfer of property in connection with
the performance of services under section 83 also occurs with
respect to compensation deferred under a nonqualified deferred
compensation plan if the plan provides that upon a change in
the employer's financial health, assets will be restricted to
the payment of nonqualified deferred compensation. An amount is
treated as restricted even if the assets are available to
satisfy the claims of general creditors. For example, the Act
applies in the case of a plan that provides that upon a change
in financial health, assets will be transferred to a rabbi
trust.
The transfer of property occurs as of the earlier of when
the assets are so restricted or when the plan provides that
assets will be restricted. It is intended that the transfer of
property occurs to the extent that assets are restricted or
will be restricted with respect to such compensation. For
example, in the case of a plan that provides that upon a change
in the employer's financial health, a trust will become funded
to the extent of all deferrals, all amounts deferred under the
plan are treated as property transferred under section 83. If a
plan provides that deferrals of certain individuals will be
funded upon a change in financial health, the transfer of
property would occur with respect to compensation deferred by
such individuals. The Act is not intended to apply when assets
are restricted for a reason other than change in financial
health (e.g., upon a change in control) or if assets are
periodically restricted under a structured schedule and
scheduled restrictions happen to coincide with a change in
financial status. Any subsequent increases in the value of, or
any earnings with respect to, restricted assets are treated as
additional transfers of property. Interest at the underpayment
rate plus one percentage point is imposed on the underpayments
that would have occurred had the amounts been includible in
income for the taxable year in which first deferred or, if
later, the first taxable year not subject to a substantial risk
of forfeiture. The amount required to be included in income is
also subject to an additional 20-percent tax.
Definition of nonqualified deferred compensation plan
A nonqualified deferred compensation plan is any plan that
provides for the deferral of compensation other than a
qualified employer plan or any bona fide vacation leave, sick
leave, compensatory time, disability pay, or death benefit
plan.\949\ A qualified employer plan means a qualified
retirement plan, tax-deferred annuity, simplified employee
pension, and SIMPLE.\950\ A qualified governmental excess
benefit arrangement (sec. 415(m)) is a qualified employer plan.
An eligible deferred compensation plan (sec. 457(b)) is also a
qualified employer plan under the Act. A tax-exempt or
governmental deferred compensation plan that is not an eligible
deferred compensation plan is not a qualified employer plan.
The application of the Act is not limited to arrangements
between an employer and employee.
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\949\ The Act does not apply to a plan meeting the requirements of
section 457(e)(12) if the plan was in existence as of May 1, 2004, was
providing nonelective deferred compensation described in section
457(e)(12) on such date, and is established or maintained by an
organization incorporated on July 2, 1974. If the plan has a material
change in the class of individuals eligible to participate in the plan
after May 1, 2004, the Act applies to compensation provided under the
plan after the date of such change.
\950\ A qualified employer plan also includes a section 501(c)(18)
trust.
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For purposes of the Act, it is not intended that the term
``nonqualified deferred compensation plan'' include an
arrangement taxable under section 83 providing for the grant of
an option on employer stock with an exercise price that is not
less than the fair market value of the underlying stock on the
date of grant if such arrangement does not include a deferral
feature other than the feature that the option holder has the
right to exercise the option in the future. The Act is not
intended to change the tax treatment of incentive stock options
meeting the requirements of 422 or options granted under an
employee stock purchase plan meeting the requirements of
section 423.
It is intended that the Act does not apply to annual
bonuses or other annual compensation amounts paid within 2\1/2\
months after the close of the taxable year in which the
relevant services required for payment have been performed.
Other rules
Interest imposed under the Act is treated as interest on an
underpayment of tax. Income (whether actual or notional)
attributable to nonqualified deferred compensation is treated
as additional deferred compensation and is subject to the Act.
The Act is not intended to prevent the inclusion of amounts in
gross income under any provision or rule of law earlier than
the time provided in the Act. Any amount included in gross
income under the Act is not required to be included in gross
income under any provision of law later than the time provided
in the Act. The Act does not affect the rules regarding the
timing of an employer's deduction for nonqualified deferred
compensation.
Treasury regulations
The Act provides the Secretary authority to prescribe
regulations as are necessary to carry out the purposes of Act,
including regulations: (1) providing for the determination of
amounts of deferral in the case of defined benefit plans; (2)
relating to changes in the ownership and control of a
corporation or assets of a corporation; (3) exempting from the
provisions providing for transfers of property arrangements
that will not result in an improper deferral of U.S. tax and
will not result in assets being effectively beyond the reach of
creditors; (4) defining financial health; and (5) disregarding
a substantial risk of forfeiture. It is intended that
substantial risk of forfeitures may not be used to manipulate
the timing of income inclusion. It is intended that substantial
risks of forfeiture should be disregarded in cases in which
they are illusory or are used in a manner inconsistent with the
purposes of the Act. For example, if an executive is
effectively able to control the acceleration of the lapse of a
substantial risk of forfeiture, such risk of forfeiture should
be disregarded and income inclusion should not be postponed on
account of such restriction. The Secretary may also address in
regulations issues relating to stock appreciation rights.
Aggregation rules
Under the Act, except as provided by the Secretary,
employer aggregation rules apply. It is intended that the
Secretary issue guidance providing aggregation rules as are
necessary to carry out the purposes of the Act. For example, it
is intended that aggregation rules would apply in the case of
separation from service so that the separation from service
from one entity within a controlled group, but continued
service for another entity within the group, would not be a
permissible distribution event. It is also intended that
aggregation rules would not apply in the case of a change in
control so that the change in control of one member of a
controlled group would not be a permissible distribution event
for participants of a deferred compensation plan of another
member of the group.
Reporting requirements
Amounts required to be included in income under the Act are
subject to reporting and Federal income tax withholding
requirements. Amounts required to be includible in income are
required to be reported on an individual's Form W-2 (or Form
1099) for the year includible in income.
The Act also requires annual reporting to the IRS of
amounts deferred. Such amounts are required to be reported on
an individual's Form W-2 (or Form 1099) for the year deferred
even if the amount is not currently includible in income for
that taxable year. It is expected that annual reporting of
annual amounts deferred will provide the IRS greater
information regarding such arrangements for enforcement
purposes. It is intended that the information reported would
provide an indication of what arrangements should be examined
and challenged. Under the Act, the Secretary is authorized,
through regulations, to establish a minimum amount of deferrals
below which the reporting requirement does not apply. The
Secretary may also provide that the reporting requirement does
not apply with respect to amounts of deferrals that are not
reasonably ascertainable. It is intended that the exception for
amounts not reasonable ascertainable only apply to nonaccount
balance plans and that amounts be required to be reported when
they first become reasonably ascertainable.\951\
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\951\ It is intended that the exception be similar to that under
Treas. Reg. sec. 31.3121(v)(2)-1(e)(4).
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Effective Date
In general
The provision is generally effective for amounts deferred
in taxable years beginning after December 31, 2004. Earnings on
amounts deferred before the effective date are subject to the
provision to the extent that such amounts deferred are subject
to the provision.
Amounts deferred in taxable years beginning before January
1, 2005, are subject to the provision if the plan under which
the deferral is made is materially modified after October 3,
2004. The addition of any benefit, right or feature is a
material modification. The exercise or reduction of an existing
benefit, right, or feature is not a material modification. For
example, an amendment to a plan on November 1, 2004, to add a
provision that distributions may be allowed upon request if
participants are required to forfeit 10 percent of the amount
of the distribution (i.e., a ``haircut'') would be a material
modification to the plan so that the rules of the provision
would apply to the plan. Similarly, accelerating vesting under
a plan after October 3, 2004, would be a material modification.
A change in the plan administrator would not be a material
modification. As another example, amending a plan to remove a
distribution provision (e.g., to remove a ``haircut'') would
not be considered a material modification.
Operating under the terms of a deferred compensation
arrangement that complies with prior law and is not materially
modified after October 3, 2004, with respect to amounts
deferred before January 1, 2005, is permissible, as such
amounts would not be subject to the requirements of the
provision. For example, subsequent deferrals with respect to
amounts deferred before January 1, 2005, under a plan that is
not materially modified after October 3, 2004, would be subject
to prior law and would not be subject to the provision.\952\ No
inference is intended that all deferrals before the effective
date are permissible under prior law. It is expected that the
IRS will challenge pre-effective date deferral arrangements
that do not comply with prior law.
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\952\ There is no inference that all subsequent deferral elections
under plans that are not materially modified are permissible under
prior law.
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For purposes of the effective date, an amount is considered
deferred before January 1, 2005, if the amount is earned and
vested before such date. To the extent there is no material
modification after October 3, 2004, prior law applies with
respect to vested rights.
No later than 60 days after the date of enactment, the
Secretary shall issue guidance providing a limited period of
time during which a nonqualified deferred compensation plan
adopted before January 1, 2005,\953\ may, without violating the
requirements of the provision relating to distributions,
accelerations, and elections be amended (1) to provide that a
participant may terminate participation in the plan, or cancel
an outstanding deferral election with respect to amounts
deferred after December 31, 2004, if such amounts are
includible in income of the participant as earned, or if later,
when not subject to a substantial risk of forfeiture, and (2)
to conform with the provision with respect to amounts deferred
after December 31, 2004. It is expected that the Secretary may
provide exceptions to certain requirements of the provision
during the transition period (e.g., the rules regarding timing
of elections) for plans coming into compliance with the
provision. Moreover, it is expected that the Secretary will
provide a reasonable time, during the transition period but
after the issuance of guidance, for plans to be amended and
approved by the appropriate parties in accordance with this
provision.
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\953\ A technical correction may be necessary so that the statute
reflects this intent. See section 2(1)(10)(D) of H.R. 5395 and S. 3019,
the ``Tax Technical Corrections Act of 2004,'' introduced November 19,
2004.
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Funding provisions
Notwithstanding the general effective date, the effective
date of the funding provisions relating to offshore trusts and
financial triggers is January 1, 2005.\954\ Thus, for example,
amounts set aside in an offshore trust before such date for the
purpose of paying deferred compensation and plans providing for
the restriction of assets in connection with a change in the
employer's financial health are subject to the funding
provisions on January 1, 2005.
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\954\ A technical correction may be necessary so that the statute
reflects this intent. See section 2(a)(10)(C) of H.R. 5395 and S. 3019,
the ``Tax Technical Corrections Act of 2004,'' introduced November 19,
2004.
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6. Extend the present-law intangible amortization provisions to
acquisitions of sports franchises (sec. 886 of the Act and sec.
197 of the Code)
Present and Prior Law
The purchase price allocated to intangible assets
(including franchise rights) acquired in connection with the
acquisition of a trade or business generally must be
capitalized and amortized over a 15-year period.\955\ These
rules were enacted in 1993 to minimize disputes regarding the
proper treatment of acquired intangible assets. The rules do
not apply to a franchise to engage in professional sports and
any intangible asset acquired in connection with such a
franchise.\956\ However, other special rules apply to certain
of these intangible assets.
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\955\ Sec. 197.
\956\ Sec. 197(e)(6).
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Under section 1056, when a franchise to conduct a sports
enterprise is sold or exchanged, the basis of a player contract
acquired as part of the transaction is generally limited to the
adjusted basis of such contract in the hands of the transferor,
increased by the amount of gain, if any, recognized by the
transferor on the transfer of the contract. Moreover, not more
than 50 percent of the consideration from the transaction may
be allocated to player contracts unless the transferee
establishes to the satisfaction of the Commissioner that a
specific allocation in excess of 50 percent is proper. However,
these basis rules may not apply if a sale or exchange of a
franchise to conduct a sports enterprise is effected through a
partnership.\957\ Basis allocated to the franchise or to other
valuable intangible assets acquired with the franchise may not
be amortizable if these assets lack a determinable useful life.
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\957\ P.D.B. Sports, Ltd. v. Comm., 109 T.C. 423 (1997).
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In general, section 1245 provides that gain from the sale
of certain property is treated as ordinary income to the extent
depreciation or amortization was allowed on such property.
Section 1245(a)(4) provides special rules for recapture of
depreciation and deductions for losses taken with respect to
player contracts. The special recapture rules apply in the case
of the sale, exchange, or other disposition of a sports
franchise. Under the special recapture rules, the amount
recaptured as ordinary income is the amount of gain not to
exceed the greater of (1) the sum of the depreciation taken
plus any deductions taken for losses (i.e., abandonment losses)
with respect to those player contracts which are initially
acquired as a part of the original acquisition of the franchise
or (2) the amount of depreciation taken with respect to those
player contracts which are owned by the seller at the time of
the sale of the sports franchise.
Reasons for Change
Section 197 was enacted to minimize disputes regarding the
measurement of acquired intangible assets. Prior to the
enactment of section 197, there were many disputes regarding
the value and useful life of various intangible assets acquired
together in a business acquisition. Furthermore, in the absence
of a showing of a reasonably determinable useful life, an asset
could not be amortized. Taxpayers tended to identify and
allocate large amounts of purchase price to assets said to have
short useful lives, while the IRS would allocate a large amount
of value to intangible value for which no determinable useful
life could be shown (e.g., goodwill), and would deny
amortization for that amount of purchase price.
The prior-law rules for acquisitions of sports franchises
did not eliminate the potential for disputes, because they
addressed only player contracts, while a sports franchise
acquisition can involve many intangibles other than player
contracts. In addition, disputes could arise regarding the
appropriate period for amortization of particular player
contracts. The Congress believed expending taxpayer and
government resources disputing these items was an unproductive
use of economic resources. The Congress further believed that
the section 197 rules should apply to all types of businesses
regardless of the nature of their assets.
Explanation of Provision
The Act extends the 15-year recovery period for intangible
assets to franchises to engage in professional sports and any
intangible asset acquired in connection with the acquisition of
such a franchise (including player contracts). Thus, the same
rules for amortization of intangibles that apply to other
acquisitions also apply to acquisitions of sports franchises.
The Act also repeals the special rules under section 1245(a)(4)
and makes other conforming changes.
Effective Date
The provision is effective for property acquired after the
date of enactment (October 22, 2004). The amendment to section
1245(a)(4) applies to franchises acquired after the date of
enactment (October 22, 2004).
7. Increase continuous levy for certain Federal payments (sec. 887 of
the Act and sec. 6331(h) of the Code)
Present and Prior Law
Under present and prior law, if any person is liable for
any internal revenue tax and does not pay it within 10 days
after notice and demand \958\ by the IRS, the IRS may, after
providing notice of collection due process rights, collect the
tax by levy upon all property and rights to property belonging
to the person,\959\ unless there is an explicit statutory
restriction on doing so. A levy is the seizure of the person's
property or rights to property. Property that is not cash is
sold pursuant to statutory requirements.\960\
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\958\ Notice and demand is the notice given to a person liable for
tax stating that the tax has been assessed and demanding that payment
be made. The notice and demand must be mailed to the person's last
known address or left at the person's dwelling or usual place of
business (sec. 6303).
\959\ Sec. 6331.
\960\ Secs. 6335-6343.
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A continuous levy is applicable to specified Federal
payments.\961\ This includes any Federal payment for which
eligibility is not based on the income and/or assets of a
payee. Thus, a Federal payment to a vendor of goods or services
to the government is subject to continuous levy. Under prior
law, this continuous levy attached up to 15 percent of any
specified Federal payment due the taxpayer.
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\961\ Sec. 6331(h).
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Reasons for Change
There had recently been reports of abuses of the Federal
tax system by some Federal contractors. Consequently, the
Congress believed that it was appropriate to increase the
permissible percentage of specified Federal payments subject to
levy.
Explanation of Provision
The Act permits a levy of up to 100 percent of a Federal
payment to a vendor of goods or services to the Federal
Government.
Effective Date
The provision is effective on the date of enactment
(October 22, 2004).
8. Modification of straddle rules (sec. 888 of the Act and sec. 1092 of
the Code)
Present and Prior Law
Straddle rules
In general
A ``straddle'' generally refers to offsetting positions
(sometimes referred to as ``legs'' of the straddle) with
respect to actively traded personal property. Positions are
offsetting if there is a substantial diminution in the risk of
loss from holding one position by reason of holding one or more
other positions in personal property. A ``position'' is an
interest (including a futures or forward contract or option) in
personal property. When a taxpayer realizes a loss with respect
to a position in a straddle, the taxpayer may recognize that
loss for any taxable year only to the extent that the loss
exceeds the unrecognized gain (if any) with respect to
offsetting positions in the straddle.\962\ Deferred losses are
carried forward to the succeeding taxable year and are subject
to the same limitation with respect to unrecognized gain in
offsetting positions.
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\962\ Sec. 1092.
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Positions in stock
Under prior law, the straddle rules generally did not apply
to positions in stock. However, the straddle rules did apply
where one of the positions was stock and at least one of the
offsetting positions was: (1) an option with respect to the
stock, (2) a securities futures contract (as defined in section
1234B) with respect to the stock, or (3) a position with
respect to substantially similar or related property (other
than stock) as defined in Treasury regulations. In addition,
the straddle rules applied to stock of a corporation formed or
availed of to take positions in personal property that offset
positions taken by any shareholder.
Although the straddle rules apply to offsetting positions
that consist of stock and an option with respect to stock, the
straddle rules generally do not apply if the option is a
``qualified covered call option'' written by the taxpayer.\963\
In general, a qualified covered call option is defined as an
exchange-listed option that is not deep-in-the-money and is
written by a non-dealer more than 30 days before expiration of
the option.
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\963\ However, if the option written by the taxpayer is a qualified
covered call option that is in-the-money, then (1) any loss with
respect to such option is treated as long-term capital loss if, at the
time such loss is realized, gain on the sale or exchange of the
offsetting stock held by the taxpayer would be treated as long-term
capital gain, and (2) the holding period of such stock does not include
any period during which the taxpayer is the grantor of the option (sec.
1092(f)).
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The prior-law stock exception from the straddle rules
largely had been curtailed by statutory amendment and
regulatory interpretation. Under proposed Treasury regulations,
the application of the stock exception essentially would be
limited to offsetting positions involving direct ownership of
stock and short sales of stock.\964\
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\964\ Prop. Treas. Reg. sec. 1.1092(d)-2(c).
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Unbalanced straddles
When one position with respect to personal property offsets
only a portion of one or more other positions (``unbalanced
straddles''), prior law directed the Secretary to prescribe by
regulations the method for determining the portion of such
other positions that is to be taken into account for purposes
of the straddle rules.\965\ To date, no such regulations have
been promulgated.
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\965\ Prior-law sec. 1092(c)(2)(B).
---------------------------------------------------------------------------
Unbalanced straddles can be illustrated with the following
example: Assume the taxpayer holds two shares of stock (i.e.,
is long) in XYZ corporation--share A with a $30 basis and share
B with a $40 basis. When the value of the XYZ stock is $45 per
share, the taxpayer pays a $5 premium to purchase a put option
on one share of the XYZ stock with an exercise price of $40.
The issue arises as to whether the purchase of the put option
creates a straddle with respect to share A, share B, or both.
Assume that, when the value of the XYZ stock is $100, the put
option expires unexercised. Taxpayer incurs a loss of $5 on the
expiration of the put option, and sells share B for a $60 gain.
On a literal reading of the straddle rules, the $5 loss would
be deferred because the loss ($5) does not exceed the
unrecognized gain ($70) in share A, which is also an offsetting
position to the put option-notwithstanding that the taxpayer
recognized more gain than the loss through the sale of share B.
This problem is exacerbated when the taxpayer has a large
portfolio of actively traded personal property that may be
offsetting the loss leg of the straddle.
Although Treasury has not issued regulations to address
unbalanced straddles, the IRS issued a private letter ruling in
1999 that addressed an unbalanced straddle situation.\966\
Under the facts of the ruling, a taxpayer entered into a
costless collar with respect to a portion of the shares of a
particular stock held by the taxpayer.\967\ Other shares were
held in an account as collateral for a loan and still other
shares were held in excess of the shares used as collateral and
the number of shares specified in the collar. The ruling
concluded that the collar offset only a portion of the stock
(i.e., the number of shares specified in the costless collar)
because that number of shares determined the payoff under each
option comprising the collar. The ruling further concluded
that:
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\966\ Priv. Ltr. Rul. 199925044 (Feb. 3, 1999).
\967\ A costless collar generally is comprised of the purchase of a
put option and the sale of a call option with the same trade dates and
maturity dates and set such that the premium paid substantially equals
the premium received. The collar can be considered as economically
similar to a short position in the stock.
In the absence of regulations under section
1092(c)(2)(B), we conclude that it is permissible for
Taxpayer to identify which shares of Corporation stock
are part of the straddles and which shares are used as
collateral for the loans using appropriately modified
versions of the methods of section 1.1012-1(c)(2) and
(3) [providing rules for adequate identification of
shares of stock sold or transferred by a taxpayer] or
section 1.1092(b)-3T(d)(4) [providing requirements and
methods for identification of positions that are part
of a section 1092(b)(2) identified mixed straddle].
Holding period for dividends-received deduction
If an instrument issued by a U.S. corporation is classified
for tax purposes as stock, a corporate holder of the instrument
generally is entitled to a dividends-received deduction for
dividends received on that instrument.\968\ The dividends-
received deduction is allowed to a corporate shareholder only
if the shareholder satisfies a 46-day holding period for the
dividend-paying stock (or a 91-day holding period for certain
dividends on preferred stock).\969\ The holding period must be
satisfied for each dividend over a period that is immediately
before and immediately after the taxpayer becomes entitled to
receive the dividend. The 46- or 91-day holding period
generally does not include any time during which the
shareholder is protected (other than by writing a qualified
covered call) from the risk of loss that is otherwise inherent
in the ownership of any equity interest.\970\
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\968\ Sec. 243. The amount of the deduction is 70 percent of
dividends received if the recipient owns less than 20 percent (by vote
and value) of stock of the payor. If the recipient owns 20 percent or
more of the stock, the deduction is increased to 80 percent. If the
recipient owns 80 percent or more of the stock, the deduction is
further increased to 100 percent for qualifying dividends.
\969\ Sec. 246(c).
\970\ Sec. 246(c)(4).
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Reasons for Change
The Congress believed that the straddle rules should be
modified in several respects. While the prior-law rules
provided authority for the Secretary to issue guidance
concerning unbalanced straddles, the Congress was of the view
that such guidance was not forthcoming. Therefore, the Congress
believed that it was necessary to provide such guidance by
statute. The Congress further believed that it was appropriate
to repeal the general exception from the straddle rules for
positions in stock, particularly in light of statutory changes
in the straddle rules and elsewhere in the Code that have
significantly diminished the continuing utility of the
exception. In addition, the Congress believed that the
treatment of physically settled positions under the straddle
rules required clarification.
Explanation of Provision
Straddle rules
In general
The Act modifies the straddle rules in three respects: (1)
permits taxpayers to identify offsetting positions of a
straddle; (2) provides a special rule to clarify the treatment
of certain physically settled positions of a straddle; and (3)
repeals the stock exception from the straddle rules.
Identified straddles
Under the Act, taxpayers generally are permitted to
identify the offsetting positions that are components of a
straddle at the time the taxpayer enters into a transaction
that creates a straddle, including an unbalanced straddle.\971\
Taxpayers are not permitted to identify offsetting positions of
a straddle that itself is part of a larger straddle. However,
this prohibition does not preclude the identification of a
straddle involving offsetting positions merely because the
offsetting positions comprise an unbalanced straddle.\972\
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\971\ However, to the extent provided by Treasury regulations,
taxpayers are not permitted to identify offsetting positions of a
straddle if the fair market value of the straddle position already held
by the taxpayer at the creation of the straddle is less than its
adjusted basis in the hands of the taxpayer.
\972\ The Act preserves a special rule that also applied to prior-
law identified straddles, which provides that any position that is not
part of an identified straddle shall not be treated as offsetting with
respect to any position which is part of an identified straddle. Sec.
1092(c)(2)(B). For example, if a taxpayer holds an unbalanced straddle
comprised of 100 shares of XYZ corporation and a put option on 50
shares of XYZ corporation, the taxpayer may identify 50 of the shares
and the put option as an identified straddle under the Act. The
identified straddle is not considered part of a larger straddle merely
by virtue of the remaining (unidentified) 50 shares held by the
taxpayer because such shares (which are not part of the identified
straddle) are not treated as offsetting with respect to the put option
(which is part of the identified straddle).
---------------------------------------------------------------------------
If there is a loss with respect to any identified position
that is part of an identified straddle, the general straddle
loss deferral rules do not apply to such loss. Instead, the
basis of each of the identified positions that offset the loss
position in the identified straddle is increased by an amount
that bears the same ratio to the loss as the unrecognized gain
(if any) with respect to such offsetting position bears to the
aggregate unrecognized gain with respect to all positions that
offset the loss position in the identified straddle.\973\ Any
loss with respect to an identified position that is part of an
identified straddle cannot otherwise be taken into account by
the taxpayer or any other person to the extent that the loss
increases the basis of any identified positions that offset the
loss position in the identified straddle.
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\973\ For this purpose, ``unrecognized gain'' is the excess of the
fair market value of an identified position that is part of an
identified straddle at the time the taxpayer incurs a loss with respect
to another identified position in the identified straddle, over the
fair market value of such position when the taxpayer identified the
position as a position in the identified straddle.
---------------------------------------------------------------------------
In addition, the Act provides the Secretary authority to
issue regulations that would specify (1) the proper methods for
clearly identifying a straddle as an identified straddle (and
identifying positions as positions in an identified straddle),
(2) the application of the identified straddle rules to a
taxpayer that fails to properly identify the positions of an
identified straddle,\974\ and (3) provide an ordering rule for
dispositions of less than an entire position that is part of an
identified straddle.
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\974\ For example, although the Act does not require taxpayers to
identify any positions of a straddle as an identified straddle, it may
be necessary to provide rules requiring all balanced offsetting
positions to be included in an identified straddle if a taxpayer elects
to identify any of the offsetting positions as an identified straddle.
---------------------------------------------------------------------------
Physically settled straddle positions
The Act also clarifies the straddle rules with respect to
taxpayers that settle a position that is part of a straddle by
delivering property to which the position relates.
Specifically, the Act clarifies that the straddle loss deferral
rules treat as a two-step transaction the physical settlement
of a straddle position that, if terminated, would result in the
realization of a loss. With respect to the physical settlement
of such a position, the taxpayer is treated as having
terminated the position for its fair market value immediately
before the settlement. The taxpayer then is treated as having
sold at fair market value the property used to physically
settle the position.
Stock exception repeal
The Act also eliminates the exception from the straddle
rules for stock (other than the exception relating to qualified
covered call options). Thus, offsetting positions comprised of
actively traded stock and a position with respect to such stock
or substantially similar or related property generally
constitute a straddle.\975\
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\975\ It is intended that Treasury regulations defining
substantially similar or related property for this purpose will
continue to apply subsequent to repeal of the stock exception and
generally will constitute the exclusive definition of a straddle with
respect to offsetting positions involving stock. See Prop. Treas. Reg.
sec. 1.1092(d)-2(b). However, the general straddles rules regarding
substantial diminution in risk of loss will continue to apply to stock
of corporations formed or availed of to take positions in personal
property that offset positions taken by the shareholder.
---------------------------------------------------------------------------
Dividends-received deduction holding period
The Act also modifies the required 46- or 91-day holding
period for the dividends-received deduction by providing that
the holding period does not include any time during which the
shareholder is protected from the risk of loss otherwise
inherent in the ownership of any equity interest if the
shareholder obtains such protection by writing an in-the-money
call option on the dividend-paying stock.
Effective Date
The provision is effective for positions established on or
after the date of enactment (October 22, 2004) that
substantially diminish the risk of loss from holding offsetting
positions (regardless of when such offsetting positions were
established).
9. Add vaccines against Hepatitis A to the list of taxable vaccines
(sec. 889 of the Act and sec. 4132 of the Code)
Present and Prior Law
A manufacturers' excise tax is imposed at the rate of 75
cents per dose \976\ on the following vaccines routinely
recommended for administration to children: diphtheria,
pertussis, tetanus, measles, mumps, rubella, polio, HIB
(haemophilus influenza type B), hepatitis B, varicella (chicken
pox), rotavirus gastroenteritis, and streptococcus pneumoniae.
The tax applies to any vaccine that is a combination of vaccine
components equals 75 cents times the number of components in
the combined vaccine.
---------------------------------------------------------------------------
\976\ Sec. 4131.
---------------------------------------------------------------------------
Amounts equal to net revenues from this excise tax are
deposited in the Vaccine Injury Compensation Trust Fund to
finance compensation awards under the Federal Vaccine Injury
Compensation Program for individuals who suffer certain
injuries following administration of the taxable vaccines. This
program provides a substitute Federal, ``no fault'' insurance
system for the State-law tort and private liability insurance
systems otherwise applicable to vaccine manufacturers. All
persons immunized after September 30, 1988, with covered
vaccines must pursue compensation under this Federal program
before bringing civil tort actions under State law.
Reasons for Change
The Congress was aware that the Centers for Disease Control
and Prevention have recommended that children in 17 highly
endemic States be inoculated with a hepatitis A vaccine. The
population of children in the affected States exceeds 20
million. Several of the affected States mandate childhood
vaccination against hepatitis A. The Congress was aware that
the Advisory Commission on Childhood Vaccines has recommended
that the vaccine excise tax be extended to cover vaccines
against hepatitis A. For these reasons, the Congress believed
it was appropriate to include vaccines against hepatitis A as
part of the Vaccine Injury Compensation Program. Making the
hepatitis A vaccine taxable is a first step.\977\ In the
unfortunate event of an injury related to this vaccine,
families of injured children are eligible for the no-fault
arbitration system established under the Vaccine Injury
Compensation Program rather than going to Federal Court to seek
compensatory redress.
---------------------------------------------------------------------------
\977\ The Congress recognized that, to become covered under the
Vaccine Injury Compensation Program, the Secretary of Health and Human
Services also must list the hepatitis A vaccine on the Vaccine Injury
Table. In addition, after the Secretary of Health and Human Service
lists the vaccine on the Vaccine Injury Table, the Congress must make a
revision to the Trust Fund expenditure purposes under Code sec. 9510.
---------------------------------------------------------------------------
Explanation of Provision
The Act adds any vaccine against hepatitis A to the list of
taxable vaccines.
Effective Date
The provision is effective for vaccines sold on or after
the first day of the first month beginning more than four weeks
after the date of enactment (October 22, 2004).
10. Add vaccines against influenza to the list of taxable vaccines
(sec. 890 of the Act and sec. 4132 of the Code)
Present and Prior Law
A manufacturers' excise tax is imposed at the rate of 75
cents per dose \978\ on the following vaccines routinely
recommended for administration to children: diphtheria,
pertussis, tetanus, measles, mumps, rubella, polio, HIB
(haemophilus influenza type B), hepatitis B, varicella (chicken
pox), rotavirus gastroenteritis, and streptococcus pneumoniae.
The tax applies to any vaccine that is a combination of vaccine
components equals 75 cents times the number of components in
the combined vaccine.
---------------------------------------------------------------------------
\978\ Sec. 4131.
---------------------------------------------------------------------------
Amounts equal to net revenues from this excise tax are
deposited in the Vaccine Injury Compensation Trust Fund to
finance compensation awards under the Federal Vaccine Injury
Compensation Program for individuals who suffer certain
injuries following administration of the taxable vaccines. This
program provides a substitute Federal, ``no fault'' insurance
system for the State-law tort and private liability insurance
systems otherwise applicable to vaccine manufacturers. All
persons immunized after September 30, 1988, with covered
vaccines must pursue compensation under this Federal program
before bringing civil tort actions under State law.
Reasons for Change
The Congress understood that on October 15, 2003, the
Advisory Committee on Immunization Practices of the Centers for
Disease Control and Prevention issued a recommendation for the
routine annual vaccination of infants six to 23 months of age
with an inactivated influenza vaccine licensed by the FDA. This
is the first recommendation for ``routine use'' in children
although trivalent influenza vaccine products have long been
available and approved for use in children of varying ages and
these vaccines have long been recommended for use by seniors.
For these reasons, the Congress believed it was appropriate to
include trivalent vaccines against influenza as part of the
Vaccine Injury Compensation Program. Making an influenza
vaccine taxable is a first step.\979\ In the unfortunate event
of an injury related to these vaccines, an injured individual
is eligible for the no-fault arbitration system established
under the Vaccine Injury Compensation Program rather than going
to Federal Court to seek compensatory redress.
---------------------------------------------------------------------------
\979\ The Committee recognizes that, to become covered under the
Vaccine Injury Compensation Program, the Secretary of Health and Human
Services also must list each trivalent vaccine against influenza on the
Vaccine Injury Table. In addition, after the Secretary of Health and
Human Service lists the vaccine on the Vaccine Injury Table, the
Congress must make a revision to the Trust Fund expenditure purposes
under Code sec. 9510.
---------------------------------------------------------------------------
Explanation of Provision
The Act adds any trivalent vaccine against influenza to the
list of taxable vaccines.
Effective Date
The provision is effective for vaccines sold or used on or
after the later of the first day of the first month beginning
more than four weeks after the date of enactment (October 22,
2004) or the date on which the Secretary of Health and Human
Services lists any such vaccine for purposes of compensation
for any vaccine-related injury or death through the Vaccine
Injury Compensation Trust Fund.
11. Extension of IRS user fees (sec. 891 of the Act and sec. 7528 of
the Code)
Present and Prior Law
The IRS generally charges a fee for requests for a letter
ruling, determination letter, opinion letter, or other similar
ruling or determination.\980\ Under prior law, these user fees
were authorized by statute through December 31, 2004.
---------------------------------------------------------------------------
\980\ Sec. 7528.
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that it was appropriate to provide a
further extension of the applicability of these user fees.
Explanation of Provision
The Act extends the statutory authorization for these user
fees through September 30, 2014.
Effective Date
The provision is effective for requests made after the date
of enactment (October 22, 2004).
12. Extension of Customs user fees (sec. 892 of the Act)
Present and Prior Law
Section 13031 of the Consolidated Omnibus Budget
Reconciliation Act of 1985 (``COBRA'') \981\ authorized the
Secretary of the Treasury to collect certain service fees.
Section 412 of the Homeland Security Act of 2002 \982\
authorized the Secretary of the Treasury to delegate such
authority to the Secretary of Homeland Security. Provided for
under 19 U.S.C. 58c, these fees include: processing fees for
air and sea passengers, commercial trucks, rail cars, private
aircraft and vessels, commercial vessels, dutiable mail
packages, barges and bulk carriers, merchandise, and Customs
broker permits. COBRA was amended on several occasions but most
recently by Pub. L. No. 108-121, which extended authorization
for the collection of these fees through March 1, 2005.\983\
---------------------------------------------------------------------------
\981\ Pub. L. No. 99-272.
\982\ Pub. L. No. 107-296.
\983\ Sec. 201, 117 Stat. 1335.
---------------------------------------------------------------------------
Reasons for Change
The Congress believed it was important to extend these fees
to cover the expenses of the services provided. However, the
Congress also believed it was important that any fee imposed be
a true user fee. That is, the Congress believed that when the
Congress authorizes the executive branch to assess user fees,
those fees must be determined to reflect only the cost of
providing the service for which the fee is assessed.
Explanation of Provision
The Act extends the passenger and conveyance processing
fees and the merchandise processing fees authorized under COBRA
through September 30, 2014. For fiscal years after September
30, 2005, the Secretary is to charge fees in amounts that are
reasonably related to the costs of providing customs services
in connection with the activity or item for which the fee is
charged.
The Act also includes a sense of the Congress regarding the
extent to which fees are related to the costs of providing
customs services in connection with the activities or items for
which the fees have been charged under such paragraphs. The Act
further provides that the Secretary conduct a study of all the
fees collected by the Department of Homeland Security.
Effective Date
The provision is effective on the date of enactment
(October 22, 2004).
13. Prohibition on nonrecognition of gain through complete liquidation
of holding company (sec. 893 of the Act and sec. 332 of the
Code)
Present and Prior Law
A U.S. corporation owned by foreign persons is subject to
U.S. income tax on its net income. In addition, the earnings of
the U.S. corporation are subject to a second tax, when
dividends are paid to the corporation's shareholders.
In general, dividends paid by a U.S. corporation to
nonresident alien individuals and foreign corporations that are
not effectively connected with a U.S. trade or business are
subject to a U.S. withholding tax on the gross amount of such
income at a rate of 30 percent. The 30-percent withholding tax
may be reduced pursuant to an income tax treaty between the
United States and the foreign country where the foreign person
is resident.
In addition, the United States imposes a branch profits tax
on U.S. earnings of a foreign corporation that are shifted out
of a U.S. branch of the foreign corporation. The branch profits
tax is comparable to the second-level taxes imposed on
dividends paid by a U.S. corporation to foreign shareholders.
The branch profits tax is 30 percent (subject to possible
income tax treaty reduction) of a foreign corporation's
dividend equivalent amount. The ``dividend equivalent amount''
generally is the earnings and profits of a U.S. branch of a
foreign corporation attributable to its income effectively
connected with a U.S. trade or business.
In general, U.S. withholding tax is not imposed with
respect to a distribution of a U.S. corporation's earnings to a
foreign corporation in complete liquidation of the subsidiary,
because the distribution is treated as made in exchange for
stock and not as a dividend. In addition, detailed rules apply
for purposes of exempting foreign corporations from the branch
profits tax for the year in which it completely terminates its
U.S. business conducted in branch form. The exemption from the
branch profits tax generally applies if, among other things,
for three years after the termination of the U.S. branch, the
foreign corporation has no income effectively connected with a
U.S. trade or business, and the U.S. assets of the terminated
branch are not used by the foreign corporation or a related
corporation in a U.S. trade or business.
Regulations under section 367(e) provide that the
Commissioner may require a domestic liquidating corporation to
recognize gain on distributions in liquidation made to a
foreign corporation if a principal purpose of the liquidation
is the avoidance of U.S. tax. Avoidance of U.S. tax for this
purpose includes, but is not limited to, the distribution of a
liquidating corporation's earnings and profits with a principal
purpose of avoiding U.S. tax.
Reasons for Change
The Congress was concerned that foreign corporations were
establishing a U.S. holding company to receive tax-free
dividends from U.S. operating companies, liquidating the U.S.
holding company to distribute the U.S. earnings free of U.S.
withholding taxes, and then reestablishing another U.S. holding
company, with the intention of escaping U.S. withholding taxes.
The Congress believed that instances of such withholding tax
abuse will be significantly restricted by imposing U.S.
withholding taxes on a liquidating distribution to foreign
corporate shareholders of earnings and profits of a U.S.
holding company created within five years of the liquidation.
Explanation of Provision
The Act treats as a dividend any distribution of earnings
by a U.S. holding company to a foreign corporation in a
complete liquidation, if the U.S. holding company was in
existence for less than five years.
Effective Date
The provision is effective for distributions occurring on
or after the date of enactment (October 22, 2004).
14. Effectively connected income to include certain foreign source
income (sec. 894 of the Act and sec. 864 of the Code)
Present and Prior Law
Nonresident alien individuals and foreign corporations
(collectively, foreign persons) are subject to U.S. tax on
income that is effectively connected with the conduct of a U.S.
trade or business; the U.S. tax on such income is calculated in
the same manner and at the same graduated rates as the tax on
U.S. persons.\984\ Foreign persons also are subject to a 30-
percent gross-basis tax, collected by withholding, on certain
U.S.-source income, such as interest, dividends and other fixed
or determinable annual or periodical (``FDAP'') income, that is
not effectively connected with a U.S. trade or business. This
30-percent withholding tax may be reduced or eliminated
pursuant to an applicable tax treaty. Foreign persons generally
are not subject to U.S. tax on foreign-source income that is
not effectively connected with a U.S. trade or business.
---------------------------------------------------------------------------
\984\ Secs. 871(b) and 882.
---------------------------------------------------------------------------
Detailed rules apply for purposes of determining whether
income is treated as effectively connected with a U.S. trade or
business (so-called ``U.S.-effectively connected
income'').\985\ The rules differ depending on whether the
income at issue is U.S-source or foreign-source income. Under
these rules, U.S.-source FDAP income, such as U.S.-source
interest and dividends, and U.S.-source capital gains are
treated as U.S.-effectively connected income if such income is
derived from assets used in or held for use in the active
conduct of a U.S. trade or business, or from business
activities conducted in the United States. All other types of
U.S.-source income are treated as U.S.-effectively connected
income (sometimes referred to as the ``force of attraction
rule'').
---------------------------------------------------------------------------
\985\ Sec. 864(c).
---------------------------------------------------------------------------
In general, foreign-source income is not treated as U.S.-
effectively connected income.\986\ However, foreign-source
income, gain, deduction, or loss generally is considered to be
effectively connected with a U.S. business only if the person
has an office or other fixed place of business within the
United States to which such income, gain, deduction, or loss is
attributable and such income falls into one of three categories
described below.\987\ For these purposes, income generally is
not considered attributable to an office or other fixed place
of business within the United States unless such office or
fixed place of business is a material factor in the production
of the income, and such office or fixed place of business
regularly carries on activities of the type that generate such
income.\988\
---------------------------------------------------------------------------
\986\ Sec. 864(c)(4).
\987\ Sec. 864(c)(4)(B).
\988\ Sec. 864(c)(5).
---------------------------------------------------------------------------
The first category consists of rents or royalties for the
use of patents, copyrights, secret processes, or formulas, good
will, trademarks, trade brands, franchises, or other similar
intangible properties derived in the active conduct of the U.S.
trade or business.\989\ The second category consists of
interest or dividends derived in the active conduct of a
banking, financing, or similar business within the United
States, or received by a corporation whose principal business
is trading in stocks or securities for its own account.\990\
Notwithstanding the foregoing, foreign-source income consisting
of dividends, interest, or royalties is not treated as
effectively connected if the items are paid by a foreign
corporation in which the recipient owns, directly, indirectly,
or constructively, more than 50 percent of the total combined
voting power of the stock. \991\ The third category consists of
income, gain, deduction, or loss derived from the sale or
exchange of inventory or property held by the taxpayer
primarily for sale to customers in the ordinary course of the
trade or business where the property is sold or exchanged
outside the United States through the foreign person's U.S.
office or other fixed place of business.\992\ Such amounts are
not treated as effectively connected if the property is sold or
exchanged for use, consumption, or disposition outside the
United States and an office or other fixed place of business of
the taxpayer in a foreign country materially participated in
the sale or exchange.
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\989\ Sec. 864(c)(4)(B)(i).
\990\ Sec. 864(c)(4)(B)(ii).
\991\ Sec. 864(c)(4)(D)(i).
\992\ Sec. 864(c)(4)(B)(iii).
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The Code provides sourcing rules for enumerated types of
income, including interest, dividends, rents, royalties, and
personal services income.\993\ For example, interest income
generally is sourced based on the residence of the obligor.
Dividend income generally is sourced based on the residence of
the corporation paying the dividend. Thus, interest paid on
obligations of foreign persons and dividends paid by foreign
corporations generally are treated as foreign-source income.
---------------------------------------------------------------------------
\993\ Secs. 861--865.
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Other types of income are not specifically covered by the
Code's sourcing rules. For example, fees for accepting or
confirming letters of credit have been sourced under principles
analogous to the interest sourcing rules.\994\ In addition,
under regulations, payments in lieu of dividends and interest
derived from securities lending transactions are sourced in the
same manner as interest and dividends, including for purposes
of determining whether such income is effectively connected
with a U.S. trade or business.\995\ Moreover, income from
notional principal contracts (such as interest rate swaps)
generally is sourced based on the residence of the recipient of
the income, but is treated as U.S.-source effectively connected
income if it arises from the conduct of a United States trade
or business.\996\
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\994\ See Bank of America v. United States, 680 F.2d 142 (Ct. Cl.
1982).
\995\ Treas. Reg. sec. 1.864-5(b)(2)(ii).
\996\ Treas. Reg. sec. 1.863-7(b)(3).
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that prior law created arbitrary
distinctions between economically similar transactions that
were equally related to a U.S. trade of business. The Congress
believed that the rules for determining whether foreign-source
income (e.g., interest and dividends) is U.S.-effectively
connected income should be the same as the rules for
determining whether income that is economically equivalent to
such foreign-source income is U.S.-effectively connected
income.
Explanation of Provision
Under the Act, each category of foreign-source income that
is treated as effectively connected with a U.S. trade or
business is expanded to include economic equivalents of such
income (i.e., economic equivalents of certain foreign-source
(1) rents and royalties, (2) dividends and interest, and (3)
income on sales or exchanges of goods in the ordinary course of
business). Thus, such economic equivalents are treated as U.S.-
effectively connected income in the same circumstances that
foreign-source rents, royalties, dividends, interest, or
certain inventory sales are treated as U.S.-effectively
connected income. For example, foreign-source interest and
dividend equivalents are treated as U.S.-effectively connected
income if the income is attributable to a U.S. office of the
foreign person, and such income is derived by such foreign
person in the active conduct of a banking, financing, or
similar business within the United States, or the foreign
person is a corporation whose principal business is trading in
stocks or securities for its own account.
Effective Date
The provision is effective for taxable years beginning
after the date of enactment (October 22, 2004).
15. Recapture of overall foreign losses on sale of controlled foreign
corporation stock (sec. 895 of the Act and sec. 904 of the
Code)
Present and Prior Law
U.S. persons may credit foreign taxes against U.S. tax on
foreign-source income. The amount of foreign tax credits that
may be claimed in a year is subject to a limitation that
prevents taxpayers from using foreign tax credits to offset
U.S. tax on U.S.-source income. The amount of foreign tax
credits generally is limited to a portion of the taxpayer's
U.S. tax which portion is calculated by multiplying the
taxpayer's total U.S. tax by a fraction, the numerator of which
is the taxpayer's foreign-source taxable income (i.e., foreign-
source gross income less allocable expenses or deductions) and
the denominator of which is the taxpayer's worldwide taxable
income for the year.\997\ Separate limitations are applied to
specific categories of income.\998\
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\997\ Sec. 904(a).
\998\ Section 404 of the Act reduces the number of limitation
categories from nine to two, effective for taxable years beginning
after December 31, 2006.
---------------------------------------------------------------------------
Special recapture rules apply in the case of foreign losses
for purposes of applying the foreign tax credit
limitation.\999\ Under these rules, losses for any taxable year
in a limitation category which exceed the aggregate amount of
foreign income earned in other limitation categories (a so-
called ``overall foreign loss'') are recaptured by resourcing
foreign-source income earned in a subsequent year as U.S.-
source income.\1000\ The amount resourced as U.S.-source income
generally is limited to the lesser of the amount of the overall
foreign losses not previously recaptured, or 50 percent of the
taxpayer's foreign-source income in a given year (the ``50-
percent limit''). Taxpayers may elect to recapture a larger
percentage of such losses.
---------------------------------------------------------------------------
\999\ Sec. 904(f).
\1000\ Sec. 904(f)(1).
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A special recapture rule applies to ensure the recapture of
an overall foreign loss where property which was used in a
trade or business predominantly outside the United States is
disposed of prior to the time the loss has been
recaptured.\1001\ In this regard, dispositions of trade or
business property used predominantly outside the United States
are treated as resulting in the recognition of foreign-source
income (regardless of whether gain would otherwise be
recognized upon disposition of the assets), in an amount equal
to the lesser of the excess of the fair market value of such
property over its adjusted basis, or the amount of unrecaptured
overall foreign losses. Such foreign-source income is resourced
as U.S.-source income without regard to the 50-percent limit.
For example, if a U.S. corporation transfers its foreign branch
business assets to a foreign corporation in a nontaxable
section 351 transaction, the taxpayer would be treated for
purposes of the recapture rules as having recognized foreign-
source income in the year of the transfer in an amount equal to
the excess of the fair market value of the property disposed
over its adjusted basis (or the amount of unrecaptured foreign
losses, if smaller). Such income would be recaptured as U.S.-
source income to the extent of any prior unrecaptured overall
foreign losses.\1002\
---------------------------------------------------------------------------
\1001\ Sec. 904(f)(3).
\1002\ Coordination rules apply in the case of losses recaptured
under the branch loss recapture rules. Sec. 367(a)(3)(C).
---------------------------------------------------------------------------
Detailed rules apply in allocating and apportioning
deductions and losses for foreign tax credit limitation
purposes. In the case of interest expense, such amounts
generally are apportioned to all gross income under an asset
method, under which the taxpayer's assets are characterized as
producing income in statutory or residual groupings (i.e.,
foreign-source income in the various limitation categories or
U.S.-source income).\1003\ Interest expense is apportioned
among these groupings based on the relative asset values in
each. Taxpayers may elect to value assets based on either tax
book value or fair market value.
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\1003\ Sec. 864(e) and Temp. Treas. Reg. sec. 1.861-9T.
---------------------------------------------------------------------------
Each corporation that is a member of an affiliated group is
required to apportion its interest expense using apportionment
fractions determined by reference to all assets of the
affiliated group. For this purpose, an affiliated group
generally is defined to include only domestic corporations.
Stock in a foreign subsidiary, however, is treated as a foreign
asset that may attract the allocation of U.S. interest expense
for these purposes.\1004\ If tax basis is used to value assets,
the adjusted basis of the stock of certain 10-percent or
greater owned foreign corporations or other non-affiliated
corporations must be increased by the amount of earnings and
profits of such corporation accumulated during the period the
U.S. shareholder held the stock, for purposes of the interest
apportionment.
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\1004\ Under section 401 of the Act, effective for taxable years
beginning after December 31, 2008, a taxpayer may elect to apportion
interest expense on the basis of the assets of the worldwide affiliated
group. For purposes of determining the assets of such group, stock of
group members is not taken into account.
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Reasons for Change
The Congress believed that dispositions of corporate stock
should be subject to the special recapture rules for overall
foreign losses. Ownership of stock in a foreign subsidiary can
lead to, or increase, an overall foreign loss as a result of
interest expenses allocated against foreign-source income under
the interest expense allocation rules. The recapture of overall
foreign losses created by such interest expense allocations may
be avoided if, for example, the stock of the foreign subsidiary
subsequently were transferred to unaffiliated parties in non-
taxable transactions. The Congress believed that overall
foreign losses should be recaptured when stock of a controlled
foreign corporation is disposed of regardless of whether such
stock is disposed of in a nontaxable transaction.
Explanation of Provision
Under the Act, the special recapture rule for overall
foreign losses that currently applies to dispositions of
foreign trade or business assets applies to the disposition of
stock in a controlled foreign corporation controlled by the
taxpayer. Thus, a disposition of controlled foreign corporation
stock by a controlling shareholder results in the recognition
of foreign-source income in an amount equal to the lesser of
the fair market value of the stock over its adjusted basis, or
the amount of prior unrecaptured overall foreign losses. Such
income is resourced as U.S.-source income for foreign tax
credit limitation purposes without regard to the 50-percent
limit.
Although the Act generally extends to all dispositions of
such stock, regardless of whether gain or loss is recognized on
the transfer, exceptions are made for certain internal
restructurings. Contributions to corporations or partnerships
under sections 351 and 721, respectively, and certain stock and
asset reorganizations do not trigger recapture of overall
foreign losses, provided that the transferor's underlying
indirect interest in the disposed controlled foreign
corporation does not change. In addition, a disposition of
controlled foreign corporation stock in a transaction in which
the taxpayer or a member of its consolidated group acquires the
assets of the controlled foreign corporation in a liquidation
under section 332 or a reorganization does not trigger the
recapture of overall foreign losses. However, any gain
recognized in connection with a transaction meeting any of
these exceptions, such as boot, triggers recapture of overall
foreign losses to the extent of such gain.
Effective Date
The provision applies to dispositions after the date of
enactment (October 22, 2004).
16. Recognition of cancellation of indebtedness income realized on
satisfaction of debt with partnership interest (sec. 896 of the
Act and sec. 108 of the Code)
Present and Prior Law
A corporation that transfers shares of its stock in
satisfaction of its debt must recognize cancellation of
indebtedness income in the amount that would be realized if the
debt were satisfied with money equal to the fair market value
of the stock.\1005\ Prior to enactment of this provision in
1993, case law provided that a corporation did not recognize
cancellation of indebtedness income when it transferred stock
to a creditor in satisfaction of debt (referred to as the
``stock-for-debt exception'').\1006\
---------------------------------------------------------------------------
\1005\ Sec. 108(e)(8).
\1006\ E.g., Motor Mart Trust v. Commissioner, 4 T.C. 931 (1945),
aff'd, 156 F.2d 122 (1st Cir. 1946), acq. 1947-1 C.B. 3; Capento Sec.
Corp. v. Commissioner, 47 B.T.A. 691 (1942), nonacq. 1943 C.B. 28,
aff'd, 140 F.2d 382 (1st Cir. 1944); Tower Bldg. Corp. v. Commissioner,
6 T.C. 125 (1946), acq. 1947-1 C.B. 4; Alcazar Hotel, Inc. v.
Commissioner, 1 T.C. 872 (1943), acq. 1943 C.B. 1.
---------------------------------------------------------------------------
When cancellation of indebtedness income is realized by a
partnership, it generally is allocated among the partners in
accordance with the partnership agreement, provided the
allocations under the agreement have substantial economic
effect. A partner who is allocated cancellation of indebtedness
income is entitled to exclude it if the partner qualifies for
one of the various exceptions to recognition of such income,
including the exception for insolvent taxpayers or that for
qualified real property business indebtedness of taxpayers
other than subchapter C corporations.\1007\ The availability of
each of these exceptions is determined at the partner, rather
than the partnership, level.
---------------------------------------------------------------------------
\1007\ Sec. 108(a).
---------------------------------------------------------------------------
In the case of a partnership that transfers to a creditor a
capital or profits interest in the partnership in satisfaction
of its debt, no prior-law Code provision expressly required the
partnership to realize cancellation of indebtedness income.
Thus, it was unclear whether the partnership was required to
recognize cancellation of indebtedness income under either the
case law that established the stock-for-debt exception or the
statutory repeal of the stock-for-debt exception. It also was
unclear whether any requirement to recognize cancellation of
indebtedness income was affected if the cancelled debt is
nonrecourse indebtedness.\1008\
---------------------------------------------------------------------------
\1008\ See, e.g., Fulton Gold Corp. v. Commissioner, 31 B.T.A. 519
(1934); American Seating Co. v. Commissioner, 14 B.T.A. 328, aff'd in
part and rev'd in part, 50 F.2d 681 (7th Cir. 1931); Hiatt v.
Commissioner, 35 B.T.A. 292 (1937); Hotel Astoria, Inc. v.
Commissioner, 42 B.T.A. 759 (1940); Rev. Rul. 91-31, 1991-1 C.B. 19.
---------------------------------------------------------------------------
Reasons for Change
The Congress believed that further guidance was necessary
with regard to the application of the stock-for-debt exception
in the context of transfers of partnership interests in
satisfaction of partnership debt. In particular, the Congress
believed that it was necessary to clarify that the treatment of
corporate indebtedness that is satisfied with transfers of
stock of the debtor corporation also applies to partnership
indebtedness that is satisfied with transfers of capital or
profits interests in the debtor partnership.
Explanation of Provision
The Act provides that when a partnership transfers a
capital or profits interest in the partnership to a creditor in
satisfaction of partnership debt, the partnership generally
recognizes cancellation of indebtedness income in the amount
that would be recognized if the debt were satisfied with money
equal to the fair market value of the partnership interest. The
Act applies without regard to whether the cancelled debt is
recourse or nonrecourse indebtedness. Any cancellation of
indebtedness income recognized under the Act is allocated
solely among the partners who held interests in the partnership
immediately prior to the satisfaction of the debt.
Under the Act, no inference is intended as to the treatment
under prior law of the transfer of a partnership interest in
satisfaction of partnership debt.
Effective Date
The provision is effective for cancellations of
indebtedness occurring on or after the date of enactment
(October 22, 2004).
17. Denial of installment sale treatment for all readily tradable debt
(sec. 897 of the Act and sec. 453 of the Code)
Present and Prior Law
Taxpayers are permitted to recognize as gain on a
disposition of property only that proportion of payments
received in a taxable year which is the same as the proportion
that the gross profit bears to the total contract price (the
``installment method'').\1009\ However, the installment method
is not available if the taxpayer sells property in exchange for
a readily tradable evidence of indebtedness that is issued by a
corporation or a government or political subdivision.\1010\
---------------------------------------------------------------------------
\1009\ Sec. 453.
\1010\ Sec. 453(f)(3). Instead, the receipt of such indebtedness is
treated as a receipt of payment.
---------------------------------------------------------------------------
No similar provision under prior law prohibited the use of
the installment method where the taxpayer sells property in
exchange for readily tradable indebtedness issued by a
partnership or an individual.
Reasons for Change
The Congress believed that the prior-law exception from the
installment method for dispositions of property in exchange for
readily tradable debt was too narrow in scope and, in general,
should be extended to apply to all dispositions in exchange for
readily tradable debt, regardless of the nature of the issuer
of such debt.
Explanation of Provision
The Act denies installment sale treatment with respect to
all sales in which the taxpayer receives indebtedness that is
readily tradable regardless of the nature of the issuer. For
example, if the taxpayer receives readily tradable debt of a
partnership in a sale, the partnership debt is treated as
payment on the installment note, and the installment method is
unavailable to the taxpayer.
Effective Date
The provision is effective for sales occurring on or after
date of enactment (October 22, 2004).
18. Modify treatment of transfers to creditors in divisive
reorganizations (sec. 898 of the Act and secs. 357 and 361 of
the Code)
Present and Prior Law
Section 355 of the Code permits a corporation
(``distributing'') to separate its businesses by distributing a
controlled subsidiary (``controlled'') tax-free, if certain
conditions are met. In cases where the distributing corporation
contributes property to the controlled corporation that is to
be distributed, no gain or loss is recognized if the property
is contributed solely in exchange for stock or securities of
the controlled corporation (which are subsequently distributed
to distributing's shareholders). The contribution of property
to a controlled corporation that is followed by a distribution
of its stock and securities may qualify as a reorganization
described in section 368(a)(1)(D). That section also applies to
certain transactions that do not involve a distribution under
section 355 and that are considered 'acquisitive'' rather than
``divisive'' reorganizations.
The contribution in the course of either a divisive or an
acquisitive section 368(a)(1)(D) reorganization was subject to
the rules of section 357(c) under prior law. That section
provides that the transferor corporation will recognize gain if
the amount of liabilities assumed by controlled exceeds the
basis of the property transferred to it.
Because the contribution transaction in connection with a
section 355 distribution is a reorganization under section
368(a)(1)(D), it also was subject to certain other rules
applicable to both divisive and acquisitive reorganizations
under prior law. One such rule, in section 361(b), stated
generally under prior law that a transferor corporation will
not recognize gain if it receives money or other property and
distributes that money or other property to its shareholders or
creditors. The amount of property that may be distributed to
creditors without gain recognition was unlimited under this
provision for both divisive and acquisitive reorganizations.
Reasons for Change
The Congress was concerned that taxpayers engaged in
section 355 transactions could effectively avoid the rules that
require gain recognition if the controlled corporation assumes
liabilities of the transferor that exceed the basis of the
assets transferred to such corporation. This could occur
because of the rules of section 361(b), which state that the
transferor can receive money or other property from the
transferee without gain recognition, so long as the money or
property is distributed to creditors of the transferor. For
example, a transferor corporation could receive money from the
transferee corporation (e.g., money obtained from a borrowing
by the transferee) and use that money to pay the transferor's
creditors, without gain recognition. Such a transaction is
economically similar to the actual assumption by the transferee
of the transferor's liabilities, but was taxed differently
under prior law because section 361(b) did not contain a
limitation on the amount that can be distributed to creditors.
The Congress also believed that it was appropriate to
liberalize the treatment of acquisitive reorganizations that
are included under section 368(a)(1)(D). The Congress believed
that in these cases, the transferor should be permitted to
assume liabilities of the transferee without application of the
rules of section 357(c). This is because in an acquisitive
reorganization under section 368(a)(1)(D), the transferor must
generally transfer substantially all its assets to the
acquiring corporation and then go out of existence. Assumption
of its liabilities by the acquiring corporation thus does not
enrich the transferor corporation, which ceases to exist and
whose liability was limited to its assets in any event, by
corporate form. The Congress believed that it was appropriate
to conform the treatment of acquisitive reorganizations under
section 368(a)(1)(D) to that of other acquisitive
reorganizations.
Explanation of Provision
The Act limits the amount of money plus the fair market
value of other property that a distributing corporation can
distribute to its creditors without gain recognition under
section 361(b) in a divisive reorganization under section
368(a)(1)(D) to the amount of the basis of the assets
contributed to a controlled corporation in the divisive
reorganization.\1011\ In addition, the Act provides that
acquisitive reorganizations under section 368(a)(1)(D) are no
longer subject to the liabilities assumption rules of section
357(c).
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\1011\ It is not intended that basis may be double counted both for
this purpose and for purposes of section 357(c). It is intended that
the basis against which the amount of money plus the fair market value
of property distributed to creditors is measured under this provision
will be reduced by amounts treated as assumed liabilities under section
357. A technical correction may be necessary so that the statute
reflects this intent.
---------------------------------------------------------------------------
Effective Date
The provision is effective for transactions on or after the
date of enactment (October 22, 2004).
19. Clarify definition of nonqualified preferred stock (sec. 899 of the
Act and sec. 351(g) of the Code)
Present and Prior Law
The Taxpayer Relief Act of 1997 amended sections 351, 354,
355, 356, and 1036 to treat ``nonqualified preferred stock'' as
boot in corporate transactions, subject to certain exceptions.
For this purpose, preferred stock is defined as stock that is
``limited and preferred as to dividends and does not
participate in corporate growth to any significant extent.''
Nonqualified preferred stock is defined as any preferred stock
if (1) the holder has the right to require the issuer or a
related person to redeem or purchase the stock, (2) the issuer
or a related person is required to redeem or purchase, (3) the
issuer or a related person has the right to redeem or
repurchase, and, as of the issue date, it is more likely than
not that such right will be exercised, or (4) the dividend rate
varies in whole or in part (directly or indirectly) with
reference to interest rates, commodity prices, or similar
indices, regardless of whether such varying rate is provided as
an express term of the stock (as in the case of an adjustable
rate stock) or as a practical result of other aspects of the
stock (as in the case of auction stock). For this purpose,
clauses (1), (2), and (3) apply if the right or obligation may
be exercised within 20 years of the issue date and is not
subject to a contingency which, as of the issue date, makes
remote the likelihood of the redemption or purchase.
Reasons for Change
The Congress was concerned that taxpayers may attempt to
avoid characterization of an instrument as nonqualified
preferred stock by including illusory participation rights or
including terms that taxpayers argue create an ``unlimited''
dividend.
Clarification was desirable to conserve IRS resources that
otherwise might have to be devoted to this area.
Explanation of Provision
The Act clarifies the definition of nonqualified preferred
stock to ensure that stock for which there is not a real and
meaningful likelihood of actually participating in the earnings
and profits of the corporation is not considered to be outside
the definition of stock that is limited and preferred as to
dividends and does not participate in corporate growth to any
significant extent.\1012\
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\1012\ It is also intended that stock that by its terms appears not
to be limited or preferred as to dividends will be treated as limited
or preferred as to dividends if there is not a real and meaningful
likelihood that the stock will participate in earnings beyond a limited
or preference dividend. A technical correction may be necessary so that
the statute reflects this intent.
---------------------------------------------------------------------------
As one example, instruments that are preferred on
liquidation and that are entitled to the same dividends as may
be declared on common stock do not escape being nonqualified
preferred stock by reason of that right if the corporation does
not in fact pay dividends either to its common or preferred
stockholders. As another example, stock that entitles the
holder to a dividend that is the greater of seven percent or
the dividends common shareholders receive does not avoid being
preferred stock if the common shareholders are not expected to
receive dividends greater than seven percent.
No inference is intended as to the characterization of
stock under prior law that has terms providing for unlimited
dividends or participation rights but, based on all the facts
and circumstances, is limited and preferred as to dividends and
does not participate in corporate growth to any significant
extent.
Effective Date
The provision is effective for transactions after May 14,
2003.
20. Modify definition of controlled group of corporations (sec. 900 of
the Act and sec. 1563 of the Code)
Present and Prior Law
Under present law, a tax is imposed on the taxable income
of corporations. The rates are as follows:
MARGINAL FEDERAL CORPORATE INCOME TAX RATES
------------------------------------------------------------------------
Then the income tax rate is:
If taxable income is:
------------------------------------------------------------------------
$0-$50,000................................ 15 percent of taxable income
$50,001-$75,000........................... 25 percent of taxable income
$75,001-$10,000,000....................... 34 percent of taxable income
Over $10,000,000.......................... 35 percent of taxable income
------------------------------------------------------------------------
The first two graduated rates described above are phased
out by a five-percent surcharge for corporations with taxable
income between $100,000 and $335,000. Also, the application of
the 34-percent rate is phased out by a three-percent surcharge
for corporations with taxable income between $15 million and
$18,333,333.
The component members of a controlled group of corporations
are limited to one amount in each of the taxable income
brackets shown above.\1013\ For this purpose, a controlled
group of corporations means a parent-subsidiary controlled
group and a brother-sister controlled group.
---------------------------------------------------------------------------
\1013\ Component members are also limited to one alternative
minimum tax exemption and one accumulated earnings credit.
---------------------------------------------------------------------------
A brother-sister controlled group under prior law meant two
or more corporations if five or fewer persons who are
individuals, estates or trusts own (or constructively own)
stock possessing (1) at least 80 percent of the total combined
voting power of all classes of stock entitled to vote and at
least 80 percent of the total value of all stock, and (2) more
than 50 percent of percent of the total combined voting power
of all classes of stock entitled to vote or more than 50
percent of the total value of all stock, taking into account
the stock ownership of each person only to the extent the stock
ownership is identical with respect to each corporation.\1014\
---------------------------------------------------------------------------
\1014\ Sec. 1563(a)(2). The Supreme Court held in United States v.
Vogel Fertilizer, 455 U.S. 16 (1982), that Treas. Reg. sec. 1.1563-
1(a)(3), as it was then written, was invalid insofar as it would
require an individual's stock to be taken into account, for purposes of
the 80-percent brother-sister corporation ownership test, where that
individual did not own stock in each of the corporations in the
asserted controlled group. In that case, one corporation was owned
77.49 percent by one shareholder and 22.51 by an unrelated shareholder.
The 77.49 percent shareholder of that first corporation also owned 87.5
percent of the voting stock and more than 90 percent of the value of
the stock of a second corporation. The Supreme Court held the
corporations were not a controlled group, even though they would have
been one had the then applicable Treasury regulations been considered
valid in their application to the case. The Treasury regulations were
subsequently changed to conform to the Supreme Court decision. T.D.
8179, 53 F.R. 6603 (March 2, 1988).
---------------------------------------------------------------------------
Reasons for Change
The Congress was concerned that taxpayers may be able to
obtain benefits, such as multiple lower-bracket corporate tax
rates, through the use of corporations that are effectively
under common control even though the 80-percent test of present
law is not satisfied. The Congress believed it was appropriate
to eliminate the 80-percent test for purposes of the currently
effective provisions under section 1561 (corporate tax
brackets, the accumulated earnings credit, and the minimum
tax).
Explanation of Provision
Under the Act, a brother-sister controlled group means two
or more corporations if five or fewer persons who are
individuals, estates or trusts own (or constructively own)
stock possessing more than 50 percent of the total combined
voting power of all classes of stock entitled to vote, or more
than 50 percent of the total value of all stock, taking into
account the stock ownership of each person only to the extent
the stock ownership is identical with respect to each
corporation.
The Act applies only for purposes of section 1561,
currently relating to corporate tax brackets, the accumulated
earnings credit, and the minimum tax. The Act does not affect
other Code sections or other provisions that utilize or refer
to the section 1563 brother-sister corporation controlled group
test for other purposes.\1015\
---------------------------------------------------------------------------
\1015\ As one example, the Act does not change the present-law
standards relating to deferred compensation, contained in subchapter D
of the Code, that refer to section 1563.
---------------------------------------------------------------------------
Effective Date
The provision applies to taxable years beginning after the
date of enactment (October 22, 2004).
21. Establish specific class lives for utility grading costs (sec. 901
of the Act and sec. 168 of the Code)
Present and Prior Law
A taxpayer is allowed a depreciation deduction for the
exhaustion, wear and tear, and obsolescence of property that is
used in a trade or business or held for the production of
income. For most tangible property placed in service after
1986, the amount of the depreciation deduction is determined
under the modified accelerated cost recovery system (``MACRS'')
using a statutorily prescribed depreciation method, recovery
period, and placed in service convention. For some assets, the
recovery period for the asset is provided in section 168. In
other cases, the recovery period of an asset is determined by
reference to its class life. The class lives of assets placed
in service after 1986 are generally set forth in Revenue
Procedure 87-56.\1016\ If no class life is provided, the asset
is allowed a seven-year recovery period under MACRS.
---------------------------------------------------------------------------
\1016\ 1987-2 C.B. 674 (as clarified and modified by Rev. Proc. 88-
22, 1988-1 C.B. 785).
---------------------------------------------------------------------------
Assets that are used in the transmission and distribution
of electricity for sale are included in asset class 49.14, with
a class life of 30 years and a MACRS recovery period of 20
years. The cost of initially clearing and grading land
improvements are specifically excluded from asset class 49.14.
Prior to adoption of the accelerated cost recovery system, the
IRS ruled that an average useful life of 84 years for the
initial clearing and grading relating to electric transmission
lines and 46 years for the initial clearing and grading
relating to electric distribution lines, would be accepted.
However, the result in this ruling was not incorporated in the
asset classes included in Rev. Proc. 87-56 or its predecessors.
Accordingly, such costs are depreciated over a seven-year
recovery period under MACRS as assets for which no class life
is provided.
A similar situation exists with regard to gas utility trunk
pipelines and related storage facilities. Such assets are
included in asset class 49.24, with a class life of 22 years
and a MACRS recovery period of 15 years. Initial clearing and
grade improvements are specifically excluded from the asset
class, and no separate asset class is provided for such costs.
Accordingly, such costs are depreciated over a seven-year
recovery period under MACRS as assets for which no class life
is provided.
Reasons for Change
The Congress believed the clearing and grading costs in
question are incurred for the purpose of installing the
transmission lines or pipelines and are properly seen as part
of the cost of installing such lines or pipelines and their
cost should be recovered in the same manner. The clearing and
grading costs are not expected to have a useful life other than
the useful life of the transmission line or pipeline to which
they relate.
Explanation of Provision
The Act assigns a class life to depreciable electric and
gas utility clearing and grading costs incurred to locate
transmission and distribution lines and pipelines. The Act
includes these assets in the asset classes of the property to
which the clearing and grading costs relate (generally, asset
class 49.14 for electric utilities and asset class 49.24 for
gas utilities, giving these assets a recovery period of 20
years and 15 years, respectively).
Effective Date
The provision is effective for property placed in service
after the date of enactment (October 22, 2004).
22. Provide consistent amortization period for intangibles (sec. 902 of
the Act and secs. 195, 248, and 709 of the Code)
Present and Prior Law
At the election of the taxpayer, start-up
expenditures\1017\ and organizational expenditures\1018\ may be
amortized over a period of not less than 60 months, beginning
with the month in which the trade or business begins. Start-up
expenditures are amounts that would have been deductible as
trade or business expenses, had they not been paid or incurred
before business began. Organizational expenditures are
expenditures that are incident to the creation of a corporation
(sec. 248) or the organization of a partnership (sec. 709), are
chargeable to capital, and that would be eligible for
amortization had they been paid or incurred in connection with
the organization of a corporation or partnership with a limited
or ascertainable life.
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\1017\ Sec. 195
\1018\ Secs. 248 and 709.
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Treasury regulations\1019\ require that a taxpayer file an
election to amortize start-up expenditures no later than the
due date for the taxable year in which the trade or business
begins. The election must describe the trade or business,
indicate the period of amortization (not less than 60 months),
describe each start-up expenditure incurred, and indicate the
month in which the trade or business began. Similar
requirements apply to the election to amortize organizational
expenditures. A revised statement may be filed to include
start-up and organizational expenditures that were not included
on the original statement, but a taxpayer may not include as a
start-up expenditure any amount that was previously claimed as
a deduction.
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\1019\ Treas. Reg. sec. 1.195-1.
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Section 197 requires most acquired intangible assets (such
as goodwill, trademarks, franchises, and patents) that are held
in connection with the conduct of a trade or business or an
activity for the production of income to be amortized over 15
years beginning with the month in which the intangible was
acquired.
Reasons for Change
The Congress believed that allowing a fixed amount of
start-up and organizational expenditures to be deductible,
rather than requiring their amortization, may help encourage
the formation of new businesses that do not require significant
start-up or organizational costs to be incurred. In addition,
the Congress believed a consistent amortization period for
intangibles was appropriate.
Explanation of Provision
The Act modifies the treatment of start-up and
organizational expenditures. A taxpayer is allowed to elect to
deduct up to $5,000 of start-up and $5,000 of organizational
expenditures in the taxable year in which the trade or business
begins. However, each $5,000 amount is reduced (but not below
zero) by the amount by which the cumulative cost of start-up or
organizational expenditures exceeds $50,000, respectively.
Start-up and organizational expenditures that are not
deductible in the year in which the trade or business begins
would be amortized over a 15-year period consistent with the
amortization period for section 197 intangibles.
Effective Date
The provision is effective for start-up and organizational
expenditures incurred after the date of enactment (October 22,
2004). Start-up and organizational expenditures that are
incurred on or before the date of enactment (October 22, 2004)
continue to be eligible to be amortized over a period not to
exceed 60 months. However, all start-up and organizational
expenditures related to a particular trade or business, whether
incurred before or after the date of enactment (October 22,
2004), are considered in determining whether the cumulative
cost of start-up or organizational expenditures exceeds
$50,000.
23. Freeze of provision regarding suspension of interest where
Secretary fails to contact taxpayer (sec. 903 of the Act and
sec. 6404(g) of the Code)
Present and Prior Law
In general, interest and penalties accrue during periods
for which taxes were unpaid without regard to whether the
taxpayer was aware that there was tax due. The Code suspends
the accrual of certain penalties and interest after 1 year
after the filing of the tax return\1020\ if the IRS has not
sent the taxpayer a notice specifically stating the taxpayer's
liability and the basis for the liability within the specified
period.\1021\ With respect to taxable years beginning before
January 1, 2004, the one-year period is increased to 18 months.
Interest and penalties resume 21 days after the IRS sends the
required notice to the taxpayer. The provision is applied
separately with respect to each item or adjustment. The
provision does not apply where a taxpayer has self-assessed the
tax. The suspension only applies to taxpayers who file a timely
tax return. The provision applies only to individuals and does
not apply to the failure to pay penalty, in the case of fraud,
or with respect to criminal penalties.
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\1020\ If the return is filed before the due date, for this purpose
it is considered to have been filed on the due date.
\1021\ Sec. 6404(g). This provision was added to the Code by sec.
3305 of the IRS Restructuring and Reform Act of 1998 (Pub. L. No. 105-
206, July 22,1998).
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Explanation of Provision
The Act makes the 18-month rule the permanent rule. The Act
also adds gross misstatements\1022\ and listed and reportable
avoidance transactions\1023\ to the list of provisions to which
the suspension of interest rules do not apply.
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\1022\ This includes any substantial omission of items to which the
six-year statute of limitations applies (sec. 6051(e)), gross valuation
misstatements (sec. 6662(h)), and similar provisions.
\1023\ A reportable avoidance transaction is a reportable
transaction with a significant tax avoidance purpose.
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Effective Date
The provision is effective for taxable years beginning
after December 31, 2003,\1024\ except that the addition of
listed and reportable avoidance transactions applies to
interest accruing after October 3, 2004.
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\1024\ It is intended that this provision apply retroactively to
the period beginning January 1, 2004 and ending on the date of
enactment. The due date for returns for the taxable period beginning
January 1, 2004 is generally April 15, 2005; April 15, 2005 is
therefore the date from which the 12-month period that must pass under
present-law prior to the commencement of suspension is calculated.
Consequently, suspension of interest would generally not begin until
April 15, 2006. Accordingly, the provision has no actual retroactive
effect.
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24. Increase in withholding from supplemental wage payments in excess
of $1 million (sec. 904 of the Act and sec. 13273 of the
Revenue Reconciliation Act of 1993)
Present and Prior Law
An employer must withhold income taxes from wages paid to
employees; there are several possible methods for determining
the amount of income tax to be withheld. The IRS publishes
tables (Publication 15, ``Circular E'') to be used in
determining the amount of income tax to be withheld. The tables
generally reflect the income tax rates under the Code so that
withholding approximates the ultimate tax liability with
respect to the wage payments. In some cases, ``supplemental''
wage payments (e.g., bonuses or commissions) may be subject to
withholding at a flat rate,\1025\ based on the third lowest
income tax rate under the Code (25 percent for 2005).\1026\
Under prior law, special rules did not apply to wages in excess
of $1 million.
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\1025\ Sec. 13273 of the Revenue Reconciliation Act of 1993.
\1026\ Sec. 101(c)(11) of the Economic Growth and Tax Relief
Reconciliation Act of 2001.
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Reasons for Change\1027\
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\1027\ See S. 2424, the ``National Employee Savings and Trust
Equity Guarantee Act,'' which was reported by the Senate Committee on
Finance on May 14, 2004 (S. Rep. No. 108-266).
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The Congress believed that because most employees who
receive annual supplemental wage payments in excess of $1
million will ultimately be taxed at the highest marginal rate,
it is appropriate to raise the withholding rate on such
payments so that withholding more closely approximates the
ultimate tax liability with respect to these payments.
Explanation of Provision
Under the Act, once annual supplemental wage payments to an
employee exceed $1 million, any additional supplemental wage
payments to the employee in that year are subject to
withholding at the highest income tax rate (e.g., 35 percent
for 2004 and 2005), regardless of any other withholding rules
and regardless of the employee's Form W-4.
This rule applies only for purposes of wage withholding;
other types of withholding (such as pension withholding and
backup withholding) are not affected.
Effective Date
The provision is effective for payments made after December
31, 2004.
25. Capital gain treatment on sale of stock acquired from exercise of
statutory stock options to comply with conflict of interest
requirements (sec. 905 of the Act and sec. 421 of the Code)
Present and Prior Law
Statutory stock options
Generally, when an employee exercises a compensatory option
on employer stock, the difference between the option price and
the fair market value of the stock (i.e., the ``spread'') is
includible in income as compensation. Upon such exercise, an
employer is allowed a corresponding compensation deduction. In
the case of an incentive stock option or an option to purchase
stock under an employee stock purchase plan (collectively
referred to as ``statutory stock options''), the spread is not
included in income at the time of exercise.\1028\
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\1028\ Sec. 421.
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If an employee disposes of stock acquired upon the exercise
of a statutory option, the employee generally is taxed at
capital gains rates with respect to the excess of the fair
market value of the stock on the date of disposition over the
option price, and no compensation expense deduction is
allowable to the employer, unless the employee fails to meet a
holding period requirement. The employee fails to meet this
holding period requirement if the disposition occurs within two
years after the date the option is granted or one year after
the date the option is exercised. The gain upon a disposition
that occurs prior to the expiration of the applicable holding
period(s) (a ``disqualifying disposition'') does not qualify
for capital gains treatment. In the event of a disqualifying
disposition, the income attributable to the disposition is
treated by the employee as income received in the taxable year
in which the disposition occurs, and a corresponding deduction
is allowable to the employer for the taxable year in which the
disposition occurs.
Sale of property to comply with conflict of interest requirements
The Code provides special rules for recognizing gain on
sales of property which are required in order to comply with
certain conflict of interest requirements imposed by the
Federal Government.\1029\ Certain executive branch Federal
employees (and their spouses and minor or dependent children)
who are required to divest property in order to comply with
conflict of interest requirements may elect to postpone the
recognition of resulting gains by investing in certain
replacement property within a 60-day period. The basis of the
replacement property is reduced by the amount of the gain not
recognized. Permitted replacement property is limited to any
obligation of the United States or any diversified investment
fund approved by regulations issued by the Office of Government
Ethics. The rule applies only to sales under certificates of
divestiture issued by the President or the Director of the
Office of Government Ethics.
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\1029\ Sec. 1043.
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Reasons for Change\1030\
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\1030\ See S. 2424, the ``National Employee Savings and Trust
Equity Guarantee Act,'' which was reported by the Senate Committee on
Finance on May 14, 2004 (S. Rep. No. 108-266).
---------------------------------------------------------------------------
To comply with Federal conflict of interest requirements,
executive branch personnel may be required, before the
statutory holding period requirements have been satisfied, to
divest holdings of stock acquired pursuant to the exercise of
statutory stock options. Because Federal conflict of interest
requirements mandate the sale of such shares, the Congress
believed that such individuals should be afforded the tax
treatment that would be allowed had the individual held the
stock for the required holding period.
Explanation of Provision
Under the Act, an eligible person who, in order to comply
with Federal conflict of interest requirements, is required to
sell shares of stock acquired pursuant to the exercise of a
statutory stock option is treated as satisfying the statutory
holding period requirements, regardless of how long the stock
was actually held. An eligible person generally includes an
officer or employee of the executive branch of the Federal
Government (and any spouse or minor or dependent children whose
ownership in property is attributable to the officer or
employee). Because the sale is not treated as a disqualifying
disposition, the individual is afforded capital gain treatment
on any resulting gains. Such gains are eligible for deferral
treatment under section 1043.
The employer granting the option is not allowed a deduction
upon the sale of the stock by the individual.
Effective Date
The provision is effective for sales after the date of
enactment (October 22, 2004).
26. Application of basis rules to nonresident aliens (sec. 906 of the
Act sec. 83 and new sec. 72(w) of the Code)
Present and Prior Law
Distributions from retirement plans
Distributions from retirement plans are includible in gross
income under the rules relating to annuities\1031\ and, thus,
are generally includible in income, except to the extent the
amount received represents investment in the contract (i.e.,
the participant's basis). The participant's basis includes
amounts contributed by the participant on an after-tax basis,
together with certain amounts contributed by the employer,
minus the aggregate amount (if any) previously distributed to
the extent that such amount was excludable from gross income.
Amounts contributed by the employer are included in the
calculation of the participant's basis only to the extent that
such amounts were includible in the gross income of the
participant, or to the extent that such amounts would have been
excludable from the participant's gross income if they had been
paid directly to the participant at the time they were
contributed.\1032\
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\1031\ Secs. 72 and 402.
\1032\ Sec. 72(f).
---------------------------------------------------------------------------
Employer contributions to retirement plans and other
payments for labor or personal services performed outside the
United States by a nonresident alien generally are not treated
as U.S. source income. Such contributions, therefore, generally
would not be includible in the nonresident alien's gross income
if they had been paid directly to the nonresident alien at the
time they were contributed. Consequently, the amounts of such
contributions generally are includible in the employee's basis
and are not taxed by the United States if a distribution is
made when the employee is a U.S. citizen or resident.\1033\
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\1033\ Rev. Rul. 58-236, 1958-1 C.B. 37.
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Earnings on contributions are not included in basis unless
previously includible in income. In general, in the case of a
nonexempt trust, earnings are includible in income when
distributed or made available.\1034\ In the case of highly
compensated employees, the amount of the vested accrued benefit
under the trust (other than the employee's investment in the
contract) is generally required to be included in income
annually (to the extent not previously includible). That is,
earnings, as well as contributions, that are part of the vested
accrued benefit are currently includible in income.\1035\
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\1034\ Sec. 402(b)(2).
\1035\ Sec. 402(b)(4).
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Property transferred in connection with the performance of services
The Code contains rules governing the amount and timing of
income and deductions attributable to transfers of property in
connection with the performance of services. If, in connection
with the performance of services, property is transferred to
any person other than the person for whom such services are
performed, in general, an amount is includible in the gross
income of the person performing the services (the ``service
provider'') for the taxable year in which the property is first
vested (i.e., transferable or not subject to a substantial risk
of forfeiture).\1036\ The amount includible in the service
provider's income is the excess of the fair market value of the
property over the amount (if any) paid for the property. Basis
in such property includes any amount that is included in income
as a result of the transfer.\1037\
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\1036\ Sec. 83(a).
\1037\ Treas. Reg. sec. 1.61-2(d)(i).
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U.S. income tax treaties
Under the 1996 U.S. Model Income Tax Treaty (``U.S.
Model'') and some U.S. income tax treaties in force, retirement
plan distributions beneficially owned by a resident of a treaty
country in consideration for past employment generally are
taxable only by the individual recipient's country of
residence. Under the U.S. Model treaty and some U.S. income tax
treaties, this exclusive residence-based taxation rule is
limited to the taxation of amounts that were not previously
included in taxable income in the other country. For example,
if a treaty country had imposed tax on a resident individual
with respect to some portion of a retirement plan's earnings,
subsequent distributions to that person while a resident of the
United States would not be taxable in the United States to the
extent the distributions were attributable to such previously
taxed amounts.
Compensation of employees of foreign governments or international
organizations
Under section 893, wages, fees, and salaries of any
employee of a foreign government or international organization
(including a consular or other officer or a nondiplomatic
representative) received as compensation for official services
to the foreign government or international organization
generally are excluded from gross income when (1) the employee
is not a citizen of the United States, or is a citizen of the
Republic of the Philippines (whether or not a citizen of the
United States); (2) in the case of an employee of a foreign
government, the services are of a character similar to those
performed by employees of the United States in foreign
countries; and (3) in the case of an employee of a foreign
government, the foreign government grants an equivalent
exemption to employees of the United States performing similar
services in such foreign country. The Secretary of State
certifies the names of the foreign countries which grant an
equivalent exclusion to employees of the United States
performing services in those countries, and the character of
those services.
The exclusion does not apply to employees of controlled
commercial entities or employees of foreign governments whose
services are primarily in connection with commercial activity
(whether within or outside the United States) of the foreign
government.
Reasons for Change
The Congress believed the rules which governed the
calculation of basis provided an inflated basis in assets in
retirement and similar arrangements for many individuals who
became U.S. residents after accruing benefits under such
arrangements. The Congress believed the ability of former
nonresident aliens to receive tax-free distributions from such
arrangements of amounts which had not been previously taxed was
inconsistent with the taxation of benefits paid to individuals
who both accrue and receive distributions of benefits from such
arrangements as U.S. residents (i.e., basis generally includes
only previously-taxed amounts). The Congress believed that the
rule which allowed basis in contributions to such arrangements
for individuals who became U.S. residents after they accrued
benefits was inappropriate. While there was no comparable
statutory provision providing basis for earnings, the Congress
was aware that some taxpayers took the position that there was
basis in the earnings on such contributions, even though such
amounts had not been subject to tax. The Congress believed it
was appropriate to provide more equitable taxation with respect
to the distributions of both contributions and earnings from
such arrangements.
Explanation of Provision
Employee or employer contributions are not included in
basis (under sec. 72) if: (1) the employee was a nonresident
alien at the time the services were performed with respect to
which the contribution was made; (2) the contribution is with
respect to compensation for labor or personal services from
sources without the United States; and (3) the contribution was
not subject to income tax (and would have been subject to
income tax if paid as cash compensation when the services were
rendered) under the laws of the United States or any foreign
country.
Additionally, earnings on employer or employee
contributions are not included in basis if: (1) the earnings
are paid or accrued with respect to any employer or employee
contributions which were made with respect to compensation for
labor or personal services; (2) the employee was a nonresident
alien at the time the earnings were paid or accrued; and (3)
the earnings were not subject to income tax under the laws of
the United States or any foreign country.
The Act does not change the rules applicable to calculation
of basis with respect to contributions or earnings while an
employee is a U.S. resident.
There is no inference that the Act applies in any case to
create tax jurisdiction with respect to wages, fees, and
salaries otherwise exempt under section 893. Similarly, there
is no inference that the Act applies where contrary to an
agreement of the United States that has been validly authorized
by Congress (or in the case of a treaty, ratified by the
Senate), and which provides an exemption for income.
Most U.S. tax treaties specifically address the taxation of
pension distributions. The U.S. Model treaty provides for
exclusive residence-based taxation of pension distributions to
the extent such distributions were not previously included in
taxable income in the other country. For purposes of the U.S.
Model treaty, the United States treats any amount that has
increased the recipient's basis (as defined in sec. 72) as
having been previously included in taxable income. The
following example illustrates how the Act could affect the
amount of a distribution that may be taxed by the United States
pursuant to a tax treaty.
Assume the following facts. A, a nonresident alien
individual, performs services outside the United States, in A's
country of residence, country Z. A's employer makes
contributions on behalf of A to a pension plan established in
country Z. For U.S. tax purposes, no portion of the
contributions or earnings are included in A's income (and would
not be included in income if the amounts were paid as cash
compensation when the services were performed) because such
amounts relate to services performed without the United
States.\1038\ Later in time, A retires and becomes a permanent
resident of the United States.
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\1038\ Sec. 872.
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Under the Act, the employer contributions to the pension
plan would not be taken into account in determining A's basis
if A was not subject to income tax on the contributions by a
foreign country and the contributions would have been subject
to tax by a foreign country if the contributions had been paid
to A as cash compensation when the services were performed.
Thus, in those circumstances, A would be subject to U.S. tax on
the distribution of all of the contributions, as such
distributions are made. However, if the contributions would not
have been subject to tax in the foreign country if they had
been paid to A as cash compensation when the services were
performed, under the provision, the contributions would be
included in A's basis. Earnings that accrued while A was a
nonresident alien would not result in basis if not taxed under
U.S. or foreign law. Earnings that accrued while A was a
permanent resident of the United States would be subject to the
existing rules. This result generally is consistent with the
treatment of pension distributions under the U.S. Model treaty.
The Act authorizes the Secretary of the Treasury to issue
regulations to carry out the purposes of the Act, including
regulations treating contributions as not subject to income tax
under the laws of any foreign country under appropriate
circumstances. For example, Treasury could provide that foreign
income tax that was merely nominal would not satisfy the
``subject to income tax'' requirement.
The Act also changes the rules for determining basis in
property received in connection with the performance of
services in the case of an individual who was a nonresident
alien at the time of the performance of services, if the
property is treated as income from sources outside the United
States. In that case, the individual's basis in the property
does not include any amount that was not subject to income tax
(and would have been subject to income tax if paid as cash
compensation when the services were performed) under the laws
of the United States or any foreign country.
Effective Date
The provision is effective for distributions occurring on
or after the date of enactment (October 22, 2004). No inference
is intended that the earnings subject to the provision are
included in basis under the law in effect before the date of
enactment (October 22, 2004).
27. Deduction for personal use of company aircraft and other
entertainment expenses (sec. 907 of the Act and sec. 274(e) of
the Code)
Present and Prior Law
Under present and prior law, no deduction is allowed with
respect to (1) an activity generally considered to be
entertainment, amusement or recreation, unless the taxpayer
establishes that the item was directly related to (or, in
certain cases, associated with) the active conduct of the
taxpayer's trade or business, or (2) a facility (e.g., an
airplane) used in connection with such activity.\1039\ The Code
includes a number of exceptions to the general rule disallowing
deductions of entertainment expenses. Under one exception, the
deduction disallowance rule does not apply to expenses for
goods, services, and facilities to the extent that the expenses
are reported by the taxpayer as compensation and wages to an
employee.\1040\ The deduction disallowance rule also does not
apply to expenses paid or incurred by the taxpayer for goods,
services, and facilities to the extent that the expenses are
includible in the gross income of a recipient who is not an
employee (e.g., a nonemployee director) as compensation for
services rendered or as a prize or award.\1041\ The exceptions
apply only to the extent that amounts are properly reported by
the company as compensation and wages or otherwise includible
in income. In no event can the amount of the deduction exceed
the amount of the actual cost, even if a greater amount is
includible in income.
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\1039\ Sec. 274(a).
\1040\ Sec. 274(e)(2).
\1041\ Sec. 274(e)(9).
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Except as otherwise provided, gross income includes
compensation for services, including fees, commissions, fringe
benefits, and similar items. In general, an employee or other
service provider must include in gross income the amount by
which the fair value of a fringe benefit exceeds the amount
paid by the individual. Treasury regulations provide rules
regarding the valuation of fringe benefits, including flights
on an employer-provided aircraft.\1042\ In general, the value
of a non-commercial flight is determined under the base
aircraft valuation formula, also known as the Standard Industry
Fare Level formula or ``SIFL''.\1043\ If the SIFL valuation
rules do not apply, the value of a flight on a company-provided
aircraft is generally equal to the amount that an individual
would have to pay in an arm's-length transaction to charter the
same or a comparable aircraft for that period for the same or a
comparable flight.\1044\
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\1042\ Treas. Reg. sec. 1.61-21.
\1043\ Treas. Reg. sec. 1.61-21(g).
\1044\ Treas. Reg. sec. 1.61-21(b)(6).
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In the context of an employer providing an aircraft to
employees for nonbusiness (e.g., vacation) flights, the
exception for expenses treated as compensation was interpreted
by the Tax Court in 2000, as not limiting the company's
deduction for operation of the aircraft to the amount of
compensation reportable to its employees,\1045\ which can
result in a deduction multiple times larger than the amount
required to be included in income. In many cases, the
individual including amounts attributable to personal travel in
income directly benefits from the enhanced deduction, resulting
in a net deduction for the personal use of the company
aircraft.
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\1045\ Sutherland Lumber-Southwest, Inc. v. Comm., 114 T.C. 197
(2000), aff'd, 255 F.3d 495 (8th Cir. 2001), acq., AOD 2002-02 (Feb.
11, 2002).
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Explanation of Provision
Under the Act, in the case of specified individuals, the
exceptions to the general entertainment expense disallowance
rule for expenses treated as compensation or includible in
income apply only to the extent of the amount of expenses
treated as compensation or includible in income. Specified
individuals include individuals who, with respect to an
employer or other service recipient, are subject to the
requirements of section 16(a) of the Securities and Exchange
Act of 1934, or would be subject to such requirements if the
employer or service recipient were an issuer of equity
securities referred to in section 16(a). Such individuals
generally include officers (as defined by section 16(a)),\1046\
directors, and 10-percent-or-greater owners of private and
publicly-held companies. No deduction is allowed with respect
to expenses for (1) a nonbusiness activity generally considered
to be entertainment, amusement or recreation, or (2) a facility
(e.g., an airplane) used in connection with such activity to
the extent that such expenses exceed the amount treated as
compensation or includible in income to the specified
individuals. For example, a company's deduction attributable to
aircraft operating costs for a specified individual's vacation
use of a company aircraft is limited to the amount reported as
compensation to the individual. As under present and prior law,
the amount of the deduction cannot exceed the actual cost.
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\1046\ An officer is defined as the president, principal financial
officer, principal accounting officer (or, if there is no such
accounting officer, the controller), any vice-president in charge of a
principal business unit, division or function (such as sales,
administration or finance), any other officer who performs a policy-
making function, or any other person who performs similar policy-making
functions.
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The Act is intended to overturn Sutherland Lumber-
Southwest, Inc. v. Commissioner with respect to specified
individuals. As under present and prior law, the exceptions
apply only if amounts are properly reported by the company as
compensation and wages or otherwise includible in income.
Effective Date
The provision is effective for expenses incurred after the
date of enactment (October 22, 2004).
28. Residence and source rules related to a United States possession
(sec. 908 of the Act and new sec. 937 of the Code)
Present and Prior Law
In general
Generally, U.S. citizens are subject to U.S. income
taxation on their worldwide income. Thus, all income earned by
U.S. citizens is subject to U.S. income tax, regardless of its
source.
The U.S. income taxation of alien individuals varies
depending on whether they are resident or non-resident aliens.
A resident alien is generally taxed in the same manner as a
U.S. citizen.\1047\ In contrast, a nonresident alien is
generally subject to U.S. tax only on certain gross U.S. source
income at a flat 30 percent rate (unless such rate is
eliminated or reduced by treaty) and on net income that has a
sufficient nexus to the United States at the graduated rates
applicable to U.S. citizens and residents under section 1.
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\1047\ Section 7701(a)(30) defines a citizen or resident of the
United States as ``U.S. persons.''
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An alien is considered a resident of the United States if
the individual: (1) has entered the United States as a lawful
permanent resident and is such a resident at any time during
the calendar year, (2) is present in the United States for a
substantial period of time (the so-called ``substantial
presence test''), or (3) makes an election to be treated as a
resident of the United States (sec. 7701(b)). An alien who does
not meet the definition of a ``resident alien'' is considered
to be a non-resident alien for U.S. income tax purposes.
Under the substantial presence test, an alien individual is
generally treated as a resident alien if he or she is present
in the United States for 31 days during the taxable year and
the sum of the number of days on which such individual was
present in the United States (when multiplied by the applicable
multiplier) during the current year and the preceding two
calendar years equals or exceeds 183 days. The applicable
multiplier for the current year is one; the first preceding
year is one-third; and the second preceding year is one-sixth.
An alien individual who meets the above test may
nevertheless be a nonresident if he or she (1) is present in
the United States for fewer than 183 days during the current
year; (2) has a tax home in a foreign country during the year;
and (3) has a closer connection to that country than to the
United States.
For purposes of the substantial presence test, the United
States includes the states and the District of Columbia, but
does not include U.S. possessions. An individual is present in
the United States for a particular day if he or she is
physically present in the United States during any time during
such day. However, in certain circumstances an individual's
presence in the United States is ignored, including presence in
the United States as a result of certain medical emergencies.
U.S. income taxation of residents of U.S. possessions
Generally, special U.S. income tax rules apply with respect
to U.S. persons who are bona fide residents of certain U.S.
possessions (i.e., Puerto Rico, Virgins Islands, Guam, Northern
Mariana Islands and American Samoa) and who have possession
source income or income effectively connected to the conduct of
a trade or business within a possession.
Generally under prior law, a bona fide resident of a U.S.
possession (regardless of whether the individual is a U.S.
citizen or alien) was determined using the principles of a
subjective, facts-and-circumstances test set forth in the
regulations under section 871. Prior to the adoption of
present-law section 7701(b), this subjective test was used to
determine whether an alien individual was a resident of the
United States. Under these rules, an individual is generally a
resident of the United States if an individual (1) is actually
present in the United States, and (2) is not a mere transient
or sojourner.\1048\ Whether individuals are transients is
determined by their intentions with regard to the length and
nature of their stay. However, the regulations provide that
section 7701(b) (discussed above) provides the basis for
determining whether an alien individual is a resident of a U.S.
possession with a mirror income tax code.\1049\
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\1048\ Treas. Reg. sec. 1.871-2(b).
\1049\ A U.S. possession with a mirror income tax code is ``a
United States possession . . . that administers income tax laws that
are identical (except for the substitution of the name of the
possession or territory for the term `United States' where appropriate)
to those in the United States.'' Treas. Reg. sec. 7701(b)-1(d)(1).
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The principles that generally apply for determining income
from sources within and without the United States also
generally applied in determining income from sources within and
without a U.S. possession.\1050\ Under prior law, the Code and
regulations did not indicate how to determine whether income
was effectively connected with the conduct of a trade or
business within a U.S. possession. However, section 864(c)
provides rules for determining whether income is effectively
connected to a trade or business conducted within the United
States.
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\1050\ Treas. Reg. sec. 1.863-6.
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Information reporting
Section 7654(e) provides that Treasury may require
information reporting with respect to individuals that may take
advantage of certain special U.S. income tax rules with respect
to U.S. possessions. Section 6688 provides that an individual
may be subject to a $100 penalty if the individual fails to
furnish the information required by regulations issued pursuant
to section 7654(e).
Explanation of Provision
The Congress understood that certain U.S. citizens and
residents were claiming that they were exempt from U.S. income
tax on their worldwide income based on a position that they
were bona fide residents of the Virgin Islands or another
possession. However, these individuals often did not spend a
significant amount of time in the particular possession during
a taxable year and, in some cases, continued to live and work
in the United States. Under the Virgin Island's Economic
Development Program, many of these same individuals secured a
reduction of up to 90 percent of their Virgin Islands income
tax liability on income they took the position was Virgin
Islands source or effectively connected with the conduct of a
Virgin Islands trade or business. The Congress was also aware
that taxpayers were taking the position that income earned for
services performed in the United States was Virgin Islands
source or that their U.S. activities generated income
effectively connected with the conduct of a Virgin Islands
trade or business.
The Congress believed that the various exemptions from U.S.
tax provided to residents of possessions should not be
available to individuals who continue to live and work in the
United States. The Congress also believed that the special U.S.
income tax rules applicable to residents in a possession needed
to be rationalized. The Congress was further concerned that the
general rules for determining whether income was effectively
connected with the conduct of a trade or business in a
possession presented numerous opportunities for erosion of the
U.S. tax base.
Generally, the Act provides that the term ``bona fide
resident'' means a person who meets a two-part test with
respect to Guam, American Samoa, the Northern Mariana Islands,
Puerto Rico, or the Virgin Islands, as the case may be, for the
taxable year. First, an individual must be present in the
possession for at least 183 days in the taxable year. Second,
an individual must (i) not have a tax home outside such
possession during the taxable year and (ii) not have a closer
connection to the United States or a foreign country during
such year.
The Act also grants authority to Treasury to create
exceptions to these general rules as appropriate. The Congress
intends for such exceptions to cover, in particular, persons
whose presence outside a possession for extended periods of
time lacks a tax avoidance purpose, such as military personnel,
workers in the fisheries trade, and retirees who travel outside
the possession for certain personal reasons.
An individual is present in a possession for a particular
day if he is physically present in such possession during any
time during such day. In certain circumstances an individual's
presence outside a possession is ignored (e.g., certain medical
emergencies) as provided under the principles of section
7701(b).
The Act provides that a taxpayer must file a notice in the
first taxable year they claim bona fide residence in a
possession. The Act imposes a penalty of $1000 for the failure
to file such notice or to comply with any filing required by
regulation under section 7654(e).
The Act generally codifies the existing rules for
determining when income is considered to be from sources within
a possession by providing that, as a general rule, for all
purposes of the Code, the principles for determining whether
income is U.S. source are applicable for purposes of
determining whether income is possession source. In addition,
the Act provides that the principles for determining whether
income is effectively connected with the conduct of a U.S.
trade or business are applicable for purposes of determining
whether income is effectively connected to the conduct of a
possession trade or business. However, the Act further provides
that, except as provided in regulations, any income treated as
U.S. source income or as effectively connected with the conduct
of a U.S. trade or business is not treated as income from
within any possession or as effectively connected with a trade
or business within any such possession.
The Act also grants authority to the Secretary to create
exceptions to these general rules regarding possession source
income and income effectively connected with a possession trade
or business as appropriate. It is anticipated that this
authority will be used to continue the existing treatment of
income from the sale of goods manufactured in a possession. It
also is intended for this authority to be used to prevent
abuse, for example, to prevent U.S. persons from avoiding U.S.
tax on appreciated property by acquiring residence in a
possession prior to its disposition.
No inference is intended as to the prior-law rules for
determining (1) bona fide residence in a possession, (2)
whether income is possession source, and (3) whether income is
effectively connected with the conduct of a trade or business
within a possession.
Effective Date
Generally, the provision is effective for taxable years
ending after the date of enactment (October 22, 2004). The
first prong of the two-part residency test (i.e., the 183-day
test) is effective for taxable years beginning after date of
enactment (October 22, 2004). The general effective date
applies with respect to the second prong of such test. The rule
providing that income treated as U.S. source income or as
effectively connected with the conduct of a U.S. trade or
business is not treated as income from within any possession or
as effectively connected with the conduct of a trade or
business within any such possession is effective for income
earned after the date of enactment (October 22, 2004).
29. Dispositions of transmission property to implement Federal Energy
Regulatory Commission restructuring policy (sec. 909 of the Act
and sec. 451 of the Code)
Present and Prior Law
Generally, a taxpayer recognizes gain to the extent the
sales price (and any other consideration received) exceeds the
seller's basis in the property. The recognized gain is subject
to current income tax unless the gain is deferred or not
recognized under a special tax provision.
Reasons for Change \1051\
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\1051\ See H.R. 1531, the ``Energy Tax Policy Act of 2003,'' which
was reported by the Committee on Ways and Means on April 9, 2003 (H.R.
Rep. No. 108-67).
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The Congress recognized that electric deregulation has been
occurring, and is continuing to occur, at both the Federal and
State level. Federal and State energy regulators are calling
for the ``unbundling'' of electric transmission assets held by
vertically integrated utilities, with the transmission assets
ultimately placed under the ownership or control of independent
transmission providers (or other similarly-approved operators).
This policy is intended to improve transmission management and
facilitate the formation of competitive markets. To facilitate
the implementation of these policy objectives, the Congress
believed it was appropriate to assist taxpayers in moving
forward with industry restructuring by providing a tax deferral
for gain associated with certain dispositions of electric
transmission assets.
Explanation of Provision
The Act permits taxpayers to elect to recognize gain from
qualifying electric transmission transactions ratably over an
eight-year period beginning in the year of sale if the amount
realized from such sale is used to purchase exempt utility
property within the applicable period \1052\ (the
``reinvestment property''). If the amount realized exceeds the
amount used to purchase reinvestment property, any realized
gain shall be recognized to the extent of such excess in the
year of the qualifying electric transmission transaction. Any
remaining realized gain is recognized ratably over the eight-
year period.
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\1052\ The applicable period for a taxpayer to reinvest the
proceeds is four years after the close of the taxable year in which the
qualifying electric transmission transaction occurs.
---------------------------------------------------------------------------
A qualifying electric transmission transaction is the sale
or other disposition of property used by the taxpayer in the
trade or business of providing electric transmission services,
or an ownership interest in such an entity, to an independent
transmission company prior to January 1, 2007. In general, an
independent transmission company is defined as: (1) an
independent transmission provider \1053\ approved by the FERC;
(2) a person (i) who the FERC determines under section 203 of
the Federal Power Act (or by declaratory order) is not a
``market participant'' and (ii) whose transmission facilities
are placed under the operational control of a FERC-approved
independent transmission provider before the close of the
period specified in such authorization, but not later than
January 1, 2007; \1054\ or (3) in the case of facilities
subject to the jurisdiction of the Public Utility Commission of
Texas, (i) a person which is approved by that Commission as
consistent with Texas State law regarding an independent
transmission organization, or (ii) a political subdivision, or
affiliate thereof, whose transmission facilities are under the
operational control of an organization described in (i).
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\1053\ For example, a regional transmission organization, an
independent system operator, or and independent transmission company.
\1054\ A technical correction may be necessary so that the statute
reflects this intent.
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Exempt utility property is defined as: (1) property used in
the trade or business of generating, transmitting,
distributing, or selling electricity or producing,
transmitting, distributing, or selling natural gas, or (2)
stock in a controlled corporation whose principal trade or
business consists of the activities described in (1).
If a taxpayer is a member of an affiliated group of
corporations filing a consolidated return, the proposal permits
the reinvestment property to be purchased by any member of the
affiliated group (in lieu of the taxpayer).
If a taxpayer elects the application of the provision, then
the statutory period for the assessment of any deficiency, for
any taxable year in which any part of the gain eligible for the
provision is realized, attributable to such gain shall not
expire prior to the expiration of three years from the date the
Secretary of the Treasury is notified by the taxpayer of the
reinvestment property or an intention not to reinvest.
An electing taxpayer is required to attach a statement to
that effect in the tax return for the taxable year in which the
transaction takes place in the manner as the Secretary shall
prescribe. The election shall be binding for that taxable year
and all subsequent taxable years.\1055\ In addition, an
electing taxpayer is required to attach a statement that
identifies the reinvestment property in the manner as the
Secretary shall prescribe.
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\1055\ The Act also provides that the installment sale rules shall
not apply to any qualifying electric transmission transaction for which
a taxpayer elects the application of this provision.
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Effective Date
The provision is effective for transactions occurring after
the date of enactment (October 22, 2004), in taxable years
ending after such date.
30. Expansion of limitation on expensing of certain passenger
automobiles (sec. 910 of the Act and sec. 179 of the Code)
Present and Prior Law
A taxpayer is allowed to recover, through annual
depreciation deductions, the cost of certain property used in a
trade or business or for the production of income. The amount
of the depreciation deduction allowed with respect to tangible
property for a taxable year is determined under the modified
accelerated cost recovery system (``MACRS''). Under MACRS,
passenger automobiles generally are recovered over five years.
However, section 280F limits the annual depreciation deduction
with respect to certain passenger automobiles.\1056\
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\1056\ The limitation is commonly referred to as the ``luxury
automobile depreciation limitation.'' For passenger automobiles
(subject to the such limitation) placed in service in 2002, the maximum
amount of allowable depreciation is $7,660 for the year in which the
vehicle was placed in service, $4,900 for the second year, $2,950 for
the third year, and $1,775 for the fourth and later years. This
limitation applies to the combined depreciation deduction provided
under present law for depreciation, including section 179 expensing and
the temporary 30 percent additional first year depreciation allowance.
For luxury automobiles eligible for the 50 percent additional first
depreciation allowance, the first year limitation is increased by an
additional $3,050.
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For purposes of the depreciation limitation, passenger
automobiles are defined broadly to include any four-wheeled
vehicles that are manufactured primarily for use on public
streets, roads, and highways and which are rated at 6,000
pounds unloaded gross vehicle weight or less.\1057\ In the case
of a truck or a van, the depreciation limitation applies to
vehicles that are rated at 6,000 pounds gross vehicle weight or
less. Sports utility vehicles are treated as a truck for the
purpose of applying the section 280F limitation.
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\1057\ Sec. 280F(d)(5). Exceptions are provided for any ambulance,
hearse, or any vehicle used by the taxpayer directly in the trade or
business of transporting persons or property for compensation or hire.
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In lieu of depreciation, a taxpayer with a sufficiently
small amount of annual investment may elect to expense such
investment (sec. 179). The Jobs and Growth Tax Relief
Reconciliation Act (``JGTRRA'') of 2003 \1058\ increased the
amount a taxpayer may deduct, for taxable years beginning in
2003 through 2005, to $100,000 of the cost of qualifying
property placed in service for the taxable year.\1059\ In
general, qualifying property is defined as depreciable tangible
personal property that is purchased for use in the active
conduct of a trade or business. The $100,000 amount is reduced
(but not below zero) by the amount by which the cost of
qualifying property placed in service during the taxable year
exceeds $400,000. Prior to the enactment of JGTRRA (and for
taxable years beginning in 2006 and thereafter), a taxpayer
with a sufficiently small amount of annual investment may elect
to deduct up to $25,000 of the cost of qualifying property
placed in service for the taxable year. The $25,000 amount is
reduced (but not below zero) by the amount by which the cost of
qualifying property placed in service during the taxable year
exceeds $200,000. Passenger automobiles subject to section 280F
are eligible for section 179 expensing only to the extent of
the applicable limits contained in section 280F.
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\1058\ Pub. L. No. 108-27, sec. 202 (2003).
\1059\ Additional section 179 incentives are provided with respect
to a qualified property used by a business in the New York Liberty Zone
(sec. 1400L(f)), an empowerment zone (sec. 1397A), or a renewal
community (sec. 1400J).
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Reasons for Change
The Congress believed that section 179 expensing provides
two important benefits for small business. First, it lowers the
cost of capital for property used in a trade or business. With
a lower cost of capital, the Congress believed small business
would invest in more equipment and employ more workers. Second,
it eliminates depreciation recordkeeping requirements with
respect to expensed property. However, the Congress understood
that some taxpayers were using section 179 to lower the cost of
purchasing certain types of vehicles (1) that are not subject
to the luxury automobile limitations imposed by Congress and
(2) for which the specific features of such vehicle are not
necessary for purposes of conducting the taxpayer's business.
The Congress was concerned about such market distortions and
did not believe that the United States taxpayers should
subsidize a portion of such purchase. The provision places new
restrictions on the ability of certain vehicles to qualify for
the expensing provisions of section 179.
Explanation of Provision
The Act limits the ability of taxpayers to claim deductions
under section 179 for certain vehicles not subject to section
280F to $25,000. The Act applies to sport utility vehicles
rated at 14,000 pounds gross vehicle weight or less (in place
of the present law 6,000 pound rating). For this purpose, a
sport utility vehicle is defined to exclude any vehicle that:
(1) is designed for more than nine individuals in seating
rearward of the driver's seat; (2) is equipped with an open
cargo area, or a covered box not readily accessible from the
passenger compartment, of at least six feet in interior length;
or (3) has an integral enclosure, fully enclosing the driver
compartment and load carrying device, does not have seating
rearward of the driver's seat, and has no body section
protruding more than 30 inches ahead of the leading edge of the
windshield.
The following example illustrates the operation of the Act.
Example.--Assume that during 2004, on a date which is after
the date of enactment, a calendar year taxpayer acquires and
places in service a sport utility vehicle subject to the Act
that costs $70,000. In addition, assume that the property
otherwise qualifies for the expensing election under section
179. Under the Act, the taxpayer is first allowed a $25,000
deduction under section 179. The taxpayer is also allowed an
additional first-year depreciation deduction (sec. 168(k)) of
$22,500 based on $45,000 ($70,000 original cost less the
section 179 deduction of $25,000) of adjusted basis. Finally,
the remaining adjusted basis of $22,500 ($45,000 adjusted basis
less $22,500 additional first-year depreciation) is eligible
for an additional depreciation deduction of $4,500 under the
general depreciation rules (automobiles are five-year recovery
property). The remaining $18,000 of cost ($70,000 original cost
less $52,000 deductible currently) is recovered in 2005 and
subsequent years pursuant to the general depreciation rules.
Effective Date
The provision is effective for property placed in service
after the date of enactment (October 22, 2004).
PART EIGHTEEN: THE REVENUE PROVISIONS OF THE RONALD W. REAGAN NATIONAL
DEFENSE AUTHORIZATION ACT FOR FISCAL YEAR 2005 (PUBLIC LAW 108-375)
\1060\
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\1060\ H.R. 4200. The House Committee on Armed Services reported
the bill on May 14, 2004 (H.R. Rep. No. 108-491). The House passed the
bill on May 20, 2004. The Senate Committee on Armed Services reported
S. 2400 on May 11, 2004 (S. Rep. No. 108-260). The Senate passed H. R.
4200, as amended by the provisions of S. 2400, on June 23, 2004. The
conference report was filed on October 8, 2004 (H.R. Rep. No. 108-767),
and was passed by the House on October 9, 2004, and the Senate on
October 9, 2004. The President signed the bill on October 28, 2004.
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A. Exclusion from Gross Income of Travel Benefits under Operation Hero
Miles (sec. 585(b) of the Act and sec. 134 of the Code)
Present and Prior Law
Qualified military benefits are not included in gross
income. Generally, a qualified military benefit is any
allowance or in-kind benefit (other than personal use of a
vehicle) which: (1) is received by any member or former member
of the uniformed services of the United States or any dependent
of such member by reason of such member's status or service as
a member of such uniformed services; and (2) was excludable
from gross income on September 9, 1986, under any provision of
law, regulation, or administrative practice which was in effect
on such date. Generally, other than certain cost of living
adjustments, no modification or adjustment of any qualified
military benefit after September 9, 1986, is taken into account
for purposes of this exclusion from gross income.
Explanation of Provision
Under the Act, qualified military benefits include a travel
benefit provided under a Department of Defense program under
which travel benefits donated to the Department of Defense from
various sources (including members of the public) are used to:
(1) facilitate the travel while on leave of a member of the
armed forces who is serving on active duty outside the United
States; or (2) facilitate the travel of the family of a member
of the armed forces who is recuperating from a service-related
injury or illness, in order for the family to be reunited with
the member.\1061\ For this purpose, travel benefit means
frequent traveler miles, credits for tickets, or tickets for
air or surface transportation issued by an air carrier or a
surface carrier, respectively, that serves the public.
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\1061\ 10 U.S.C. section 2613. Authorization for this program,
referred to as ``Operation Hero Miles,'' is provided by section 585(a)
of the Act.
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Effective Date
The provision applies to travel benefits provided after the
date of the enactment of the Act (October 28, 2004).
PART NINETEEN: THE REVENUE PROVISIONS OF THE CONSOLIDATED
APPROPRIATIONS ACT, 2005 (PUBLIC LAW 108-447) \1062\
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\1062\ H.R. 4818. The House Committee on Appropriations reported
the bill as an original measure on July 13, 2004 (H.R. Rep. No. 108-
599). The House passed the bill on July 15, 2004. The Senate passed the
bill in lieu of S. 2812 with an amendment on September 23, 2004. The
conference report was filed on November 20, 2004 (H.R. Rep. No. 108-
792) and was passed by the House and the Senate on November 20, 2004.
The bill was signed by the President on December 8, 2004.
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A. Application of the ERISA Anticutback Rules to Certain Multiemployer
Plan Amendments (Division J, sec. 110 of the Act and sec. 204(g) of
ERISA)
Present and Prior Law
Under the Code and the Employee Retirement Income Security
Act of 1974 (``ERISA''), a participant's accrued benefit under
a qualified retirement plan must become vested (or
nonforfeitable) in accordance with one of two alternative
minimum vesting schedules.\1063\ For this purpose, an accrued
benefit under a multiemployer plan is not treated as
forfeitable solely because the plan provides that benefit
payments are suspended for the period that the employee is
employed, after benefits commence, in the same industry, in the
same trade or craft, and in the same geographic area covered by
the plan as when payments commenced.
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\1063\ Code sec. 411; ERISA sec. 203.
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Under the ``anticutback'' rule of the Code and ERISA, a
plan amendment may not reduce participants' accrued
benefits.\1064\ An amendment also violates the anticutback rule
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.
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\1064\ Code sec. 411(d)(6); ERISA sec. 204(g).
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On June 7, 2004, the Supreme Court held that an amendment
to a multiemployer plan that expanded the circumstances in
which a participant's benefit payments were suspended and that
applied to previously accrued benefits violated the anticutback
rule.\1065\
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\1065\ Central Laborers' Pension Fund v. Heinz, 541 U.S. 739
(2004).
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Explanation of Provision
The Act limits the application of the anticutback rule of
ERISA to a plan amendment adopted before June 7, 2004, by a
multiemployer pension plan covering primarily employees working
in the State of Alaska. Under the Act, the anticutback rule of
ERISA does not apply at any time (whether before or after
enactment of the provision) to the extent that the plan
amendment: (1) provides for the suspension of the payment of
benefits, modifies the conditions under which the payment of
benefits is suspended, or suspends certain actuarial
adjustments in benefit payments; and (2) applies to
participants who have not retired before the adoption of the
amendment. The Act does not change the application of the
anticutback rule of the Code to such a plan amendment.
Effective Date
The provision is effective on the date of enactment
(October 22, 2004).
PART TWENTY: AN ACT TO TREAT CERTAIN ARRANGEMENTS MAINTAINED BY THE
YMCA RETIREMENT FUND AS CHURCH PLANS FOR PURPOSES OF CERTAIN PROVISIONS
OF THE INTERNAL REVENUE CODE OF 1986, AND FOR OTHER PURPOSES (PUBLIC
LAW 108-476) \1066\
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\1066\ H.R. 5365. The House passed the bill on a motion to suspend
the rules and pass the bill on November 19, 2004. The Senate passed the
bill without amendment by unanimous consent on December 7, 2004. The
President signed the bill on December 21, 2004.
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A. Certain Arrangements Maintained by the YMCA Retirement Fund Treated
as Church Plans (sec. 1 of the Act and secs. 401(a), 403(b), and
7702(j) of the Code)
Present and Prior Law
Special retirement plan rules for church plans
In general
Tax-favored retirement plans are subject to various
requirements under the Code. However, church plans are exempt
from some of these requirements or are subject to special
rules. In general, a church plan is a plan established and
maintained for its employees by a church or by a convention or
association of churches that is exempt from tax.\1067\ In
addition, the term ``church plan'' includes a plan established
or maintained by an organization: (1) that is controlled by or
associated with a church and (2) the principal purpose or
function of which is the administration or funding of a
retirement or welfare benefit plan or program for church
employees. Such organizations are referred to here as ``church-
associated organizations.''
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\1067\ Sec. 414(e).
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Retirement plans are generally subject to the requirements
of the Employee Retirement Income Security Act of 1974
(``ERISA''), as well as to the requirements of the Code.
However, church plans generally are exempt from ERISA.
Tax-sheltered annuities
Favorable tax treatment applies to annuity contracts
purchased for an employee by an employer that is a tax-exempt
charitable organization or an educational institution and that
meet certain requirements (``tax-sheltered annuities'').\1068\
For this purpose, a ``retirement income account'' is treated as
an annuity contract. A retirement income account means a
defined contribution program established or maintained by a
church or a convention or association of churches or a church-
associated organization. Subject to certain exceptions, the
same rules apply to retirement income accounts that apply to
tax-sheltered annuities, except that the purchase of an annuity
contract is not required.
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\1068\ Sec. 403(b).
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Tax-sheltered annuity contracts must be purchased under a
plan that meets certain nondiscrimination requirements. The
nondiscrimination requirements do not apply to an annuity
contract purchased by a church, a convention or association of
churches, or certain church-controlled organizations.\1069\
Contributions to a tax-sheltered annuity are generally subject
to limitations, but a higher limitation may apply to a tax-
sheltered annuity maintained by a church.\1070\
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\1069\ For purposes of the exemption from the nondiscrimination
rules, church and church-controlled organization are defined as in
section 3121(w)(3). This definition generally applies to a narrower
class of organizations than the definition of church plan in section
414(e).
\1070\ Sec. 415(c)(7).
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Minimum distribution rules apply to tax-favored retirement
arrangements, including tax-sheltered annuities.\1071\ Special
minimum distribution rules apply to payments from an annuity
contract purchased with an employee's benefit by a plan from an
insurance company.\1072\ Annuity payments from a retirement
income account may be eligible for these special minimum
distribution rules even though the payments are not made under
an annuity contract purchased from an insurance company.\1073\
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\1071\ Secs. 401(a)(9) and 403(b)(10).
\1072\ Treas. Reg. sec. 1.401(a)(9)-6, A-4.
\1073\ Treas. Reg. sec. 1.403(b)-3, A-1(c)(3).
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Qualified retirement plans
Church plans are exempt from many of the rules that apply
to qualified retirement plans, unless the church elects to have
the requirements apply.\1074\ For example, unless such an
election has been made, a church plan is exempt from: (1) the
prohibition on assignment or alienation of benefits (sec.
401(a)(13)); (2) joint and survivor annuity requirements (sec.
401(a)(11)); (3) vesting requirements and anti-cutback
protections (sec. 411); (4) funding requirements (sec. 412);
and (5) prohibited transaction rules (sec. 4975).
---------------------------------------------------------------------------
\1074\ Sec. 410(d). A church plan with respect to which such an
election has been made is referred to as an ``electing'' church plan.
Electing church plans are subject to ERISA.
---------------------------------------------------------------------------
Under the joint and survivor annuity rules, a plan is
generally required to provide benefits in the form of a
qualified joint and survivor annuity (``QJSA'') unless the
participant and his or her spouse consent to another form of
benefit. A QJSA is an annuity for the life of the participant,
with a survivor annuity for the life of the spouse that is not
less than 50 percent (and not more than 100 percent) of the
amount of the annuity payable during the joint lives of the
participant and his or her spouse.
The joint and survivor annuity requirements generally do
not apply to defined contribution plans other than money
purchase pension plans. A money purchase pension plan is a type
of defined contribution plan that provides for a set level of
required employer contributions, generally as a specified
percentage of participants' compensation, and for the
distribution of benefits in the form of an annuity.
Special life insurance rule for church plans
The Code contains a definition of the term ``life insurance
contract,'' which applies for purposes of the Code, including
the exclusion from gross income for the proceeds of a life
insurance contract paid by reason of the death of the
insured.\1075\ This definition generally requires the contract
to be a life insurance contract under applicable law. However,
this requirement does not apply to a plan or arrangement that
provides for the payment of benefits by reason of the death of
individuals covered under the plan or arrangement and that is
provided by a church for the benefit of its employees and their
beneficiaries, either directly or through a church-associated
organization.
---------------------------------------------------------------------------
\1075\ Sec. 101(a).
---------------------------------------------------------------------------
Retirement plans maintained by the YMCA Retirement Fund
Employees of the Young Men's Christian Association
(``YMCA'') are covered by two plans maintained by the YMCA
Retirement Fund.\1076\ The YMCA Retirement Plan provides for
employer contributions and after-tax employee contributions and
is designed to be a qualified money purchase pension plan. The
YMCA Tax-Deferred Contribution Plan allows employees to make
pretax contributions under salary reduction agreements and is
designed to be a tax-sheltered annuity arrangement.
Contributions under both plans are maintained in accounts under
the YMCA Retirement Fund. Benefits under the plans are payable
in the form of annuities without the purchase of commercial
annuity contracts. Besides retirement benefits, the plans
provide benefits in the case of death or disability.
---------------------------------------------------------------------------
\1076\ The YMCA Retirement Fund is a corporation created by an Act
of the State of New York that became law on April 30, 1921 (1921 New
York Laws, Chapter 459).
---------------------------------------------------------------------------
Explanation of Provision
The Act specifies the treatment of the retirement plans
maintained by the YMCA Retirement Fund for certain purposes of
the Code. In general, under the Act, for purposes of the rules
governing qualified retirement plans and tax-sheltered
annuities, any retirement plan maintained by the YMCA
Retirement Fund as of January 1, 2003 (a ``YMCA retirement
plan''), is treated as a church plan maintained by a church-
associated organization.
In the case of a YMCA retirement plan that allows
contributions to be made under a salary reduction agreement
(i.e., the YMCA Tax-Deferred Contribution Plan), church plan
treatment does not apply for purposes of the special
contribution limit applicable to tax-sheltered annuities
maintained by churches. In addition, any account maintained for
a participant or beneficiary of the plan is treated for
purposes of the Code as a retirement income account. However,
an account is not treated as an annuity contract purchased by a
church for purposes of the nondiscrimination rules applicable
to tax-sheltered annuities.
In the case of a YMCA retirement plan that is subject to
the qualification requirements of the Code (i.e., the YMCA
Retirement Plan), the plan (but not any reserves held by the
YMCA Retirement Fund) is treated for purposes of the Code as a
defined contribution plan that is a money purchase pension
plan. In addition, the plan is treated as having made an
election under section 410(d) for plan years beginning after
December 31, 2005. Thus, the plan is treated as an electing
church plan for plan years beginning after December 31, 2005.
Notwithstanding the election, nothing in ERISA or the Code
shall prohibit the YMCA Retirement Fund from commingling for
investment purposes the assets of the electing plan with the
assets of the Fund and with the assets of any employee benefit
plan maintained by the Fund. In addition, nothing in the Act is
to be construed as subjecting any commingled assets, other than
the assets of the electing plan, to any provision of ERISA. The
Act also allows the plan, notwithstanding the joint and
survivor annuity rules of the Code and ERISA, to offer a lump-
sum distribution option to participants who have not attained
age 55 without offering such participants an annuity option. In
addition, any account maintained for a participant or
beneficiary of the plan is treated as a retirement income
account for purposes of the minimum distribution rules.
For purposes of the definition of life insurance contract
under the Code, a YMCA retirement plan is treated as an
arrangement that provides for the payment of benefits by reason
of the death of individuals covered under the arrangement and
that is provided by a church for the benefit of its employees
and their beneficiaries, directly or through a church-
associated organization.
Effective Date
The provision is effective for plan years beginning after
December 31, 2003.
PART TWENTY-ONE: AN ACT TO MODIFY THE TAXATION OF ARROW COMPONENTS
(PUBLIC LAW 108-493) \1077\
---------------------------------------------------------------------------
\1077\ H.R. 5394 was introduced on November 19, 2004. It was passed
by the House under suspension of the rules on December 6, 2004. The
Senate passed the measure by unanimous consent on December 8, 2004. The
President signed the measure on December 23, 2004.
---------------------------------------------------------------------------
A. Excise Tax on Arrows (sec. 1 of the Act and sec. 4161 of the Code)
Present and Prior Law
Under prior law, section 332(b) of the AJCA imposed a 12-
percent tax on the sale by the manufacturer, importer or
producer of arrows generally. An arrow for this purpose was
defined as a taxable arrow shaft to which additional components
are attached. In the case of any arrow comprised of a shaft or
any other component upon which tax has been imposed, the amount
of the arrow tax was equal to the excess of (1) the arrow tax
that would have been imposed but for this exception, over (2)
the amount of tax paid with respect to such components.\1078\
---------------------------------------------------------------------------
\1078\ Under present and prior law, a credit or refund may be
obtained when an item was taxed and it is used in the manufacture or
production of another taxable item. Sec. 6416(b)(3). As arrow
components and finished arrows are both taxable, in lieu of a refund of
the tax paid on components, the provision suspended the application of
sec. 6416(b)(3) and permitted the taxpayer to reduce the tax due on the
finished arrow by the amount of the previous tax paid on the components
used in the manufacture of such arrow.
---------------------------------------------------------------------------
Present and prior law also imposes an 11-percent excise tax
on the sale by the manufacturer, importer or producer of any
part of an accessory for taxable bows, and any quivers or
broadheads for use with arrows (1) over 18 inches long or (2)
designed for use with a taxable bow (if shorter than 18
inches).
Prior law imposed a 12.4 percent excise tax on the sale by
the manufacturer, importer or producer of certain arrow
components. Under prior law points (other than broadheads) were
taxed at 12.4 percent as arrow components.
Explanation of Provision \1079\
---------------------------------------------------------------------------
\1079\ Section 332 of AJCA made two changes unaffected by Pub. L.
No. 108-493: (1) increased the draw weight for a taxable bow from 10
pounds or more to a peak draw weight of 30 pounds or more; and (2)
subjected certain broadheads (a type of arrow point) to an excise tax
equal to 11 percent of the sales price instead of 12.4 percent.
---------------------------------------------------------------------------
The Act repealed the 12-percent excise tax on arrows
imposed by section 332(b) of AJCA and required that the law be
administered as if that provision was never enacted. In
addition, after March 31, 2005, the 12.4-percent tax on arrow
components is repealed and replaced with a tax equal to 39
cents per arrow shaft on the first sale of such shaft (whether
sold separately or incorporated as part of a finished or
unfinished product). Points are subject to the 11-percent
excise tax imposed on accessories. A 39-cent amount is adjusted
for inflation after 2005.
Effective Dates
The provisions relating to the tax on shafts and points are
effective for articles sold by the manufacturer, producer or
importer after March 31, 2005.
=======================================================================
APPENDIX:
ESTIMATED BUDGET EFFECTS OF TAX LEGISLATION
ENACTED IN THE 108TH CONGRESS
=======================================================================
APPENDIX:
ESTIMATED BUDGET EFFECTS OF TAX LEGISLATION ENACTED IN THE 108TH CONGRESS
Fiscal Years 2003-2014
[Millions of dollars]
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Provision Effective 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2003-14
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
PART ONE: JOBS AND GROWTH TAX RELIEF
I. Acceleration of Certain Previously
Enacted Tax Reductions
1. Expand the child credit to $1,000 for tyba 12/31/02.................. -13,712 -5,820 -12,956 .......... .......... .......... .......... .......... .......... .......... .......... .......... -32,488
2003 through 2004; revert to present-law
phase in for 2005 (\1\)..................
2. Accelerate the expansion of the 15% tyba 12/31/02.................. -4,936 -24,904 -5,234 .......... .......... .......... .......... .......... .......... .......... .......... .......... -35,074
individual income tax rate bracket and
the increase in the standard deduction
for married taxpayers filing joint
returns; revert to present-law phase in
for 2005.................................
3. Accelerate the expansion of the 10% tyba 12/31/02.................. -1,549 -8,445 -1,912 .......... .......... .......... .......... .......... .......... .......... .......... .......... -11,906
bracket; revert to present-law phase in
for 2005.................................
4. Accelerate the 2006 rate schedule..... tyba 12/31/02.................. -9,531 -38,809 -19,930 -5,915 .......... .......... .......... .......... .......... .......... .......... .......... -74,185
5. Increase individual AMT exemption tyba 12/31/02.................. -1,176 -10,346 -6,260 .......... .......... .......... .......... .......... .......... .......... .......... .......... -17,782
amount by $4,500 single and $9,000 joint
for 2003 and 2004........................
Total of Acceleration of Certain ............................... -30,904 -88,324 -46,292 -5,915 .......... .......... .......... .......... .......... .......... .......... .......... -171,435
Previously Enacted Tax Reductions
II. Growth Incentives for Business
1. Increase bonus depreciation to 50% and ppisa 5/5/03 (\2\)............. -9,918 -33,298 -11,684 9,414 9,300 8,112 6,648 4,987 3,586 2,212 1,447 .......... -9,194
extend through 12/31/04..................
2. Increase section 179 expensing-- tyba 12/31/02.................. -1,647 -2,681 -3,690 -1,027 2,724 1,842 1,290 937 647 410 243 .......... -952
increase the amount that can be expensed
from $25,000 to $100,000 and increase the
phaseout threshold amount from $200,000
to $400,000; include software in section
179 property; and index both the
deduction limit and the phaseout
threshold after 2003 (sunset after 2005).
Total of Growth Incentives for ............................... -11,565 -35,979 -15,374 8,387 12,024 9,954 7,938 5,924 4,233 2,622 1,690 .......... -10,146
Business.............................
III. Reductions in Taxes on Dividends and
Capital Gains
1. Tax capital gains with a 15%/5% rate so/a 5/6/03.................... -62 -928 -1,335 -3,042 -4,454 -3,544 509 -9,532 .......... .......... .......... .......... -22,386
structure for 2003 through 2007, and
15%/0% in 2008 (sunset
12/31/08)...............................
2. Tax dividends with a 15%/5% rate dri tyba....................... -4,250 -17,506 -19,215 -20,081 -21,263 -23,203 -19,689 -493 .......... .......... .......... .......... -125,700
structure for 2003 through 2007, and 15%/ 12/31/02.......................
0% in 2008 (sunset 12/31/08) (\3\).......
Total of Reductions in Taxes on ............................... -4,312 -18,434 -20,550 -23,123 -25,717 -26,747 -19,180 -10,025 .......... .......... .......... .......... -148,086
Dividends and Capital Gains..........
IV. Temporary State Fiscal Relief Fund DOE............................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
(outlay effects) (\4\).....................
V. Special Estimated Tax Rules for Certain DOE............................ -6,325 6,325 ......... .......... .......... .......... .......... .......... .......... .......... .......... .......... ...........
Corporate Estimated Tax Payments (25% of
estimated payments otherwise due on
September 15, 2003 are payable on October
1, 2003)...................................
TOTAL OF PART ONE: JOBS AND GROWTH TAX ............................... -53,106 -136,412 -82,216 -20,651 -13,693 -16,793 -11,242 -4,101 4,233 2,622 1,690 .......... -329,667
RELIEF RECONCILIATION ACT OF 2003..........
PART TWO: SURFACE TRANSPORTATION EXTENSION DOE............................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
ACT OF 2003--Extension of Highway Trust
Fund and Aquatic Resources Trust Fund
Expenditure Authority (P.L. 108-88, signed
into law by the President on September 30,
2003)......................................
PART THREE: EXTEND THE TEMPORARY ASSISTANCE
FOR NEEDY FAMILIES BLOCK GRANT PROGRAM, AND
CERTAIN TAX AND TRADE PROGRAMS (P.L. 108-
89, signed into law by the President on
October 1, 2003)
I. Disclosure of Return Information DOE............................ ......... .......... ......... The Congressional Budget Office Did Not Estimate This Provision .......... .......... ...........
Relating to Student Loans (\4\)............
II. Extension of IRS User Fees (through 12/ rma DOE........................ ......... 33 8 .......... .......... .......... .......... .......... .......... .......... .......... .......... 41
31/04) (\4\)...............................
III. Extension of Customs User Fees DOE............................ ......... 698 ......... .......... .......... .......... .......... .......... .......... .......... .......... .......... 698
(through
3/31/04) (\4\)............................
TOTAL OF PART THREE: EXTEND THE TEMPORARY ............................... ......... 731 8 .......... .......... .......... .......... .......... .......... .......... .......... .......... 739
ASSISTANCE FOR NEEDY FAMILIES BLOCK GRANT
PROGRAM, AND CERTAIN TAX AND TRADE PROGRAMS
PART FOUR: MILITARY FAMILY TAX RELIEF ACT OF
2003 (P.L. 108-121, signed into law by the
President on November 11, 2003)
I. Provisions to Improve Tax Equity for
Military Personnel
1. Exclusion of gain on sale of a soea 5/6/97.................... ......... -68 -14 -14 -15 -15 -16 -17 -17 -18 -18 .......... -212
principal residence by a member of the
uniformed and foreign services...........
2. Treatment of death gratuities payable
with respect to deceased members of the
armed forces:
a. Increase the death gratuity benefit Doo/a 9/11/01.................. ......... -33 -9 -9 -9 -9 -8 -8 -8 -8 -8 .......... -112
for members of the armed forces to
$12,000 (outlays)......................
b. Exclusion from gross income of doa 9/10/01.................... ......... -2 -1 -1 -1 -1 -1 -1 -1 -1 -1 .......... -10
certain death gratuity payments........
3. Exclusion for amounts received under pma DOE........................ ......... (\5\) -2 -2 -2 -2 -2 -2 -2 -2 -2 .......... -19
Department of Defense Homeowners
Assistance Program.......................
4. Expansion of combat zone filing rules (\6\).......................... ......... -9 (\5\) (\5\) (\5\) -1 -1 -1 -1 -1 -1 .......... -13
to contingency operations................
5. Modification of membership requirement tyba DOE....................... ......... (\5\) -1 -1 -2 -2 -2 -2 -2 -2 -2 .......... -17
for exemption from tax for certain
veterans' organizations..................
6. Clarification of treatment of certain tyba 12/31/02.................. ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
dependent care assistance programs
provided to members of the uniformed
services of the United States............
7. Treatment of service academy tyba 12/31/02.................. ......... (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) .......... -2
appointments as scholarships for purposes
of qualified tuition programs and
Coverdell Education Savings Accounts.....
8. Suspension of tax-exempt status of dmbo/a......................... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
terrorist organizations.................. DOE............................
9. Above-the-line deduction for overnight apoi tyba...................... ......... -90 -77 -78 -80 -82 -84 -87 -89 -91 -93 .......... -851
travel expenses (not exceeding per diem 12/31/02.......................
levels) of National Guard and reserve
members traveling more than 100 miles
from home................................
10. Tax relief and assistance for (\7\).......................... ......... (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) .......... (\5\)
families of astronauts who lose their
lives in the line of duty................
Total of Provisions to Improve Tax ............................... ......... -202 -104 -105 -109 -112 -114 -118 -120 -123 -125 .......... -1,236
Equity for Military Personnel........
II. Extension of Customs User Fees
1. Passenger and c o n vey- DOE............................ ......... 75 206 .......... .......... .......... .......... .......... .......... .......... .......... .......... 281
ance processing fee (through 3/1/05)
(\4\)....................................
2. Merchandise processing fee (through 3/ DOE............................ ......... 545 480 .......... .......... .......... .......... .......... .......... .......... .......... .......... 1,025
1/05) (\4\)..............................
Total of Extension of Customs User ............................... ......... 619 686 .......... .......... .......... .......... .......... .......... .......... .......... .......... 1,305
Fees.................................
TOTAL OF PART FOUR: MILITARY FAMILY TAX ............................... ......... 417 582 -105 -109 -112 -114 -118 -120 -123 -125 .......... 69
RELIEF ACT OF 2003.........................
PART FIVE: CERTAIN PROVISIONS CONTAINED IN
THE MEDICARE PRESCRIPTION DRUG,
IMPROVEMENT, AND MODERNIZATION ACT OF 2003
(P.L. 108-173, signed into law by the
President on December 8, 2003)
A. Disclosure of Return Information for DMa DOE........................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
Purposes of Providing Transitional
Assistance Under Medicare Discount Card
Program....................................
B. Disclosure of Return Information (\8\).......................... ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
Relating to Income-Related Reduction in
Part B Premium Subsidy.....................
C. Health Savings Accounts................. tyba 12/31/03.................. ......... -160 -474 -533 -597 -650 -704 -754 -801 -849 -897 .......... -6,419
D. Indirect Tax Effects of Reductions in (\10\)......................... ......... 2 4 1,580 2,301 2,648 2,903 3,264 3,569 4,102 4,571 .......... 24,944
Employer Costs for Prescription Drug
Insurance and Medicare Subsidies to
Employers (\4\) (\9\)......................
E. Tax Exclusion for Certain Subsidies to tyba DOE....................... ......... .......... ......... -1,130 -1,644 -1,889 -2,070 -2,322 -2,540 -2,923 -3,257 .......... -17,775
Employers (\4\) (\11\).....................
F. Exception to Form 1099 Information pma 12/31/02................... ......... -23 -24 -24 -25 -26 -27 -27 -28 -29 -30 .......... -263
Reporting Requirements for Certain Health
Arrangements...............................
TOTAL OF PART FIVE: CERTAIN PROVISIONS ............................... ......... -181 -494 -107 35 83 102 161 200 301 387 .......... 487
CONTAINED IN THE MEDICARE PRESCRIPTION
DRUG, IMPROVEMENT, AND MODERNIZATION ACT OF
2003.......................................
PART SIX: VISION 100--CENTURY OF AVIATION (\12\)......................... ......... .......... ......... The Joint Committee on Taxation Did Not Estimate This Provision .......... .......... ...........
REAUTHORIZATION ACT (P.L. 108-176, signed
into law by the President on December 12,
2003)......................................
PART SEVEN: SERVICE MEMBERS CIVIL RELIEF ACT DOE............................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
(P.L. 108-189, signed into law by the
President on December 19, 2003)............
PART EIGHT: SURFACE TRANSPORTATION EXTENSION DOE............................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
ACT OF 2004--EXTENSION OF HIGHWAY TRUST
FUND AND AQUATIC RESOURCES TRUST FUND
EXPENDITURE AUTHORITY (P.L. 108-202, signed
into law by the President on February 29,
2004)......................................
PART NINE: REVENUE PROVISIONS OF THE SOCIAL
SECURITY PROTECTION ACT OF 2004 (P.L. 108-
203, signed into law by the President on
March 2, 2004)
A. Technical Amendment Clarifying Treatment aiiiTWWIIA..................... ......... (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\)
for Certain Purposes of Individual Work
Plans Under the Ticket to Work and Self-
Sufficiency Program........................
B. Clarification Respecting the FICA and DOE............................ ......... .......... ......... .......... .......... Negligible or No Revenue Effect .......... .......... .......... .......... ...........
SECA Tax Exemptions for an Individual Whose
Earnings are Subject to the Laws of a
Totalization Agreement Partner (\4\).......
C. Technical Amendments (\4\).............. various........................ ......... .......... ......... .......... .......... Negligible or No Revenue Effect .......... .......... .......... .......... ...........
TOTAL OF PART NINE: REVENUE PROVISIONS OF ............................... ......... (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\)
THE SOCIAL SECURITY PROTECTION ACT OF 2004.
PART TEN: PENSION FUNDING EQUITY ACT OF 2004
(\13\) (P.L. 108-218, signed into law by
the President on April 10, 2004)
I. Pension Funding
A. Temporary replacement of interest rate pyba 12/31/03.................. ......... 3,299 5,563 1,247 -1,261 -1,004 -2,216 -2,737 -1,888 -1,160 -828 .......... -985
used for purposes of pension funding and
PBGC variable rate premiums for 2004 and
2005; employers may elect whether to use
temporary replacement interest rate in
applying deduction limits; allow the use of
5.5% for purposes of applying section 415
to lump sums in 2004 and 2005 (\14\).......
B. Partially waive deficit reduction pyba 12/27/03.................. ......... 14 44 32 -46 -72 -47 -31 -33 -28 -20 .......... -187
contributions for 2 years for plans of
certain employers not subject to the
deficit reduction contributions rules in
2000; additional required contribution
would generally be the greater of: (1) 20
percent of the otherwise applicable
additional contribution or (2) the amount
of the excess, if any, of (i) the expected
increase in current liability due to
current year accruals, over (ii) the
regular funding contribution for the year;
applies to passenger airlines, steel and
iron ore pellets industries, and a certain
tax-exempt organization (sunset plan
years beginning after 12/27/05) (\14\)
(\15\).....................................
C. Multiemployer plan funding notices pyba 12/31/04.................. ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
(\16\).....................................
D. Provide deferral for up to 2 years of up DOE............................ ......... 1 4 3 -5 -4 (\17\) (\17\) (\17\) (\17\) (\17\) .......... -1
to 80% of certain charges to funding
standard account of eligible multiemployer
plans; applies to charges attributable to
net experience loss for first plan year
beginning after 12/31/01, that would
otherwise be made for plan years
beginning after 6/30/03, and before
7/1/05....................................
Total of Pension Funding.............. ............................... ......... 3,314 5,611 1,282 -1,312 -1,080 -2,263 -2,768 -1,921 -1,188 -848 .......... -1,173
II. Other Provisions
A. 2-year extension of transition rule to pyba 12/31/03.................. ......... 2 6 2 -3 -2 -2 -2 -1 -1 (\5\) .......... -1
pension funding requirements...............
B. Procedures applicable to disputes (\19\)......................... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
involving pension plan withdrawal liability
(\18\).....................................
C. Sense of Congress Regarding Defined DOE............................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
Benefit Pension System Reform..............
D. Allow employers to transfer excess DOE............................ ......... .......... ......... 18 38 40 40 40 40 40 40 .......... 298
defined benefit plan assets to a special
account for health benefits of retirees
(sunset 12/31/13)..........................
E. Repeal of section 809 related to the tyba 12/31/04.................. ......... .......... -25 -33 -43 -47 -43 -38 -39 -39 -39 .......... -347
reduction in policyholder dividends........
F. Limit 501(c)(15) to organizations with tyba 12/31/03.................. ......... 47 105 118 120 127 134 137 141 146 152 .......... 1,228
gross receipts of $600,000 and premiums at
least 50% of gross receipts; and to mutual
insurance companies with gross receipts
less than $150,000 and premium income at
least 35% of gross receipts; and modify
definition of insurance company. Transition
relief for insurance companies in
receivership or liquidation on April 1,
2004, limited to lesser of four years or
time spent in receivership.................
Total of Other Provisions............. ............................... ......... 49 86 105 112 118 129 137 141 146 153 .......... 1,178
TOTAL OF PART TEN: PENSION FUNDING EQUITY ............................... ......... 3,363 5,697 1,387 -1,200 -962 -2,134 -2,631 -1,780 -1,042 -695 .......... 5
ACT OF 2004................................
PART ELEVEN: SURFACE TRANSPORTATION DOE............................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
EXTENSION ACT OF 2004, PART II--EXTENSION
OF HIGHWAY TRUST FUND AND AQUATIC RESOURCES
TRUST FUND EXPENDITURE AUTHORITY (P.L. 108-
224, signed into law by the President on
April 30, 2004)............................
PART TWELVE: SURFACE TRANSPORTATION DOE............................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
EXTENSION ACT OF 2004, PART III--EXTENSION
OF HIGHWAY TRUST FUND AND AQUATIC RESOURCES
TRUST FUND EXPENDITURE AUTHORITY (P.L. 108-
263, signed into law by the President on
June 30, 2004).............................
PART THIRTEEN: SURFACE TRANSPORTATION DOE............................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
EXTENSION ACT OF 2004, PART IV--EXTENSION
OF HIGHWAY TRUST FUND AND AQUATIC RESOURCES
TRUST FUND EXPENDITURE AUTHORITY (P.L. 108-
280, signed into law by the President on
July 30, 2004).............................
PART FOURTEEN: SURFACE TRANSPORTATION DOE............................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
EXTENSION ACT OF 2004, PART V--EXTENSION OF
HIGHWAY TRUST FUND AND AQUATIC RESOURCES
TRUST FUND EXPENDITURE AUTHORITY (P.L. 108-
310, signed into law by the President on
September 30, 2004)........................
PART FIFTEEN: WORKING FAMILIES TAX RELIEF
ACT OF 2004 (P.L. 108-311, signed into law
by the President on October 4, 2004)
I. Tax Reduction Provisions:
1. Extension of Family Tax Provisions:
a. Extend $1,000 child tax credit tyba 12/31/04.................. ......... .......... -2,638 -13,193 -13,198 -13,227 -12,376 -6,942 .......... .......... .......... .......... -61,574
through 12/31/09.......................
b. Extend marriage penalty relief tyba 12/31/04.................. ......... .......... -5,415 -5,412 -3,050 -1,493 -323 .......... .......... .......... .......... .......... -15,693
through 12/31/08.....................
c. Extend 10% bracket through 12/31/10. tyba 12/31/04.................. ......... .......... -4,262 -6,423 -6,796 -4,330 -3,229 -3,315 -1,006 .......... .......... .......... -29,361
2. Accelerate refundability of child tyba 12/31/03.................. ......... .......... -1,993 .......... .......... .......... .......... .......... .......... .......... .......... .......... -1,993
credit to 2004...........................
3. Extend individual AMT relief through tyba 12/31/04.................. ......... .......... -9,031 -13,546 .......... .......... .......... .......... .......... .......... .......... .......... -22,577
12/31/05.................................
4. Inclusion of combat pay in earned (\20\)......................... ......... .......... -49 -50 -24 -21 -18 -19 -17 .......... .......... .......... -199
income for purposes of the child tax
credit and for purposes of earned income
credit at taxpayer's election............
Total of Tax Reduction Provisions..... ............................... ......... .......... -23,388 -38,624 -23,068 -19,071 -15,946 -10,276 -1,023 .......... .......... .......... -131,396II. Uniform Definition of a Qualifying tyba 12/31/04.................. ......... .......... -84 -206 -209 -218 -225 -229 -183 -75 -75 -76 -1,580
Child for the Dependency Exemption, the
Child Credit, the EIC, the Dependent Care
Credit, and Head-of-Household Filing StatusIII. Extension of Certain Expiring
Provisions
1. Extension of the R&E credit (sunset 12/ epoia 6/30/04.................. ......... .......... -3,480 -1,986 -936 -678 -390 -90 .......... .......... .......... .......... -7,560
31/05)...................................
2. Parity in the application of DOE............................ ......... .......... -4 -43 -10 .......... .......... .......... .......... .......... .......... .......... -57
certain limits to men-
tal health benefits (sunset 12/31/05)
(\21\)...................................
3. Work opportunity tax credit (sunset 12/ wpoifibwa...................... ......... .......... -278 -181 -81 -39 -23 -9 -1 .......... .......... .......... -614
31/05)................................... 12/31/03.......................
4. Welfare-to-work tax credit (sunset 12/ wpoifibwa...................... ......... .......... -35 -39 -28 -14 -7 -4 -1 (\5\) .......... .......... -127
31/05)................................... 12/31/03.......................
5. Qualified zone academy bonds (sunset oia 12/31/03................... ......... .......... -3 -10 -20 -27 -28 -28 -28 -28 -28 -28 -231
12/31/05)................................
6. Increase in limit on cover over of rum abiUSa......................... ......... .......... -151 -18 .......... .......... .......... .......... .......... .......... .......... .......... -169
excise tax revenues (from $10.50 to 12/31/03.......................
$13.25 per proof gallon) to Puerto Rico
and the Virgin Islands (sunset 12/31/05).
7. Extension of enhanced deduction for cmd tyba....................... ......... .......... -198 -62 .......... .......... .......... .......... .......... .......... .......... .......... -260
qualified computer contributions (sunset 12/31/03.......................
for taxable years beginning after 12/31/
05)......................................
8. Above-the-line deduction for teacher tyba 12/31/03.................. ......... .......... -227 -192 .......... .......... .......... .......... .......... .......... .......... .......... -419
classroom expenses capped at $250
annually (sunset 12/31/05)...............
9. Expensing of ``Brownfields'' epoia 12/31/03................. ......... .......... -409 -93 32 38 39 34 30 26 22 20 -261
environmental remediation costs (sunset
12/31/05)................................
10. New York Liberty Zone bond provisions
(\22\):
a. Extend authority to issue Liberty generally DOE.................. ......... .......... -4 -18 -34 -47 -58 -65 -65 -65 -65 -65 -486
Zone bonds (sunset 12/31/09); add
municipal assistance corporation to
eligible advance refunding bonds.......
b. Extend authority to issue advance generally DOE.................. ......... .......... -6 -15 -16 -15 -12 -10 -8 -6 -4 -2 -93
refunding bonds (sunset 12/31/05)......
11. Tax incentives for investment in the (\23\)......................... ......... .......... -161 -56 -18 -12 -17 -62 -74 -42 -42 -37 -522
District of Columbia (sunset 12/31/05)...
12. Combined employment tax reporting do/a DOE....................... ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
(s u n s e t
12/31/05)...............................
13. Treatment of nonrefundable personal tyba 12/31/03.................. ......... .......... -332 -260 .......... .......... .......... .......... .......... .......... .......... .......... -592
credits under the individual alternative
minimum tax (s u n s e t
12/31/05) (\24\)........................
14. Tax credit for electricity production fpisa 12/31/03................. ......... .......... -44 -75 -97 -111 -127 -139 -144 -149 -151 -126 -1,163
from wind, closed-loop biomass, and
poultry litter--facilities placed in
service date (sunset 12/31/05)...........
15. Extension of suspension of 100% of tyba 12/31/03.................. ......... .......... -78 -16 .......... .......... .......... .......... .......... .......... .......... .......... -94
taxable income limit with respect to
marginal p r o d u c t i o n (sunset 12/
31/05)...................................
16. Indian employment tax credit (sunset DOE............................ ......... .......... -25 -34 -10 .......... .......... .......... .......... .......... .......... .......... -68
12/31/05)................................
17. Accelerated depreciation for business DOE............................ ......... .......... -150 -261 -97 21 71 111 90 48 5 -10 -173
property on Indian reservation
(sunset
12/31/05)...............................
18. Disclosure of tax return information DOE............................ ......... .......... ......... .......... No Revenue Effect .......... .......... .......... .......... ..........
to carry out administration of income
contingent r e p a y m e n t of
student l o a n s (sunset
12/31/05) (\4\).........................
19. Tax credit for qualified electric ppisa.......................... ......... .......... -5 -1 (\25\) (\25\) (\25\) (\25\) (\25\) (\25\) .......... .......... -5
vehicles (100% benefit through 12/31/05). 12/31/03.......................
20. Deduction for clean-fuel vehicles ppisa.......................... ......... .......... -119 -16 25 16 12 7 2 .......... .......... .......... -72
(100% benefit through 12/31/05).......... 12/31/03.......................
21. Disclosures relating to terrorist a
c t i v i t i e s (sunset 12/31/05):
a. Extension of authority to make dmo/a DOE...................... ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
disclosures regarding terrorist
activities.............................
b. Technical correction regarding (\26\)......................... ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
disclosure of taxpayer identity to law
enforcement officials investigating
terrorist activities...................
22. Joint Committee on Taxation report DOE............................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
and joint hearing on IRS strategic plans
(sunset 12/31/05)........................
23. Availability of Archer medical 1/1/04......................... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
savings accounts (sunset 12/31/05)....... Total of Extension of C e r t a i n E ............................... ......... .......... -5,709 -3,376 -1,290 -868 -540 -255 -199 -216 -263 -248 -12,966
x p i r i n g Provisions............IV. Tax Technical Correction Provisions..... DOE............................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........TOTAL OF PART FIFTEEN: WORKING FAMILIES TAX ............................... ......... .......... -29,181 -42,206 -24,567 -20,157 -16,711 -10,760 -1,405 -291 -338 -324 -145,942
RELIEF ACT OF 2004.........................PART SIXTEEN: CLARIFY TAX TREATMENT OF BONDS oia DOE........................ ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
AND OTHER OBLIGATIONS ISSUED BY THE
GOVERNMENT OF AMERICAN SAMOA (P.L. 108-326,
signed into law by the P r e s i d e n t
o n
O c t o b e r 16, 2004)....................PART SEVENTEEN: AMERICAN JOBS CREATION ACT
OF 2004 (P.L. 108-357, signed into law by
the President on October 22, 2004)I. Provisions Relating to Repeal of
Exclusion for Extraterritorial Income
1. Repeal of exclusion for ta 12/31/04.................... ......... .......... 354 1,317 3,528 5,475 5,737 5,985 6,275 6,562 6,840 7,126 49,199
extraterritorial income (\27\)...........
2. Deduction relating to income tyba 12/31/04.................. ......... .......... -2,054 -3,052 -4,396 -6,241 -6,722 -8,841 -10,741 -11,122 -11,525 -11,815 -76,509
attributable to United States production
activities............................... Total of Provisions Rel a t i n g to ............................... ......... .......... -1,700 -1,735 -868 -766 -985 -2,856 -4,466 -4,560 -4,685 -4,689 -27,310
Repeal of Exclusion for
Extraterritorial Income..............II. Business Tax Incentives
A. Small Business Expensing--increase tyba 12/31/05.................. ......... .......... ......... -3,814 -6,636 -488 3,786 2,416 1,665 1,116 609 249 -1,095
section 179 expensing from $25,000 to
$100,000 and increase the phaseout
threshold amount from $200,000 to $400,000;
include software in section 179 property;
and extend indexing of both the deduction
limit and the phaseout threshold (sunset
after 2007)................................
B. Depreciation
1. 15-year straight-line cost recovery ppisa DOE...................... ......... .......... -65 -147 -185 -181 -174 -158 -151 -159 -156 -149 -1,523
for qualified leasehold improvements
(sunset after 2005)......................
2. 15-year straight-line cost recovery ppisa DOE...................... ......... .......... -141 -33 -40 -40 -40 -40 -40 -40 -40 -40 -494
for qualified restaurant improvements
(sunset after 2005)......................
C. Community Revitalization
1. Modification of targeted areas and low- DMA DOE........................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
income communities designated for new
markets tax credit.......................
2. Expansion of designated renewal (\28\)......................... ......... .......... -35 -10 -10 -9 -9 (\29\) 8 9 9 8 -37
community area based on 2000 census data.
3. Modification of income requirement for (\30\)......................... ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
census tracts within high migration rural
counties.................................
D. S Corporation Reform and Simplification
1. Treat members of family as one generally tyba 12/31/04........ ......... .......... -1 -4 -6 -8 -9 -9 -10 -10 -10 -10 -76
shareholder (6 generations; multiple
families per S corporation) (includes
interaction with line 2. below)..........
2. Increase in number of eligible tyba 12/31/04.................. ......... .......... -18 -43 -56 -66 -74 -79 -82 -83 -84 -84 -669
shareholders to 100......................
3. Expansion of bank S corporation DOE............................ ......... .......... -23 -34 -36 -37 -39 -41 -43 -45 -47 -49 -394
eligible shareholders to include IRAs....
4. Disregard unexercised powers of tyba 12/31/04.................. ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
appointment in determining potential
current beneficiaries of ESBT............
5. Transfer of suspended losses incident tosa 12/31/04.................. ......... .......... -1 -2 -2 -2 -3 -3 -3 -3 -3 -3 -25
to divorce...............................
6. Use of passive activity loss by tma 12/31/04................... ......... .......... -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -7
subchapter S trust income beneficiaries..
7. Exclusion of investment securities tyba 12/31/04.................. ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
income from passive income test for bank
S corporations...........................
8. Relief from inadvertently invalid ematma......................... ......... .......... -2 -1 -1 -1 -1 -1 -1 -1 -1 -1 -14
qualified subchapter S subsidiary 12/31/04.......................
elections and terminations...............
9. Information returns for qualified tyba 12/31/04.................. ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
subchapter S subsidiaries................
10. Repayment of loan for qualifying dma 12/31/97................... ......... .......... -1 (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) -1 -1 -1 -5
employer securities held by an ESOP......
E. Other Business Incentives
1. Repeal of 4.3-cent General Fund excise 1/1/05......................... ......... .......... -33 -74 -139 -170 -174 -179 -184 -189 -193 -198 -1,532
taxes on railroad diesel fuel and inland
waterway fuel (reduce excise taxes by 1
cent/gallon from 1/1/05 through 6/30/05,
2 cents/gallon from 7/1/05 through 12/31/
06, and 4.3 cents/gallon thereafter).....
2. Modification of application of the ppisa DOE...................... ......... .......... -182 -139 -81 -32 -24 -24 -28 -31 -35 -39 -615
income forecast method of accounting.....
3. Improvements related to real estate tyba 12/31/00 & tyba DOE....... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
investment trusts........................
4. Special rules for certain film and pca DOE........................ ......... .......... -82 -99 -94 -60 -1 62 93 81 40 18 -42
television production (sunset taxable
years beginning after 12/31/08)..........
5. Provide a 50% tax credit for certain epoid tyba..................... ......... .......... -63 -121 -109 -88 -59 -38 -21 -4 (\5\) (\5\) -501
expenditures for maintaining railroad 12/31/04.......................
tracks (sunset 12/31/07).................
6. Suspension of the occupational taxes 7/1/05......................... ......... .......... -66 -78 -78 -12 .......... .......... .......... .......... .......... .......... -234
relating to distilled spirits, wine,
and beer (sunset 6/30/08)..............
7. Modification of unrelated business (\31\)......................... ......... .......... -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -9
income limitation on investment in
certain debt-financed properties of SBICs
8. Tonnage tax election for income from tyba DOE....................... ......... .......... -2 -4 -5 -6 -6 -6 -6 -7 -7 -8 -57
international shipping...................
F. Exclusion of Incentive Stock Options and saptoea DOE.................... ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
Employee Stock Purchase Plan Stock Options
From Wages................................. Total of Business Tax Incentives...... ............................... ......... .......... -717 -4,605 -7,480 -1,203 3,171 1,898 1,196 631 79 -309 -7,329III. Provisions Relating to Tax Relief for
Agriculture and Small Manufacturers
A. Volumetric Ethanol Excise Tax Credit
1. Provide excise tax credit (in lieu of fsoua.......................... ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
reduced tax rate on gasoline) to certain 12/31/04.......................
blenders of alcohol fuel mixtures (sunset
12/31/10)................................
2. Provide that all alcohol fuels excise fsoua.......................... ......... .......... ......... .......... .......... .......... .......... .......... 1,131 1,559 1,586 1,614 5,890
tax credits and payments are paid from 12/31/04.......................
the General Fund (\32\) (\33\)...........
3. Repeal reduced-rate sales of gasoline fsoua.......................... ......... .......... 16 23 23 23 23 23 23 22 22 22 220
for blending with alcohol and reduced- 12/31/04.......................
rate sales of alcohol fuel blends........
4. Provide outlay payments (in lieu of fsoua.......................... ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
excise tax credits and refunds) to 12/31/04.......................
producers of alcohol fuel mixtures.......
5. Transfer full amount of alcohol fuel fsoua.......................... ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
excise taxes to the Highway Trust Fund 9/30/04........................
(i.e., repeal 2.5/2.8 cents transfer to
General Fund)............................
6. Provide excise tax credits for fsoua.......................... ......... .......... -33 -57 -16 .......... .......... .......... .......... .......... .......... .......... -107
biodiesel used to produce a qualified 12/31/04.......................
fuel mixture (\34\) ($1.00/gallon for
agribiodiesel and $0.50/gallon for
biodiesel) and provide that the excise
tax credits are paid from the G e n e r a
l F u n d (s u n s e t
12/31/06) (\35\)........................
7. Provide outlay payments (in lieu of fsoua.......................... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
excise tax credits and refunds) to 12/31/04.......................
producers of biodiesel fuel mixtures.....
8. Extension of section 40 alcohol fuels DOE............................ ......... .......... ......... .......... .......... -2 -6 -8 -8 -6 -3 .......... -34
income tax credit (sunset 12/31/10)......
9. Biodiesel income tax credit--provide fpasoua........................ ......... .......... ......... .......... .......... Estimate Included in Item 6. Above .......... .......... .......... ...........
income tax credits for biodiesel fuel and 12/31/04.......................
biodiesel used to produce a qualified
fuel mixture ($1.00/gallon for agribio-
diesel and $0.50/gallon for biodiesel)
(sunset 12/31/06)........................
10. Information reporting for persons 1/1/05......................... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
claiming ethanol and biodiesel tax
benefits.................................
B. Agricultural Incentives
1. Special rules for livestock sold on trda 12/31/02.................. ......... .......... -18 -7 -4 -3 -3 -3 4 6 2 (\29\) -27
account of weather-related conditions....
2. Payment of dividends on stock of di tyba DOE.................... ......... .......... (\5\) (\5\) -1 -1 -1 -1 -2 -2 -3 -4 -15
cooperatives without reducing patronage
dividends................................
3. Allow small ethanol producer tyea DOE....................... ......... .......... -8 -8 -9 -10 -11 -12 -10 -6 -3 .......... -77
cooperatives to pass the small producer
credit through to cooperative members....
4. Extend income averaging to fishermen tyba 12/31/03.................. ......... .......... -3 -3 -4 -5 -6 -7 -7 -8 -9 -10 -61
and provide that income averaging for
farmers and fishermen will not increase
AMT liability............................
5. Capital gains treatment to apply to sota 12/31/04.................. ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
outright sales of timber by landowner....
6. Modify cooperative marketing to tyba DOE....................... ......... .......... -1 -2 -4 -5 -6 -7 -9 -10 -11 -12 -68
include value-added processing involving
animals..................................
7. Extend declaratory judgment relief to pfa DOE........................ ......... .......... ......... .......... .......... Estimate Included in Line Above .......... .......... .......... .......... ...........
farm cooperatives........................
8. Certain expenses of rural letter tyba 12/31/03.................. ......... .......... -2 -3 -3 -3 -3 -3 -4 -4 -4 -4 -33
carriers.................................
9. Treatment of certain income of tyba DOE....................... ......... .......... -10 -19 -8 .......... .......... .......... .......... .......... .......... .......... -38
electric cooperatives (sunset 12/31/06)
10. Exclude from gross income and tyba 12/31/03.................. ......... .......... -2 -2 -2 -4 -5 -6 -8 -11 -14 -18 -72
employment taxes payments made to
individuals under NHSC Loan Repayment
Program and certain State loan repayment
programs.................................
11. Modified safe-harbor rules for timber tyba DOE....................... ......... .......... (\5\) (\5\) -1 -1 -2 -2 -3 -4 -5 -5 -23
REITs....................................
12. Deduction of the first $10,000 of epoia DOE...................... ......... .......... -55 -37 -25 -11 -1 2 8 13 20 22 -64
qualified reforestation costs............
C. Incentive for Small Manufacturers
1. Net income from publicly traded tyba DOE....................... ......... .......... -1 -2 -3 -5 -5 -6 -6 -7 -7 -7 -49
partnerships treated as qualifying income
for regulated investment company.........
2. Simplification of excise tax imposed asbmpoi........................ ......... .......... -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -9
on bows and arrows (\36\)................ 30da DOE.......................
3. Reduce excise tax on fishing tackle asbmpoia....................... ......... .......... -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -11
boxes to 3 percent (\37\)................ 12/31/04.......................
4. Repeal excise tax on sonar devices asbmpoia....................... ......... .......... (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) -1 -1 -1 -1 -4
suitable for finding fish (\38\)......... 12/31/04.......................
5. Charitable contribution deduction cma 12/31/04................... ......... .......... (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) -4
for certain expenses in support of
Native Alaska subsistence whaling........
6. Extended placed in service date for ppisa.......................... ......... .......... -1,265 -175 576 346 271 194 54 .......... .......... .......... ...........
bonus depreciation for certain aircraft 9/10/01 (\39\).................
(excluding aircraft used in the
transportation industry).................
7. Special placed in service rule for sa 6/4/04...................... ......... .......... -27 8 6 4 4 4 2 1 .......... .......... ...........
bonus depreciation for certain property
subject to syndication...................
8. Expensing of capital costs incurred epoia 12/31/02................. ......... .......... -16 -8 -12 -28 -53 -21 3 4 5 6 -119
for production in complying with
Environmental Protection Agency sulfur
regulations for small refiners...........
9. Credit for small refiners for epoia 12/31/02................. ......... .......... ......... .......... .......... Estimate Included in Line Above .......... .......... .......... .......... ...........
production for diesel fuel in compliance
with Environmental Protection Agency
sulfur regulations for small refiners....
10. Modification to small issue bonds-- bia 9/30/09.................... ......... .......... ......... .......... .......... .......... .......... -6 -14 -22 -30 -38 -110
increase capital expenditure limit from
$10 million to $20 million (maximum bond
limit remains at $10 million)............
11. Oil and gas from marginal wells...... pi tyba........................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
12/31/04.......................
Total of Provisions Relating to Tax ............................... ......... .......... -1,427 -294 511 293 194 139 1,151 1,522 1,543 1,563 5,185
Relief for Agriculture and Small
Manufacturers........................IV. Tax Reform and Simplification for United
States Businesses
1. Interest expense allocation rules..... tyba 12/31/08.................. ......... .......... ......... .......... .......... .......... -908 -2,487 -2,586 -2,689 -2,797 -2,909 -14,376
2. Recharacterize overall domestic loss.. lii tyba....................... ......... .......... ......... .......... -57 -680 -713 -756 -793 -829 -862 -895 -5,585
12/31/06.......................
3. Apply look-through rules for dividends tyba 12/31/02.................. ......... .......... -662 -51 -23 -6 -1 (\40\) (\40\) (\40\) (\40\) (\40\) -743
from noncontrolled section 902
corporations.............................
4. Base differences and reduction to 2 (\41\)......................... ......... .......... -8 -13 -615 -900 -927 -1,002 -1,039 -1,078 -1,119 -1,161 -7,862
foreign tax credit baskets...............
5. Attribution of stock ownership through tyba DOE....................... ......... .......... -1 -3 -3 -3 -3 -3 -3 -3 -3 -3 -28
partnerships in determining section 902
and 960 credits..........................
6. Foreign tax credit treatment of deemed ataro/a 8/5/97................. ......... .......... -26 -5 -5 -5 -5 -5 -5 -5 -5 -5 -71
payments under section 367(d)............
7. United States property not to include (\42\)......................... ......... .......... -3 -20 -21 -22 -23 -24 -25 -27 -29 -31 -225
certain assets of controlled foreign
corporations.............................
8. Translation of foreign taxes.......... tyba 12/31/04.................. ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
9. Eliminate secondary withholding tax pma 12/31/04................... ......... .......... -2 -3 -3 -3 -3 -3 -3 -3 -3 -3 -29
with respect to dividends paid by certain
foreign corporations.....................
10. Provide equal treatment for interest tyba 12/31/03.................. ......... .......... -3 -2 -2 -2 -2 -2 -2 -3 -3 -3 -24
paid by foreign partnerships and foreign
corporations doing business in the U.S...
11. Treatment of certain dividends of (\43\)......................... ......... .......... -7 -59 -63 -57 .......... .......... .......... .......... .......... .......... -186
regulated investment companies (sunset
after 3 years)...........................
12. Look-through treatment under subpart (\42\)......................... ......... .......... -39 -91 -96 -101 -106 -111 -116 -122 -129 -137 -1,048
F for sales of partnership interests.....
13. Repeal of rules applicable to foreign (\42\)......................... ......... .......... -25 -65 -73 -81 -91 -102 -114 -128 -143 -162 -984
personal holding companies and foreign
investment companies, personal holding
company rules as they apply to foreign
corporations, and include in subpart F
personal service contract income, as
defined under the foreign personal
holding company rules....................
14. Determination of foreign personal teia 12/31/04.................. ......... .......... -4 -10 -10 -10 -10 -11 -11 -11 -11 -12 -100
holding company income with respect to
transactions in commodities..............
15. Modify treatment of aircraft leasing (\42\)......................... ......... .......... -33 -172 -98 -75 -76 -88 -98 -108 -118 -129 -995
and shipping income (\44\)...............
16. Modification of exceptions under (\42\)......................... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
subpart F for active financing income....
17. 10-year foreign tax credit (\45\)......................... ......... .......... -349 -271 -338 -500 -668 -779 -857 -942 -1,036 -1,191 -6,931
carryforward; 1-year foreign tax credit
carryback................................
18. Modify FIRPTA rules for REITs........ tyba DOE....................... ......... .......... -2 -7 -10 -12 -14 -15 -17 -19 -21 -23 -140
19. Exclusion of certain horse-racing and wma DOE........................ ......... .......... -1 -3 -3 -3 -3 -3 -3 -3 -3 -3 -27
dog-racing gambling winnings from the
income of nonresident alien individuals..
20. Reduce withholding tax applicable to Dpa DOE........................ ......... .......... -5 -7 -8 -9 -10 -10 -11 -12 -13 -14 -99
dividends paid to Puerto Rico companies
to 10%...................................
21. Repeal the 90% limitation on the use tyba 12/31/04.................. ......... .......... -265 -395 -376 -361 -348 -338 -329 -323 -319 -317 -3,371
of foreign tax credits against the AMT...
22. Incentives to reinvest foreign (\46\)......................... ......... .......... 2,788 -2,119 -1,267 -838 -553 -379 -300 -264 -192 -137 -3,261
earnings in the United States............
23. Delay in effective date of final (\47\)......................... ......... .......... -24 -4 (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) (\5\) -28
regulations governing exclusion of income
from international operation of ships or
aircraft.................................
24. Study of earnings stripping DOE............................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
provisions...............................
25. Interaction.......................... ............................... ......... .......... 3 192 248 253 410 429 450 473 497 523 3,478 Total of Tax Reform a n d S im pli fi ............................... ......... .......... 1,332 -3,108 -2,823 -3,415 -4,054 -5,689 -5,862 -6,096 -6,309 -6,612 -42,635
ca ti on for U n i t e d S t a t e s
Businesses...........................V. Deduction of State and Local General tyba 12/31/03.................. ......... .......... -3,080 -1,915 .......... .......... .......... .......... .......... .......... .......... .......... -4,995
Sales Taxes (sunset 12/31/05)..............VI. Fair and Equitable Tobacco Reform
Provisions
A. Revenue effects......................... DOE............................ ......... .......... 1,098 1,089 964 964 964 964 964 964 964 1,205 10,140
B. Outlay effects (\4\).................... DOE............................ ......... .......... -1,464 -964 -964 -964 -964 -964 -964 -964 -964 -964 -10,140 Total of Fair and Equitable Tobacco ............................... ......... .......... -366 125 .......... .......... .......... .......... .......... .......... .......... 241 ...........
Reform Provisions....................VII. Miscellaneous Provisions
1. Qualified green building and bia 12/31/04................... ......... .......... -3 -9 -15 -22 -27 -31 -31 -31 -31 -31 -231
sustainable design project bonds ($2
billion authority) (sunset 9/30/09)......
2. Exclusion of gain or loss on sale or PAa 12/31/04................... ......... .......... 1 1 1 -6 -18 -28 -38 -49 -34 -15 -185
exchange of certain Brownfield sites from
unrelated business taxable income (sunset
12/31/09)................................
3. Civil rights tax relief............... josoa DOE...................... ......... .......... -5 -21 -29 -31 -34 -36 -38 -42 -44 -47 -327
4. 7-year recovery period for certain ppisa DOE & before 2008........ ......... .......... -13 -19 -26 -23 -14 -9 -6 -3 3 9 -101
track facilities.........................
5. Permit life insurance companies tax- tyba 12/31/04.................. ......... .......... -78 -54 -51 -48 -48 -48 -49 -51 -52 -54 -533
free distributions from policyholder
surplus accounts (sunset 12/31/06).......
6. Treat certain Alaska pipeline property generally ppisa 12/31/04....... ......... .......... ......... .......... .......... .......... .......... .......... .......... .......... .......... -150 -150
as 7-year property.......................
7. Extension of enhanced oil recovery cpoii tyba..................... ......... .......... ......... .......... .......... -32 -91 -101 -61 -23 1 11 -295
credit to Alaska gas processing 12/31/04.......................
facilities...............................
8. Method of accounting for naval ca DOE......................... ......... .......... -26 -52 -99 -62 -42 -57 -35 -32 -38 -52 -495
shipbuilders.............................
9. Modify minimum cost requirement for tyea DOE....................... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
transfer of excess defined benefit assets
10. Extension and expansion of credit for eposfqfa....................... ......... .......... -218 -279 -322 -366 -375 -261 -177 -135 -94 -49 -2,278
electricity produced from certain 10/22/04.......................
renewable resources--expand section 45
credit to include closed-loop biomass,
open-loop biomass, geothermal solar,
small irrigation, municipal solid waste,
and refined coal to list of qualified
energy resources.........................
11. Allow the section 40 and section 45 tyea DOE....................... ......... .......... -10 -5 -4 -3 -2 -2 2 6 1 -3 -21
credits to be taken against the AMT......
12. Inclusion of primary and secondary DOE............................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
medical strategies for children and
adults with sickle cell disease as
medical assistance under the Medicaid
program (\48\)...........................
13. Temporary suspension of customs duty 15da DOE....................... ......... .......... -19 -20 -5 .......... .......... .......... .......... .......... .......... .......... -44
on certain ceiling fans (s u n s
e t
12/31/06) (\4\).........................
14. Temporary suspension of customs duty 15da DOE & DOE................. ......... .......... -1 -1 -3 -3 -1 .......... .......... .......... .......... .......... -9
on certain steam generators (sunset 12/31/
08) and certain reactor vessel heads and
pressurizers used in nuclear facilities
(sunset 12/31/08) (\4\)..................
Total of Miscellaneous Provisions..... ............................... ......... .......... -372 -459 -553 -596 -652 -573 -433 -360 -288 -381 -4,669VIII. Revenue Provisions
A. Provisions to Reduce Tax Avoidance
Through Individual and Corporate
Expatriation
1. Tax treatment of expatriated entities. tyea 3/4/03.................... ......... .......... 96 50 59 63 67 77 90 100 109 119 830
2. Excise tax on stock compensation of generally...................... ......... .......... 18 7 7 7 8 11 11 11 11 11 102
insiders in expatriated corporations 3/4/03.........................
(rate tracks capital gains rate, applies
to executives in affiliated groups)......
3. Reinsurance of United States risks in rra DOE........................ ......... .......... (\29\) (\29\) (\29\) (\29\) (\29\) (\29\) (\29\) (\29\) (\29\) (\29\) 5
foreign jurisdictions....................
4. Revision of tax rules for individuals iwea 6/3/04.................... ......... .......... 23 21 24 28 32 37 43 49 56 64 377
who expatriate...........................
5. Reporting of taxable mergers and aa DOE......................... ......... .......... 2 3 3 3 3 3 3 3 3 3 29
acquisitions.............................
6. Studies............................... DOE............................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
B. Provisions Relating to Tax Shelters
1. Provisions relating to reportable (\49\)......................... ......... .......... 50 119 120 124 131 139 150 164 179 195 1,371
transactions and tax shelters............
2. Modifications to the substantial tyba DOE....................... ......... .......... ......... 7 15 23 26 30 34 38 38 38 249
understatement penalty for nonreportable
transactions.............................
3. Modification of actions to enjoin da DOE......................... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
certain conduct related to tax shelters
and reportable transactions..............
4. Impose a civil penalty (of up to voa DOE........................ ......... .......... ......... (\29\) (\29\) (\29\) (\29\) (\29\) (\29\) (\29\) (\29\) (\29\) 3
$10,000) on failure to report interest in
foreign financial accounts...............
5. Regulation of individuals practicing ata DOE........................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
before the Department of Treasury........
6. Treatment of stripped interest in bond pada DOE....................... ......... .......... 13 11 8 5 3 (\29\) (\29\) (\29\) (\29\) (\29\) 40
and preferred stock funds................
7. Minimum holding period for foreign tax apoamt 30da DOE................ ......... .......... 3 3 3 3 4 4 4 4 5 5 38
credit on withholding tax on income other
than dividends...........................
8. Disallowance of certain partnership ctada DOE...................... ......... .......... 28 56 62 60 54 47 43 43 44 44 481
loss transfers with partner level loss
limits for transfer of interest in
electing investment partnerships.........
9. No reduction of basis under section Da DOE......................... ......... .......... 6 12 19 23 27 28 30 33 34 36 249
734 in stock held by partnership in
corporate partner........................
10. Repeal of special rules for FASITs... after 12/31/04................. ......... .......... (\29\) (\29\) (\29\) (\29\) (\29\) (\29\) (\29\) (\29\) (\29\) (\29\) 5
11. Limitation on transfer or importation ta DOE......................... ......... .......... 51 99 147 164 180 198 218 240 264 290 1,851
of built-in losses.......................
12. Clarification of banking business for DOE............................ ......... .......... 40 34 34 36 38 40 42 44 46 50 404
purposes of determining investment of
earnings in United States property.......
13. Deny deduction for interest paid to tyba DOE....................... ......... .......... ......... 1 1 3 4 4 4 4 4 4 29
the IRS on underpayments involving
certain tax motivated transactions.......
14. Clarification of rules for payment of toa DOE........................ ......... .......... 55 28 7 3 3 3 4 4 5 5 117
estimated tax for certain deemed asset
sales....................................
15. Exclusion of like-kind exchange soea DOE....................... ......... .......... 11 13 15 17 19 21 23 25 27 29 200
property from nonrecognition treatment on
the sale or exchange of a principal
residence................................
16. Prevent mismatching of deductions and pao/a DOE...................... ......... .......... 40 82 80 33 35 37 39 41 43 45 475
income inclusions in transactions with
related foreign persons..................
17. Deposits made to suspend the running Dma DOE........................ ......... .......... 150 -6 -6 -6 -6 -6 -7 -7 -7 -7 93
of interest on potential underpayments...
18. Authorize IRS to enter into iaeio/a DOE.................... ......... .......... 52 10 5 (\25\) (\25\) (\25\) (\25\) (\25\) (\25\) (\25\) 67
installment agreements that provide for
partial payment..........................
19. Affirmation of consolidated return (\50\)......................... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
regulation authority.....................
20. Expanded disallowance of deduction diia 10/3/04................... ......... .......... 94 90 94 96 98 101 103 106 109 113 1,004
for interest on convertible debt.........
21. Reform the tax treatment for leasing (\51\)......................... ......... .......... 589 934 1,416 1,955 2,474 2,923 3,352 3,805 4,293 4,819 26,560
transactions with tax-indifferent parties
with additional coverage of Indian and
intangible assets and assets subject to a
fixed purchase price option with an
exception for aircraft and vessels.......
C. Reduction of Fuel Tax Evasion
1. Exemption from certain excise taxes (\52\)......................... ......... .......... 76 95 95 95 95 95 95 95 95 95 931
for mobile machinery vehicles............
2. Modified definition of off-highway (\52\)......................... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
vehicle..................................
3. Aviation jet fuel--move point of (\53\)......................... ......... .......... 297 429 433 436 439 439 437 435 434 432 4,211
taxation of aviation fuel to the rack;
provide that certain refueler trucks are
treated as terminals.....................
4. Dye fuel mechanically, security (\54\)......................... ......... .......... ......... 42 46 47 47 47 47 47 47 47 417
standards, and related penalties.........
5. Elimination of administrative review Paa DOE........................ ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
for taxable use of dyed fuel.............
6. Extension of penalty on untaxed DOE............................ ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
chemically altered fuel mixtures.........
7. Termination of dyed diesel use by fsa 12/31/04................... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
intercity buses..........................
8. Authority to inspect on-site records.. DOE............................ ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
9. Assessable penalty for refusal of 1/1/05......................... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
entry....................................
10. Registration of all pipeline or 3/1/05......................... ......... .......... 56 125 127 128 129 129 130 129 129 129 1,211
vessel operators required for exemption
of bulk transfers; Secretary must publish
list of registered persons (\55\)........
11. Display of registration and penalty 1/1/05 &....................... ......... .......... ......... .......... Revenue Effects Included in Line 10. .......... .......... .......... .......... ...........
for failure to display................... pia 12/31/04...................
12. Penalties for failure to register and pia 12/31/04................... ......... .......... 1 2 2 2 2 2 2 2 2 2 20
failure to report........................
13. Registration of persons within 1/1/05......................... ......... .......... ......... .......... Revenue Effects Included in Line 10. .......... .......... .......... .......... ...........
foreign trade zones......................
14. Certain reports filed electronically. 1/1/06......................... ......... .......... ......... .......... Revenue Effects Included in Line 10. .......... .......... .......... .......... ...........
15. Taxable fuel refunds for certain 1/1/05......................... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
ultimate vendors.........................
16. Two-party exchanges.................. DOE............................ ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
17. Modifications to heavy vehicle use tpba DOE....................... ......... .......... 121 124 126 128 131 131 133 135 137 139 1,305
tax......................................
18. Dedication of revenue from certain Pao/a DOE...................... ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
penalties to the Highway Trust Fund......
19. Simplify the heavy truck tire tax (\57\)......................... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
(\56\)...................................
20. Taxation of transmix and diesel fuel frsoua......................... ......... .......... 74 107 108 108 108 108 108 108 107 106 1,043
blendstocks.............................. 12/31/04.......................
21. Treasury study on fuel compliance.... DOE............................ ......... .......... ......... .......... .......... No Revenue Effect .......... .......... .......... .......... ...........
D. Other Revenue Provisions
1. Permit private sector debt collection DOE............................ ......... .......... ......... 59 150 137 121 110 110 110 110 110 1,017
companies to collect tax debts...........
2. Modify charitable contribution rules cma 6/3/04..................... ......... .......... 307 318 330 342 356 369 384 399 414 434 3,653
for donations of patents and other
intellectual property; provide for
additional charitable deductions in
future years based on income attributable
to the contributed property..............
3. Require increased reporting for cma 6/3/04..................... ......... .......... 9 9 10 10 10 10 10 11 11 11 102
noncash charitable contributions.........
4. Provide that deduction for charitable cma 12/31/04................... ......... .......... 30 251 253 256 258 261 263 266 269 272 2,379
contribution of vehicles generally equals
the sales price..........................
5. Treatment of nonqualified deferred ada 12/31/04................... ......... .......... 158 135 44 21 20 18 144 189 172 151 1,051
compensation plans.......................
6. Extension of amortization of aoa DOE........................ ......... .......... 52 88 71 37 22 21 19 22 24 26 382
intangibles to acquisitions of sports
franchises...............................
7. Increase continuous levy for certain DOE............................ ......... .......... 8 14 16 19 19 20 21 22 23 24 185
Federal payments.........................
8. Modification of straddle rules........ peo/a DOE...................... ......... .......... 21 24 27 31 34 36 38 39 40 41 331
9. Addition of vaccines against Hepatitis (\59\)......................... ......... .......... 1 2 2 2 2 2 2 2 1 1 16
A to the list of taxable vaccines (\58\).
10. Addition of vaccines against (\60\)......................... ......... .......... 26 29 31 32 32 32 32 33 33 33 314
Influenza to the list of taxable vaccines
(\58\)...................................
11. Extension of IRS user fees through 9/ ra DOE......................... ......... .......... 25 33 35 38 39 41 43 45 47 50 396
30/14 (\4\)..............................
12. Extension of Customs User Fees (\4\):
a. Extend passenger and conveyance DOE............................ ......... .......... 105 331 348 365 383 402 423 444 466 489 3,756
processing fee through 9/30/14.......
b. E x t e n d merchandise processing DOE............................ ......... .......... 679 1,234 1,308 1,386 1,470 1,558 1,651 1,750 1,855 1,967 14,858
fee through through 9/30/14............
13. Prohibition on nonrecognition of gain doo/a DOE...................... ......... .......... 13 15 17 19 21 23 25 27 29 31 220
through complete liquidation of holding
company..................................
14. Effectively connected income to tyba DOE....................... ......... .......... 5 7 8 9 10 10 10 10 11 11 91
include economic equivalents of certain
categories of foreign-source income......
15. Recapture of overall foreign losses DA DOE......................... ......... .......... 3 7 8 9 9 9 10 10 10 10 85
on sale of controlled foreign corporation
stock....................................
16. Recognize cancellation of coio/a DOE..................... ......... .......... 4 4 4 4 5 5 5 5 6 6 48
indebtedness income realized on
satisfaction of debt with partnership
interest.................................
17. Deny installment sale treatment for soo/a DOE...................... ......... .......... 51 57 8 11 12 13 15 17 18 19 221
all readily tradable debt................
18. Modify treatment of transfers to to/a DOE....................... ......... .......... 8 9 10 10 10 11 11 12 12 12 105
creditors in divisive reorganizations....
19. Clarify definition of nonqualified ta 5/14/03..................... ......... .......... 5 8 8 8 8 8 8 7 7 7 74
preferred stock..........................
20. Modification of definition of tyba DOE....................... ......... .......... 3 5 4 3 2 2 2 1 1 1 24
controlled group of corporations.........
21. Establish specific class lives for ppisa DOE...................... ......... .......... 13 31 53 72 85 96 106 115 118 118 806
utility grading costs....................
22. Provide consistent amortization (\61\)......................... ......... .......... -152 362 500 521 447 402 345 285 214 161 3,085
periods for intangibles..................
23. Freeze of provision regarding tyba 12/31/03 & iaa 10/3/04.... ......... .......... ......... 23 176 187 188 190 192 195 196 198 1,545
suspension of interest where Secretary
fails to contact taxpayer; remove listed
and reportable avoidance transactions
from interest and penalty suspension.....
24. Increase in withholding from pma 12/31/04................... ......... .......... 111 43 5 (\25\) (\25\) (\25\) 4 7 8 8 186
supplemental wage payments in excess of
$1 million...............................
25. Capital gain treatment on sale of sa DOE......................... ......... .......... 1 1 1 1 1 1 1 1 1 1 10
stock acquired from exercise of statutory
stock options to comply with conflict-of-
interest requirements....................
26. Application of basis rules to doo/a DOE...................... ......... .......... 14 16 18 21 23 25 27 30 32 35 241
nonresident aliens.......................
27. Limit deduction for certain eia DOE........................ ......... .......... 172 201 209 217 225 234 244 255 264 272 2,292
entertainment expenses (including company-
provided aircraft) for covered employees
(\62\)...................................
28. Modify residence test in U.S. generally...................... ......... .......... 3 8 12 16 25 35 41 49 58 63 310
possessions.............................. tyea DOE.......................
29. Dispositions of transmission property ta DOE......................... ......... .......... -3,147 -1,823 172 939 955 964 970 845 507 15 395
to implement FERC restructuring policy
(with reinvestment obligation (applies to
sales or dispositions completed prior to
1/1/07)).................................
30. Expansion of limitation on ppisa DOE...................... ......... .......... 137 136 99 -50 -98 -74 -39 -23 -13 -2 71
depreciation of certain passenger
automobiles.............................. Total of Revenue Provisions........... ............................... ......... .......... 611 4,135 6,987 8,257 8,845 9,482 10,255 10,838 11,158 11,388 81,966TOTAL OF PART SEVENTEEN: AMERICAN JOBS ............................... ......... .......... -5,719 -7,856 -4,226 2,570 6,519 2,401 1,841 1,975 1,498 1,201 213
CREATION ACT OF 2004.......................PART EIGHTEEN: REVENUE PROVISIONS OF RONALD tbpa DOE....................... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
W. REAGAN NATIONAL DEFENSE AUTHORIZATION
ACT--FOR FISCAL YEAR 2005--EXCLUSION FROM
GROSS INCOME OF TRAVEL BENEFITS UNDER
OPERATION HERO MILES (P.L. 108-375, signed
into law by the President on October 28,
2004)......................................PART NINETEEN: THE REVENUE PROVISIONS OF THE DOE............................ ......... .......... ......... The Joint Committee on Taxation Did Not Estimate This Provision .......... .......... ...........
CONSOLIDATED APPROPRIATIONS ACT, 2005--
APPLICATION OF THE ERISA ANTICUT- BACK
RULES TO CERTAIN MULTIEMPLOYER PLAN
AMENDMENTS (P.L. 108-447, signed into law
by the President on December 8, 2004)......PART TWENTY: CERTAIN ARRANGEMENTS MAINTAINED pyba........................... ......... .......... ......... .......... .......... Negligible Revenue Effect .......... .......... .......... .......... ...........
BY THE YMCA RETIREMENT FUND TREATED AS 12/31/03.......................
CHURCH PLANS (P.L. 108-476, signed into law
by the President on December 21, 2004).....PART TWENTY-ONE: MODIFY TAXATION OF ARROW asa 3/31/05.................... ......... .......... -1 .......... .......... .......... .......... .......... .......... .......... .......... .......... -1
COMPONENTS (P.L. 108-493, signed into law
by the President on December 23, 2004).....========================================================================================================================================================================================================================================
Note: Details may not add to totals due to rounding.Source: Joint Committee on Taxation.
Legend for ``Effective'' column: aa = acquisitions after DOE = date of enactment pia = penalties imposed after
abiUSa = articles brought into the United States after doo/a = distributions occurring on or after pma = payments made after
ada = amounts deferred after Doo/a = deaths occurring on or after ppisa = property placed in service
after
aiiiTWWIIA = as if included in the Ticket to Work Dpa = dividends paid after pyba = plan years beginning after
Incentives Improvement Act of 1999 dri = dividends received in ra = requests after
aoa = acquisitions occurring after eia = expenses incurred after rma = requests made after
apoamt = amounts paid or accrued more than ematma = elections made and terminations made after rra = risk reinsured after
asa = articles sold after epoia = expenditures paid or incurred after sa = sales after
asbmpoia = articles sold by the manufacturer, epoid = expenditures paid or incurred during saptoea = stock acquired pursuant to
producer, or importer after eposfqfa = electricity produced or sold from options exercised after
ata = actions taken after qualifying facilities after so/a = sales on or after
ataro/a = amounts treated as received on or after fpasoua = fuel produced, and sold or used, after soo/a = sales occurring on or after
bi =bonds issued fpisa = facilities placed in service after soea = sales or exchanges after
bia = bonds issued after frsoua = fuel removed, sold or used after sota = sales of timber after
bib = bonds issued before fsa = fuel sold after ta = transactions after
ca = construction after fsoua = fuel sold or used after tbpa = travel benefits provided
after
cma = contributions made after iaa = interest accrued after teia = transactions entered into
after
cmd = contributions made during iaeio/a = installment agreements entered into on or tma = transfers made after
after
coio/a = cancellations of indebtedness on or after iwea = individuals who expatriate after toa = transactions occurring after
cpoii = costs paid or incurred in josoa = judgments or settlements occurring after to/a = transactions on or after
ctada = contributions, transfers, and distributions lf = losses for tosa = transfers of stock after
after
da = day after lii = losses incurred in tpba = taxable periods beginning
after
Da = distributions after oia = obligations issued after trda = tax returns due after
DA = dispositions after pa = production after tyba = taxable years beginning after
di = distributions in Paa = penalties assessed after tyea = taxable years ending after
diia = debt instrument issued after PAa = property acquired after voa = violations occurring after
dma = distributions made after pada = purchases and dispositions after wma = wagers made after
Dma = deposits made after pao/a = payments accrued on or after wpoifibwa = wages paid or incurred
DMa = disclosures made after Pao/a = penalties assessed on or after for individuals beginning work
after
DMA = designations made after pca = productions commencing after 15da = 15 days after
dmo/a = disclosures made on or after peo/a = positions established on or after 30da = 30 days after
dmbo/a = designations made before, on, or after pfa = pleadings filed after 90da = 90 days after
doa = deaths occurring after pi = production in
do/a = disclosures on or after
\1\ Advance payment of 2003 child credit paid by rebate with safe harbor.
\2\ Does not apply to any property with binding contract in place before May 6, 2003.
\3\ Any dividend described in Internal Revenue Code section 404(k) would be taxed at ordinary rates. RIC and REIT shareholders receive tax relief to the
extent that dividends paid by the RIC or REIT are qualified dividends received by the RIC or REIT. Taxed REIT income would receive the preferential
tax rates when distributed as dividends. The provision excludes qualified dividends from investment income for the purpose of Internal Revenue Code
Section 163(d). Certain anti-abuse rules, including the imposition of a 60-day holding period, apply. Certain foreign dividends would qualify for the
preferential rates.
\4\ Estimate provided by the Congressional Budget Office.
\5\ Loss of less than $500,000.
\6\ The provision applies to any period for performing an act which has not expired before the date of enactment.
\7\ Generally effective for qualified individuals whose lives are lost in a space mission after December 31, 2002.
\8\ Premium adjustments under Section 1839(i) of the Social Security Act for months beginning with January 2007.
\9\ The estimate includes the indirect revenue effect that would exist if the Medicare subsidies to employers were taxable but the employers responded
to the subsidies as if they were excludable.[Footnotes for the Appendix are continued on the following page]
Footnotes for the Appendix continued:\10\ The indirect tax effects that begin in fiscal year 2004 are attributable to provisions in Title XI (enhancing generic competition, drug
importation) which are effective upon the date of enactment. The provisions of Title I that affect employers (Part D program and related subsidies)
are effective January 1, 2006.
\11\ Although the tax exclusion will be effective for taxable years beginning after the date of enactment, the exclusion will have no effect until
January 1, 2006, when the Medicare subsidies to employers will begin to be paid.
\12\ The provision extending expenditure authority is effective on the date of enactment. The provision relating to the domestic flight segment tax for
flight segments beginning after December 31, 2002, is effective as if included in the provisions of the Taxpayer Relief Act of 1997 to which it
relates.
\13\ The conference agreement also contains a provision relating to the antitrust status of graduate medical resident matching programs.
\14\ Estimate does not include the effects on PBGC variable rate premiums which are the responsibility of the Congressional Budget Office.
\15\ Provision includes interaction with item A.
\16\ Provision provides penalty assessable by the Department of Labor for failure to provide notice.
\17\ Negligible revenue effect.
\18\ Estimate does not include the effects on PBGC which are the responsibility of the Congressional Budget Office.
\19\ Provision applies to any employer that receives a notification under Section 4219(b)(1) of ERISA after October 31, 2003.
\20\ For purposes of the child tax credit, effective for taxable years beginning after December 31, 2003; for purposes of earned income credit at
taxpayer's election, effective for taxable years ending after the date of enactment and before January 1, 2006.
\21\ This provision will have a negligible effect on penalty excise tax receipts. However it will have an indirect effect on income tax receipts through
increases in employer-contributions for health insurance and corresponding decreases in cash wages. The table shows this indirect revenue effect,
which was estimated by the Congressional Budget Office.
\22\ The New York City Liberty Zone is defined as all business addresses located on or south of Canal Street, East Broadway (east of its intersection
with Canal Street), or Grand Street (east of its intersection with East Broadway) in the Borough of Manhattan, New York, NY.
\23\ Generally effective January 1, 2004, except for the bond provision which is effective for obligations issued after the date of enactment.
\24\ The Economic Growth and Tax Relief Reconciliation Act of 2001 provides that the child tax credit and adoption tax credit are allowed for purposes
of the alternative minimum tax for 2002 through 2010.
\25\ Gain of less than $500,000.
\26\ Effective as if included in section 201 of the Victims of Terrorism Tax Relief Act of 2001.
\27\ Includes estimate for general transition and transition for binding contracts, if in effect on September 17, 2003, and for renewals of binding
contracts if original contract was in effect on September 17, 2003.
\28\ Effective as if included in the amendment made by section 101 of the Community Renewal Tax Relief Act of 2000.
\29\ Gain of less than $1 million.
\30\ Effective as if included in the amendment made by section 121(a) of the Community Renewal Tax Relief Act of 2000.
\31\ Effective for debt incurred after date of enactment by SBICs licensed after date of enactment.
\32\ The bill provides that the excise tax credit expires after December 31, 2010. If this bill is enacted, the Congressional Budget Office's subsequent
baseline would not assume extension of the excise tax credit beyond its expiration because the requirement to assume extension of excise taxes
dedicated to trust funds does not apply to excise tax credits paid from the General Fund. For purposes of this revenue estimate, therefore, it is
assumed that the excise tax credit would expire as scheduled. This treatment generates changes in revenues after December 31, 2010.
\33\ The provision would result in an indirect increase in farm program outlays of $171 million in the fiscal years 2011 through 2014.
\34\ Tax credits would be provided for on-road and off-road uses of biodiesel.
\35\ The provision would result in an indirect increase in farm program outlays of $64 million in the fiscal years 2005 through 2007.
\36\ Estimate does not include a reduction in outlays from the Wildlife Trust Fund of $8 million for 2005 through 2014.
\37\ Estimate does not include a reduction in outlays from the Aquatic Resources Trust Fund of $10 million for 2005 through 2014.
\38\ Estimate does not include a reduction in outlays from the Aquatic Resources Trust Fund of $3 million for 2005 through 2014.
\39\ Provision is effective as if included in the amendments made by section 101 of the Job Creation and Worker Assistance Act of 2002.
\40\ Loss of less than $1 million.
\41\ Base difference change effective in taxable years beginning after 2004, for taxes paid or incurred after 2004. Basket change in taxable years
beginning after 2006. Pre-effective date excess credits carried forward to new basket that would apply under new system.
\42\ Effective for taxable years of foreign corporations beginning after December 31, 2004, and for taxable years of U.S. shareholders with or within
which such taxable years of such foreign corporations end.
\43\ Effective for dividends with respect to taxable years of regulated investment companies beginning after December 31, 2004.
\44\ Estimate accounts for interaction with reduction to 2 foreign tax credit baskets.
\45\ Effective for excess foreign taxes that may be carried forward to any taxable year ending after the date of enactment. Carryback period effective
for credits arising in taxable years beginning after the date of enactment.[Footnotes for the Appendix are continued on the following page]Footnotes for the Appendix continued:\46\ Effective for the first taxable year beginning on or after date of enactment, or for the last taxable year beginning before date of enactment, at
the taxpayer's election.
\47\ Effective for taxable years of a foreign corporation seeking qualified foreign corporation status beginning after September 24, 2004.
\48\ Estimate does not include an increase in outlays of $126 million over the fiscal years 2005 through 2014.
\49\ Effective dates for provisions relating to reportable transactions and tax shelters: the penalty for failure to disclose reportable transactions is
effective for returns and statements the due date of which is after the date of enactment; the modification to the accuracy-related penalty for listed
or reportable transactions is effective for taxable years ending after the date of enactment; the tax shelter exception to confidentiality privileges
is effective for communications made on or after the date of enactment; the statute of limitations for unreported listed transactions applies to all
taxable years for which the statute of limitations under section 6501 has not run as of the date of enactment; the disclosure of reportable
transactions by material advisors is effective for transactions with respect to which material aid, assistance or advice is provided after the date of
enactment; the investor list penalty is effective for returns the due date for which is after the date of enactment; the modification of penalty for
failure to maintain investor lists is effective for requests made after the date of enactment; and the penalty on promoters of tax shelters is
effective for activities after the date of enactment.
\50\ Effective for all taxable years, whether beginning before, on, or after the date of enactment.
\51\ Generally effective for leases entered into after March 12, 2004 with exception for pending transportation leases with FTA.
\52\ Generally effective after the date of enactment, except for fuel taxes, effective for taxable years beginning after the date of enactment.
\53\ Effective for aviation-grade kerosene removed, entered into the United States, or sold after December 31, 2004.
\54\ Effective 180 days after the date on which the Secretary issues the regulations, which are required no later than 180 days after the date of
enactment.
\55\ Bulk transfers to unregistered parties would be taxed at the time of the transfer. The Secretary would be required to publish a list of certain
registered persons by January 1, 2005.
\56\ The revenue neutral tax rate on each 10 pounds of tire capacity above 3,500 pounds is 9.45 cents on tires in general and 4.725 cents for biasply
tires.
\57\ Effective for sales in calendar years beginning more than 30 days after the date of enactment.
\58\ Estimated outlay effects provided by the Congressional Budget Office.
\59\ Effective for vaccines sold and used beginning on the first day of the first month beginning more than four weeks after the date of enactment.
\60\ Effective for vaccines sold and used on or after the later of the first day of the first month beginning more than four weeks after the date of
enactment, or the date on which the Secretary of Health and Human Services lists the vaccine in the Vaccine Injury Compensation Trust Fund.
\61\ Generally effective for start-up and organizational expenditures incurred after the date of enactment.
\62\ Applies to individuals subject to section 16 of the Securities and Exchange Act of 1934 for private and public companies.