[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 
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                           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

                              ----------                              
                                                                   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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

      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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                             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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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.
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    \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.
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    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\
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    \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.
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    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).
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    \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.
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                             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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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).
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                        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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                             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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                             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.
---------------------------------------------------------------------------
    \56\ Pub. L. No. 99-272.
    \57\ Pub. L. No. 107-296.
---------------------------------------------------------------------------

                        Explanation of Provision

    The Act extends the authorization for the collection of 
customs user fees though March 31, 2004.\58\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                             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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \73\ Present law does not provide relief from self-employment tax 
liability.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \74\ Such amounts may, however, be excludable from gross income 
under the death benefit exclusion provided in section 102 of the 
Victims Act.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \75\ Thus, for example, payments made over a period of years could 
qualify for the exclusion.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \77\ Sec. 201; 117 Stat. 1335.
---------------------------------------------------------------------------

                        Explanation of Provision

    The Act extends the authorization for the collection of 
customs user fees though March 1, 2005.\78\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                             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)).
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                             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.
---------------------------------------------------------------------------
    \81\ Adjustments are determined pursuant to section 1839(i) of the 
Social Security Act (as added by the provision).
---------------------------------------------------------------------------

                             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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \86\ Sec. 162.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \101\ Sec. 2056.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \103\ Sec. 61.
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \104\ Sec. 6041.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \107\ Rev. Rul. 2003-43, 2003-21 I.R.B. 935 (May 27, 2003).
    \108\ Id.
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \110\ This term is defined in sec. 106(c)(2).
---------------------------------------------------------------------------

                             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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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).
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \122\ Sec. 233 of the Social Security Act.
---------------------------------------------------------------------------

                           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.
---------------------------------------------------------------------------
    \123\ Secs. 1401-1403.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \124\ Pub. L. No. 104-188.
---------------------------------------------------------------------------

                           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.
---------------------------------------------------------------------------
    \125\ Secs. 3101-3128.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \128\ Code sec. 412; ERISA sec. 302. The Code also imposes limits 
on deductible contributions, as discussed below.
---------------------------------------------------------------------------
            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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
            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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \137\ Pub. L. No. 107-147.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
            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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
            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\
---------------------------------------------------------------------------
    \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'').
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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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \151\ Code sec. 411(d)(6); ERISA sec. 204(g).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \153\ ERISA sec. 101(d).
    \154\ ERISA sec. 4011. Multiemployer plans are not required to pay 
variable rate premiums.
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \159\ Sec. 412(d).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \160\ Sec. 4971.
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \162\ Sec. 420.
---------------------------------------------------------------------------
    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).
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \165\ ERISA sec. 101(e). ERISA also provides that a qualified 
transfer is not a prohibited transaction under ERISA or a prohibited 
reversion.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \174\ See Inter-American Life Insurance Co. v. Comm'r, supra.
---------------------------------------------------------------------------

                             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\
---------------------------------------------------------------------------

    \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\

---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------

    \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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
            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\
---------------------------------------------------------------------------
    \196\ Treas. Reg. sec. 1.152-1(b).
    \197\ Id.
    \198\ Id.
    \199\ Rev. Rul. 66-28, 1966-1 C.B. 31.
---------------------------------------------------------------------------
            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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
            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).
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
    \205\ Sec. 32.
---------------------------------------------------------------------------
            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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
            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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
            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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \219\ Sec. 21(e)(5).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \226\ A technical correction may be necessary so that the statute 
reflects this intent.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \227\ See secs. 2(b)(1)(A)(i) and 32(c)(3)(A) as amended by the 
Act, and sec. 21(e)(5).
---------------------------------------------------------------------------
            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\
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    \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)).
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                             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.
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    \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).
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                        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.
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    \230\ The excise tax does not apply to benefits for services 
furnished on or after September 30, 2001, and before January 10, 2002.
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                        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.
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    \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\

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    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                        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\
---------------------------------------------------------------------------
    \245\ Sec. 45 was subsequently modified to include additional 
qualifying facilities by the American Jobs Creation Act of 2004, 
described in Part Seventeen.
---------------------------------------------------------------------------

                             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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                        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\

---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \249\ Sec. 6103.
    \250\ Pub. L. No. 108-89 (2003).
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \254\ Sec. 6103(b)(3).
    \255\ Sec. 6103(i)(7)(A).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \256\ Sec. 6103(i)(7)(A)(ii).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \257\ Sec. 6103(b)(2)(A).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
          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\
---------------------------------------------------------------------------
    \265\ Accordingly, the provision deletes the specific list of 
matters required to be covered in the annual report.
---------------------------------------------------------------------------

                             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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \267\ These amounts are indexed for inflation, rounded to the 
nearest $50.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                             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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \315\ 12. U.S.C. 4702(17) (defines ``low-income'' for purposes of 
12. U.S.C. 4702(20)).
---------------------------------------------------------------------------

                             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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                        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)).
---------------------------------------------------------------------------
    \320\ A technical correction may be necessary so that the statute 
reflects this intent.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \323\ A technical correction may be necessary so that the statute 
reflects this intent.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------
    \324\ Notice 97-5, 1997-1 C.B. 352, sets forth guidance relating to 
passive investment income on banking assets.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \325\ Sec. 4975.
    \326\ Sec. 4975(d)(3). An ESOP that borrows money to purchase 
employer stock is referred to as a ``leveraged'' ESOP.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \328\ Sec. 404(k)(5)(B).
    \329\ Sec. 404(k)(2)(B).
---------------------------------------------------------------------------

                        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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \335\ Sec. 856(d)(2)(B).
    \336\ Sec. 856(d)(8).
---------------------------------------------------------------------------
            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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \339\ Sec. 1361(c)(5), without regard to paragraph (B)(iii) 
thereof.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \342\ Secs. 856(c)(6) and 857(b)(5).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \344\ Secs. 856(m)(3) and 856(m)(4)(A).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------
    \346\ The Act does not modify any of the standards of section 482 
as they apply to REITs and to TRSs.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
            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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \363\ Sec. 5117(b).
---------------------------------------------------------------------------
    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.
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    \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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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)).
---------------------------------------------------------------------------
            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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \390\ Sec. 9503(b)(4)(E).
    \391\ Sec. 9503(b)(4)(F).
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \398\ Sec. 40.
---------------------------------------------------------------------------

                            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.
---------------------------------------------------------------------------

                           Reasons for Change

    The Congress believed that providing a new income tax 
credit for biodiesel fuel will promote energy self-
sufficiency.\400\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                        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.
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    \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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \407\ Section 162(o).
---------------------------------------------------------------------------

                        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\
---------------------------------------------------------------------------
    \408\ Announcement 96-24, ``Proposed Examination Guidelines 
Regarding Rural Electric Cooperatives,'' 1996-16 I.R.B. 35.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \409\ Sec. 1382.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \413\ Sec. 501(c)(12).
    \414\ Rev. Rul. 72-36, 1972-1 C.B. 151.
---------------------------------------------------------------------------
    Rural electric cooperatives generally are subject to the 
tax on unrelated trade or business income under section 511.

                        Reasons for Change \415\

---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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).
---------------------------------------------------------------------------
    \416\ Under the provision, references to FERC are treated as 
including references to the Public Utility Commission of Texas.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \429\ The Act therefore changes the $10,000 ceiling from an 
aggregate to a per-property limit.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \430\ A technical correction may be necessary so that the statute 
reflects this intent.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \431\ A technical correction may be necessary so that the statute 
reflects this intent.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \432\ Sec. 852(b).
    \433\ Sec. 851(a).
    \434\ Sec. 851(b).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \435\ Sec. 851(b)(2).
    \436\ Sec. 851(b).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \437\ Sec. 851(b)(3).
    \438\ Sec. 851(d).
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------
    \439\ Sec. 7704(a), (c), and (d).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \440\ Sec. 469.
    \441\ Sec. 469(k).
---------------------------------------------------------------------------

                           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'').
---------------------------------------------------------------------------
    \442\ H.R. Rep. No. 100-391, pt. 2 of 2, at 1006 (1987)
    \443\ Id.
---------------------------------------------------------------------------
    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).
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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).
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------

                             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).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \480\ Treas. Reg. sec. 1.904-4(e)(3)(i) and (2)(i).
    \481\ Treas. Reg. sec. 1.904-4(e)(3)(ii).
---------------------------------------------------------------------------

``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\
---------------------------------------------------------------------------
    \482\ Treas. Reg. sec. 1.904-6.
    \483\ Treas. Reg. sec. 1.904-6(a)(1)(iv).
---------------------------------------------------------------------------

                           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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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).
---------------------------------------------------------------------------
    \488\ T.D. 8708, 1997-1 C.B. 137.
---------------------------------------------------------------------------

                           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\
---------------------------------------------------------------------------
    \489\ Secs. 865(d) and 862(a).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \490\ Sec. 904(d).
    \491\ Sec. 904(d)(3).
---------------------------------------------------------------------------

                           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\
---------------------------------------------------------------------------
    \492\ Secs. 951-964.
    \493\ Sec. 951(a)(1)(B).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \494\ Sec. 956(a).
    \495\ Secs. 956 and 959.
    \496\ Secs. 951(a)(1)(B) and 959.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \497\ Sec. 956(c)(1).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

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).
---------------------------------------------------------------------------

                           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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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).
---------------------------------------------------------------------------
    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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

 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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                           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).
---------------------------------------------------------------------------

                           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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    Deductions are disallowed for expenses that are directly 
allocable to the deductible portion of any dividend.\554\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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'').
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------
    \577\ Sec. 104(a)(2).
    \578\ Sec. 265(a)(1).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \579\ Sec. 212.
    \580\ Sec. 67.
    \581\ Sec. 68.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------

                        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).
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                        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).
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \591\ A technical correction may be necessary so that the statute 
reflects this intent.
---------------------------------------------------------------------------

                             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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \595\ Treas. Reg. sec. 1.420-1(a).
    \596\ Treas. Reg. sec. 1.420-1(b)(1).
    \597\ Treas. Reg. sec. 1.420.
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \600\ A technical correction may be necessary so that the statute 
reflects this intent.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
            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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                           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:
---------------------------------------------------------------------------
    \629\ In the case of a nominee, the nominee must furnish the 
information to the shareholder in the manner prescribed by the Treasury 
Secretary.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
            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.
---------------------------------------------------------------------------
    \651\ See the previous discussion regarding the penalty under new 
section 6707A for failing to disclose a reportable transaction.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \667\ Sec. 6111(d).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \672\ Sec. 6707.
---------------------------------------------------------------------------
    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\

---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \674\ The terms ``reportable transaction'' and ``listed 
transaction'' have the same meaning as previously described in 
connection with the taxpayer-related provisions.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \675\ See the previous discussion regarding the disclosure 
requirements under new section 6707A.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \676\ The terms ``reportable transaction'' and ``listed 
transaction'' have the same meaning as previously described in 
connection with the taxpayer-related provisions.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                             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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \681\ Treas. Reg. sec. 301.6112-1(c)(1).
    \682\ Treas. Reg. sec. 301.6112-1(c)(2) and (3).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \683\ Treas. Reg. sec. 301.6112-1(b).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \684\ Sec. 6112(c)(2).
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------
    \685\ Sec. 6708.
---------------------------------------------------------------------------

                           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\

---------------------------------------------------------------------------
    \686\ Notice 2004-80, 2004-50 I.R.B. 963, provides interim guidance 
concerning the application of this provision.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                             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.
---------------------------------------------------------------------------
    \691\ Sec. 6700.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \692\ Sec. 6662(a) and (d)(1)(A).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \693\ Sec. 6662(d)(2)(B).
---------------------------------------------------------------------------

                           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\
---------------------------------------------------------------------------
    \694\ Sec. 7408.
---------------------------------------------------------------------------

                           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.
---------------------------------------------------------------------------
    \695\ Sec. 6707, as amended by other provisions of the Act.
    \696\ Sec. 6708, as amended by other provisions of the Act.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \697\ 31 U.S.C. sec. 5314.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \698\ 31 U.S.C. sec. 5321(a)(5).
    \699\ 31 U.S.C. sec. 5322.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                           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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                           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\
---------------------------------------------------------------------------
    \704\ Helvering v. Horst, 311 U.S. 112 (1940).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \707\ Sec. 1286.
    \708\ Sec. 1286(e).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \709\ Sec. 1286(a).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \712\ Sec. 305(e)(5).
    \713\ Sec. 305(e)(1).
    \714\ Sec. 305(e)(3).
---------------------------------------------------------------------------

                           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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \723\ Treas. Reg. sec. 1.704-3(a)(7).
---------------------------------------------------------------------------

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).
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \726\ Sec. 731(a) and (b).
    \727\ Sec. 732(b).
    \728\ Sec. 732(a).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \729\ Sec. 732(a)(1) and (c).
    \730\ Sec. 732(d).
    \731\ Treas. Reg. sec. 1.732-1(d)(4).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \732\ Sec. 734(a).
    \733\ Sec. 734(b).
---------------------------------------------------------------------------

                           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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \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.''
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                             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.
---------------------------------------------------------------------------
    \738\ Sec. 721(a).
    \739\ Sec. 731(a) and (b).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \740\ Sec. 732(b).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \741\ Sec. 754.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \742\ Sec. 755(a).
    \743\ Sec. 755(b).
---------------------------------------------------------------------------

                           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.
---------------------------------------------------------------------------
    \745\ Sections 860H through 860L.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \747\ See secs. 860A-860G.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                        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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \751\ Sec. 351.
    \752\ Sec. 358.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \756\ Secs. 951-964.
    \757\ Sec. 951(a)(1)(B).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \758\ Sec. 956(a).
    \759\ Secs. 956 and 959.
    \760\ Secs. 951(a)(1)(B) and 959.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \761\ Sec. 956(c)(1).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \764\ Sec. 163(a).
---------------------------------------------------------------------------

                           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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                           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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                           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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                             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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                           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\
---------------------------------------------------------------------------
    \793\ Prop. Treas. Reg. sec. 1.263(g)-4.
---------------------------------------------------------------------------

                        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\
---------------------------------------------------------------------------
    \794\ Frank Lyon Co. v. United States, 435 U.S. 561, 583-84 (1978).
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \802\ Sec. 168(i)(2).
---------------------------------------------------------------------------

                           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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
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    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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \836\ Sec. 4092(a).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \839\ Sec. 4092(c).
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \843\ See sec. 4081(a)(1)(B).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    The Secretary is required to prescribe necessary 
regulations relating to dyeing, including specifically the 
labeling of retail diesel fuel and kerosene pumps.\852\
---------------------------------------------------------------------------
    \852\ Sec. 4082(e).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \853\ Sec. 6715(a).
    \854\ Sec. 6715(a).
    \855\ Sec. 6715(b).
    \856\ Sec. 6715(d).
    \857\ Sec. 6715(c)(1).
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                           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.
---------------------------------------------------------------------------
    \861\ The operator remains liable under current Treas. Reg. sec. 
48.4081-2(c) for any unpaid tax on removed undyed fuel.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \862\ Sec. 4081.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \867\ Treas. Reg. sec. 48.4083-1(c)(1).
---------------------------------------------------------------------------

                           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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \871\ Treas. Reg. sec. 48.4083-1(b)(2).
    \872\ Sec. 4083(c); Treas. Reg. sec. 48.4083-1(b)(1).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \873\ Secs. 4083(c)(3) and 7342.
    \874\ Sec. 6671.
---------------------------------------------------------------------------

                        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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \877\ Treas. Reg. sec. 48.4081-3(e)(2).
    \878\ Treas. Reg. sec. 48.4081-3(b).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \879\ Sec. 6103(k)(7).
---------------------------------------------------------------------------

                           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\
---------------------------------------------------------------------------
    \880\ Sec. 4101; Treas. Reg. sec. 48.4101-1(a) and (c)(1).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \881\ Sec. 7272(a).
    \882\ Sec. 7232.
---------------------------------------------------------------------------

                           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\
---------------------------------------------------------------------------
    \883\ Sec. 4101; Treas. Reg. sec. 48.4101-1(a) and (c)(1).
---------------------------------------------------------------------------

                        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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                           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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                        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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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:
---------------------------------------------------------------------------
    \891\ In the provision, this person is referred to as the 
``delivering person.''
---------------------------------------------------------------------------
          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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \893\ Sec. 6156.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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\

---------------------------------------------------------------------------
    \896\ All Code references are with respect to those in effect 
immediately prior to the enactment of the Act.
---------------------------------------------------------------------------

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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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).
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    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).
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    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \921\ See sec. 1221(a)(3), 1231(b)(1)(C).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \922\ Sec. 170(f)(3).
    \923\ Sec. 1011(b) and Treas. Reg. sec. 1.1011-2.
    \924\ Sec. 170(f)(8).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                           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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                           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.
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    \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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                        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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
            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).
---------------------------------------------------------------------------

                             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.
---------------------------------------------------------------------------
    \952\ There is no inference that all subsequent deferral elections 
under plans that are not materially modified are permissible under 
prior law.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \955\ Sec. 197.
    \956\ Sec. 197(e)(6).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \957\ P.D.B. Sports, Ltd. v. Comm., 109 T.C. 423 (1997).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \961\ Sec. 6331(h).
---------------------------------------------------------------------------

                           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.
---------------------------------------------------------------------------
    \962\ Sec. 1092.
---------------------------------------------------------------------------
            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.
---------------------------------------------------------------------------
    \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)).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \964\ Prop. Treas. Reg. sec. 1.1092(d)-2(c).
---------------------------------------------------------------------------
            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.
---------------------------------------------------------------------------
    \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:
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                           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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                           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).
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    \1017\ Sec. 195
    \1018\ Secs. 248 and 709.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \1019\ Treas. Reg. sec. 1.195-1.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                             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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                        Reasons for Change\1027\

---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \1028\ Sec. 421.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \1029\ Sec. 1043.
---------------------------------------------------------------------------

                        Reasons for Change\1030\

---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \1033\ Rev. Rul. 58-236, 1958-1 C.B. 37.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \1034\ Sec. 402(b)(2).
    \1035\ Sec. 402(b)(4).
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------
    \1036\ Sec. 83(a).
    \1037\ Treas. Reg. sec. 1.61-2(d)(i).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \1038\ Sec. 872.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \1039\ Sec. 274(a).
    \1040\ Sec. 274(e)(2).
    \1041\ Sec. 274(e)(9).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \1042\ Treas. Reg. sec. 1.61-21.
    \1043\ Treas. Reg. sec. 1.61-21(g).
    \1044\ Treas. Reg. sec. 1.61-21(b)(6).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------

                        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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \1047\ Section 7701(a)(30) defines a citizen or resident of the 
United States as ``U.S. persons.''
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                             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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------

                             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.
---------------------------------------------------------------------------
    \1063\ Code sec. 411; ERISA sec. 203.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \1064\ Code sec. 411(d)(6); ERISA sec. 204(g).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \1065\ Central Laborers' Pension Fund v. Heinz, 541 U.S. 739 
(2004).
---------------------------------------------------------------------------

                        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\
---------------------------------------------------------------------------

    \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.''
---------------------------------------------------------------------------
    \1067\ Sec. 414(e).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \1068\ Sec. 403(b).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
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).
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        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.
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    \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.

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