[JPRT 115-1-18]
[From the U.S. Government Publishing Office]




                                     

                        [JOINT COMMITTEE PRINT]

 
 
                         GENERAL EXPLANATION OF
                           PUBLIC LAW 115-97

                               ----------                              

                         Prepared by the Staff

                                 of the

                      JOINT COMMITTEE ON TAXATION
















[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]







                             DECEMBER 2018



                                                               JCS-1-18


























                        [JOINT COMMITTEE PRINT]


                         GENERAL EXPLANATION OF

                           PUBLIC LAW 115-97

                               __________

                         Prepared by the Staff

                                 of the

                      JOINT COMMITTEE ON TAXATION




















          [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
 
 
 
 
                           DECEMBER 2018





                               ______
		 
                     U.S. GOVERNMENT PUBLISHING OFFICE 
		 
33-137                    WASHINGTON : 2018             JCS-1-18






















                      JOINT COMMITTEE ON TAXATION
                       115th Congress, 2d Session

                                 ------                                

              SENATE                                   HOUSE 
ORRIN G. HATCH, Utah,                     KEVIN BRADY, Texas,
  Chairman                                 Vice Chairman        
CHUCK GRASSLEY, Iowa                      SAM JOHNSON, Texas       
MIKE CRAPO, Idaho                    DEVIN NUNES, California         
RON WYDEN, Oregon                RICHARD NEAL, Massachusetts             
DEBBIE STABENOW, Michigan                JOHN LEWIS, Georgia                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
    
               Thomas A. Barthold, Chief of Staff
            Robert Harvey, Deputy Chief of Staff
             David Lenter, Deputy Chief of Staff

























                            C O N T E N T S

                              ----------                              
                                                                   Page
INTRODUCTION.....................................................     1

TITLE I..........................................................     3

SUBTITLE A--INDIVIDUAL TAX REFORM................................     3

PART I--TAX RATE REFORM..........................................     3

          A.  Modification of Rates (sec. 11001 of the Act and 
              sec. 1 of the Code)................................     3
          B.  Inflation Adjustments Based On Chained CPI (sec. 
              11002 of the Act and sec. 1(f) of the Code)........     9

PART II--DEDUCTION FOR QUALIFIED BUSINESS INCOME OF PASS-THRU 
  ENTITIES.......................................................    11
          A.  Deduction for Qualified Business Income (sec. 11011 
              of the Act and sec. 199A of the Code)..............    11
          B.  Limitation on Losses for Taxpayers Other Than 
              Corporations (sec. 11012 of the Act and sec. 461(l) 
              of the Code).......................................    38

PART III--TAX BENEFITS FOR FAMILIES AND INDIVIDUALS..............    42

          A.  Increase in Standard Deduction (sec. 11021 of the 
              Act and sec. 63 of the Code).......................    42
          B.  Increase in and Modification of Child Tax Credit 
              (sec. 11022 of the Act and sec. 24 of the Code)....    43
          C.  Modifications to the Deduction for Charitable 
              Contributions (secs. 11023, 13704, and 13705 of the 
              Act and sec. 170 of the Code)......................    46
          D.  Increased Contributions to ABLE Accounts (sec. 
              11024 of the Act and secs. 25B and 529A of the 
              Code)..............................................    52
          E.  Rollovers to ABLE Programs from 529 Programs (sec. 
              11025 of the Act and secs. 529 and 529A of the 
              Code)..............................................    54
          F.  Treatment of Certain Individuals Performing 
              Services in the Sinai Peninsula of Egypt (sec. 
              11026 of the Act and secs. 2, 112, 692, 2201, 3401, 
              4253, 6013, and 7508 of the Code)..................    55
          G.  Temporary Reduction in Medical Expense Deduction 
              Floor (sec. 11027 of the Act and sec. 213 of the 
              Code)..............................................    56
          H.  Relief for 2016 Disaster Areas (sec. 11028 of the 
              Act and secs. 72(t), 165, 401-403, 408, 457, and 
              3405 of the Code)..................................    57

PART IV--EDUCATION...............................................    61

          A.  Treatment of Student Loans Discharged on Account of 
              Death or Disability (sec. 11031 of the Act and sec. 
              108 of the Code)...................................    61
          B.  529 Account Funding for Elementary and Secondary 
              Education (sec. 11032 of the Act and sec. 529 of 
              the Code)..........................................    62

PART V--DEDUCTIONS AND EXCLUSIONS................................    65

          A.  Suspension of Deduction for Personal Exemptions 
              (sec. 11041 of the Act and sec. 151 of the Code)...    65
          B.  Limitation on Deduction for State and Local, etc. 
              Taxes (sec. 11042 of the Act and sec. 164 of the 
              Code)..............................................    67
          C.  Limitation on Deduction for Qualified Residence 
              Interest (sec. 11043 of the Act and sec. 163(h) of 
              the Code)..........................................    69
          D.  Modification of Deduction for Personal Casualty 
              Losses (sec. 11044 of the Act and sec. 165 of the 
              Code)..............................................    71
          E.  Suspension of Miscellaneous Itemized Deductions 
              (sec. 11045 of the Act and secs. 62, 67 and 212 of 
              the Code)..........................................    72
          F.  Suspension of Overall Limitation on Itemized 
              Deductions (sec. 11046 of the Act and sec. 68 of 
              the Code)..........................................    74
          G.  Suspension of Exclusion for Qualified Bicycle 
              Commuting Reimbursement (sec. 11047 of the Act and 
              sec. 132(f) of the Code)...........................    75
          H.  Suspension of Exclusion for Qualified Moving 
              Expense Reimbursement (sec. 11048 of the Act and 
              sec. 132(g) of the Code)...........................    76
          I.  Suspension of Deduction for Moving Expenses (sec. 
              11049 of the Act, and sec. 217 of the Code)........    77
          J.  Limitation on Wagering Losses (sec. 11050 of the 
              Act and sec. 165(d) of the Code)...................    78
          K.  Repeal of Deduction for Alimony Payments (sec. 
              11051 of the Act and secs. 61, 71, 215, and 682 of 
              the Code)..........................................    78

PART VI--INCREASE IN ESTATE AND GIFT TAX EXEMPTION...............    80

          A.  Increase in Estate and Gift Tax Exemption (sec. 
              11061 of the Act and secs. 2001 and 2010 of the 
              Code)..............................................    80

PART VII--EXTENSION OF TIME LIMIT FOR CONTESTING IRS LEVY........    90

          A.  Extension of Time Limit for Contesting IRS Levy 
              (sec. 11071 of the Act and secs. 6343 and 6532 of 
              the Code)..........................................    90

PART VIII--INDIVIDUAL MANDATE....................................    91

          A.  Elimination of Shared Responsibility Payment for 
              Individuals Failing to Maintain Minimum Essential 
              Coverage (sec. 11081 of the Act and sec. 5000A of 
              the Code)..........................................    91

SUBTITLE B--ALTERNATIVE MINIMUM TAX..............................    92

          A.  Repeal of Tax for Corporations; Credit for Prior 
              Year Minimum Tax Liability of Corporations; 
              Increased Exemption for Individuals (secs. 12001-
              12003 of the Act and secs. 53 and 55-59 of the 
              Code)..............................................    92

SUBTITLE C--BUSINESS-RELATED PROVISIONS..........................    99

PART I--CORPORATE PROVISIONS.....................................    99

          A.  21-Percent Corporate Tax Rate (sec. 13001 of the 
              Act and sec. 11 of the Code).......................    99
          B.  Reduction in Dividends-Received Deduction to 
              Reflect Lower Corporate Income Tax Rates (sec. 
              13002 of the Act and sec. 243 of the Code).........   103

PART II--SMALL BUSINESS REFORMS..................................   104

          A.  Modifications of Rules for Expensing Depreciable 
              Business Assets (sec. 13101 of the Act and sec. 179 
              of the Code).......................................   104
          B.  Small Business Accounting Method Reform and 
              Simplification (sec. 13102 of the Act and secs. 
              263A, 448, 460, and 471 of the Code)...............   107

PART III--COST RECOVERY AND ACCOUNTING METHODS...................   115

SUBPART A--COST RECOVERY.........................................   115

          A.  Temporary 100-Percent Expensing for Certain 
              Business Assets (sec. 13201 of the Act and sec. 
              168(k) of the Code)................................   115
          B.  Modifications to Depreciation Limitations on Luxury 
              Automobiles and Personal Use Property (sec. 13202 
              of the Act and sec. 280F of the Code)..............   128
          C.  Modifications of Treatment of Certain Farm Property 
              (sec. 13203 of the Act and sec. 168 of the Code)...   130
          D.  Applicable Recovery Period for Real Property (sec. 
              13204 of the Act and sec. 168 of the Code).........   133
          E.  Use of Alternative Depreciation System for Electing 
              Farming Businesses (sec. 13205 of the Act and sec. 
              168 of the Code)...................................   139
          F.  Amortization of Research and Experimental 
              Expenditures (sec. 13206 of the Act and sec. 174 of 
              the Code)..........................................   142
          G.  Expensing of Certain Costs of Replanting Citrus 
              Plants Lost by Reason of Casualty (sec. 13207 of 
              the Act and sec. 263A of the Code).................   145

SUBPART B--ACCOUNTING METHODS....................................   148

          A.  Certain Special Rules for Taxable Year of Inclusion 
              (sec. 13221 of the Act and sec. 451 of the Code)...   148

PART IV--BUSINESS-RELATED EXCLUSIONS AND DEDUCTIONS..............   172

          A.  Limitation on Deduction for Interest (sec. 13301 of 
              the Act and sec. 163(j) of the Code)...............   172
          B.  Modification of Net Operating Loss Deduction (sec. 
              13302 of the Act and sec. 172 of the Code).........   180
          C.  Like-Kind Exchanges of Real Property (sec. 13303 of 
              the Act and sec. 1031 of the Code).................   182
          D.  Limitation on Deduction by Employers of Expenses 
              for Fringe Benefits (sec. 13304 of the Act and sec. 
              274 of the Code)...................................   185
          E.  Repeal of Deduction for Income Attributable to 
              Domestic Production Activities (sec. 13305 of the 
              Act and former sec. 199 of the Code)...............   191
          F.  Denial of Deduction for Certain Fines, Penalties, 
              and Other Amounts (sec. 13306 of the Act and sec. 
              162 of the Code)...................................   193
          G.  Denial of Deduction for Settlements Subject to 
              Nondisclosure Agreements Paid in Connection with 
              Sexual Harassment or Sexual Abuse (sec. 13307 of 
              the Act and sec. 162 of the Code)..................   195
          H.  Repeal of Deduction for Local Lobbying Expenses 
              (sec. 13308 of the Act and sec. 162 of the Code)...   195
          I.  Recharacterization of Certain Gains in the Case of 
              Partnership Profits Interests Held in Connection 
              with Performance of Investment Services (sec. 13309 
              of the Act and sec. 1061 of the Code)..............   197
          J.  Prohibition on Cash, Gift Cards, and Other 
              Nontangible Personal Property as Employee 
              Achievement Awards (sec. 13310 of the Act and secs. 
              74(c) and 274(j) of the Code)......................   204
          K.  Elimination of Deduction for Living Expenses 
              Incurred by Members of Congress (sec. 13311 of the 
              Act and sec. 162 of the Code)......................   204
          L.  Certain Contributions by Governmental Entities Not 
              Treated as Contributions to Capital (sec. 13312 of 
              the Act and sec. 118 of the Code)..................   205
          M.  Repeal of Rollover of Publicly Traded Securities 
              Gain into Specialized Small Business Investment 
              Companies (sec. 13313 of the Act and former sec. 
              1044 of the Code)..................................   206
          N.  Certain Self-Created Property Not Treated as a 
              Capital Asset (sec. 13314 of the Act and sec. 
              1221(a)(3) of the Code)............................   206

PART V--BUSINESS CREDITS.........................................   209

          A.  Modification of Orphan Drug Credit (sec. 13401 of 
              the Act and secs. 45C and 280C of the Code)........   209
          B.  Rehabilitation Credit Limited to Certified Historic 
              Structures (sec. 13402 of the Act and sec. 47 of 
              the Code)..........................................   210
          C.  Employer Credit for Paid Family and Medical Leave 
              (sec. 13403 of the Act and new sec. 45S of the 
              Code)..............................................   211
          D.  Repeal of Tax Credit Bonds (sec. 13404 of the Act 
              and former secs. 54A, 54B, 54C, 54D, 54E, 54F and 
              6431 of the Code)..................................   214

PART VI--PROVISIONS RELATED TO SPECIFIC ENTITIES AND INDUSTRIES..   218

SUBPART A--PARTNERSHIPS PROVISIONS...............................   218

          A.  Treatment of Gain or Loss of Foreign Persons from 
              Sale or Exchange of Interests in Partnerships 
              Engaged in Trade or Business Within the United 
              States (sec. 13501 of the Act and secs. 864(c) and 
              1446 of the Code)..................................   218
          B.  Modify Definition of Substantial Built-in Loss in 
              the Case of Transfer of Partnership Interest (sec. 
              13502 of the Act and sec. 743(d) of the Code)......   221
          C.  Charitable Contributions and Foreign Taxes Taken 
              into Account in Determining Limitation on Allowance 
              of Partner's Share of Loss (sec. 13503 of the Act 
              and sec. 704 of the Code)..........................   222
          D.  Repeal of Technical Termination of Partnerships 
              (sec. 13504 of the Act and sec. 708(b) of the Code)   224

SUBPART B--INSURANCE REFORMS.....................................   225

          A.  Net Operating Losses of Life Insurance Companies 
              (sec. 13511 of the Act and sec. 805 of the Code)...   225
          B.  Repeal of Small Life Insurance Company Deduction 
              (sec. 13512 of the Act and former sec. 806 of the 
              Code)..............................................   226
          C.  Adjustment for Change in Computing Reserves (sec. 
              13513 of the Act and sec. 807(f) of the Code)......   227
          D.  Repeal of Special Rule for Distributions to 
              Shareholders from Pre-1984 Policyholders Surplus 
              Account (sec. 13514 of the Act and former sec. 815 
              of the Code).......................................   228
          E.  Modification of Proration Rules for Property and 
              Casualty Insurance Companies (sec. 13515 of the Act 
              and sec. 832(b) of the Code).......................   230
          F.  Repeal of Special Estimated Tax Payments (sec. 
              13516 of the Act and former sec. 847 of the Code)..   231
          G.  Computation of Life Insurance Tax Reserves (sec. 
              13517 of the Act and sec. 807 of the Code).........   233
          H.  Modification of Rules for Life Insurance Proration 
              for Purposes of Determining the Dividends Received 
              Deduction (sec. 13518 of the Act and sec. 812 of 
              the Code)..........................................   237
          I.  Capitalization of Certain Policy Acquisition 
              Expenses (sec. 13519 of the Act and sec. 848 of the 
              Code)..............................................   240
          J.  Tax Reporting for Life Settlement Transactions and 
              Clarification of Tax Basis of Life Insurance 
              Transactions, and Exception to Transfer for 
              Valuable Consideration Rules (secs. 13520-13522 of 
              the Act and secs. 101 and 1016(a) and new sec. 
              6050Y of the Code).................................   241
          K.  Modification of Discounting Rules for Property and 
              Casualty Insurance Companies (sec. 13523 of the Act 
              and sec. 846(c) of the Code).......................   245

SUBPART C--BANKS AND FINANCIAL INSTRUMENTS.......................   247

          A.  Limitation on Deduction for FDIC Premiums (sec. 
              13531 of the Act and sec. 162 of the Code).........   247
          B.  Repeal of Advance Refunding Bonds (sec. 13532 of 
              the Act and sec. 149 of the Code)..................   250

SUBPART D--S CORPORATIONS........................................   251

          A.  Expansion of Qualifying Beneficiaries of an 
              Electing Small Business Trust (sec. 13541 of the 
              Act and sec. 1361(c) of the Code)..................   251
          B.  Charitable Contribution Deduction for Electing 
              Small Business Trusts (sec. 13542 of the Act and 
              sec. 641(c) of the Code)...........................   252
          C.  Modification of Treatment of S Corporation 
              Conversions to C Corporations (sec. 13543 of the 
              Act and secs. 481 and 1371 of the Code)............   253

PART VII--EMPLOYMENT.............................................   257

SUBPART A--COMPENSATION..........................................   257

          A.  Modification of Limitation on Excessive Employee 
              Remuneration (sec. 13601 of the Act and sec. 162(m) 
              of the Code).......................................   257
          B.  Excise Tax on Excess Tax-Exempt Organization 
              Executive Compensation (sec. 13602 of the Act and 
              new sec. 4960 of the Code).........................   263
          C.  Treatment of Qualified Equity Grants (sec. 13603 of 
              the Act and new sec. 83(i) of the Code)............   266
          D.  Increase in Excise Tax Rate for Stock Compensation 
              of Insiders in Expatriated Corporations (sec. 13604 
              of the Act and sec. 4985 of the Code)..............   276

SUBPART B--RETIREMENT PLANS......................................   282

          A.  Repeal of Special Rule Permitting 
              Recharacterization of Roth Conversions (sec. 13611 
              of the Act and sec. 408A(d) of the Code)...........   282
          B.  Modification of Rules Applicable to Length of 
              Service Award Plans (sec. 13612 of the Act and sec. 
              457(e) of the Code)................................   285
          C.  Extended Rollover Period for Plan Loan Offset 
              Amounts (sec. 13613 of the Act and sec. 402(c) of 
              the Code)..........................................   286

PART VIII--EXEMPT ORGANIZATIONS..................................   288

          A.  Excise Tax Based on Investment Income of Private 
              Colleges and Universities (sec. 13701 of the Act 
              and new sec. 4968 of the Code).....................   288
          B.  Unrelated Business Taxable Income Separately 
              Computed for Each Trade or Business Activity (sec. 
              13702 of the Act and sec. 512(a) of the Code)......   291
          C.  Unrelated Business Taxable Income Increased by 
              Amount of Certain Fringe Benefit Expenses for which 
              Deduction is Disallowed (sec. 13703 of the Act and 
              sec. 512 of the Code)..............................   294

PART IX--OTHER PROVISIONS........................................   297

SUBPART A--CRAFT BEVERAGE MODERNIZATION AND TAX REFORM...........   297

          A.  Production Period for Beer, Wine, and Distilled 
              Spirits (sec. 13801 of the Act and sec. 263A(f) of 
              the Code)..........................................   297
          B.  Reduced Rate of Excise Tax on Beer (sec. 13802 of 
              the Act and sec. 5051(a) of the Code)..............   299
          C.  Transfer of Beer Between Bonded Facilities (sec. 
              13803 of the Act and sec. 5414 of the Code)........   301
          D.  Reduced Rate of Excise Tax on Certain Wine (sec. 
              13804 of the Act and sec. 5041(c) of the Code).....   302
          E.  Adjustment of Alcohol Content Level for Application 
              of Excise Tax Rates (sec. 13805 of the Act and sec. 
              5041(b) of the Code)...............................   304
          F.  Definition of Mead and Low Alcohol by Volume Wine 
              (sec. 13806 of the Act and sec. 5041 of the Code)..   306
          G.  Reduced Rate of Excise Tax on Certain Distilled 
              Spirits (sec. 13807 of the Act and sec. 5001 of the 
              Code)..............................................   307
          H.  Bulk Distilled Spirits (sec. 13808 of the Act and 
              sec. 5212 of the Code).............................   308

SUBPART B--MISCELLANEOUS PROVISIONS..............................   309

          A.  Modification of Tax Treatment of Alaska Native 
              Corporations and Settlement Trusts (sec. 13821 of 
              the Act and secs. 646 and 6039H and new secs. 139G 
              and 247 of the Code)...............................   309
          B.  Amounts Paid for Aircraft Management Services (sec. 
              13822 of the Act and sec. 4621(e) of the Code).....   313
          C.  Opportunity Zones (sec. 13823 of the Act and new 
              secs. 1400Z-1 and 1400Z-2 of the Code).............   316

SUBTITLE D--INTERNATIONAL TAX PROVISIONS.........................   322

PRIOR LAW........................................................   322

          A.  General Overview of International Principles of 
              Taxation...........................................   322
              1.  Source and residence principles................   323
              2.  Origin and destination principles..............   323
              3.  Resolving overlapping or conflicting 
                  jurisdiction to tax............................   324
              4.  International principles as applied in the U.S. 
                  tax system.....................................   325
          B.  Principles Common to Inbound and Outbound Taxation.   326
              1.  Residence......................................   326
              2.  Entity classification..........................   327
              3.  Source of income rules.........................   327
              4.  Intercompany transfers.........................   330
          C.  U.S. Tax Rules Applicable to Nonresident Aliens and 
              Foreign Corporations (Inbound).....................   331
              1.  Gross-basis taxation of U.S.-source income.....   331
              2.  Net-basis taxation of U.S.-source income.......   333
              3.  Special rules..................................   336
          D.  U.S. Tax Rules Applicable to Foreign Activities of 
              U.S. Persons (Outbound)............................   338
              1.  In general.....................................   338
              2.  Anti-deferral regimes..........................   339
              3.  Foreign tax credit.............................   343
              4.  Special rules..................................   345

PART I--OUTBOUND TRANSACTIONS....................................   348

SUBPART A--ESTABLISHMENT OF PARTICIPATION EXEMPTION SYSTEM FOR 
  TAXATION OF FOREIGN INCOME.....................................   348

          A.  Deduction for Foreign-Source Portion of Dividends 
              Received by Domestic Corporations from Specified 
              10-Percent Owned Foreign Corporations (sec. 14101 
              of the Act and sec. 904(b) and new sec. 245A of the 
              Code)..............................................   348
          B.  Special Rules Relating to Sales or Transfers 
              Involving Specified 10-Percent Owned Foreign 
              Corporations (sec. 14102 of the Act and secs. 
              367(a)(3), 961, 964(e), and 1248 and new sec. 91 of 
              the Code)..........................................   351
          C.  Treatment of Deferred Foreign Income Upon 
              Transition to Participation Exemption System of 
              Taxation and Deemed Repatriation at Two-Tier Rate 
              (sec. 14103 of the Act and secs. 78, 904, 907, and 
              965 of the Code)...................................   355

SUBPART B--RULES RELATED TO PASSIVE AND MOBILE INCOME............   368

          A.  Current Year Inclusion of Global Intangible Low-
              Taxed Income by U.S. Shareholders (sec. 14201 of 
              the Act and sec. 78 and new secs. 951A and 960(d) 
              of the Code).......................................   368
          B.  Deduction for Foreign-Derived Intangible Income and 
              Global Intangible Low-Taxed Income (sec. 14202 of 
              the Act and new sec. 250 of the Code)..............   377
          C.  Repeal of Treatment of Foreign Base Company Oil 
              Related Income as Subpart F Income (sec. 14211 of 
              the Act and sec. 954(a) of the Code)...............   383
          D.  Repeal of Inclusion Based on Withdrawal of 
              Previously Excluded Subpart F Income from Qualified 
              Investment (sec. 14212 of the Act and sec. 955 of 
              the Code)..........................................   383
          E.  Modification of Stock Attribution Rules for 
              Determining Status as a Controlled Foreign 
              Corporation (sec. 14213 of the Act and secs. 318 
              and 958 of the Code)...............................   384
          F.  Modification of Definition of United States 
              Shareholder (sec. 14214 of the Act and sec. 951 of 
              the Code)..........................................   385
          G.  Elimination of Requirement that Corporation Must Be 
              Controlled for 30 Days Before Subpart F Inclusions 
              Apply (sec. 14215 of the Act and sec. 951(a)(1) of 
              the Code)..........................................   386
          H.  Limitations on Income Shifting Through Intangible 
              Property Transfers (sec. 14221 of the Act and secs. 
              367 and 482 of the Code)...........................   386
          I.  Certain Related Party Amounts Paid or Accrued in 
              Hybrid Transactions or With Hybrid Entities (sec. 
              14222 of the Act and sec. 267A of the Code)........   389
          J.  Shareholders of Surrogate Foreign Corporations Not 
              Eligible for Reduced Rate on Dividends (sec. 14223 
              of the Act and sec. 1(h)(11)(C)(iii) of the Code)..   391

SUBPART C--MODIFICATIONS RELATED TO FOREIGN TAX CREDIT SYSTEM....   392

          A.  Repeal of Section 902 Indirect Foreign Tax Credits; 
              Determination of Section 960 Credit on Current Year 
              Basis (sec. 14301 of the Act and secs. 902, 960, 
              and 78 of the Code)................................   392
          B.  Separate Foreign Tax Credit Limitation Basket for 
              Foreign Branch Income (sec. 14302 of the Act and 
              sec. 904 of the Code)..............................   394
          C.  Source of Income from Sales of Inventory Determined 
              Solely on Basis of Production Activities (sec. 
              14303 of the Act and sec. 863(b) of the Code)......   396
          D.  Election to Increase Percentage of Domestic Taxable 
              Income Offset by Overall Domestic Loss Treated as 
              Foreign Source (sec. 14304 of the Act and sec. 
              904(g) of the Code)................................   397

PART II--INBOUND TRANSACTIONS....................................   399

          A.  Base Erosion and Anti-Abuse Tax (sec. 14401 of the 
              Act and sec. 6038A and new sec. 59A of the Code)...   399

PART III--OTHER PROVISIONS.......................................   410

          A.  Restriction on Insurance Business Exception to the 
              Passive Foreign Investment Company Rules (sec. 
              14501 of the Act and sec. 1297 of the Code)........   410
          B.  Repeal of Fair Market Value Method of Interest 
              Expense Apportionment (sec. 14502 of the Act and 
              sec. 864 of the Code)..............................   412

APPENDIX: TECHNICAL EXPLANATION OF MODIFICATION OF DEDUCTION FOR 
  QUALIFIED BUSINESS INCOME OF A COOPERATIVE AND ITS PATRONS 
  (ENACTED MARCH 23, 2018, PUB. L. NO. 115-141)..................   413

ESTIMATED BUDGET EFFECTS OF TAX LEGISLATION ENACTED IN PUBLIC LAW 
  115-97.........................................................   433
                              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, the Senate Committee on 
Finance, and the Treasury Department's Office of Tax Policy, 
provides an explanation of Public Law No. 115-97 (also referred 
to as the ``Act'' throughout).\2\ The explanation of the 
provisions follows the order of the Act.
---------------------------------------------------------------------------
    \1\ This document may be cited as follows: Joint Committee on 
Taxation, General Explanation of Public Law No. 115-97 (JCS-1-18), 
December 2018.
    \2\ Pub. L. No. 115-97, 31 Stat. 2054.
---------------------------------------------------------------------------
    For each provision, the document includes a description of 
prior law, an explanation of the provision, and the effective 
date. The prior law section describes the law in effect 
immediately prior to enactment and does not reflect changes to 
the law made by the provision or by subsequent legislation. For 
contemporaneous legislative history related to the Act, please 
see the relevant House Ways and Means Committee report,\3\ the 
reconciliation recommendations submitted by the Senate Budget 
Committee,\4\ and the Conference Report.\5\ This document 
includes citations to some, but not necessarily all, 
regulations and other administrative guidance issued as of the 
time of publication of the document. These citations are 
included strictly as reference tools for readers.
---------------------------------------------------------------------------
    \3\ Report of the Committee on Ways and Means on H.R. 1, the ``Tax 
Cuts and Jobs Act,'' H. Rep. No. 115-409, November 13, 2017.
    \4\ Reconciliation Recommendations Pursuant to H. Con. Res. 71, S. 
Prt. 115-20, December 2017.
    \5\ Conference Report to Accompany H.R. 1, the ``Tax Cuts and Jobs 
Act'', Rep. No. 115-466, December 15, 2017.
---------------------------------------------------------------------------
    Section references are to the Internal Revenue Code of 
1986, as amended, (the ``Code'') unless otherwise indicated.

                                TITLE I

                   SUBTITLE A--INDIVIDUAL TAX REFORM

                        PART I--TAX RATE REFORM

A. Modification of Rates (sec. 11001 of the Act and sec. 1 of the Code)

                               Prior Law

In general
    To determine regular tax liability, an individual taxpayer 
generally must apply the tax rate schedules (or the tax tables) 
to his or her taxable income. The rate schedules are broken 
into several ranges of income, known as income brackets, and 
the marginal tax rate increases as a taxpayer's income 
increases.
Tax rate schedules
    Separate rate schedules apply based on an individual's 
filing status. For 2017, the regular individual income tax rate 
schedules are as follows:

       TABLE 1.--FEDERAL INDIVIDUAL INCOME TAX RATES FOR 2017 \6\
------------------------------------------------------------------------
         If taxable income is:               Then income tax equals:
------------------------------------------------------------------------
                           Single Individuals
 
Not over $9,325........................  10% of the taxable income
Over $9,325 but not over $37,950.......  $932.50 plus 15% of the excess
                                          over $9,325
Over $37,950 but not over $91,900......  $5,226.25 plus 25% of the
                                          excess over $37,950
Over $91,900 but not over $191,650.....  $18,713.75 plus 28% of the
                                          excess over $91,900
Over $191,650 but not over $416,700....  $46,643.75 plus 33% of the
                                          excess over $191,650
Over $416,700 but not over $418,400....  $120,910.25 plus 35% of the
                                          excess over $416,700
Over $418,400..........................  $121,505.25 plus 39.6% of the
                                          excess over $418,400
------------------------------------------------------------------------
                           Heads of Households
 
Not over $13,350.......................  10% of the taxable income
Over $13,350 but not over $50,800......  $1,335 plus 15% of the excess
                                          over $13,350
Over $50,800 but not over $131,200.....  $6,952.50 plus 25% of the
                                          excess over $50,800
Over $131,200 but not over $212,500....  $27,052.50 plus 28% of the
                                          excess over $131,200
Over $212,500 but not over $416,700....  $49,816.50 plus 33% of the
                                          excess over $212,500
Over $416,700 but not over $444,550....  $117,202.50 plus 35% of the
                                          excess over $416,700
Over $444,550..........................  $126,950 plus 39.6% of the
                                          excess over $444,550
------------------------------------------------------------------------
     Married Individuals Filing Joint Returns and Surviving Spouses
 
Not over $18,650.......................  10% of the taxable income
Over $18,650 but not over $75,900......  $1,865 plus 15% of the excess
                                          over $18,650
Over $75,900 but not over $153,100.....  $10,452.50 plus 25% of the
                                          excess over $75,900
Over $153,100 but not over $233,350....  $29,752.50 plus 28% of the
                                          excess over $153,100
Over $233,350 but not over $416,700....  $52,222.50 plus 33% of the
                                          excess over $233,350
Over $416,700 but not over $470,700....  $112,728 plus 35% of the excess
                                          over $416,700
Over $470,700..........................  $131,628 plus 39.6% of the
                                          excess over $470,700
------------------------------------------------------------------------
               Married Individuals Filing Separate Returns
 
Not over $9,325........................  10% of the taxable income
Over $9,325 but not over $37,950.......  $932.50 plus 15% of the excess
                                          over $9,325
Over $37,950 but not over $76,550......  $5,226.25 plus 25% of the
                                          excess over $37,950
Over $76,550 but not over $116,675.....  $14,876.25 plus 28% of the
                                          excess over $76,550
Over $116,675 but not over $208,350....  $26,111.25 plus 33% of the
                                          excess over $116,675
Over $208,350 but not over $235,350....  $56,364 plus 35% of the excess
                                          over $208,350
Over $235,350..........................  $65,814 plus 39.6% of the
                                          excess over $235,350
------------------------------------------------------------------------
                           Estates and Trusts
 
Not over $2,550........................  15% of the taxable income
Over $2,550 but not over $6,000........  $382.50 plus 25% of the excess
                                          over $2,550
Over $6,000 but not over $9,150........  $1,245 plus 28% of the excess
                                          over $6,000
Over $9,150 but not over $12,500.......  $2,127 plus 33% of the excess
                                          over $9,150
Over $12,500...........................  $3,232.50 plus 39.6% of the
                                          excess over $12,500
------------------------------------------------------------------------

Unearned income of children
    Special rules (generally referred to as the ``kiddie tax'') 
apply to the net unearned income of certain children.\7\ 
Generally, the kiddie tax applies to a child if: (1) the child 
has not reached the age of 19 by the close of the taxable year, 
or the child is a full-time student under the age of 24, and 
either of the child's parents is alive at such time; (2) the 
child's unearned income exceeds. $2,100 (for 2017); and (3) the 
child does not file a joint return.\8\ The kiddie tax applies 
regardless of whether the child may be claimed as a dependent 
by either or both parents. For children above age 17, the 
kiddie tax applies only to children whose earned income does 
not exceed one-half of the amount of their support.
---------------------------------------------------------------------------
    \6\ Rev. Proc. 2016-55, 2016-45 I.R.B. 707, Sec. 3.01.
    \7\ Sec. 1(g).
    \8\ Sec. 1(g)(2).
---------------------------------------------------------------------------
    Under these rules, the net unearned income of a child (for 
2017, unearned income over $2,100) is taxed at the parents' tax 
rates if the parents' tax rates are higher than the tax rates 
of the child.\9\ The remainder of a child's taxable income 
(i.e., earned income, plus unearned income up to $2,100 (for 
2017), less the child's standard deduction) is taxed at the 
child's rates, regardless of whether the kiddie tax applies to 
the child. For these purposes, unearned income is income other 
than wages, salaries, professional fees, other amounts received 
as compensation for personal services actually rendered, and 
distributions from qualified disability trusts.\10\ In general, 
a child is eligible to use the preferential tax rates for 
qualified dividends and capital gains.\11\
---------------------------------------------------------------------------
    \9\ Special rules apply for determining which parent's rate applies 
where a joint return is not filed.
    \10\ Sec. 1(g)(4) and sec. 911(d)(2).
    \11\ Sec. 1(h).
---------------------------------------------------------------------------
    The kiddie tax is calculated by computing the ``allocable 
parental tax.'' This involves adding the net unearned income of 
the child to the parent's income and then applying the parent's 
tax rate. A child's ``net unearned income'' is the child's 
unearned income less the sum of (1) the minimum standard 
deduction allowed to dependents ($1,050 for 2017 \12\), and (2) 
the greater of (a) such minimum standard deduction amount or 
(b) the amount of allowable itemized deductions that are 
directly connected with the production of the unearned 
income.\13\
---------------------------------------------------------------------------
    \12\ Sec. 3.02 of Rev. Proc. 2016-55, supra.
    \13\ Sec. 1(g)(4).
---------------------------------------------------------------------------
    The allocable parental tax equals the hypothetical increase 
in tax to the parent that results from adding the child's net 
unearned income to the parent's taxable income.\14\ If the 
child has net capital gains or qualified dividends, these items 
are allocated to the parent's hypothetical taxable income 
according to the ratio of net unearned income to the child's 
total unearned income. If a parent has more than one child 
subject to the kiddie tax, the net unearned income of all 
children is combined, and a single kiddie tax is calculated. 
Each child is then allocated a proportionate share of the 
hypothetical increase, based upon the child's net unearned 
income relative to the aggregate net unearned income of all of 
the parent's children subject to the tax.
---------------------------------------------------------------------------
    \14\ Sec. 1(g)(3).
---------------------------------------------------------------------------
    Generally, a child must file a separate return to report 
his or her income.\15\ The parents' tax is not affected by the 
child's income, and the total tax due from the child is the 
greater of:
---------------------------------------------------------------------------
    \15\ Sec. 1(g)(6). See Form 8615, Tax for Certain Children Who Have 
Unearned Income.
---------------------------------------------------------------------------
          1. The sum of (a) the tax payable by the child on the 
        child's earned income and unearned income up to $2,100 
        (for 2017), plus (b) the allocable parental tax on the 
        child's unearned income, or
          2. The tax on the child's income without regard to 
        the kiddie tax provisions.\16\
---------------------------------------------------------------------------
    \16\ Sec. 1(g)(1).
---------------------------------------------------------------------------
    If a child's gross income is only from interest and 
dividends and the amount of the gross income (in 2017) is 
greater than $1,050, and less than $10,500, the parents may 
elect to report the child's gross income on the parents' return 
and the child is treated as having no gross income. A tax at 
the rate of 10 percent is imposed on up to $1,050 of the 
child's gross income included on the parents' return.
Capital gains rates
    In the case of an individual, estate, or trust, adjusted 
net capital gain is taxed at rates of 0, 15, and 20 percent. 
The amount taxed at a zero rate is the amount that would 
otherwise be taxed at a 0-, 10-, or 15-percent rate if the gain 
were ordinary income; the amount taxed at a 15-percent rate is 
the amount that would otherwise be taxed at a 25-, 28-, 33-, or 
35-percent rate if the gain were ordinary income; and the 
amount taxed at a 20-percent rate is the amount that would 
otherwise be taxed at a 39.6-percent rate if the gain were 
ordinary income. The same rates applicable to adjusted net 
capital gain under the regular tax apply to the alternative 
minimum tax.
    The maximum rate on unrecaptured section 1250 gain is 25 
percent, and the maximum rate on net collectibles gain and 
certain gain from the sale of small business stock is 28 
percent.
    The ``adjusted net capital gain'' of an individual is the 
net capital gain reduced (but not below zero) by the gain (if 
any) taxed at maximum rates of 25 and 28 percent. 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. Net capital 
gain is increased by the amount of qualified dividend income.
    In addition, a tax is imposed on net investment income in 
the case of an individual, estate, or trust. In the case of an 
individual, the tax is 3.8 percent of the lesser of net 
investment income, which includes gains and dividends, or the 
excess of modified adjusted gross income over the threshold 
amount. The threshold amount is $250,000 in the case of a joint 
return or surviving spouse, $125,000 in the case of a married 
individual filing a separate return, and $200,000 in the case 
of any other individual.

                        Explanation of Provision

    The provision temporarily replaces the existing rate 
structure with a new rate structure.

         TABLE 2.--FEDERAL INDIVIDUAL INCOME TAX RATES FOR 2018
------------------------------------------------------------------------
         If taxable income is:               Then income tax equals:
------------------------------------------------------------------------
                           Single Individuals
 
Not over $9,525........................  10% of the taxable income
Over $9,525 but not over $38,700.......  $952.50 plus 12% of the excess
                                          over $9,525
Over $38,700 but not over $82,500......  $4,453.50 plus 22% of the
                                          excess over $38,700
Over $82,500 but not over $157,500.....  $14,089.50 plus 24% of the
                                          excess over $82,500
Over $157,500 but not over $200,000....  $32,089.50 plus 32% of the
                                          excess over $157,500
Over $200,000 but not over $500,000....  $45,689.50 plus 35% of the
                                          excess over $200,000
Over $500,000..........................  $150,689.50 plus 37% of the
                                          excess over $500,000
------------------------------------------------------------------------
                           Heads of Households
 
Not over $13,600.......................  10% of the taxable income
Over $13,600 but not over $51,800......  $1,360 plus 12% of the excess
                                          over $13,600
Over $51,800 but not over $82,500......  $5,944 plus 22% of the excess
                                          over $51,800
Over $82,500 but not over $157,500.....  $12,698 plus 24% of the excess
                                          over $82,500
Over $157,500 but not over $200,000....  $30,698 plus 32% of the excess
                                          over $157,500
Over $200,000 but not over $500,000....  $44,298 plus 35% of the excess
                                          over $200,000
Over $500,000..........................  $149,298 plus 37% of the excess
                                          over $500,000
------------------------------------------------------------------------
     Married Individuals Filing Joint Returns and Surviving Spouses
 
Not over $19,050.......................  10% of the taxable income
Over $19,050 but not over $77,400......  $1,905 plus 12% of the excess
                                          over $19,050
Over $77,400 but not over $165,000.....  $8,907 plus 22% of the excess
                                          over $77,400
Over $165,000 but not over $315,000....  $28,179 plus 24% of the excess
                                          over $165,000
Over $315,000 but not over $400,000....  $64,179 plus 32% of the excess
                                          over $315,000
Over $400,000 but not over $600,000....  $91,379 plus 35% of the excess
                                          over $400,000
Over $600,000..........................  $161,379 plus 37% of the excess
                                          over $600,000
------------------------------------------------------------------------
               Married Individuals Filing Separate Returns
 
Not over $9,525........................  10% of the taxable income
Over $9,525 but not over $38,700.......  $952.50 plus 12% of the excess
                                          over $9,525
Over $38,700 but not over $82,500......  $4,453.50 plus 22% of the
                                          excess over $38,700
Over $82,500 but not over $157,500.....  $14,089.50 plus 24% of the
                                          excess over $82,500
Over $157,500 but not over $200,000....  $32,089.50 plus 32% of the
                                          excess over $157,500
Over $200,000 but not over $300,000....  $45,689.50 plus 35% of the
                                          excess over $200,000
Over $300,000..........................  $80,689.50 plus 37% of the
                                          excess over $300,000
------------------------------------------------------------------------
                           Estates and Trusts
 
Not over $2,550........................  10% of the taxable income
Over $2,550 but not over $9,150........  $255 plus 24% of the excess
                                          over $2,550
Over $9,150 but not over $12,500.......  $1,839 plus 35% of the excess
                                          over $9,150
Over $12,500...........................  $3,011.50 plus 37% of the
                                          excess over $12,500
------------------------------------------------------------------------

    The provision's rate structure does not apply to taxable 
years beginning after December 31, 2025.
    Under the provision, the brackets applicable to single 
filers, married taxpayers filing separately, and heads of 
household are rounded down to the nearest $25, while other 
brackets are rounded down to the nearest $50.\17\
---------------------------------------------------------------------------
    \17\ A technical correction may be needed in order to round the 
bracket breakpoints applicable to heads of household down to the 
nearest $25. The correction would retain uniformity between those 
bracket breakpoints and the bracket breakpoints for single filers, 
which are intended to be identical for the 32-, 35-, and 37-percent 
brackets.
---------------------------------------------------------------------------

Simplification of tax on unearned income of children

    The provision temporarily simplifies the ``kiddie tax'' by 
separating the child's tax from the tax situation of the 
child's parent or of any sibling. It is intended that the net 
unearned income (both ordinary income and net capital gain) of 
a child to whom the provision applies is taxed according to the 
tax table applicable to a trust, while earned taxable income 
\18\ of a child is taxed according to the tax table applicable 
to the child (normally the table applicable to unmarried 
individuals).\19\
---------------------------------------------------------------------------
    \18\ For this purpose, earned taxable income means taxable income 
reduced (but not below zero) by net unearned income. Sec. 1(j)(4)(D).
    \19\ A technical correction may be necessary for the ``kiddie tax'' 
to fully reflect this intent. As currently enacted, a child to whom the 
``kiddie tax'' applies uses modified unmarried and estates and trusts 
brackets to calculate tax on income. The brackets are modified so that 
the total amount taxed at a given rate does not exceed the amount that 
would be taxed at that rate in the case of an individual to whom the 
kiddie tax does not apply.
    The following examples illustrate how the tax for a child to whom 
the ``kiddie tax'' applies may be calculated, by applying the estates 
and trusts brackets to net unearned income and applying modified 
unmarried brackets to earned taxable income.
    Example 1.--Assume a child to whom the ``kiddie tax'' applies is a 
dependent of another taxpayer and has interest income of $8,000 and no 
other income for taxable year 2018. The child is allowed a standard 
deduction of $1,050 (section 63(c)(5)(A) limits the basic standard 
deduction in the case of certain dependents to the greater of, for 
2018, (i) $1,050 or (ii) the sum of $350 and the child's earned income) 
and thus the child's taxable income is $6,950. The child's net unearned 
income is $8,000 less $2,100 (section 1(g)(4)(A) provides for a 
reduction in the amount of net unearned income by twice the basic 
standard deduction, which for 2018 is $1,050, if the child does not 
itemize deductions), which is $5,900. The child's earned taxable income 
is $1,050 ($6,950 less $5,900).
    The tax on the net unearned income of $5,900 may be calculated by 
computing the tax on a trust with that amount of taxable income. The 
tax is $255 plus 24 percent of the excess over $2,550, which is $1,059 
($255 plus $804). Next, the tax brackets for unmarried taxpayers are 
reduced by any net unearned income taxed at that same rate. $2,550 of 
unearned income is taxed at 10 percent, so the top of the 10-percent 
bracket is reduced to $6,975 ($9,525 less $2,550). $3,350 of unearned 
income is taxed at 24 percent, so the top of the 24-percent bracket is 
reduced to $154,150 ($157,500 less $3,350). No changes are made to the 
top of the 12-, 
22-, 32-, and 35-percent brackets.
    The tax on $1,050 of earned taxable income is subject to this 
revised rate schedule. Thus, the tax on this income is $105 ($1,050 at 
10 percent). The child's total tax liability is $1,164 ($1,059 plus 
$105). Note that in this example, a portion of the child's income is 
subject to tax under a rate schedule other than the estates and trusts 
rate schedule, notwithstanding that the taxpayer has only unearned 
income. This is a result of reducing unearned income by two standard 
deductions to arrive at net unearned income.
    Example 2.--Assume a child to whom the ``kiddie tax'' applies is a 
dependent of another taxpayer and has interest income of $18,000 and 
wages of $18,000 for the taxable year 2018. The child is allowed a 
standard deduction of $12,000 (which is less than the sum of $18,000 
plus $350) and thus the child's taxable income is $24,000. The child's 
net unearned income is $15,900 ($18,000 less $2,100). The child's 
earned taxable income is $8,100 ($24,000 less $15,900).
    The tax on the net unearned income of $15,900 may be calculated by 
computing the tax on a trust with that amount of taxable income. The 
tax is $3,011.50 plus 37 percent of the excess over $12,500, which is 
$4,269.50 ($3,011.50 plus $1,258). Next, the tax brackets for unmarried 
taxpayers are reduced by any net unearned income taxed at that same 
rate. $2,550 of net unearned income is taxed at 10 percent, so the top 
of the 10-percent bracket is reduced to $6,975 ($9,525 less $2,550). 
$6,600 of net unearned income is taxed at 24 percent, so the top of the 
24-percent bracket is reduced to $150,900 ($157,500 less $6,600). 
$3,400 of net unearned income is taxed at 35 percent, so the top of the 
35-percent bracket is reduced to $496,600 ($500,000 less $3,400). No 
changes are made to the endpoints of the 12-, 22-, or 32-percent 
brackets.
    The tax on $8,100 of earned taxable income is subject to this 
revised rate schedule. Thus the tax on this income is $832.50 ($6,975 
at 10 percent and $1,125 at 12 percent). The child's total tax 
liability is $5,102 ($4,269.50 plus $832.50).
---------------------------------------------------------------------------
    The provision's simplification of the ``kiddie tax'' does 
not apply to taxable years beginning after December 31, 2025.

Maximum rates on capital gains and qualified dividends

    The provision generally retains the prior-law maximum rates 
on net capital gain and qualified dividends. The breakpoints 
between the zero- and 15-percent rates (``15-percent 
breakpoint'') and the 15- and 20-percent rates (``20-percent 
breakpoint'') are based on the same amounts as the breakpoints 
under prior law, except the breakpoints are indexed using the 
Chained Consumer Price Index in taxable years beginning after 
2017. Thus, for 2018, the 15-percent breakpoint is $77,200 for 
joint returns and surviving spouses (one-half of this amount 
for married taxpayers filing separately), $51,700 for heads of 
household, $2,600 for estates and trusts, and $38,600 for other 
unmarried individuals. The 20-percent breakpoint is $479,000 
for joint returns and surviving spouses (one-half of this 
amount for married taxpayers filing separately), $452,400 for 
heads of household, $12,700 for estates and trusts, and 
$425,800 for other unmarried individuals.
    Therefore, in the case of an individual (including an 
estate or trust) with adjusted net capital gain, to the extent 
the gain would not result in taxable income exceeding the 15-
percent breakpoint, the gain is not taxed. Generally, any 
adjusted net capital gain that would result in taxable income 
exceeding the 15-percent breakpoint but not exceeding the 20-
percent breakpoint is taxed at 15 percent.\20\ The remaining 
adjusted net capital gain is taxed at 20 percent.
---------------------------------------------------------------------------
    \20\ In certain circumstances adjusted net capital gain in this 
range may be taxed at different rates due to the fact that the 15-
percent breakpoints ($38,600, $51,700, and $77,200 for unmarried, head 
of household, and married filing jointly respectively) are $100 or $200 
less than the top of the 12-percent ordinary bracket ($38,700, $51,800, 
and $77,400 for unmarried, head of household, and married filing 
jointly respectively).
---------------------------------------------------------------------------
    Unrecaptured section 1250 gain generally is taxed at a 
maximum rate of 25 percent, and net collectibles gain and 
certain gain from the sale of small business stock is taxed at 
a maximum rate of 28 percent.

Paid preparer due diligence requirement for head of household status

    The provision directs the Secretary of the Treasury to 
promulgate due diligence requirements for paid preparers in 
determining eligibility for a taxpayer to file as head of 
household. For 2018, a penalty of $520 is imposed for each 
failure to meet these requirements.\21\
---------------------------------------------------------------------------
    \21\ This amount is indexed for inflation. Sec. 6695(h).
---------------------------------------------------------------------------
    The Treasury Department has provided guidance addressing 
Federal income tax withholding for 2018.\22\
---------------------------------------------------------------------------
    \22\ See Internal Revenue Service, Publication 15, (Circular E), 
Employer's Tax Guide 2018, pp. 21-25 and the IRS withholding calculator 
available at irs.gov/W4App.
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

 B. Inflation Adjustments Based On Chained CPI (sec. 11002 of the Act 
                       and sec. 1(f) of the Code)


                               Prior Law

    Many dollar amounts in the Code are adjusted for inflation 
to protect taxpayers from the effects of rising prices. Under 
prior law, most of the adjustments are based on annual changes 
in the level of the Consumer Price Index for All Urban 
Consumers (``CPI-U''). The CPI-U is an index that measures 
prices paid by typical urban consumers on a broad range of 
goods and services, and is developed and published by the 
Department of Labor. Generally, the Code adjusts applicable 
calendar year amounts for cost of living by using the 
percentage by which the price index for the preceding calendar 
year exceeds the price index for a base calendar year.\23\ The 
IRS annually issues a publication setting forth the inflation-
adjusted amounts for taxable years beginning in the next 
calendar year.
---------------------------------------------------------------------------
    \23\ Sec. 1(f). Under prior law, the indexing base calendar year is 
the year referenced in section 1(f)(3)(B) as modified.
---------------------------------------------------------------------------
    Among the inflation-indexed individual income tax amounts 
are the following: (1) the regular income tax brackets; (2) the 
basic standard deduction; (3) the additional standard deduction 
for the aged and blind; (4) the personal exemption amount; (5) 
the thresholds for the overall limitation on itemized 
deductions and the personal exemption phase-out; (6) the phase-
in and phase-out thresholds of the earned income credit; (7) 
IRA contribution limits and deductible amounts; and (8) the 
saver's credit.

                        Explanation of Provision

    The provision requires the use of the Chained Consumer 
Price Index for All Urban Consumers (``C-CPI-U'') to adjust 
amounts currently indexed by the CPI-U. The C-CPI-U, like the 
CPI-U, is a measure of the average change over time in prices 
paid by urban consumers. It is developed and published by the 
Department of Labor, but differs from the CPI-U in accounting 
for the ability of individuals to alter their consumption 
patterns in response to relative price changes.\24\ Another 
notable difference is that, unlike the CPI-U, initially 
released C-CPI-U index values are subject to a quarterly 
schedule of revisions until finalized in the following 
year.\25\
---------------------------------------------------------------------------
    \24\ The C-CPI-U accomplishes this by allowing for consumer 
substitution between item categories in the collection of consumer 
goods and services that make up the index, while the CPI-U only allows 
for modest substitution within item categories.
    \25\ Bureau of Labor Statistics, CPI Detailed Report--June 2017, 
Table 1C.
---------------------------------------------------------------------------
    The values of C-CPI-U used for cost-of-living adjustments 
for any given calendar are the latest values published as of 
the date on which the initial C-CPI-U index is published for 
the month of August for the preceding year.\26\ Generally, this 
date is in September of such preceding year.
---------------------------------------------------------------------------
    \26\ Sec. 1(f)(6)(A).
---------------------------------------------------------------------------
    Under the provision, indexed amounts in the Code use the C-
CPI-U and the CPI-U or solely the C-CPI-U in taxable years 
beginning after December 31, 2017. In the case of applicable 
dollar amounts with a base calendar year \27\ prior to 2016, 
the provision indexes these amounts as if the CPI-U applies 
through 2017 and the C-CPI-U applies for years thereafter; the 
provision does not index these applicable amounts from their 
base years using only the C-CPI-U. However, amounts with cost-
of-living adjustment base years of 2016 and later are indexed 
using solely the C-CPI-U. Therefore, amounts that are reset for 
2018 (and given indexing base years of 2017) \28\ are indexed 
by the C-CPI-U in taxable years beginning after December 31, 
2018.
---------------------------------------------------------------------------
    \27\ Under the provision, the indexing base calendar year is the 
year referenced in section 1(f)(3)(A)(ii) as modified.
    \28\ For example, the basic standard deduction. Sec. 63(c)(7).

    The Treasury Department has published cost-of-living 
adjustments for 2018 and 2019.\29\
---------------------------------------------------------------------------
    \29\ Rev. Proc. 2018-18, 2018-10 I.R.B. 392 (March 2, 2018); Rev. 
Proc. 2018-57, 2018-49 I.R.B. 827 (Nov. 15, 2018).
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

 PART II--DEDUCTION FOR QUALIFIED BUSINESS INCOME OF PASS-THRU ENTITIES

 A. Deduction for Qualified Business Income (sec. 11011 of the Act and 
                         sec. 199A of the Code)

                               Prior Law

Individual income tax rates
    To determine regular tax liability, an individual taxpayer 
generally applies the tax rate schedules (or the tax tables) to 
his or her taxable income. The rate schedules are broken into 
several ranges of income, known as income brackets, and the 
taxpayer's marginal tax rate increases as income increases. 
Separate rate schedules apply based on an individual's filing 
status (i.e., single, head of household, married filing 
jointly, or married filing separately). For 2017, the regular 
individual income tax rate schedule provides rates of 10, 15, 
25, 28, 33, 35, and 39.6 percent.
Partnerships
    Partnerships generally are treated for Federal income tax 
purposes as passthrough entities not subject to tax at the 
entity level.\30\ Items of income (including tax-exempt 
income), gain, loss, deduction, and credit of the partnership 
are taken into account by the partners in computing their 
income tax liability based on the partnership's method of 
accounting and regardless of whether the income is distributed 
to the partners.\31\ A partner's deduction for partnership 
losses is limited to the partner's adjusted basis in its 
partnership interest.\32\ Losses not allowed as a result of 
that limitation generally are carried forward to the next year. 
A partner's adjusted basis in a partnership interest generally 
equals (1) the sum of (a) the amount of money and the adjusted 
basis of property contributed to the partnership, or the amount 
paid for the partnership interest, (b) the partner's 
distributive share of partnership income, and (c) the partner's 
share of partnership liabilities, reduced by (2) the sum of (a) 
the partner's distributive share of losses allowed as a 
deduction and certain nondeductible expenditures, and (b) any 
partnership distributions to the partner.\33\ Partners 
generally may receive distributions of partnership property 
without recognition of gain or loss, subject to some 
exceptions.\34\
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    \30\ Sec. 701.
    \31\ Sec. 702(a).
    \32\ Sec. 704(d). In addition, passive loss and at-risk limitations 
limit the extent to which certain types of income can be offset by a 
partner's share of partnership deductions (secs. 469 and 465). These 
limitations do not apply to corporate partners, except certain closely-
held corporations.
    \33\ Sec. 705.
    \34\ Sec. 731. Gain or loss may nevertheless be recognized, for 
example, on the distribution of money or marketable securities in 
excess of basis, distributions with respect to contributed property, or 
in the case of disproportionate distributions (which can result in 
ordinary income).
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    Partnerships may allocate items of income, gain, loss, 
deduction, and credit among the partners, provided the 
allocations have substantial economic effect.\35\ In general, 
an allocation has substantial economic effect to the extent the 
partner to which the allocation is made receives the economic 
benefit or bears the economic burden of such allocation and the 
allocation substantially affects the dollar amounts to be 
received by the partners from the partnership independent of 
tax consequences.\36\
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    \35\ Sec. 704(b)(2).
    \36\ Treas. Reg. sec. 1.704-1(b)(2).
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    State laws of every State provide for the establishment of 
limited liability companies \37\ (``LLCs''), which are neither 
partnerships nor corporations under applicable State law, but 
which are generally treated as partnerships for Federal tax 
purposes.\38\
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    \37\ The first LLC statute was enacted in Wyoming in 1977. All 
States (and the District of Columbia) now have an LLC statute, though 
the tax treatment of LLCs for State tax purposes may differ.
    \38\ Any domestic nonpublicly traded unincorporated entity with two 
or more members generally is treated as a partnership for Federal 
income tax purposes, while any single-member domestic unincorporated 
entity generally is treated as disregarded for Federal income tax 
purposes (i.e., treated as not separate from its owner). Instead of the 
applicable default treatment, however, an LLC may elect to be treated 
as a corporation for Federal income tax purposes. Treas. Reg. sec. 
301.7701-3 (known as the ``check-the-box'' regulations).
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    A publicly traded partnership generally is treated as a 
corporation for Federal tax purposes.\39\ For this purpose, a 
publicly traded partnership means any partnership if interests 
in the partnership are traded on an established securities 
market or interests in the partnership are readily tradable on 
a secondary market (or the substantial equivalent thereof).\40\ 
An exception from corporate treatment is provided for certain 
publicly traded partnerships, 90 percent or more of whose gross 
income comprises one or more types of qualifying income.\41\
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    \39\ Sec. 7704(a).
    \40\ Sec. 7704(b).
    \41\ Sec. 7704(c)(2). Qualifying income is defined to include 
interest, dividends, and gains from the disposition of a capital asset 
(or of property described in section 1231(b)) that is held for the 
production of income that is qualifying income. Sec. 7704(d). 
Qualifying income also includes rents from real property, gains from 
the sale or other disposition of real property, and income and gains 
from the exploration, development, mining or production, processing, 
refining, transportation (including pipelines transporting gas, oil, or 
products thereof), or the marketing of any mineral or natural resource 
(including fertilizer, geothermal energy, and timber), industrial 
source carbon dioxide, or the transportation or storage of certain fuel 
mixtures, alternative fuel, alcohol fuel, or biodiesel fuel. It also 
includes income and gains from commodities (not described in section 
1221(a)(1)) or futures, options, or forward contracts with respect to 
such commodities (including foreign currency transactions of a 
commodity pool) where a principal activity of the partnership is the 
buying and selling of such commodities, futures, options, or forward 
contracts. However, the exception for partnerships with qualifying 
income does not apply to any partnership resembling a mutual fund 
(i.e., that would be described in section 851(a) if it were a domestic 
corporation), which includes a corporation registered under the 
Investment Company Act of 1940 (Pub. L. No. 76-768 (1940)) as a 
management company or unit investment trust. Sec. 7704(c)(3).
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S corporations
    An S corporation \42\ generally is not subject to Federal 
income tax at the corporate level.\43\ Items of income 
(including tax-exempt income), gain, loss, deduction, and 
credit of the S corporation are taken into account by the S 
corporation shareholders in computing their income tax 
liabilities (based on the S corporation's method of accounting 
and regardless of whether the income is distributed to the 
shareholders). A shareholder's deduction for corporate losses 
is limited to the sum of the shareholder's adjusted basis in 
its S corporation stock and the indebtedness of the S 
corporation to such shareholder. Losses not allowed as a result 
of that limitation generally are carried forward to the next 
year. A shareholder's adjusted basis in the S corporation stock 
generally equals (1) the sum of (a) the shareholder's capital 
contributions to the S corporation and (b) the shareholder's 
pro rata share of S corporation income, reduced by (2) the sum 
of (a) the shareholder's pro rata share of losses allowed as a 
deduction and certain nondeductible expenditures, and (b) any S 
corporation distributions to the shareholder.\44\
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    \42\ An S corporation is so named because its Federal tax treatment 
is governed by subchapter S of the Code.
    \43\ Secs. 1363 and 1366.
    \44\ Sec. 1367. If any amount that would reduce the adjusted basis 
of a shareholder's S corporation stock exceeds the amount that would 
reduce that basis to zero, the excess is applied to reduce (but not 
below zero) the shareholder's basis in any indebtedness of the S 
corporation to the shareholder. If, after a reduction in the basis of 
such indebtedness, there is an event that would increase the adjusted 
basis of the shareholder's S corporation stock, such increase is 
instead first applied to restore the reduction in the basis of the 
shareholder's indebtedness. Sec. 1367(b)(2).
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    In general, an S corporation shareholder is not subject to 
tax on corporate distributions unless the distributions exceed 
the shareholder's basis in the stock of the corporation.
            Electing S corporation status
    To be eligible to elect S corporation status, a corporation 
may not have more than 100 shareholders and may not have more 
than one class of stock.\45\ Only individuals (other than 
nonresident aliens), certain tax-exempt organizations, and 
certain trusts and estates are permitted shareholders of an S 
corporation.
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    \45\ Sec. 1361. For this purpose, a husband and wife and all 
members of a family are treated as one shareholder. Sec. 1361(c)(1).
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Sole proprietorships

    Unlike a C corporation, partnership, or S corporation, a 
business conducted as a sole proprietorship is not treated as 
an entity distinct from its owner for Federal income tax 
purposes.\46\ Rather, the business owner is taxed directly on 
business income, and files Schedule C (sole proprietorships 
generally), Schedule E (rental real estate and royalties), or 
Schedule F (farms) with his or her individual tax return. 
Furthermore, transfer of a sole proprietorship is treated as a 
transfer of each individual asset of the business. Nonetheless, 
a sole proprietorship is treated as an entity separate from its 
owner for employment tax purposes,\47\ for certain excise 
taxes,\48\ and certain information reporting requirements.\49\
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    \46\ A single-member unincorporated entity is disregarded for 
Federal income tax purposes, unless its owner elects to be treated as a 
C corporation. Treas. Reg. sec. 301.7701-3(b)(1)(ii). Sole 
proprietorships often are conducted through legal entities for nontax 
reasons. While sole proprietorships generally may have no more than one 
owner, a married couple that files a joint return and jointly owns and 
operates a business may elect to have that business treated as a sole 
proprietorship under section 761(f).
    \47\ Treas. Reg. sec. 301.7701-2(c)(2)(iv).
    \48\ Treas. Reg. sec. 301.7701-2(c)(2)(v).
    \49\ Treas. Reg. sec. 301.7701-2(c)(2)(vi).
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Trade or business

    For Federal income tax purposes, a taxpayer conducting 
activities giving rise to income or loss must evaluate whether 
its activities rise to the level of constituting a trade or 
business, and if so, how many trades or businesses the taxpayer 
has.
    Many areas of Federal income tax law require a taxpayer to 
make a threshold determination of whether its activities rise 
to the level of constituting a trade or business. For example, 
expenses are deductible under section 162 if they are incurred 
``in carrying on any trade or business,'' \50\ the passive 
activity loss limitation of section 469 can limit losses from 
an activity that ``involves the conduct of any trade or 
business,'' \51\ and research and experimental expenditures are 
eligible for deduction under section 174 if they are paid or 
incurred ``in connection with [a] trade or business.'' \52\
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    \50\ Sec. 162(a).
    \51\ Sec. 469(c)(1)(A). A passive activity generally is one in 
which the taxpayer does not materially participate, and additional 
rules apply.
    \52\ Sec. 174(a). Another example outside the domestic context is 
that a foreign corporation may be subject to U.S. corporate income tax 
rules if it is engaged in the ``conduct of a trade or business within 
the United States.'' These examples are not exhaustive.
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    Courts have held that for an activity to rise to the level 
of constituting a trade or business, ``the taxpayer must be 
involved in the activity with continuity and regularity and . . 
. the taxpayer's primary purpose for engaging in the activity 
must be for income or profit.'' \53\ In order to meet this 
standard, the taxpayer must satisfy two requirements: (1) 
regular and continuous conduct of the activity; \54\ and (2) a 
primary purpose to earn a profit.\55\ Whether a taxpayer's 
activities meet these factors depends on the facts and 
circumstances of each case.\56\ While most activities 
determined to be trades or businesses are so treated because 
the taxpayer offers goods or services to the public, a trade or 
business may also include other activities if such activities 
are the source of the taxpayer's livelihood.\57\
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    \53\ Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987).
    \54\ This first factor depends on the extent of the taxpayer's 
activities. For example, a taxpayer who devoted 60 to 80 hours per week 
to gambling on dog races was determined to have engaged in the activity 
regularly and continuously such that the gambling activity rose to the 
level of constituting a trade or business. See Commissioner v. 
Groetzinger, 480 U.S. 23 (1987). As another example, a taxpayer who 
executed a total of 372 securities trades in a year, with at least one 
trade taking place on 110 days of the year, was determined not to have 
engaged in securities trading on a regular or continuous basis. See 
Holsinger v. Commissioner, T.C. Memo 2008-191. As a third example, a 
married couple who owned two homes, one of which they lived in and 
renovated while monitoring the home market with an eye toward potential 
sale, and the other of which they rented out but eventually planned to 
occupy, were held to have neither engaged in the activity with 
sufficient frequency nor possessed the required profit motive necessary 
to meet the standard for being engaged in a trade or business. See 
Ohana v. Commissioner, T.C. Memo 2014-83.
    \55\ This second factor depends on the taxpayer's state of mind. 
The taxpayer must have a good faith intention to make a profit from the 
activity, and not be engaged in it ``merely for pleasure, exhibition, 
or social diversion.'' See Doggett v. Burnet, 65 F.2d 191 (D.C. Cir. 
1933), rev'g 23 B.T.A. 744 (1931).
    \56\ See, e.g., Higgins v. Commissioner, 61 S. Ct. 475 (1941).
    \57\ Commissioner v. Groetzinger, 480 U.S. 23, at 34-35 (1987).
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    Once a taxpayer has made the threshold determination that 
its activities rise to the level of constituting a trade or 
business, the taxpayer must determine whether it is carrying on 
a single unified trade or business (involving one or more 
activities) or multiple separate trades or businesses. The 
determination of whether the taxpayer is conducting one, or 
multiple, trades or businesses is relevant to the taxpayer's 
choices of methods of accounting used to compute taxable income 
(e.g., the cash method or an accrual method, and various 
special methods of accounting for certain items).\58\ Under 
section 446, a taxpayer with multiple separate trades or 
businesses may use different overall methods of accounting (and 
different special methods of accounting for an item, if 
applicable) to compute taxable income for each trade or 
business.\59\ However, a taxpayer with a single unified trade 
or business must use the same overall method of accounting for 
the activities (and the same special method of accounting, if 
applicable) within that trade or business.\60\ A taxpayer 
filing its first return may adopt any permissible method of 
accounting in connection with each separate trade or 
business.\61\
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    \58\ Sec. 446(c) and Treas. Reg. sec. 1.446-1(c)(1).
    \59\ Sec. 446(d) and Treas. Reg. sec. 1.446-1(d)(1). For example, a 
taxpayer may account for a personal service trade or business using the 
cash method and may account for a manufacturing business on an accrual 
method if such activities constitute separate trades or businesses. For 
a discussion of trades or businesses eligible to use the cash method 
and an accrual method, including changes to such rules by the Act, see 
discussion of section 13102 of the Act (Small Business Accounting 
Method Reform).
    \60\ For example, a taxpayer with a single trade or business that 
includes both manufacturing and service activities generally must 
account for such trade or business using an accrual method. See, e.g., 
Thompson Electric, Inc. v. Commissioner, T.C. Memo. 1995-292. For a 
discussion of trades or businesses eligible to use the cash method and 
an accrual method, including changes to such rules by the Act, see 
discussion of section 13102 of the Act (Small Business Accounting 
Method Reform).
    \61\ Treas. Reg. sec. 1.446-1(e)(1). See also, Rev. Rul. 90-38, 
1990-1 C.B. 57 (holding that a taxpayer adopts a method of accounting 
(1) when it uses a permissible method of accounting on a single tax 
return, or (2) when it uses the same impermissible method of accounting 
on two or more consecutive tax returns). Except as otherwise provided, 
section 446(e) requires taxpayers to secure the consent of the 
Secretary before changing a method of accounting, including any change 
in method of accounting attributable to a taxpayer's redetermination of 
how many separate trades or businesses it has.
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    Treasury regulations provide that activities are not 
considered separate and distinct trades or businesses unless 
they each keep a complete and separable set of books and 
records.\62\ Courts evaluating whether activities are separate 
and distinct trades or businesses have looked to factors such 
as the existence of common management, use of shared office 
space (or lack thereof), use of shared employees (or the lack 
thereof), and the nature of each business.\63\ The IRS has 
ruled that an entity that is disregarded for Federal income tax 
purposes, and thus treated as a separate division of its owner 
(e.g., a single-member limited liability company or a qualified 
subchapter S subsidiary); may constitute a separate trade or 
business under section 446 depending on the taxpayer's facts 
and circumstances.\64\
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    \62\ Treas. Reg. sec. 1.446-1(d)(2).
    \63\ Two cases addressing activities involving chicken farming and 
other related activities illustrate the nature of the analysis. First, 
in Peterson Produce, Inc. v. United States, 313 F.2d 609 (8th Cir. 
1963), aff'g 205 F. Supp. 229 (W.D. Ark. 1962), the court upheld a U.S. 
district court determination that the taxpayer's newly-formed chicken 
farming division was not separate and distinct from the taxpayer's feed 
and hatchery trade or business because the existing business primarily 
sold chicks to the new division and the taxpayer did not keep separate 
books and records for the two activities. In Burgess Poultry Mkt., Inc. 
v. United States, 64-2 USTC 9515 (E.D. Tex. 1964), however, the court 
held that the taxpayer's two divisions, one of which raised chicks and 
the other of which processed broiler chickens, were separate and 
distinct trades or businesses because they kept separate books and 
records, had separate employees, and did substantial business with 
third parties. See also Rev. Rul. 74-270, 1974-1 C.B. 109 (ruling that 
a bank's commercial banking division and trust division were separate 
trades or businesses where they had separate books and records, 
separate employees, separate office space, and separate management).
    \64\ See, e.g., Sections 9.01 and 15.07(4)(b) of Rev. Proc. 2018-1, 
2018-1 I.R.B. 1 (and its predecessors). See also CCA 201430013, July 
25, 2014.
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Cooperatives and their patrons

    Certain corporations are eligible to be treated as 
cooperatives and taxed under the special rules of subchapter T 
of the Code.\65\ In general, the subchapter T rules apply to 
any corporation operating on a cooperative basis (except mutual 
savings banks, insurance companies, most tax-exempt 
organizations, and certain utilities).
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    \65\ Secs. 1381-1388.
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    For Federal income tax purposes, a cooperative subject to 
the cooperative tax rules of subchapter T generally computes 
its income as if it were a taxable corporation, except that, in 
determining its taxable income, the cooperative does not take 
into account amounts paid for the taxable year as (1) patronage 
dividends, to the extent paid in money, qualified written 
notices of allocation, or other property (except nonqualified 
written notices of allocation) with respect to patronage 
occurring during such taxable year, and (2) per-unit retain 
allocations, to the extent paid in money, qualified per-unit 
retain certificates, or other property (except nonqualified 
per-unit retain certificates) with respect to marketing 
occurring during such taxable year.\66\
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    \66\ Secs. 1382 (determination of taxable income) and 1388 
(definitions).
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    Patronage dividends are amounts paid to a patron (1) on the 
basis of quantity or value of business done with or for such 
patron, (2) under an obligation of the cooperative to pay such 
amount that existed before the cooperative received the amount 
so paid, and (3) which are determined by reference to the net 
earnings of the cooperative from business done with or for its 
patrons.\67\ Per-unit retain allocations are allocations to a 
patron with respect to products marketed for him, the amount of 
which is fixed without reference to the net earnings of the 
organization pursuant to an agreement between the organization 
and the patron.\68\
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    \67\ Sec. 1388(a).
    \68\ Sec. 1388(f).
---------------------------------------------------------------------------
    Because a patron of a cooperative that receives patronage 
dividends or per-unit retain allocations generally must include 
such amounts in gross income,\69\ excluding patronage dividends 
and per-unit retain allocations paid by the cooperative from 
the cooperative's taxable income in effect allows the 
cooperative to be a conduit with respect to profits derived 
from transactions with its patrons.
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    \69\ Sec. 1385(a)(1) and (3).
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Treatment of taxpayers with domestic production activities income under 
        section 199 \70\
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    \70\ For a discussion of the repeal of section 199, see the 
description of section 13305 of the Act (Repeal of Deduction for Income 
Attributable to Domestic Production Activities).
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            In general
    Section 199 provides a deduction from taxable income (or, 
in the case of an individual, adjusted gross income \71\) that 
is equal to nine percent of the lesser of the taxpayer's 
qualified production activities income or taxable income 
(determined without regard to the section 199 deduction) for 
the taxable year.\72\ The amount of the deduction for a taxable 
year is limited to 50 percent of the W-2 wages paid by the 
taxpayer and properly allocable to domestic production gross 
receipts during the calendar year that ends in such taxable 
year.\73\ W-2 wages are the total wages subject to wage 
withholding,\74\ elective deferrals,\75\ and deferred 
compensation\76\ paid by the taxpayer with respect to 
employment of its employees during the calendar year ending 
during the taxable year of the taxpayer.\77\ W-2 wages do not 
include any amount that is not properly allocable to domestic 
production gross receipts as a qualified item of deduction.\78\ 
In addition, W-2 wages do not include any amount that was not 
properly included in a return filed with the Social Security 
Administration on or before the 60th day after the due date 
(including extensions) for such return.\79\
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    \71\ For this purpose, adjusted gross income is determined after 
application of sections 86, 135, 137, 219, 221, 222, and 469, and 
without regard to the section 199 deduction. Sec. 199(d)(2).
    \72\ Sec. 199(a).
    \73\ Sec. 199(b).
    \74\ Defined in sec. 3401(a).
    \75\ Within the meaning of sec. 402(g)(3).
    \76\ Deferred compensation includes compensation deferred under 
section 457, as well as the amount of any designated Roth contributions 
(as defined in section 402A).
    \77\ Sec. 199(b). In the case of a taxpayer with a short taxable 
year that does not contain a calendar year ending during such short 
taxable year, the following amounts are treated as the W-2 wages of the 
taxpayer for the short taxable year: (1) wages paid during the short 
taxable year to employees of the qualified trade or business; (2) 
elective deferrals (within the meaning of section 402(g)(3)) made 
during the short taxable year by employees of the qualified trade or 
business; and (3) compensation actually deferred under section 457 
during the short taxable year with respect to employees of the 
qualified trade or business. Amounts that are treated as W-2 wages for 
a taxable year are not treated as W-2 wages of any other taxable year. 
See Treas. Reg. sec. 1.199-2(b). In addition, in the case of a taxpayer 
who is an individual with otherwise qualified production activities 
income from sources within the commonwealth of Puerto Rico, if all the 
income for the taxable year is taxable under section 1 (income tax 
rates for individuals), the determination of W-2 wages with respect to 
the taxpayer's trade or business conducted in Puerto Rico is made 
without regard to any exclusion under the wage withholding rules (as 
provided in section 3401(a)(8)) for remuneration paid for services in 
Puerto Rico. See sec. 199(d)(8)(B).
    \78\ Sec. 199(b)(2)(B).
    \79\ Sec. 199(b)(2)(C).
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    In the case of oil related qualified production activities 
income, the deduction is reduced by three percent of the least 
of the taxpayer's oil related qualified production activities 
income, qualified production activities income, or taxable 
income (determined without regard to the section 199 deduction) 
for the taxable year.\80\ For this purpose, oil related 
qualified production activities income for any taxable year is 
the portion of qualified production activities income 
attributable to the production, refining, processing, 
transportation, or distribution of oil, gas, or any primary 
product thereof \81\ during the taxable year.
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    \80\ Sec. 199(d)(9).
    \81\ Within the meaning of sec. 927(a)(2)(C) as in effect before 
its repeal.
---------------------------------------------------------------------------
    In general, qualified production activities income is equal 
to domestic production gross receipts reduced by the sum of: 
(1) the cost of goods sold that are allocable to those 
receipts;\82\ and (2) other expenses, losses, or deductions 
which are properly allocable to those receipts.\83\ 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 \84\ that was manufactured, 
produced, grown, or extracted by the taxpayer in whole or in 
significant part within the United States; \85\ (2) any sale, 
exchange, or other disposition, or any lease, rental, or 
license, of any qualified film \86\ produced by the taxpayer; 
(3) any sale, exchange, or other disposition, or any lease, 
rental, or license, of electricity, natural gas, or potable 
water produced by the taxpayer in the United States; (4) 
construction of real property performed in the United States by 
a taxpayer in the ordinary course of a construction trade or 
business; or (5) engineering or architectural services 
performed in the United States by the taxpayer for the 
construction of real property in the United States.\87\
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    \82\ For this purpose, any item or service brought into the United 
States is treated as acquired by purchase, and its cost is treated as 
not less than its value immediately after it entered the United States. 
A similar rule applies in determining the adjusted basis of leased or 
rented property where the lease or rental gives rise to domestic 
production gross receipts. In addition, for any property exported by 
the taxpayer for further manufacture, the increase in cost or adjusted 
basis may not exceed the difference between the value of the property 
when exported and the value of the property when brought back into the 
United States after the further manufacture. See sec. 199(c)(3)(A) and 
(B).
    \83\ Sec. 199(c)(1). In computing qualified production activities 
income, the domestic production activities deduction itself is not an 
allocable deduction. Sec. 199(c)(1)(B)(ii). See also Treas. Reg. secs. 
1.199-1 through -9 for rules regarding the proper allocation of items 
of income, deduction, expense, and loss for purposes of determining 
qualified production activities income.
    \84\ Qualifying production property generally includes any tangible 
personal property, computer software, and sound recordings. Sec. 
199(c)(5).
    \85\ When used in the Code in a geographical sense, the term 
``United States'' generally includes only the States and the District 
of Columbia. Sec. 7701(a)(9). A special rule for determining domestic 
production gross receipts, however, provides that for taxable years 
beginning after December 31, 2005, and before January 1, 2017, in the 
case of any taxpayer with gross receipts from sources within the 
Commonwealth of Puerto Rico, the term ``United States'' includes the 
Commonwealth of Puerto Rico, but only if all of the taxpayer's Puerto 
Rico-sourced gross receipts are taxable under the Federal income tax 
for individuals or corporations for such taxable year. See sections 
199(d)(8)(A) and (C). Such special rule was extended to taxable years 
beginning before January 1, 2018, by the Bipartisan Budget Act of 2018, 
Pub. L. No. 115-123, February 9, 2018. In computing the 50-percent wage 
limitation, the taxpayer is permitted to take into account wages paid 
to bona fide residents of Puerto Rico for services performed in Puerto 
Rico. Sec. 199(d)(8)(B).
    \86\ Qualified film includes any motion picture film or videotape 
(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 the film (including 
compensation in the form of residuals and participations) constitutes 
compensation for services performed in the United States by actors, 
production personnel, directors, and producers. Sec. 199(c)(6).
    \87\ Sec. 199(c)(4)(A).
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    Domestic production gross receipts do not include any gross 
receipts of the taxpayer derived from property leased, 
licensed, or rented by the taxpayer for use by any related 
person.\88\ In addition, domestic production gross receipts do 
not include gross receipts which are derived from: (1) the sale 
of food and beverages prepared by the taxpayer at a retail 
establishment; (2) the transmission or distribution of 
electricity, natural gas, or potable water; or (3) the lease, 
rental, license, sale, exchange, or other disposition of 
land.\89\
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    \88\ Sec. 199(c)(7). For this purpose, a person is treated as 
related to another person if such persons are treated as a single 
employer under subsection (a) or (b) of section 52 or subsection (m) or 
(o) of section 414, except that determinations under subsections (a) 
and (b) of section 52 are made without regard to section 1563(b).
    \89\ Sec. 199(c)(4)(B).
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            Special rules
    All members of an expanded affiliated group \90\ are 
treated as a single corporation and the deduction is allocated 
among the members of the expanded affiliated group in 
proportion to each member's respective amount, if any, of 
qualified production activities income. In addition, for 
purposes of determining domestic production gross receipts, if 
all of the interests in the capital and profits of a 
partnership are owned by members of a single expanded 
affiliated group at all times during the taxable year of such 
partnership, the partnership and all members of such group are 
treated as a single taxpayer during such period.\91\
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    \90\ For this purpose, an expanded affiliated group is an 
affiliated group as defined in section 1504(a) determined (i) by 
substituting ``more than 50 percent'' for ``more than 80 percent'' each 
place it appears, and (ii) without regard to paragraphs (2) and (4) of 
section 1504(b). See sec. 199(d)(4)(B).
    \91\ Sec. 199(d)(4)(D).
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    For a tax-exempt taxpayer subject to tax on its unrelated 
business taxable income by section 511, the section 199 
deduction is determined by substituting unrelated business 
taxable income for taxable income where applicable.\92\
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    \92\ Sec. 199(d)(7).
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    The section 199 deduction is determined by only taking into 
account items that are attributable to the actual conduct of a 
trade or business.\93\
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    \93\ Sec. 199(d)(5).
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            Partnerships and S corporations
    With regard to the domestic production activities income of 
a partnership or S corporation, the deduction is determined at 
the partner or shareholder level. Each partner or shareholder 
generally takes 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 income, if 
any.\94\
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    \94\ Sec. 199(d)(1)(A).
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    In applying the W-2 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 such 
person's allocable share of W-2 wages.\95\
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    \95\ In the case of a trust or estate, the components of the 
calculation are apportioned between (and among) the beneficiaries and 
the fiduciary. See sec. 199(d)(1)(B) and Treas. Reg. sec. 1.199-5(d) 
and (e).
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            Specified agricultural and horticultural cooperatives
    In general.--With regard to specified agricultural and 
horticultural cooperatives, section 199 provides the same 
treatment of qualified production activities income derived 
from agricultural or horticultural products that are 
manufactured, produced, grown, or extracted by such 
cooperatives \96\ as it provides for qualified production 
activities income of other taxpayers, including non-specified 
cooperatives (i.e., the cooperative may claim a deduction for 
qualified production activities income). The cooperative is 
treated as having manufactured, produced, grown, or extracted 
in whole or significant part any qualifying production property 
marketed by the cooperative if such items were manufactured, 
produced, grown, or extracted in whole or significant part by 
the cooperative's patrons.\97\ In addition, the cooperative is 
treated as having manufactured, produced, grown, or extracted 
agricultural products with respect to which the cooperative 
performs storage, handling, or other processing activities 
(other than transportation activities) within the United States 
related to the sale, exchange, or other disposition of such 
products, provided the products are consumed in connection with 
or incorporated into the manufacturing, production, growth, or 
extraction of qualifying production property (whether or not by 
the cooperative).\98\ Finally, for purposes of determining the 
cooperative's section 199 deduction, qualified production 
activities income and taxable income are determined without 
regard to any deduction allowable under section 1382(b) and (c) 
(relating to patronage dividends, per-unit retain allocations, 
and nonpatronage distributions) for the taxable year.\99\
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    \96\ 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. See Treas. Reg. sec. 
1.199-6(f).
    \97\ Sec. 199(d)(3)(D) and Treas. Reg. sec. 1.199-6(d).
    \98\ See Treas. Reg. sec. 1.199-3(e)(1).
    \99\ See sec. 199(d)(3)(C) and Treas. Reg. sec. 1.199-6(c).
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    Definition of a specified agricultural or horticultural 
cooperative.--A specified agricultural or horticultural 
cooperative is an organization to which part I of subchapter T 
applies that is engaged in (a) the manufacturing, production, 
growth, or extraction in whole or significant part of any 
agricultural or horticultural product, or (b) the marketing of 
agricultural or horticultural products that the cooperative's 
patrons have so manufactured, produced, grown, or 
extracted.\100\
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    \100\ Sec. 199(d)(3)(F).
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    Allocation of the cooperative's deduction to patrons.--Any 
patron that receives a qualified payment from a specified 
agricultural or horticultural cooperative is allowed as a 
deduction for the taxable year in which such payment is 
received an amount equal to the portion of the cooperative's 
deduction for qualified production activities income that is 
(a) allowed with respect to the portion of the qualified 
production activities income to which such payment is 
attributable, and (b) identified by the cooperative in a 
written notice mailed to the patron during the payment period 
described in section 1382(d).\101\ A qualified payment is any 
amount that (a) is described in paragraph (1) or (3) of section 
1385(a) (i.e., patronage dividends and per-unit retain 
allocations), (b) is received by an eligible patron from a 
specified agricultural or horticultural cooperative, and (c) is 
attributable to qualified production activities income with 
respect to which a deduction is allowed to such 
cooperative.\102\
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    \101\ Sec. 199(d)(3)(A) and Treas. Reg. sec. 1.199-6(a). The 
written notice must be mailed by the cooperative to patrons no later 
than the 15th day of the ninth month following the close of the taxable 
year. The cooperative must report the amount of the patron's section 
199 deduction on Form 1099-PATR, ``Taxable Distributions Received From 
Cooperatives,'' issued to the patron. Treas. Reg. sec. 1.199-6(g).
    \102\ Sec. 199(d)(3)(E). For this purpose, patronage dividends and 
per-unit retain allocations include any advances on patronage and per-
unit retains paid in money during the taxable year. Treas. Reg. sec. 
1.199-6(e).
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    The cooperative cannot reduce its income under section 1382 
for any deduction allowable to its patrons under this rule 
(i.e., the cooperative must reduce its deductions allowed for 
certain payments to its patrons in an amount equal to the 
section 199 deduction allocated to its patrons).\103\
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    \103\ Sec. 199(d)(3)(B) and Treas. Reg. sec. 1.199-6(b).
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                        Explanation of Provision


In general

    The provision reflects Congress's belief that a reduction 
in the corporate income tax rate does not completely address 
the Federal income tax burden on businesses. While the 
corporate tax is a tax on capital income, the tax on income 
from noncorporate businesses may fall on both labor income and 
capital income. Treating corporate and noncorporate business 
income more similarly to each other under the Federal income 
tax requires distinguishing labor income from capital income in 
a noncorporate business.

Taxpayers with qualified business income

    For taxable years beginning after December 31, 2017, and 
before January 1, 2026, an individual taxpayer generally may 
deduct 20 percent of qualified business income with respect to 
a partnership, S corporation, or sole proprietorship, as well 
as 20 percent of aggregate qualified REIT dividends, qualified 
cooperative dividends,\104\ and qualified publicly traded 
partnership income.\105\ Eligible taxpayers also generally 
include fiduciaries and beneficiaries of trusts and estates 
with qualified business income. Special rules apply to 
specified agricultural or horticultural cooperatives. A 
limitation based on W-2 wages, or W-2 wages and capital 
investment (as applicable), phases in above a threshold amount 
of taxable income.\106\ A disallowance of the deduction on 
income of specified service trades or businesses also phases in 
above the same threshold amount of taxable income.
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    \104\ The treatment of income relating to specified agricultural 
and horticultural cooperatives (both the cooperative itself and 
payments received by patrons from the cooperative) under section 199A 
(as originally enacted December 22, 2017) was modified by the 
Consolidated Appropriations Act, 2018, Pub. L. No. 115-141, enacted 
March 23, 2018, effective as if included in section 11011 of Pub. L. 
No. 115-97. The description of the modification was originally 
published as Joint Committee on Taxation, Technical Explanation of the 
Revenue Provisions of the House Amendment to the Senate Amendment to 
H.R. 1625 (Rules Committee Print 115-66) (JCX-6-18), March 22, 2018, 
pp. 5-27, which is reproduced in the Appendix.
    \105\ Sec. 199A.
    \106\ For purposes of the provision, taxable income is computed 
without regard to the 20-percent deduction. Sec. 199A(e)(1).
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            Qualified business income
    Qualified business income is separately determined for each 
qualified trade or business of the taxpayer. For any taxable 
year, qualified business income (or qualified business loss 
\107\) means the net amount of qualified items of income, gain, 
deduction, and loss with respect to the qualified trade or 
business of the taxpayer. Qualified items of income or 
deduction \108\ are taken into account to determine qualified 
business income only to the extent they are included in taxable 
income for the year under the methods of accounting of the 
qualified trade or business.\109\ For example, in a taxable 
year, if a qualified trade or business has $100,000 of ordinary 
income from inventory sales and makes an expenditure of $25,000 
that is required to be capitalized and amortized over five 
years under applicable Federal income tax rules, the qualified 
business income is $100,000 minus $5,000 (current-year ordinary 
amortization deduction), or $95,000. The qualified business 
income is not reduced by the entire amount of the capital 
expenditure, but rather only by the amount allowed as a 
deduction in determining taxable income for the year under the 
qualified trade or business's method of accounting.
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    \107\ A qualified business loss from a qualified trade or business 
may not be combined with or netted against qualified business income 
from other qualified trades or businesses prior to applying the W-2 
wage limit or W-2 wage and capital limit, described below. 
Specifically, section 199A(b)(2) applies the W-2 wage limit or W-2 wage 
and capital limit to each respective qualified trade or business prior 
to the combination of the deductible amounts from each qualified trade 
or business in section 199A(b)(1)(A). See secs. 199A(b)(1)(A) and 
(b)(2). Examples below illustrate these rules.
    \108\ Business expenses deductible from gross income of a business 
generally only include the ordinary and necessary expenditures directly 
connected with or pertaining to such business. See Treas. Reg. sec. 
1.162-1(a).
    \109\ See, e.g., secs. 162, 166, 167, 168, 197, 263, 263A, and 
subchapter E of Chapter 1 (secs. 441-483).
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    Qualified items of gain or loss are taken into account to 
determine qualified business income or qualified business loss 
only to the extent included or allowed in the determination of 
taxable income for the year. \110\ For example, assume a 
qualified trade or business has a passive loss that is not 
allowable by reason of section 469 for taxable year 2017 in the 
amount of $50,000, and that the loss is attributable to a 
qualified trade or business. Assume further that $20,000 of the 
loss is allowed for the taxable year 2018. The $20,000 loss 
allowed in 2018 is taken into account in determining the 
taxpayer's qualified business income from the qualified trade 
or business in 2018.
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    \110\ Generally, net operating loss carryovers and carrybacks 
determined under section 172 are not qualified items of deduction or 
loss with respect to a trade or business. However, a carryover may be 
treated as such a qualified item to the extent that any portion of a 
net operating loss carryover or carryback is attributable to a loss 
that was not allowed in the prior year in which it was incurred (e.g., 
an excess business loss that was not allowed under section 461(l), as 
enacted by the Act). Consistent with this, the loss that was not 
allowed in the prior year is included in qualified business income in 
the taxable year in which the net operating loss carryover or carryback 
of which it is a part is deducted. For a discussion of the excess 
business loss rules enacted by the Act, see the description of section 
11012 of the Act (Limitation on Losses for Taxpayers Other Than 
Corporations).
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            Domestic business
    Items are treated as qualified items of income, gain, 
deduction, and loss only to the extent they are effectively 
connected with the conduct of a trade or business within the 
United States.\111\ In the case of an individual with qualified 
business income from sources within the Commonwealth of Puerto 
Rico, if all such income for the taxable year is taxable under 
section 1 (income tax rates for individuals), then the term 
``United States'' is considered to include the Commonwealth of 
Puerto Rico for purposes of determining the individual's 
qualified business income.\112\
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    \111\ For this purpose, section 864(c) is applied by substituting 
``qualified trade or business (within the meaning of section 199A)'' 
for ``nonresident alien individual or a foreign corporation'' or for 
``foreign corporation,'' each place they appear. Sec. 199A(c)(3)(A). A 
clerical correction may be needed to correct statutory references with 
respect to this substitution.
    \112\ Sec. 199A(f)(1)(C).
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            Reasonable compensation and guaranteed payments
    Qualified business income of the taxpayer does not include 
any amount paid by an S corporation that is treated as 
reasonable compensation of the taxpayer.\113\ Similarly, 
qualified business income does not include any guaranteed 
payment for services rendered with respect to the trade or 
business,\114\ and, to the extent provided in regulations, does 
not include any amount paid or incurred by a partnership to a 
partner, acting other than in his or her capacity as a partner, 
for services.\115\
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    \113\ Sec. 199A(c)(4).
    \114\ Described in sec. 707(c).
    \115\ Described in sec. 707(a).
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            Treatment of certain investment items
    Certain items are not taken into account as qualified items 
of income, gain, deduction, or loss.\116\ Specifically, 
qualified items of income, gain, deduction, or loss do not 
include (1) any item taken into account in determining net 
capital gain or net capital loss, (2) dividends, income 
equivalent to a dividend, or payments in lieu of dividends, (3) 
interest income other than that which is properly allocable to 
a trade or business, (4) the excess of gain over loss from 
commodities transactions other than those entered into (i) in 
the normal course of the trade or business or (ii) with respect 
to stock in trade or property held primarily for sale to 
customers in the ordinary course of the trade or business, 
property used in the trade or business, or supplies regularly 
used or consumed in the trade or business, (5) the excess of 
foreign currency gains over foreign currency losses from 
section 988 transactions other than transactions directly 
related to the business needs of the business activity, (6) net 
income from notional principal contracts other than clearly 
identified hedging transactions that are treated as ordinary 
(i.e., not treated as capital assets), and (7) any amount 
received from an annuity that is not received in connection 
with the trade or business. Qualified items also do not include 
any item of deduction or loss properly allocable to any of the 
preceding items.
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    \116\ See sec. 199A(c)(3)(B).
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            Qualified business loss carryover
    If the net amount of qualified business income from all 
qualified trades or businesses during the taxable year is a 
loss, the qualified business loss is carried over for purposes 
of calculating the deduction under section 199A and in the next 
taxable year is treated as a loss from a qualified trade or 
business.\117\ The qualified business loss carryover continues 
to carry forward, reduced by any qualified business income in 
subsequent years, until the taxpayer has a taxable year with 
net qualified business income. In the first succeeding taxable 
year in which the taxpayer has net qualified business income 
from all qualified trades or businesses, the taxpayer takes the 
qualified business loss carryover under section 199A(c)(2) into 
account in calculating the sum of the deductible amounts for 
its trades or businesses under section 199A(b)(1)(A). 
Specifically, the sum of the deductible amounts for its 
qualified trades or businesses for the taxable year is reduced, 
but not below zero,\118\ by 20 percent of any qualified 
business loss carryover under section 199A(c)(2) when 
determining the combined qualified business income amount for 
that subsequent year.
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    \117\ Sec. 199A(c)(2). Like a current year qualified business loss, 
a qualified business loss carryover is not associated with a particular 
qualified trade or business of the taxpayer. Like a qualified business 
loss, a qualified business loss carryover may not be aggregated with or 
netted against qualified business income in a subsequent year prior to 
applying the W-2 wage limit or W-2 wage and capital limit, described 
below, to each qualified trade or business. See below for examples 
illustrating the application of the W-2 wage limit or W-2 wage and 
capital limit in taxable years in which there is a qualified business 
loss carryover.
    \118\ A technical correction may be needed to carry out this 
intent.
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    For example, in year one, Taxpayer has qualified business 
income of $20,000 from qualified business A and a qualified 
business loss of $50,000 from qualified business B. In year 
two, Taxpayer has qualified business income of $20,000 from 
qualified business A and qualified business income of $50,000 
from qualified business B. (Neither business is subject to the 
W-2 wage, or W-2 wage and capital, limitations described 
below.) Under section 199A(c)(2), Taxpayer's $30,000 net 
qualified business loss from year one carries forward and is 
treated as a $30,000 loss from a qualified trade or business in 
year 2. To determine the deduction for year two, Taxpayer 
combines 20 percent of the qualified business income of 
businesses A and B in year 2 with 20 percent of the $30,000 
loss carryover from year 1 for a total deduction of 
$8,000.\119\
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    \119\ ($70,000 * 20 percent)-($30,000 * 20 percent) = $14,000 - 
$6,000 = $8,000. This simple example is intended to illustrate the 
operation of this rule alone. For more comprehensive examples showing 
interaction among various rules of the provision, see the additional 
examples below, in particular, example 3.
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            Qualified trade or business \120\
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    \120\ The provision does not alter the meaning of the term trade or 
business, which retains its ordinary meaning for Federal income tax 
purposes. See prior law, above, for a description of how to determine 
under prior and present law whether an activity rises to the level of a 
trade or business, and whether trades or businesses are treated as 
separate and distinct from each other for Federal income tax purposes.
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    A qualified trade or business means any trade or business 
other than a specified service trade or business and other than 
the trade or business of performing services as an 
employee.\121\
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    \121\ Sec. 199A(d)(1).
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    An activity that is treated as a trade or business for all 
relevant Federal income tax purposes (and that keeps a complete 
and separable set of books and records) may be treated as a 
qualified trade or business. For example, assume that an 
individual owns a rental building in which the ground floor 
space is rented to three unrelated commercial establishments (a 
coffee shop, a drycleaner, and a newsstand) and the upper 
floors hold apartments rented to residential tenants. For 
Federal tax purposes, the individual accounts for the rental 
activities with respect to the entire building using a single 
set of books and records. Assume further that the individual 
materially participates in the rental activity, cost recovery 
deductions under section 168 are allowable with respect to the 
building, and deductions for expenses with respect to operating 
and maintaining the building are allowable under section 162. 
Because a complete and separable set of books and records is 
kept with respect to the entire building (including the both 
the commercial and residential rentals), and because deductions 
under section 162 are allowable, the real estate rental trade 
or business is a qualified trade or business for purposes of 
section 199A.
    Whether one or more trade or business activities or rental 
activities may be treated as a single activity for purposes of 
section 469 \122\ is not determinative of a separate and 
distinct trade or business for purposes of section 199A.
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    \122\ Sec. 469(c) and Treas. Reg. sec. 1.469-4.
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            Specified service trade or business
    The provision identifies some service businesses that 
generally give rise to income from labor services, that is, 
labor income, and excludes those businesses from the provision 
(subject to a phase-in). A specified service trade or business 
means any trade or business involving the performance of 
services in the fields of health,\123\ law, accounting, 
actuarial science, performing arts,\124\ consulting,\125\ 
athletics, financial services, brokerage services, or any trade 
or business where the principal asset of such trade or business 
is the reputation or skill of one or more of its employees or 
owners, or which involves the performance of services that 
consist of investing and investment management, trading, or 
dealing in securities, partnership interests, or 
commodities.\126\ For example, a trade or business in which the 
taxpayer works as an independent contractor for various 
unrelated businesses, where the business generally holds 
minimal tangible and intangible property, is a specified 
service trade or business if the principal asset of such trade 
or business is the reputation or skill of its owner.
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    \123\ A similar list of service trades or business is provided in 
section 448(d)(2)(A) and Treas. Reg. sec. 1.448-1T(e)(4)(i). For 
purposes of section 448, Treasury regulations provide that the 
performance of services in the field of health means the provision of 
medical services by physicians, nurses, dentists, and other similar 
healthcare professionals. The performance of services in the field of 
health does not include the provision of services not directly related 
to a medical field, even though the services may purportedly relate to 
the health of the service recipient. For example, the performance of 
services in the field of health does not include the operation of 
health clubs or health spas that provide physical exercise or 
conditioning to their customers. See Treas. Reg. sec. 1.448-
1T(e)(4)(ii).
    \124\ For purposes of the similar list of services in section 448, 
Treasury regulations provide that the performance of services in the 
field of the performing arts means the provision of services by actors, 
actresses, singers, musicians, entertainers, and similar artists in 
their capacity as such. The performance of services in the field of the 
performing arts does not include the provision of services by persons 
who themselves are not performing artists (e.g., persons who may manage 
or promote such artists, and other persons in a trade or business that 
relates to the performing arts). Similarly, the performance of services 
in the field of the performing arts does not include the provision of 
services by persons who broadcast or otherwise disseminate the 
performance of such artists to members of the public (e.g., employees 
of a radio station that broadcasts the performances of musicians and 
singers). See Treas. Reg. sec. 1.448-1T(e)(4)(iii).
    \125\ For purposes of the similar list of services in section 448, 
Treasury regulations provide that the performance of services in the 
field of consulting means the provision of advice and counsel. The 
performance of services in the field of consulting does not include the 
performance of services other than advice and counsel, such as sales or 
brokerage services, or economically similar services. For purposes of 
the preceding sentence, the determination of whether a person's 
services are sales or brokerage services, or economically similar 
services, shall be based on all the facts and circumstances of that 
person's business. Such facts and circumstances include, for example, 
the manner in which the taxpayer is compensated for the services 
provided (e.g., whether the compensation for the services is contingent 
upon the consummation of the transaction that the services were 
intended to effect). See Treas. Reg. sec. 1.448-1T(e)(4)(iv).
    \126\ Sec. 199A(d)(2). For this purpose a security and a commodity 
have the meanings provided in the rules for the mark to market 
accounting method for dealers in securities. See secs. 475(c)(2) and 
(e)(2).
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    A specified service trade or business involving the 
performance of services that consist of investing and 
investment management, trading, or dealing is intended to 
include any trade or business primarily engaged in providing 
financial markets services (i.e., investing, investment 
management, trading, or dealing services with respect to 
financial instruments) to customers, as well as any trade or 
business that primarily involves investing and managing its own 
invested capital. For example, a trade or business engaged in 
providing portfolio management services to institutional and 
individual customers is a specified service trade or business. 
However, a trade or business primarily engaged in the purchase 
and sale of a physical commodity (so that it might be viewed as 
engaged in trading or dealing in commodities), and that 
regularly takes physical possession of the commodity in the 
ordinary course of its trade or business at a location or 
facility operated by the business, is not a specified service 
trade or business because its trade or business does not 
involve the performance of financial markets services.
            Phase-in of specified service trade or business limitation 
                    above threshold amount
    The exclusion from the definition of a qualified trade or 
business for specified service trades or businesses phases in 
for a taxpayer with taxable income \127\ in excess of a 
threshold amount. The threshold amount is $157,500 ($315,000 in 
the case of a joint return) (together, the ``threshold 
amount''), adjusted for inflation in taxable years beginning 
after 2018.\128\ The exclusion from the definition of a 
qualified trade or business for specified service trades or 
businesses is fully phased in for a taxpayer with taxable 
income in excess of the threshold amount plus $50,000 ($100,000 
in the case of a joint return).\129\ Thus, the range over which 
the phase-in of the specified service trade or business 
limitation \130\ applies is taxable income of $157,500 to 
$207,500 ($315,000 to $415,000 in the case of a joint return). 
A taxpayer whose taxable income exceeds the top of that range 
is not entitled to any deduction under section 199A with 
respect to a specified service trade or business.
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    \127\ For this purpose, taxable income is determined without regard 
to the section 199A deduction.
    \128\ Sec. 199A(e)(2).
    \129\ See sec. 199A(d)(3).
    \130\ The limitation based on W-2 wages, or W-2 wages and capital, 
described below, is also phased in above the threshold amount.
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    For a taxpayer with taxable income within the phase-in 
range, the computation of qualified business income with 
respect to a specified service trade or business takes into 
account only the applicable percentage of qualified items of 
income, gain, deduction, or loss, and of allocable W-2 wages, 
or of W-2 wages and capital. The applicable percentage with 
respect to any taxable year is 100 percent reduced (but not 
below zero) by the percentage equal to the ratio that the 
excess of the taxable income of the taxpayer for the taxable 
year over the threshold amount bears to $50,000 ($100,000 in 
the case of a joint return).

Tentative deductible amount for a qualified trade or business

            Taxpayers with taxable income below threshold amount
    For a taxpayer with taxable income at or below the 
threshold amount, the deductible amount for each qualified 
trade or business is equal to 20 percent of the qualified 
business income with respect to the trade or business.\131\
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    \131\ Sec. 199A(b)(3).
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            Limitation based on W-2 wages, or W-2 wages and capital
    For a taxpayer with taxable income above the threshold 
amount, the taxpayer is allowed a deductible amount for each 
qualified trade or business \132\ equal to the lesser of (1) 20 
percent of the qualified business income with respect to such 
trade or business, or (2) the greater of (a) 50 percent of the 
W-2 wages paid with respect to the qualified trade or business, 
or (b) the sum of 25 percent of the W-2 wages paid with respect 
to the qualified trade or business plus 2.5 percent of the 
unadjusted basis, immediately after acquisition, of all 
qualified property of the qualified trade or business.\133\ The 
threshold amount is $157,500 ($315,000 in the case of a joint 
return), adjusted for inflation in taxable years beginning 
after 2018.\134\
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    \132\ A qualified trade or business does not include a specified 
service trade or business (with a phase-in above the threshold amount) 
and does not include the trade or business of performing services as an 
employee, as described above.
    \133\ Sec. 199A(b)(2). The W-2 wage, or W-2 wage and capital, 
limitation applies to a qualified trade or business regardless of 
whether the business has qualified business income or qualified 
business loss for the current taxable year. For examples illustrating 
the interaction among various rules of the provision, see the 
additional examples below.
    \134\ Sec. 199A(e)(2). A phase-in for a taxpayer with taxable 
income above the threshold amount also applies with respect to the 
exclusion from the definition of a qualified trade or business in the 
case of a specified service trade or business (as described above).
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            Phase-in of limitation based on W-2 wages, or W-2 wages and 
                    capital
    The W-2 wage, or W-2 wage and capital, limitation phases in 
for a taxpayer with taxable income in excess of the threshold 
amount.\135\ The limitation applies fully for a taxpayer with 
taxable income in excess of the threshold amount plus $50,000 
($100,000 in the case of a joint return).
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    \135\ Sec. 199A(b)(3)(B). For this purpose, taxable income is 
determined without regard to the section 199A deduction.
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            Meaning of W-2 wages and qualified property
    W-2 wages are the total wages subject to wage 
withholding,\136\ elective deferrals,\137\ and deferred 
compensation \138\ paid by the qualified trade or business with 
respect to employment of its employees during the calendar year 
ending during the taxable year of the taxpayer.\139\ In the 
case of a taxpayer who is an individual with otherwise 
qualified business income from sources within the Commonwealth 
of Puerto Rico, if all the income for the taxable year is 
taxable under section 1 (income tax rates for individuals), the 
determination of W-2 wages with respect to the taxpayer's 
qualified trade or business conducted in Puerto Rico is made 
without regard to any exclusion under the wage withholding 
rules \140\ for remuneration paid for services in Puerto Rico. 
W-2 wages do not include any amount that is not properly 
allocable to qualified business income as a qualified item of 
deduction.\141\ In addition, W-2 wages do not include any 
amount that was not properly included in a return filed with 
the Social Security Administration on or before the 
60th day after the due date (including extensions) 
for the return.\142\
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    \136\ Defined in sec. 3401(a).
    \137\ Within the meaning of sec. 402(g)(3).
    \138\ Deferred compensation includes compensation deferred under 
section 457, as well as the amount of any designated Roth contributions 
(as defined in section 402A).
    \139\ Sec. 199A(b)(4). In the case of a taxpayer with a short 
taxable year that does not contain a calendar year ending during such 
short taxable year, the following amounts are treated as the W-2 wages 
of the taxpayer for the short taxable year: (1) wages paid during the 
short taxable year to employees of the qualified trade or business; (2) 
elective deferrals (within the meaning of section 402(g)(3)) made 
during the short taxable year by employees of the qualified trade or 
business; and (3) compensation actually deferred under section 457 
during the short taxable year with respect to employees of the 
qualified trade or business. Amounts that are treated as W-2 wages for 
a taxable year are not treated as W-2 wages of any other taxable year.
    \140\ As provided in sec. 3401(a)(8).
    \141\ Sec. 199A(b)(4)(B).
    \142\ Sec. 199A(b)(4)(C).
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    Qualified property means, with respect to a qualified trade 
or business for a taxable year, tangible property of a 
character subject to depreciation under section 167 that is 
held by, and available for use in, the qualified trade or 
business at the close of the taxable year, that is used at any 
point during the taxable year in the production of qualified 
business income, and for which the depreciable period has not 
ended before the close of the taxable year.\143\ The 
depreciable period with respect to qualified property of a 
taxpayer means the period beginning on the date the property 
was first placed in service by the taxpayer and ending on the 
later of (a) the date that is 10 years after that date, or (b) 
the last day of the last full year in the applicable recovery 
period that would apply to the property under section 168 
(determined without regard to the alternative depreciation 
system under section 168(g)).\144\
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    \143\ Sec. 199A(b)(6).
    \144\ The applicable recovery period for an asset is determined in 
part by statute and in part by historic Treasury guidance. Exercising 
authority granted by Congress, the Secretary issued Rev. Proc. 87-56, 
1987-2 C.B. 674, laying out the framework of recovery periods for 
enumerated classes of assets. The Secretary clarified and modified the 
list of asset classes in Rev. Proc. 88-22, 1988-1 C.B. 785. In November 
1988, Congress revoked the Secretary's authority to modify the class 
lives of depreciable property. Rev. Proc. 87-56, as modified, remains 
in effect except to the extent that Congress has, since 1988, 
statutorily modified the recovery period for certain depreciable 
assets, effectively superseding any administrative guidance with regard 
to such property. For a discussion of the changes to applicable 
recovery periods made by the Act, see the discussion of sections 13203 
(Modifications of Treatment of Certain Farm Property) and 13204 
(Applicable Recovery Period for Real Property).
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            Examples
    For example,\145\ a taxpayer (a single individual) has 
taxable income of $187,500, of which $100,000 is attributable 
to an accounting sole proprietorship after paying wages of 
$80,000 to employees. The accounting sole proprietorship pays 
W-2 wages of $80,000, and has no qualifying property. The 
taxpayer has an applicable percentage of 40 percent.\146\ In 
determining qualified business income, the taxpayer takes into 
account 40 percent of $100,000, or $40,000. In determining W-2 
wages, the taxpayer takes into account 40 percent of $80,000, 
or $32,000. The taxpayer calculates the deduction by taking the 
lesser of 20 percent of $40,000 ($8,000) or 50 percent of 
$32,000 ($16,000), which in this case is $8,000. In this 
example, the W-2 wage limitation is not binding.
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    \145\ This example illustrates the operation of the exclusion of a 
specified service trade or business when the W-2 wage, or W-2 wage and 
capital, limitation does not bind. For more comprehensive examples 
showing the interaction among various rules of the provision, see 
below.
    \146\ 1 - ($187,500 - $157,500)/$50,000 = 1 - $30,000/$50,000 = 1 - 
0.6 = 40 percent.
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    As another example,\147\ a taxpayer (who is subject to the 
W-2 wage, or W-2 wage and capital, limitation) has a sole 
proprietorship that manufactures widgets. The business buys a 
widget-making machine for $100,000 and places it in service in 
2020. The business has no employees in 2020. The limitation in 
2020 is the greater of (a) 50 percent of W-2 wages, or $0, or 
(b) the sum of 25 percent of W-2 wages ($0) plus 2.5 percent of 
the unadjusted basis of the machine immediately after its 
acquisition ($2,500). The taxpayer's section 199A deduction for 
2020 for the widget sole proprietorship may not exceed $2,500.
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    \147\ This example illustrates the operation of the W-2 wage, or W-
2 wage and capital, limitation. For more comprehensive examples showing 
the interaction among various rules of the provision, see below.
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            Regulatory authority with respect to W-2 wage, or W-2 wage 
                    and capital, limitation
    Property that is no longer available for use in the 
qualified trade or business, for example because it was sold, 
is not taken into account in determining the W-2 wage and 
capital limitation. The Secretary is required to provide rules 
for applying the limitation in cases of a short taxable year 
and when the taxpayer acquires, or disposes of, the major 
portion of a trade or business or the major portion of a 
separate unit of a trade or business during the year. The 
Secretary is required to provide guidance applying rules 
similar to the rules of section 179(d)(2) to address 
acquisitions of property from a related party, as well as in a 
sale-leaseback or other transaction as needed to carry out the 
purposes of the provision. Similarly, the Secretary is required 
to provide guidance prescribing rules for determining the 
unadjusted basis immediately after acquisition of qualified 
property acquired in like-kind exchanges or involuntary 
conversions as needed to carry out the purposes of the 
provision and to provide anti-abuse rules, including under the 
limitation based on W-2 wages and capital.
            Partnerships and S corporations
    In the case of a partnership or S corporation, the section 
199A deduction is determined at the partner or shareholder 
level. Each partner in a partnership takes into account the 
partner's allocable share of each qualified item of income, 
gain, deduction, and loss, and is treated as having W-2 wages 
and unadjusted basis of qualified property for the taxable year 
equal to the partner's allocable share of W-2 wages and 
unadjusted basis of qualified property of the partnership. The 
partner's allocable share of W-2 wages and unadjusted basis of 
qualified property are required to be determined in the same 
manner as the partner's allocable share of wage expenses and 
depreciation, respectively.\148\ Similarly, each shareholder of 
an S corporation takes into account the shareholder's pro rata 
share of each qualified item of income, gain, deduction, and 
loss of the S corporation, and is treated as having W-2 wages 
and unadjusted basis of qualified property for the taxable year 
equal to the shareholder's pro rata share of W-2 wages and 
unadjusted basis of qualified property of the S corporation.
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    \148\ The partner's allocable share of unadjusted basis of 
qualified property is determined in the same manner as the partner's 
allocable share of depreciation, regardless of whether certain items of 
qualified property are fully depreciated as of the close of the taxable 
year. The Treasury Department will provide guidance regarding the 
determination of a partner's allocable share of unadjusted basis of 
qualified property in taxable years in which the partnership does not 
have a depreciation deduction.
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            Qualified REIT dividends, qualified cooperative 
                    dividends,\149\ and qualified publicly traded 
                    partnership income
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    \149\ The discussion of qualified cooperative dividends in this 
section reflects the provision as originally enacted. Modifications 
enacted March 23, 2018, are described in the Appendix.
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    A deduction is allowed for 20 percent of the taxpayer's 
aggregate amount of qualified REIT dividends, qualified 
cooperative dividends, and qualified publicly traded 
partnership income for the taxable year.\150\ If the taxpayer's 
aggregate amount of qualified REIT dividends, qualified 
cooperative dividends, and qualified publicly traded 
partnership income is a loss for the taxable year, the combined 
qualified business income amount for that taxable year is 
reduced by 20 percent of the aggregate amount of such items.
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    \150\ See sec. 199A(a) and (b).
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    Qualified REIT dividends do not include any portion of a 
dividend received from a REIT that is a capital gain dividend 
\151\ or qualified dividend income.\152\ It is intended that 
holding period rules (similar to section 1(h)(11)(B)(iii)) 
apply to stock giving rise to qualified REIT dividends under 
section 199A, to prevent an individual from buying REIT stock 
immediately before the stock goes ex-dividend and selling it 
immediately after it goes ex-dividend and claiming the 
qualified business income deduction on the dividend.\153\
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    \151\ Defined in sec. 857(b)(3).
    \152\ Defined in sec. 1(h)(11). See sec. 199A(e)(3).
    \153\ A technical correction may be needed to carry out this 
intent.
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    A qualified cooperative dividend \154\ means any patronage 
dividend,\155\ per-unit retain allocation,\156\ qualified 
written notice of allocation,\157\ or any other similar amount, 
provided such amount is includible in gross income and is 
received from either (1) a tax-exempt organization described in 
section 501(c)(12) \158\ or a taxable or tax-exempt cooperative 
that is described in section 1381(a), or (2) a taxable 
cooperative governed by tax rules applicable to cooperatives 
before the enactment of subchapter T of the Code in 1962.\159\
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    \154\ As originally enacted. Modifications enacted March 23, 2018, 
are described in the Appendix.
    \155\ Defined in sec. 1388(a).
    \156\ Defined in sec. 1388(f).
    \157\ Defined in sec. 1388(c).
    \158\ Organizations described in section 501(c)(12) are benevolent 
life insurance associations of a purely local character, mutual ditch 
or irrigation companies, mutual or cooperative telephone companies, or 
like organizations, but only if 85 percent or more of the income 
consists of amounts collected from members for the sole purpose of 
meeting losses and expenses. Sec. 501(c)(12)(A).
    \159\ Sec. 199A(e)(4).
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    Qualified publicly traded partnership income means (with 
respect to any qualified trade or business of the taxpayer) the 
sum of (a) the net amount of the taxpayer's allocable share of 
each qualified item of income, gain, deduction, and loss of the 
partnership from a publicly traded partnership not treated as a 
corporation,\160\ and (b) gain recognized by the taxpayer on 
disposition of its interest in such partnership that is treated 
as ordinary income (for example, by reason of section 
751).\161\
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    \160\ Such items must be effectively connected with a U.S. trade or 
business, be included or allowed in determining taxable income for the 
taxable year, and not constitute excepted enumerated investment-type 
income. Such items do not include the taxpayer's reasonable 
compensation, guaranteed payments for services, or (to the extent 
provided in regulations) section 707(a) payments for services.
    \161\ Sec. 199A(e)(5).
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    Many individuals invest in REIT stock or interests in 
publicly traded partnerships indirectly through a regulated 
investment company (a ``RIC'' or mutual fund). The RIC may 
receive amounts that would be treated as qualified REIT 
dividends or qualified publicly traded partnership income \162\ 
eligible for the section 199A deduction in the hands of an 
individual RIC shareholder had that individual directly held 
the REIT stock or the interest in the publicly traded 
partnership. It is intended that in the case of an individual 
shareholder of a RIC that itself owns stock in a REIT or 
interests in a publicly traded partnership, the individual is 
treated as receiving qualified REIT dividends or qualified 
publicly traded partnership income to the extent any dividends 
received by the individual from the RIC are attributable to 
qualified REIT dividends or qualified publicly traded 
partnership income received by the RIC.
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    \162\ Sec. 199A(b)(1)(B).
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Determination of the taxpayer's deduction

    The taxpayer's deduction for qualified business income for 
the taxable year is equal to the sum of (1) the lesser of (a) 
the combined qualified business income amount for the taxable 
year, or (b) an amount equal to 20 percent of taxable income 
\163\ (reduced by any net capital gain \164\ and qualified 
cooperative dividends), plus (2) the lesser of (a) 20 percent 
of qualified cooperative dividends, or (b) taxable income 
(reduced by net capital gain). This sum may not exceed the 
taxpayer's taxable income for the taxable year (reduced by net 
capital gain).\165\ The combined qualified business income 
amount for the taxable year is the sum of the deductible 
amounts determined for each qualified trade or business carried 
on by the taxpayer \166\ and 20 percent of the taxpayer's 
qualified REIT dividends and qualified publicly traded 
partnership income.\167\
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    \163\ Section 63(a) defines taxable income as ``gross income minus 
the deductions allowed by'' chapter 1 of the Code. For these purposes, 
taxable income is also computed without regard to the deduction 
allowable under section 199A. See sec. 199A(e)(1).
    \164\ Defined in sec. 1(h).
    \165\ Sec. 199A(a).
    \166\ This amount cannot be less than zero. A technical correction 
may be necessary to reflect this intent.
    \167\ Sec. 199A(b)(1).
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Specified agricultural or horticultural cooperatives with qualified 
        business income \168\
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    \168\ The discussion in this section reflects the provision as 
originally enacted. Modifications enacted March 23, 2018, are described 
in the Appendix.
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    For taxable years beginning after December 31, 2017, and 
before January 1, 2026, a deduction is allowed to any specified 
agricultural or horticultural cooperative equal to the lesser 
of (a) 20 percent of the excess (if any) of the cooperative's 
gross income over the qualified cooperative dividends paid 
during the taxable year for the taxable year, or (b) the 
greater of 50 percent of the W-2 wages paid by the cooperative 
with respect to its trade or business or the sum of 25 percent 
of the W-2 wages of the cooperative with respect to its trade 
or business plus 2.5 percent of the unadjusted basis 
immediately after acquisition of qualified property of the 
cooperative. The cooperative's section 199A(g) deduction may 
not exceed its taxable income for the taxable year.\169\
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    \169\ For this purpose, taxable income is computed without regard 
to the cooperative's deduction under section 199A(g).
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    A specified agricultural or horticultural cooperative is an 
organization to which part I of subchapter T applies that is 
engaged in (a) the manufacturing, production, growth, or 
extraction in whole or significant part of any agricultural or 
horticultural product, (b) the marketing of agricultural or 
horticultural products that its patrons have so manufactured, 
produced, grown, or extracted, or (c) the provision of 
supplies, equipment, or services to farmers or organizations 
described in the foregoing.

Additional rules and regulatory authority

    The taxpayer's deduction for qualified business income is 
not allowed in computing adjusted gross income; instead, the 
deduction is allowed in computing taxable income.\170\ The 
deduction is available to both individuals who itemize their 
deductions and individuals who do not itemize their 
deductions.\171\
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    \170\ Sec. 62(a).
    \171\ Sec. 63(b) and (d).
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    For purposes of the provision, taxable income is determined 
without regard to the deduction allowable under the provision.
    Qualified business income is determined without regard to 
any adjustments prescribed under the rules of the alternative 
minimum tax.
    Trusts and estates are eligible for the 20-percent 
deduction under the provision. Rules similar to the rules under 
former section 199 (as in effect on December 1, 2017) apply for 
apportioning between fiduciaries and beneficiaries any W-2 
wages and unadjusted basis of qualified property under the 
limitation based on W-2 wages and capital. An electing small 
business trust (``ESBT'') \172\ is a trust eligible for the 20-
percent deduction under the provision.
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    \172\ Secs. 1361(e) and 641(c).
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    The deduction under the provision is allowed only for 
Federal income tax purposes. Thus, the deduction is not allowed 
in determining net earnings from self-employment or self-
employment tax, for example.
    For purposes of determining a substantial underpayment of 
income tax under the accuracy related penalty,\173\ a 
substantial underpayment exists if the amount of the 
understatement exceeds the greater of five percent (not 10 
percent) of the tax required to be shown on the return or 
$5,000.
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    \173\ Sec. 6662(d)(1)(A).
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    Authority is provided to promulgate regulations needed to 
carry out the purposes of the provision, including regulations 
requiring, or restricting, the allocation of items of income, 
gain, loss, or deduction, or of W-2 wages, and unadjusted basis 
of qualified property, under the provision. In addition, 
regulatory authority is provided to address reporting 
requirements appropriate under the provision, and the 
application of the provision in the case of tiered entities.
    The provision does not apply to taxable years beginning 
after December 31, 2025.

Additional examples

    The following additional examples further illustrate the 
application of the provision.
            Example 1
    H and W file a joint return for 2018 on which they report 
taxable income of $340,000 (determined without regard to this 
provision). This amount exceeds the threshold amount for joint 
filers by $25,000. H is a partner in a trade or business that 
is not a specified service trade or business (``qualified 
business A''). W has a sole proprietorship that is a specified 
service trade or business (``qualified business B''). H and W 
also received $10,000 in qualified REIT dividends during the 
tax year.
    H's allocable share of qualified business income from 
qualified business A is $200,000, such that 20 percent of the 
qualified business income with respect to the business is 
$40,000.\174\ H's allocable share of W-2 wages paid by 
qualified business A is $50,000, such that 50 percent of the W-
2 wages with respect to the business is $25,000.\175\ Business 
A has placed in service depreciable property that is qualified 
property, and H's share of the unadjusted basis of the property 
immediately after acquisition is $60,000. H's limitation under 
the wage and capital limitation is the sum of 25 percent of the 
W-2 wages ($12,500 \176\) plus 2.5 percent of the unadjusted 
basis, of qualified property ($1,500 \177\), or $14,000. Thus, 
H's limitation under the W-2 wage, or W-2 wage and capital, 
limitation is the greater of $25,000 or $14,000 (i.e., 
$25,000), subject to the applicable phase-in. As H and W's 
taxable income is above the threshold amount for a joint 
return, the application of the W-2 wage limit for qualified 
business A is phased in. Accordingly, the $40,000 amount (i.e., 
20 percent of H's qualified business income) is reduced by 25 
percent \178\ of the difference between $40,000 (i.e., H's 
deductible amount without limitation) and $25,000 (i.e., H's 
deductible amount with limitation), or $3,750.\179\ H's 
deductible amount for qualified business A is $36,250.\180\
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    \174\ $200,000 * 20 percent = $40,000.
    \175\ $50,000 * 50 percent = $25,000.
    \176\ $50,000 * 25 percent = $12,500.
    \177\ $60,000 * 2.5 percent = $1,500.
    \178\ ($340,000 - $315,000)/$100,000 = 25 percent.
    \179\ ($40,000 - $25,000) * 25 percent = $3,750.
    \180\ $40,000 - $3,750 = $36,250.
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    W's qualified business income and W-2 wages from qualified 
business B, which is a specified service trade or business, are 
$200,000 and $140,000, respectively. H and W's taxable income 
is above the threshold amount for a joint return. Thus, the 
exclusion of qualified business income and W-2 wages from the 
specified service trade or business are phased in. Assume that 
qualified business B has no qualified property, so the W-2 wage 
and capital limitation is less than the W-2 wage limitation and 
therefore not binding. W has an applicable percentage of 75 
percent.\181\ In determining includible qualified business 
income, W takes into account 75 percent of $200,000, or 
$150,000. In determining includible W-2 wages, W takes into 
account 75 percent of $140,000, or $105,000. W calculates the 
deductible amount for qualified business B by taking the lesser 
of 20 percent of $150,000 ($30,000) or 50 percent of includible 
W-2 wages of $105,000 ($52,500).\182\ W's deductible amount for 
qualified business B is $30,000.
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    \181\ 1-($340,000-$315,000)/$100,000 = 1-$25,000/$100,000 = 1-.25 = 
75 percent.
    \182\ Although H and W's taxable income is above the threshold 
amount for a joint return, the W-2 wage limit is not binding as the 20 
percent of includible qualified business income of qualified business B 
($30,000) is less than 50 percent of includible W-2 wages of qualified 
business B ($52,500).
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    H and W's combined qualified business income amount of 
$68,250 consists of the deductible amount for qualified 
business A of $36,250, the deductible amount for qualified 
business B of $30,000, and the deductible amount equal to 20 
percent of the $10,000 in qualified REIT dividends ($2,000). H 
and W's deduction is limited to 20 percent of their taxable 
income for the year ($340,000), or $68,000. The taxable income 
limit binds, and accordingly, H and W's total section 199A 
deduction for the taxable year is $68,000.
             Example 2
    Assume the same facts as Example 1, except that W's W-2 
wages from qualified business B are $60,000. Consistent with 
Example 1, W has an applicable percentage of 75 percent. 
Consistent with Example 1, in determining includible qualified 
business income, W takes into account 75 percent of $200,000, 
or $150,000, so 20 percent of the qualified business income 
with respect to qualified business B is $30,000. In determining 
includible W-2 wages, W takes into account 75 percent of 
$60,000, or $45,000. Fifty percent of the W-2 wages with 
respect to the business is $22,500. Because H and W's taxable 
income is above the threshold amount for a joint return, the 
application of the W-2 wage limit for qualified business B is 
phased in. Accordingly, the $30,000 amount (i.e., 20 percent of 
W's qualified business income) is reduced by 25 percent \183\ 
of the difference between $30,000 (i.e., W's deductible amount 
without limitation) and $22,500 (i.e., W's deductible amount 
with limitation), or $1,875.\184\ W's deductible amount for 
qualified business B is $28,125.\185\
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    \183\ ($340,000 - $315,000)/$100,000 = 25 percent.
    \184\ ($30,000 - $22,500) * 25 percent = $1,875.
    \185\ $30,000 - $1,875 = $28,125.
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    H and W's combined qualified business income amount of 
$66,375 consists of the deductible amount for qualified 
business A of $36,250, the deductible amount for qualified 
business B of $28,125, and the deductible amount equal to 20 
percent of the $10,000 in qualified REIT dividends ($2,000). H 
and W's deduction is limited to 20 percent of their taxable 
income for the year ($340,000), or $68,000. The taxable income 
limit does not bind, and accordingly H and W's total section 
199A deduction for the taxable year is $66,375.
            Example 3
    Assume the same facts as Example 1, except that H's 
qualified business A has placed in service depreciable property 
that is qualified property and H's share of the unadjusted 
basis of the property immediately after acquisition is 
$1,300,000. Consistent with Example 1, 20 percent of the 
qualified business income with respect to qualified business A 
is $40,000. Consistent with Example 1, H's allocable share of 
W-2 wages paid by qualified business A is $50,000, such that 50 
percent of the W-2 wages with respect to qualified business A 
is $25,000. H's limitation under the wage and capital 
limitation is the sum of 25 percent of the W-2 wages ($12,500) 
plus 2.5 percent of the unadjusted basis of qualified property 
($32,500 \186\), or $45,000. Thus, H's limitation under the W-2 
wage, or W-2 wage and capital, limitation is the greater of 
$25,000 or $45,000 (i.e., $45,000), subject to the applicable 
phase-in. As H's W-2 wage and capital limitation of $45,000 is 
in excess of 20 percent of H's qualified business income of 
$40,000, the W-2 wage and capital limitation is not binding and 
no phase-in of the limitation is required. H's deductible 
amount for qualified business A is $40,000.
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    \186\ $1,300,000 * 2.5 percent = $32,500.
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    H and W's combined qualified business income amount of 
$70,000 consists of the deductible amount for qualified 
business A of $40,000, the deductible amount for qualified 
business B of $30,000, and the deductible amount equal to 20 
percent of the $10,000 in qualified REIT dividends ($2,000). H 
and W's deduction is limited to 20 percent of their taxable 
income for the year ($340,000), or $68,000. The taxable income 
limit does bind, and accordingly H and W's total section 199A 
deduction for the taxable year is $68,000.
            Example 4
    H and W file a joint return on which they report taxable 
income of $100,000 (determined without regard to this 
provision). H has a sole proprietorship qualified trade or 
business that is not a specified service trade or business 
(``qualified business A''). W is a partner in a qualified trade 
or business that is not a specified service trade or business 
(``qualified business B''). H and W have a carryover qualified 
business loss under section 199A(c)(2) of $5,000.
    H's qualified business income from qualified business A is 
$60,000; 20 percent is $12,000. H and W's taxable income is 
below the threshold amount applicable to a joint return, so the 
W-2 wage, or W-2 wage and capital, limitation does not apply to 
qualified business A. H's deductible amount for qualified 
business A is $12,000. W's allocable share of qualified 
business income from qualified business B is a loss of $40,000, 
such that 20 percent of the qualified business loss with 
respect to the business is $8,000. Additionally, the carryover 
qualified business loss $5,000 is treated as a loss from a 
qualified trade or business in the current year, 20 percent of 
which is $1,000.
    H and W's combined qualified business income amount of 
$3,000 consists of the deductible amount for qualified business 
A of $12,000, the reduction to the deduction for qualified 
business B of $8,000, and the reduction to the deduction of 
$1,000 attributable to the carryover qualified business loss. H 
and W's deduction is limited to 20 percent of their taxable 
income for the year ($100,000), or $20,000. H and W's deduction 
for the taxable year is $3,000.
            Example 5
    Taxpayer files a return as a single taxpayer on which he 
reports taxable income of less than $157,500. Taxpayer has a 
sole proprietorship qualified trade or business that is not a 
specified service trade or business (``qualified business A''). 
Taxpayer is a partner in a qualified trade or business that is 
not a specified service trade or business (``qualified business 
B'').
    In year one, Taxpayer has qualified business income of 
$10,000 from qualified business A, a qualified business loss of 
$30,000 from qualified business B, and $5,000 of qualified REIT 
dividends. Taxpayer is permitted a deduction of $1,000 (i.e., 
20 percent of the $5,000 of REIT dividends) in year one and 
carries forward a qualified business loss of $20,000.
    In year two, Taxpayer has qualified business income of 
$15,000 from qualified business A, qualified business income of 
$25,000 from qualified business B, and $5,000 of qualified REIT 
dividends. Neither business is subject to the W-2 wage, or W-2 
wage and capital, limitation. To determine the deduction for 
year two, Taxpayer combines 20 percent of the $40,000 qualified 
business income of businesses A and B in year 2 ($8,000) with 
20 percent of the $20,000 qualified business loss carryover 
from year one (-$4,000) and 20 percent of the qualified REIT 
dividends ($1,000 \187\). Taxpayer's deductible amount for Year 
2 is $4,000 \188\ plus $1,000, or $5,000.
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    \187\ Qualified REIT dividends of $5,000 * 20 percent = $1,000.
    \188\ ($40,000 * 20 percent) - ($20,000 * 20 percent) = $8,000 - 
$4,000 = $4,000.
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            Example 6
    H and W file a joint return on which they report taxable 
income of $500,000 (determined without regard to this 
provision). H has a sole proprietorship qualified trade or 
business that is not a specified service trade or business 
(``qualified business A''). W is a partner in a qualified trade 
or business that is not a specified service trade or business 
(``qualified business B'').
    H's qualified business income from qualified business A is 
$800,000, such that 20 percent of the qualified business income 
with respect to the business is $160,000.\189\ H's allocable 
share of wages paid by qualified business A is $200,000, such 
that 50 percent of the W-2 wages with respect to the business 
is $100,000.\190\ Qualified business A does not have qualified 
property. H's limitation under the W-2 wage, or W-2 wage and 
capital, limitation is the sum of 25 of percent of the W-2 
wages ($50,000 \191\) plus 2.5 percent of the unadjusted basis 
of qualified property (zero), or $50,000. Thus, H's limitation 
under the W-2 wage, or W-2 wage and capital, limitation is the 
greater of $100,000 or $50,000 (i.e., $100,000). As H and W's 
taxable income is in excess of $415,000, the W-2 wage and W-2 
wage and capital limitation is fully phased-in. H's deductible 
amount for qualified business A is $100,000.
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    \189\ $800,000 * 20 percent = $160,000.
    \190\ $200,000 * 50 percent = $100,000.
    \191\ $200,000 * 25 percent = $50,000.
---------------------------------------------------------------------------
    W's qualified business loss from qualified business B is 
$100,000, such that 20 percent of the qualified business loss 
with respect to the business is a reduction to the deduction of 
$20,000.\192\ W's allocable share of wages paid by qualified 
business B is $100,000, such that 50 percent of the W-2 wages 
with respect to the business is $50,000.\193\ Qualified 
business B does not have placed in service depreciable property 
that is qualified property. W's limitation under the W-2 wage 
and capital limitation is the sum of 25 of percent of the W-2 
wages ($25,000 \194\) plus 2.5 percent of the unadjusted basis 
of qualified property (zero), or $25,000. Thus, H's limitation 
under the W-2 wage, or W-2 wage and capital, limitation is the 
greater of a reduction of $50,000 or $25,000 (i.e., $50,000). 
As H and W's taxable income is in excess of $415,000, the W-2 
wage and W-2 wage and capital limitation is fully phased-in. 
W's deductible amount for qualified business B is a reduction 
to the deduction of $20,000.\195\
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    \192\ ($100,000) * 20 percent = ($20,000).
    \193\ $100,000 * 50 percent = $50,000.
    \194\ $100,000 * 25 percent = $25,000.
    \195\ In situations where a qualified trade or business has a 
qualified business loss, and the taxpayer does not have an overall 
qualified business loss carryover arising in the taxable year, the 
amount determined under section 199A(b)(2) is equal to 20 percent of 
the qualified business loss. The application of the W-2 wage, or W-2 
wage and capital, limitation is not binding on the qualified trade or 
business as the limitation (a positive amount) is greater than 20 
percent of the qualified business loss (a negative amount). The 
application of the W-2 wage, or W-2 wage and capital, limitation to 
each separate qualified trade or business under section 199A(b)(2)(B) 
occurs prior to combining the deductible amount from each respective 
qualified trade or business (i.e., the deductible amount determined 
under section 199A(b)(2)) under section 199A(b)(1)(A).
---------------------------------------------------------------------------
    H and W's combined qualified business income amount of 
$80,000 consists of the deductible amount for qualified 
business A of $100,000 and the reduction to the deduction for 
qualified business B of $20,000. H and W's deduction is limited 
to 20 percent of their taxable income for the year ($500,000), 
or $100,000. Accordingly, H and W's deduction for the taxable 
year is $80,000.
            Example 7
    Assume the same facts as Example 6, except that H and W 
have a qualified business loss carryover from the prior year of 
$25,000. There is no qualified business loss carryover for the 
current year as H and W's net amount of qualified business 
income from all qualified trades or businesses during the 
taxable year is $675,000.
    Consistent with Example 6, H's deductible amount for 
qualified business A is $100,000 and W's deductible amount for 
qualified business B is a reduction to the deduction of 
$20,000.
    H and W's combined qualified business income amount of 
$75,000 consists of the deductible amount for qualified 
business A of $100,000, the reduction to the deduction for 
qualified business B of $20,000, and the reduction to the 
deduction for the qualified business loss carryover of 
$5,000.\196\ H and W's deduction is limited to 20 percent of 
their taxable income for the year ($500,000), or $100,000. 
Accordingly, H and W's deduction for the taxable year is 
$75,000.
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    \196\ ($25,000) * 20 percent = ($5,000). Similar to a qualified 
trade or business with a qualified business loss, in situations where 
the taxpayer has a qualified business loss carryover, but does not have 
an overall qualified business loss carryover arising in the taxable 
year, the amount determined under section 199A(b)(2) for the qualified 
business loss carryover is equal to 20 percent of the loss carryover. 
The application of the W-2 wage, or W-2 wage and capital, limitation is 
not binding on the qualified business loss carryover as the limitation 
(a positive amount) is greater than 20 percent of the qualified 
business loss carryover (a negative amount).
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            Example 8
    Assume the same facts as Example 6, except that H and W 
have a qualified business loss carryover from the prior year of 
$450,000. There is no qualified business loss carryover for the 
current year as H and W's net amount of qualified business 
income from all qualified trades or businesses during the 
taxable year is $250,000.
    Consistent with Example 6, H's deductible amount for 
qualified business A is $100,000 and W's deductible amount for 
qualified business B is a reduction to the deduction of 
$20,000.
    H and W's combined qualified business income amount of zero 
consists of the deductible amount for qualified business A of 
$100,000, the reduction to the deduction for qualified business 
B of $20,000, and the reduction to the deduction, but not below 
zero,\197\ for the qualified business loss carryover of 
$90,000.\198\ Accordingly, H and W's deduction for the taxable 
year is zero.
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    \197\ A technical correction may be necessary to reflect this 
intent.
    \198\ ($450,000) * 20 percent = ($90,000). Similar to a qualified 
trade or business with a qualified business loss, in situations where 
the taxpayer has a qualified business loss carryover, but does not have 
an overall qualified business loss carryover arising in the taxable 
year, the amount determined under section 199A(b)(2) for the qualified 
business loss carryover is equal to 20 percent of the loss carryover. 
The application of the W-2 wage, or W-2 wage and capital, limitation is 
not binding on the qualified business loss carryover as the limitation 
(a positive amount) is greater than 20 percent of the qualified 
business loss carryover (a negative amount).

    The Treasury Department has issued proposed regulations and 
published guidance addressing this provision.\199\
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    \199\ REG-107892-18, 83 Fed. Reg. 40884, August 16, 2018; and 
Notice 2018-64, 2018-35 I.R.B. 347, August 27, 2018.
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                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.
    As the repeal of former section 199 is also effective for 
taxable years beginning after December 31, 2017,\200\ any item 
taken into account in determining the qualified production 
activities income of the taxpayer under former section 199 
cannot be taken into account in determining the combined 
qualified business income amount of the taxpayer under section 
199A. For example, assume that an individual holds an interest 
in a fiscal-year partnership or S corporation, the taxable year 
of which began before January 1, 2018, and ends within or with 
the individual's first taxable year beginning after December 
31, 2017 (e.g., the individual's 2018 calendar taxable year). 
The individual's share of any item from the partnership or S 
corporation that constitutes qualified business income, 
qualified REIT dividends, qualified cooperative dividends,\201\ 
and qualified publicly traded partnership income and that is 
taken into account in determining taxable income for the 
individual's 2018 taxable year is eligible for the section 199A 
deduction. However, the individual's share of any item from the 
partnership or S corporation that would otherwise be taken into 
account in determining qualified production activities income 
for the individual's 2018 taxable year is not eligible for the 
former section 199 deduction, as former section 199 is repealed 
for taxable years beginning after December 31, 2017.
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    \200\ For a discussion of the effective date of the repeal of 
former section 199, see the description of section 13305 of the Act 
(Repeal of Deduction for Income Attributable to Domestic Production 
Activities).
    \201\ As originally enacted. Modifications enacted March 23, 2018, 
are described in the Appendix.
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  B. Limitation on Losses for Taxpayers Other Than Corporations (sec. 
             11012 of the Act and sec. 461(l) of the Code)


                               Prior Law


Loss limitation rules applicable to individuals

            Passive loss rules
    The passive loss rules limit deductions and credits from 
passive trade or business activities.\202\ The passive loss 
rules apply to individuals, estates and trusts, and closely 
held corporations. A passive activity for this purpose is a 
trade or business activity in which the taxpayer owns an 
interest, but in which the taxpayer does not materially 
participate. A taxpayer is treated as materially participating 
in an activity only if the taxpayer is involved in the 
operation of the activity on a basis that is regular, 
continuous, and substantial.\203\ 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 
makes a taxable disposition of his entire interest in the 
passive activity to an unrelated person.
---------------------------------------------------------------------------
    \202\ Sec. 469.
    \203\ Regulations provide more detailed standards for material 
participation. See Treas. Reg. sec. 1.469-5 and -5T.
---------------------------------------------------------------------------
            Excess farm loss rules
    A limitation on excess farm losses applies to taxpayers 
other than C corporations.\204\ If a taxpayer other than a C 
corporation receives an applicable subsidy \205\ for the 
taxable year, the amount of the excess farm loss is not allowed 
for the taxable year, and is carried forward and treated as a 
deduction attributable to farming businesses in the next 
taxable year. An excess farm loss for a taxable year means the 
excess of aggregate deductions that are attributable to farming 
businesses over the sum of aggregate gross income or gain 
attributable to farming businesses plus the threshold amount. 
The threshold amount is the greater of (1) $300,000 ($150,000 
for married individuals filing separately), or (2) for the 
five-consecutive-year period preceding the taxable year, the 
excess of the aggregate gross income or gain attributable to 
the taxpayer's farming businesses over the aggregate deductions 
attributable to the taxpayer's farming businesses.
---------------------------------------------------------------------------
    \204\ Sec. 461(j).
    \205\ For this purpose, an applicable subsidy means (A) any direct 
or counter-cyclical payment under title I of the Food, Conservation, 
and Energy Act of 2008, or any payment elected to be received in lieu 
of such payment, or (B) any Commodity Credit Corporation loan. Sec. 
461(j)(3).
---------------------------------------------------------------------------

                        Explanation of Provision

    For taxable years beginning after December 31, 2017, and 
before January 1, 2026, an excess business loss of a taxpayer 
other than a corporation is not allowed for the taxable year. 
The disallowed excess business loss is treated as a net 
operating loss (``NOL'') for the taxable year for purposes of 
determining any NOL carryover to subsequent taxable years.\206\
---------------------------------------------------------------------------
    \206\ See sec. 172. For a discussion of the changes made by the Act 
to section 172, see the description of section 13302 of the Act 
(Modification of Net Operating Loss Deduction). A technical correction 
may be necessary to reflect the intent that excess business losses that 
are not allowed are treated as a net operating loss arising in the 
taxable year. Thus, such excess business losses are carried over to a 
subsequent taxable year under the applicable NOL rules. For example, 
assume that for 2018, H and W file a joint return on which they report 
a $1,150,000 loss from their farming business on Schedule F (Form 
1040). H and W do not have any other income or loss for 2018. After 
application of the $500,000 threshold amount for joint filers (sec. 
461(l)(3)(A)(ii)(II)), the remaining $650,000 business loss is an 
excess business loss and is not allowed for H and W's taxable year 2018 
by reason of section 461(l)(1)(B). Under the provision, H and W have a 
$500,000 NOL for 2018 that is eligible for a two-year carryback under 
section 172(b)(1)(B), and a $650,000 NOL (increased by any portion of 
the $500,000 NOL for 2018 remaining after application of the two-year 
carryback) eligible for carryover to 2019. Because the $500,000 NOL for 
2018 arises in a taxable year beginning after December 31, 2017, it is 
subject to the 80-percent limitation under section 172(a)(2). 
Accordingly, in this example, the amount of the taxpayer's $500,000 NOL 
carried back to 2016 and 2017 is limited to 80 percent of the taxable 
income (determined without regard to the NOL deduction) for the 2016 
and 2017 taxable years, respectively.
---------------------------------------------------------------------------
    An excess business loss for the taxable year is the excess 
of aggregate deductions of the taxpayer attributable to trades 
or businesses of the taxpayer (determined without regard to the 
limitation of the provision),\207\ over the sum of aggregate 
gross income or gain attributable to trades or businesses of 
the taxpayer plus a threshold amount. The threshold amount for 
a taxable year beginning in 2018 is $250,000 (or twice the 
otherwise applicable threshold amount in the case of a joint 
return, i.e., $500,000). The threshold amount is indexed for 
inflation in taxable years beginning after 2018.
---------------------------------------------------------------------------
    \207\ It is intended that aggregate deductions (for purposes of 
section 461(l)) not include the amount of any NOL carryback or 
carryover under section 172 that is attributable to such trades or 
businesses from a different taxable year. For example, continuing the 
example in the preceding footnote, none of the $650,000 excess business 
loss in taxable year 2018 is subject to section 461(l) in a subsequent 
taxable year. Thus, any deduction with respect to any portion of the 
$650,000 that is carried over to a subsequent taxable year under the 
rules of section 172 is governed by the rules of section 172 (not 
section 461(l)). Similarly, any deduction with respect to any portion 
of the $500,000 remaining after carrybacks to 2016 and 2017 that is 
carried over to a subsequent year is governed by the rules of section 
172 (not section 461(l)).
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    The aggregate deductions taken into account to determine 
the excess business loss of the taxpayer for the taxable year 
that are attributable to trades or businesses of the taxpayer 
are determined without regard to the deduction under section 
172 or 199A.\208\ For example, assume that a taxpayer has an 
NOL carryover from a prior taxable year to the current taxable 
year. Such NOL carryover is not part of the taxpayer's 
aggregate deductions attributable to the trade or business for 
the current taxable year under section 461(l).
---------------------------------------------------------------------------
    \208\ A technical correction may be necessary to carry out this 
intent.
---------------------------------------------------------------------------
    An excess business loss (the deduction for which is limited 
by section 461(l)) does not take into account gross income or 
gains or deductions attributable to the trade or business of 
performance of services as an employee.\209\ For example, 
assume married taxpayers filing jointly for the taxable year 
have a loss from a trade or business conducted by one spouse as 
a sole proprietorship as well as wage income of the other 
spouse from employment. The wage income is not taken into 
account in determining the amount of the deduction limited 
under section 461(l).
---------------------------------------------------------------------------
    \209\ A technical correction may be necessary to carry out this 
intent. For this purpose, the trade or business of performance of 
services by the taxpayer as an employee has the same meaning as it does 
under section 62(a)(1).
---------------------------------------------------------------------------
    In the case of a partnership or S corporation, the 
provision applies at the partner or shareholder level. Each 
partner's distributive share and each S corporation 
shareholder's pro rata share of items of income, gain, 
deduction, or loss of a partnership or S corporation are taken 
into account in applying the limitation under the provision for 
the taxable year of the partner or S corporation shareholder. 
Regulatory authority is provided to require any additional 
reporting as the Secretary determines is appropriate to carry 
out the purposes of the provision (including with respect to 
any other passthrough entity to the extent necessary to carry 
out the purposes of the provision).
    The provision applies after the application of the passive 
loss rules.\210\
---------------------------------------------------------------------------
    \210\ Sec. 469.
---------------------------------------------------------------------------
    For taxable years beginning after December 31, 2017, and 
before January 1, 2026, the prior-law limitation relating to 
excess farm losses does not apply.\211\
---------------------------------------------------------------------------
    \211\ The excess farm loss rules will apply again for taxable years 
beginning after December 31, 2025.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

          PART III--TAX BENEFITS FOR FAMILIES AND INDIVIDUALS

A. Increase in Standard Deduction (sec. 11021 of the Act and sec. 63 of 
                               the Code)

                               Prior Law

    An individual who does not elect to itemize deductions 
reduces his or her adjusted gross income (``AGI'') by the 
amount of the applicable standard deduction in arriving at his 
or her taxable income. The standard deduction is the sum of the 
basic standard deduction and, if applicable, the additional 
standard deduction. The basic standard deduction varies 
depending upon a taxpayer's filing status. For 2017, the amount 
of the basic standard deduction is $6,350 for a single 
individual and a married individual filing a separate 
return,\212\ $9,350 for a head of household, and $12,700 for a 
joint return and a surviving spouse. An additional standard 
deduction is allowed to an individual who is elderly (has 
attained age 65 before the close of the taxable year) or 
blind.\213\
---------------------------------------------------------------------------
    \212\ In the case of a married individual filing a separate return 
where either spouse itemizes deductions, the standard deduction is 
zero.
    \213\ For 2017, the additional amount is $1,250 for a married 
taxpayer (for each spouse meeting the applicable criteria in the case 
of a joint return) and surviving spouses. The additional amount for 
single individuals and heads of households is $1,550. An individual who 
qualifies as both blind and elderly is entitled to two additional 
standard deductions, for a total additional amount (for 2017) of $2,500 
or $3,100, as applicable.
---------------------------------------------------------------------------
    In the case of a dependent for whom a deduction for a 
personal exemption is allowable to another taxpayer, the 
standard deduction may not exceed the greater of (i) $1,050 (in 
2017) or (ii) the sum of $350 (in 2017) plus the dependent's 
earned income. The standard deduction for an estate or trust is 
zero.
    The amount of the standard deduction is indexed annually 
for inflation.

                        Explanation of Provision

    The provision temporarily increases the basic standard 
deduction for individuals. Under the provision, the amount of 
the basic standard deduction is temporarily increased to 
$24,000 for a joint return and a surviving spouse, $18,000 for 
a head of household, and $12,000 for other individuals. The 
amount of the standard deduction is indexed for inflation using 
the C-CPI-U for taxable years beginning after December 31, 
2018.
    The additional standard deduction for the elderly and the 
blind and the basic standard deduction for dependents are not 
changed by the Act (other than the change to the inflation 
adjustment).
    The increase of the amount of the basic standard deduction 
does not apply to taxable years beginning after December 31, 
2025.\214\
---------------------------------------------------------------------------
    \214\ The standard deduction continues to be indexed with the C-
CPI-U after this sunset.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

B. Increase in and Modification of Child Tax Credit (sec. 11022 of the 
                      Act and sec. 24 of the Code)


                               Prior Law

    An individual is allowed a tax credit of $1,000 for each 
qualifying child. The aggregate amount of otherwise allowable 
child credits is phased out for an individual with income over 
a threshold amount. Specifically, the otherwise allowable child 
tax credit amount is reduced by $50 for each $1,000 (or 
fraction thereof) of modified adjusted gross income (``AGI'') 
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. For 
purposes of this limitation, modified AGI includes certain 
otherwise excludable income earned by U.S. citizens or 
residents living abroad or in certain U.S. possessions.
    The credit is allowable against both the regular tax and 
the alternative minimum tax (``AMT'').
    In some circumstances, all or a portion of the otherwise 
allowable credit is treated as a refundable credit (the 
``additional child tax credit''). The amount treated as a 
refundable credit reduces the amount of the nonrefundable 
credit. A refundable credit creates an overpayment of income 
tax to the extent the credit (together with other refundable 
credits) exceeds the taxpayer's income tax liability (reduced 
by nonrefundable credits).
    The credit is treated as refundable in an amount equal to 
15 percent of earned income in excess of $3,000 (the ``earned 
income'' formula). Earned income is defined as the sum of 
wages, salaries, tips, and other taxable employee compensation 
plus net self-employment earnings. Only items taken into 
account in computing taxable income are treated as earned 
income.\215\ However, at the taxpayer's election, combat pay 
may be treated as earned income for these purposes.
---------------------------------------------------------------------------
    \215\ Some ministers' parsonage allowances are considered self-
employment income, and thus are considered earned income for purposes 
of computing the EIC, but the allowances are excluded from gross income 
for income tax purposes, and thus are not considered earned income for 
purposes of the additional child tax credit since the income is not 
included in taxable income.
---------------------------------------------------------------------------
    A taxpayer with three or more qualifying children may 
determine the additional child tax credit using the 
``alternative formula,'' if this results in a larger additional 
child credit than determined under the earned income formula. 
Under the alternative formula, the additional child tax credit 
equals the amount by which the taxpayer's social security taxes 
exceed the taxpayer's earned income credit (``EIC'').
    The name and taxpayer identification number (``TIN'') \216\ 
of the qualifying child must appear on the return and the TIN 
must be issued on or before the due date for filing the return. 
The TIN of the taxpayer must also be issued on or before the 
due date for filing the return.
---------------------------------------------------------------------------
    \216\ A Social Security number or an Individual Taxpayer 
Identification Number (``ITIN'').
---------------------------------------------------------------------------
            Qualifying child
    Generally, for purposes of the child tax credit, a 
qualifying child is any individual under the age of 17 \217\ 
who is the taxpayer's son, daughter, stepson, stepdaughter, 
brother, sister, stepbrother, stepsister, or a descendant of 
any such individual. The child must share the same principal 
place of abode as the taxpayer for more than one-half of the 
taxable year, may not have provided over one-half of their own 
support for the taxable year, and may not file a joint return 
with a spouse.\218\ In order to qualify for the child tax 
credit, the child must be a U.S. citizen, national, or 
resident.
---------------------------------------------------------------------------
    \217\ Sec. 24(c)(1).
    \218\ Sec. 152(c).
---------------------------------------------------------------------------
            Other dependents
    An individual may be claimed as a taxpayer's dependent, for 
purposes of the deduction for personal exemptions, if the 
individual is a qualifying child \219\ or a qualifying relative 
of the taxpayer and meets certain other requirements.\220\ An 
individual is a taxpayer's qualifying relative if such 
individual (1) bears the appropriate relationship to the 
taxpayer; (2) has a gross income that does not exceed the 
personal exemption amount; (3) receives one-half of his or her 
support from the taxpayer; and (4) is not a qualifying child of 
the taxpayer. Generally, an individual bears the appropriate 
relationship to the taxpayer if the individual is the 
taxpayer's lineal descendent or ancestor, brother, sister, 
aunt, uncle, niece, or nephew. Some relations by marriage also 
qualify, including stepmothers, stepfathers, stepbrothers, 
stepsisters, sons-in-law, daughters-in-law, fathers-in-law, 
mothers-in-law, brothers-in-law, and sisters-in-law. In 
addition, an individual bears the appropriate relationship if 
the individual has the same principal place of abode as the 
taxpayer and is a member of the taxpayer's household. In order 
to claim the personal exemption deduction with respect to any 
individual, the taxpayer must include the individual's TIN on 
the tax return.
---------------------------------------------------------------------------
    \219\ In the context of the dependency rules under section 152, the 
age requirements differ from the rules for the child tax credit. Under 
these rules, an individual meets the age requirement either a) if they 
are under age 19 or b) they are a student who is under age 24. Thus, 
for example, a student who is age 20 and meets the otherwise applicable 
requirements would not be eligible for the child tax credit, but would 
still be considered a qualifying child for purposes of the dependency 
rules. See sec. 152(c)(3).
    \220\ Sec. 152(d).
---------------------------------------------------------------------------
    Children who are U.S. citizens or nationals living abroad 
or non-U.S. citizens or nationals living in Canada or Mexico 
may qualify as dependents. In addition, a legally adopted child 
who does not satisfy the residency or citizenship requirement 
may nevertheless qualify as a dependent 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.

                        Explanation of Provision

    The provision temporarily increases the child tax credit to 
$2,000 per qualifying child, and provides a $500 \221\ 
nonrefundable credit for each dependent other than a qualifying 
child.\222\ The provision generally retains the prior-law 
definition of a dependent.\223\
---------------------------------------------------------------------------
    \221\ Neither the $2,000 nor the $500 credit amounts are indexed 
for inflation.
    \222\ Qualifying child for these purposes retains the same 
definition as under the prior law child tax credit. An individual who, 
under prior law, would have been a qualifying child for purposes of the 
dependency exemption under section 151, but not a qualifying child for 
purposes of the child tax credit (e.g., a child who is age 17 or 18, or 
a student under the age of 24) is eligible to be a qualifying dependent 
for purposes of the $500 nonrefundable credit.
    \223\ A technical correction may be necessary to achieve this 
result. Additionally, under the provision the $500 nonrefundable credit 
may be claimed only with respect to any dependent who is a citizen, 
national or resident of the United States. Thus, non-U.S. citizens 
living in Canada and Mexico may not qualify for the $500 nonrefundable 
credit.
---------------------------------------------------------------------------
    The AGI threshold amount at which the credit begins to 
phase out is $400,000 in the case of a joint return and 
$200,000 for all other taxpayers. These phase-out thresholds 
are not indexed for inflation.
    To receive the credit (both the refundable and 
nonrefundable portions) for a qualifying child, a taxpayer must 
include the Social Security number of the child on the tax 
return claiming the credit.\224\ For these purposes, the Social 
Security number must be issued before the due date for the 
filing of the return for the taxable year. The Social Security 
number also must be issued to a citizen of the United States or 
pursuant to a provision of the Social Security Act relating to 
the lawful admission for employment in the United States.\225\
---------------------------------------------------------------------------
    \224\ A qualifying child with respect to whom the child tax credit 
is not allowed because the child does not have a proper Social Security 
number as the child's taxpayer identification number may nonetheless 
qualify as a dependent for purposes of the non-refundable $500 credit.
    \225\ Sec. 205(c)(2)(B)(i)(I) (or that portion of subclause (III) 
that relates to subclause (I)) of the Social Security Act.
---------------------------------------------------------------------------
    The Social Security number requirement does not apply with 
respect to a qualifying dependent for whom a $500 nonrefundable 
credit is claimed. In order to claim the $500 nonrefundable 
credit with respect to any individual, however, the taxpayer 
must include such individual's TIN on the tax return.\226\
---------------------------------------------------------------------------
    \226\ A technical correction may be necessary to reflect this 
intent.
---------------------------------------------------------------------------
    The provision lowers the earned income threshold for the 
refundable child tax credit from $3,000 to $2,500. The maximum 
amount of the refundable child credit may not exceed $1,400 per 
qualifying child. This $1,400 amount is indexed for inflation, 
although the amount may not exceed $2,000.
    The modifications described above do not apply to taxable 
years beginning after December 31, 2025.

    The Treasury Department has issued published guidance 
addressing this provision.\227\
---------------------------------------------------------------------------
    \227\ Notice 2018-70, 2018-38 I.R.B. 441, September 17, 2018.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

 C. Modifications to the Deduction for Charitable Contributions (secs. 
      11023, 13704, and 13705 of the Act and sec. 170 of the Code)


                               Prior Law


In general

    The Internal Revenue Code allows taxpayers to reduce their 
income tax liability by taking deductions for contributions to 
certain organizations, including charities, Federal, State, 
local, and Indian tribal governments, and certain other 
organizations.
    To be deductible, a charitable contribution generally must 
meet several threshold requirements. First, the recipient of 
the transfer must be eligible to receive charitable 
contributions (i.e., an organization or entity described in 
section 170(c)). Second, the transfer must be made with 
gratuitous intent and without the expectation of a benefit of 
substantial economic value in return. Third, the transfer must 
be complete and generally must be a transfer of a donor's 
entire interest in the contributed property (i.e., not a 
contingent or partial interest contribution). To qualify for a 
current year charitable deduction, payment of the contribution 
must be made within the taxable year.\228\ Fourth, the transfer 
must be of money or property--contributions of services are not 
deductible.\229\ Finally, the transfer must be substantiated 
and in the proper form.
---------------------------------------------------------------------------
    \228\ Sec. 170(a)(1).
    \229\ For example, the value of time spent volunteering for a 
charitable organization is not deductible. Incidental expenses such as 
mileage, supplies, or other expenses incurred while volunteering for a 
charitable organization, however, may be deductible.
---------------------------------------------------------------------------
    In general, a charitable deduction is not allowed for 
income, estate, or gift tax purposes if the donor transfers an 
interest in property to a charity while retaining an interest 
in that property or transferring an interest in that property 
to a noncharity for less than full and adequate 
consideration.\230\ This rule of nondeductibility, often 
referred to as the partial interest rule, generally prohibits a 
charitable deduction for contributions of income interests, 
remainder interests, or rights to use property.
---------------------------------------------------------------------------
    \230\ Secs. 170(f)(3)(A) (income tax), 2055(e)(2) (estate tax), and 
2522(c)(2) (gift tax).
---------------------------------------------------------------------------
    As discussed below, special rules limit the deductibility 
of a taxpayer's charitable contributions in a given year to a 
percentage of income, and those rules, in part, turn on whether 
the organization receiving the contributions is a public 
charity or a private foundation. Other special rules determine 
the deductible value of contributed property for each type of 
property.

Percentage limits on charitable contributions

            Individual taxpayers
    Charitable contributions by individual taxpayers are 
limited to a specified percentage of the individual's 
contribution base. The contribution base is the taxpayer's 
adjusted gross income (``AGI'') for a taxable year, 
disregarding any net operating loss carryback to the year under 
section 172.\231\
---------------------------------------------------------------------------
    \231\ Sec. 170(b)(1)(G).
---------------------------------------------------------------------------
    The deduction for charitable contributions by an individual 
taxpayer of cash and property that is not appreciated to a 
charitable organization described in section 170(b)(1)(A) 
(public charities, private foundations other than nonoperating 
private foundations, and certain governmental units) may not 
exceed 50 percent of the taxpayer's contribution base. 
Contributions of this type of property to nonoperating private 
foundations generally may be deducted up to the lesser of 30 
percent of the taxpayer's contribution base or the excess of 
(i) 50 percent of the contribution base over (ii) the amount of 
contributions subject to the 50 percent limitation.
    Contributions of appreciated capital gain property to 
public charities and other organizations described in section 
170(b)(1)(A) generally are deductible up to 30 percent of the 
taxpayer's contribution base (after taking into account 
contributions other than contributions of capital gain 
property).\232\ An individual may elect, however, to bring all 
these contributions of appreciated capital gain property for a 
taxable year within the 50-percent limitation category by 
reducing the amount of the contribution deduction by the amount 
of the appreciation in the capital gain property. Contributions 
of appreciated capital gain property to nonoperating private 
foundations are deductible up to the lesser of 20 percent of 
the taxpayer's contribution base or the excess of (i) 30 
percent of the contribution base over (ii) the amount of 
contributions subject to the 30 percent limitation.
---------------------------------------------------------------------------
    \232\ Special percentage limits and carryforward rules apply to 
qualified conservation contributions. Secs. 170(b)(1)(E) and 
170(b)(2)(B).
---------------------------------------------------------------------------
    Finally, contributions that are for the use of (not to) the 
donee charity get less favorable percentage limits. 
Contributions of capital gain property for the use of public 
charities and other organizations described in section 
170(b)(1)(A) also are limited to 20 percent of the taxpayer's 
contribution base. Property contributed for the use of an 
organization generally has been interpreted to mean property 
contributed in trust for the organization.\233\ Charitable 
contributions of income interests (where deductible) also 
generally are treated as contributions for the use of the donee 
organization.
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    \233\ Rockefeller v. Commissioner, 676 F.2d 35, 39 (2d Cir. 1982).

               TABLE 3.--CHARITABLE CONTRIBUTION PERCENTAGE LIMITS FOR INDIVIDUAL TAXPAYERS \234\
----------------------------------------------------------------------------------------------------------------
                                                                                                  Capital Gain
                                                          Ordinary Income      Capital Gain     Property for the
                                                         Property and Cash   Property to the       use of the
                                                                             Recipient \235\       Recipient
----------------------------------------------------------------------------------------------------------------
Public Charities, Private Operating Foundations, and                   50%          \236\ 30%                20%
 Private Distributing Foundations......................
Nonoperating Private Foundations.......................                30%                20%                20%
----------------------------------------------------------------------------------------------------------------

            Corporate taxpayers
    A corporation generally may deduct charitable contributions 
up to 10 percent of the corporation's taxable income for the 
taxable year.\237\ For this purpose, taxable income is 
determined without regard to: (1) the charitable contributions 
deduction; (2) any net operating loss carryback to the taxable 
year; (3) deductions for dividends received; and (4) any 
capital loss carryback to the taxable year.\238\
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    \234\ Percentages shown are the percentage of an individual's 
contribution base.
    \235\ Capital gain property contributed to public charities, 
private operating foundations, or private distributing foundations will 
be subject to the 50-percent limitation if the donor elects to reduce 
the fair market value of the property by the amount that would have 
been long-term capital gain if the property had been sold.
    \236\ Certain qualified conservation contributions to public 
charities (generally, conservation easements), qualify for more 
generous contribution limits. In general, the 30-percent limit 
applicable to contributions of capital gain property is increased to 
100 percent if the individual making the qualified conservation 
contribution is a qualified farmer or rancher or to 50 percent if the 
individual is not a qualified farmer or rancher.
    \237\ Sec. 170(b)(2)(A).
    \238\ Sec. 170(b)(2)(D).
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            Carryforwards of excess contributions
    Charitable contributions that exceed the applicable 
percentage limit generally may be carried forward for up to 
five years.\239\ In general, contributions carried over from a 
prior year are taken into account after contributions for the 
current year that are subject to the same percentage limit. 
Excess contributions made for the use of (rather than to) an 
organization generally may not be carried forward.
---------------------------------------------------------------------------
    \239\ Sec. 170(d).
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Valuation of charitable contributions

            In general
    For purposes of the income tax charitable deduction, the 
value of property contributed to charity may be limited to the 
fair market value of the property, the donor's tax basis in the 
property, or in some cases a different amount.
    Charitable contributions of cash are deductible in the 
amount contributed, subject to the percentage limits discussed 
above. In addition, a taxpayer generally may deduct the full 
fair market value of long-term capital gain property 
contributed to charity.\240\ Contributions of tangible personal 
property also generally are deductible at fair market value if 
the use by the recipient charitable organization is related to 
its tax-exempt purpose.
---------------------------------------------------------------------------
    \240\ 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. Sec. 170(e)(1)(A).
---------------------------------------------------------------------------
    In certain other cases, however, section 170(e) limits the 
deductible value of the contribution of appreciated property to 
the donor's tax basis in the property. This limitation of the 
property's deductible value to basis generally applies, for 
example, for: (1) contributions of inventory or other ordinary 
income or short-term capital gain property; \241\ (2) 
contributions of tangible personal property if the use by the 
recipient charitable organization is unrelated to the 
organization's tax-exempt purpose; \242\ and (3) contributions 
to or for the use of a private foundation (other than certain 
private operating foundations).\243\
---------------------------------------------------------------------------
    \241\ Sec. 170(e). Special rules, discussed below, apply for 
certain contributions of inventory and other property.
    \242\ Sec. 170(e)(1)(B)(i)(I).
    \243\ Sec. 170(e)(1)(B)(ii). For contributions of qualified 
appreciated stock, the above-described rule that limits the value of 
property contributed to or for the use of a private nonoperating 
foundation to the taxpayer's basis in the property does not apply; 
therefore, subject to certain limits, contributions of qualified 
appreciated stock to a nonoperating private foundation may be deducted 
at fair market value. Sec. 170(e)(5). Certain contributions of patents 
or other intellectual property also generally are limited to the 
donor's basis in the property. Sec. 170(e)(1)(B)(iii). However, a 
special rule permits additional charitable deductions beyond the 
donor's tax basis in certain situations.
---------------------------------------------------------------------------
    Although most charitable contributions of property are 
valued at fair market value or the donor's tax basis in the 
property, certain statutorily described contributions of 
appreciated inventory and other property qualify for an 
``enhanced deduction'' valuation that exceeds the donor's tax 
basis in the property, but which is less than the fair market 
value of the property.\244\
---------------------------------------------------------------------------
    \244\ Sec. 170(e)(3).
---------------------------------------------------------------------------
    Contributions of property with a fair market value that is 
less than the donor's tax basis generally are deductible at the 
fair market value of the property.
            College athletic seating rights
    In general, where a taxpayer receives or expects to receive 
a substantial return benefit for a payment to charity, the 
payment is not deductible as a charitable contribution. 
However, special rules apply to certain payments to 
institutions of higher education in exchange for which the 
payor receives the right to purchase tickets for seating at an 
athletic event. Specifically, the payor may treat 80 percent of 
a payment as a charitable contribution where: (1) the amount is 
paid to or for the benefit of an institution of higher 
education (as defined in section 3304(f)) described in section 
(b)(1)(A)(ii) (generally, a school with a regular faculty and 
curriculum and meeting certain other requirements), and (2) 
such amount would be allowable as a charitable deduction but 
for the fact that the taxpayer receives (directly or 
indirectly) as a result of the payment the right to purchase 
tickets for seating at an athletic event in an athletic stadium 
of such institution.\245\
---------------------------------------------------------------------------
    \245\ Sec. 170(l).
---------------------------------------------------------------------------

Substantiation and other formal requirements

            In general
    A donor who claims a deduction for a charitable 
contribution must maintain reliable written records regarding 
the contribution, regardless of the value or amount of such 
contribution.\246\ In the case of a charitable contribution of 
money, regardless of the amount, applicable recordkeeping 
requirements are satisfied only if the donor maintains as a 
record of the contribution a bank record or a written 
communication from the donee showing the name of the donee 
organization, the date of the contribution, and the amount of 
the contribution. In such cases, the recordkeeping requirements 
may not be satisfied by maintaining other written records.
---------------------------------------------------------------------------
    \246\ Sec. 170(f)(17).
---------------------------------------------------------------------------
    No charitable contribution deduction is allowed for a 
separate contribution of $250 or more unless the donor obtains 
a contemporaneous written acknowledgement of the contribution 
from the charity indicating whether the charity provided any 
good or service (and an estimate of the value of any such good 
or service) to the taxpayer in consideration for the 
contribution.\247\
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    \247\ Such acknowledgement must include the amount of cash and a 
description (but not value) of any property other than cash 
contributed, whether the donee provided any goods or services in 
consideration for the contribution, and a good faith estimate of the 
value of any such goods or services. Sec. 170(f)(8).
---------------------------------------------------------------------------
    In addition, any charity receiving a contribution exceeding 
$75 made partly as a gift and partly as consideration for goods 
or services furnished by the charity (a ``quid pro quo'' 
contribution) is required to inform the contributor in writing 
of an estimate of the value of the goods or services furnished 
by the charity and that only the portion exceeding the value of 
the goods or services is deductible as a charitable 
contribution.\248\
---------------------------------------------------------------------------
    \248\ Sec. 6115.
---------------------------------------------------------------------------
    If the total charitable deduction claimed for noncash 
property is more than $500, the taxpayer must attach a 
completed Form 8283 (Noncash Charitable Contributions) to the 
taxpayer's return or the deduction is not allowed.\249\ In 
general, taxpayers are required to obtain a qualified appraisal 
for donated property with a value of more than $5,000, and to 
attach an appraisal summary to the tax return.
---------------------------------------------------------------------------
    \249\ Sec. 170(f)(11).
---------------------------------------------------------------------------
            Exception for certain contributions reported by the donee 
                    organization
    Subsection 170(f)(8)(D) provides an exception to the 
contemporaneous written acknowledgment requirement described 
above. Under the exception, a contemporaneous written 
acknowledgment is not required if the donee organization files 
a return, on such form and in accordance with such regulations 
as the Secretary may prescribe, that includes the same content. 
``[T]he section 170(f)(8)(D) exception is not available unless 
and until the Treasury Department and the IRS issue final 
regulations prescribing the method by which donee reporting may 
be accomplished.'' \250\ No such final regulations have been 
issued.\251\
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    \250\ See IRS, Notice of Proposed Rulemaking, Substantiation 
Requirement for Certain Contributions, REG-138344-13 (October 13, 
2015), I.R.B. 2015-41 (preamble).
    \251\ In October 2015, the IRS issued proposed regulations that, if 
finalized, would have implemented the section 170(f)(8)(D) exception to 
the contemporaneous written acknowledgment requirement. The proposed 
regulations provided that a return filed by a donee organization under 
section 170(f)(8)(D) must include, in addition to the information 
generally required on a contemporaneous written acknowledgment: (1) the 
name and address of the donee organization; (2) the name and address of 
the donor; and (3) the taxpayer identification number of the donor. In 
addition, the return must be filed with the IRS (with a copy provided 
to the donor) on or before February 28 of the year following the 
calendar year in which the contribution was made. Under the proposed 
regulations, donee reporting would have been optional and would have 
been available solely at the discretion of the donee organization. The 
proposed regulations were withdrawn in January 2016. See Prop. Treas. 
Reg. sec 1.170A-13(f)(18).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision makes the following modifications to the 
charitable deduction rules. The first modification (relating to 
percentage limits) is temporary. The other modifications are 
permanent.

Temporary increase in percentage limit for contributions of cash to 
        public charities

            In general
    The provision adds new subparagraph 170(b)(1)(G), which 
increases the income-based percentage limit from 50 percent to 
60 percent for certain charitable contributions by an 
individual taxpayer of cash to organizations described in 
section 170(b)(1)(A) (generally, public charities and certain 
private foundations that are not nonoperating private 
foundations).\252\ To the extent such contributions exceed the 
60-percent limit for any taxable year, the excess is carried 
forward and treated as a charitable contribution that is 
subject to the 60-percent limit in each of the five succeeding 
taxable years in order of time.
---------------------------------------------------------------------------
    \252\ New sec. 170(b)(1)(G).
---------------------------------------------------------------------------
    The provision applies to the amount of charitable 
contributions taken into account for taxable years beginning 
after December 31, 2017, and before January 1, 2026.
            Coordination with certain other percentage limits 
                    applicable to individuals
    It is intended that any contribution of cash by an 
individual to an organization described in section 170(b)(1)(A) 
(generally, public charities and certain private foundations 
that are not nonoperating private foundations) shall be allowed 
to the extent that the aggregate of such contributions for the 
taxable year does not exceed 60 percent of the taxpayer's 
contribution base, reduced by the aggregate amount of the 
contributions allowed under section 170(b)(1)(A) for the year. 
In other words, the 60-percent limit for cash contributions is 
intended to be applied after (and reduced by) the amount of 
noncash contributions to organizations described in section 
170(b)(1)(A).\253\
---------------------------------------------------------------------------
    \253\ A technical correction may be needed to reflect this intent. 
In the absence of a technical correction, there is concern that some 
might interpret the provision as requiring that the 50-percent limit 
for noncash contributions under section 170(b)(1)(A) be applied after 
(and reduced by) the amount of cash contributions allowed under the 60-
percent limit of section 170(b)(1)(G).
---------------------------------------------------------------------------
    For example, assume an individual with a contribution base 
of $100,000 for taxable year 2018 makes two contributions to 
public charities: unappreciated property with a fair market 
value of $50,000 and $10,000 in cash. The individual makes no 
other charitable contributions in 2018 and has no charitable 
contribution carryforwards from a prior year. The cash 
contribution limit under new section 170(b)(1)(G) is determined 
after accounting for noncash contributions. Thus, the $50,000 
contribution of unappreciated property is accounted for first, 
using up the individual's entire 50-percent contribution limit 
under section 170(b)(1)(A) (50 percent of the individual's 
$100,000 contribution base), and leaving $10,000 in allowable 
cash contributions under the 60-percent limit ($60,000 (60 
percent of $100,000) reduced by the $50,000 in noncash 
contributions allowed under section 170(b)(1)(A)).

Denial of charitable deduction for college athletic event seating 
        rights

    The provision amends section 170(l) to provide that no 
charitable deduction shall be allowed for any amount described 
in paragraph 170(l)(2), generally, a payment to an institution 
of higher education in exchange for which the payor receives 
the right to purchase tickets for seating at an athletic event.

Repeal of substantiation exception for certain contributions reported 
        by the donee organization

    The provision repeals the section 170(f)(8)(D) exception to 
the contemporaneous written acknowledgment requirement.

                             Effective Date

    The provisions that increase the charitable contribution 
percentage limit and deny a deduction for stadium seating 
payments are effective for contributions made in taxable years 
beginning after December 31, 2017. The provision that repeals 
the substantiation exception for certain contributions reported 
by the donee organization is effective for contributions made 
in taxable years beginning after December 31, 2016.

D. Increased Contributions to ABLE Accounts (sec. 11024 of the Act and 
                    secs. 25B and 529A of the Code)


                               Prior Law


Qualified ABLE programs

    The Code provides for a tax-favored savings program 
intended to benefit disabled individuals, known as qualified 
ABLE programs.\254\ A qualified ABLE program is a program 
established and maintained by a State or agency or 
instrumentality thereof. A qualified ABLE program must meet the 
following conditions: (1) under the provisions of the program, 
contributions may be made to an account (an ``ABLE account''), 
established for the purpose of meeting the qualified disability 
expenses of the designated beneficiary of the account; (2) the 
program must limit a designated beneficiary to one ABLE 
account; and (3) the program must meet certain other 
requirements discussed below. A qualified ABLE program is 
generally exempt from income tax, but is otherwise subject to 
the taxes imposed on the unrelated business income of tax-
exempt organizations.
---------------------------------------------------------------------------
    \254\ Sec. 529A.
---------------------------------------------------------------------------
    A designated beneficiary of an ABLE account is the owner of 
the ABLE account. A designated beneficiary must be an eligible 
individual (defined below) who established the ABLE account and 
who is designated at the commencement of participation in the 
qualified ABLE program as the beneficiary of amounts paid (or 
to be paid) into and from the program.
    Contributions to an ABLE account must be made in cash and 
are not deductible for Federal income tax purposes. Except in 
the case of a rollover contribution from another ABLE account, 
an ABLE account must provide that it may not receive aggregate 
contributions during a taxable year in excess of the amount 
under section 2503(b) of the Code (the annual gift tax 
exclusion). For 2017, this is $14,000.\255\ Additionally, a 
qualified ABLE program must provide adequate safeguards to 
ensure that ABLE account contributions do not exceed the limit 
imposed on accounts under the qualified tuition program of the 
State maintaining the qualified ABLE program. Amounts in the 
account accumulate on a tax-deferred basis (i.e., income on 
accounts under the program is not subject to current income 
tax).
---------------------------------------------------------------------------
    \255\ The amount under sec. 2503(b) is indexed for inflation. In 
the case that contributions to an ABLE account exceed the annual limit, 
an excise tax in the amount of six percent of the excess contribution 
to such account is imposed on the designated beneficiary. Such tax does 
not apply in the event that the trustee of such account makes a 
corrective distribution of such excess amounts by the due date 
(including extensions) of the individual's tax return for the year in 
which the excess contribution was made.
---------------------------------------------------------------------------

Saver's credit

    Certain taxpayers may claim a nonrefundable tax credit for 
eligible taxpayers for qualified retirement savings 
contributions.\256\ The tax credit is such savings 
contributions as do not exceed $2,000 multiplied by the credit 
rate. The credit rate depends on the adjusted gross income 
(``AGI'') of the taxpayer. For this purpose, AGI is determined 
without regard to certain excludable foreign-source earned 
income and certain U.S. possession income.
---------------------------------------------------------------------------
    \256\ Sec. 25B.
---------------------------------------------------------------------------
    For taxable years beginning in 2017, married taxpayers 
filing joint returns with AGI of $62,000 or less, taxpayers 
filing head of household returns with AGI of $46,500 or less, 
and all other taxpayers filing returns with AGI of $31,000 or 
less are eligible for the credit. As the taxpayer's AGI 
increases, the credit rate available to the taxpayer is 
reduced, until, at certain AGI levels, the credit is 
unavailable. The credit rates based on AGI for taxable years 
beginning in 2017 are provided in the table below. The AGI 
levels used for the determination of the available credit rate 
are indexed for inflation.

                                    TABLE 4.--CREDIT RATES FOR SAVER'S CREDIT
----------------------------------------------------------------------------------------------------------------
             Joint Filers                Heads of Households        All Other Filers           Credit Rate
----------------------------------------------------------------------------------------------------------------
$0-$37,000...........................  $0-$27,750.............  $0-$18,500.............  50 percent
$37,001-$40,000......................  $27,751-$30,000........  $18,501-$20,000........  20 percent
$40,001-$62,000......................  $30,001-$46,500........  $20,001-$31,000........  10 percent
Over $62,000.........................  Over $46,500...........  Over $31,000...........  0 percent
----------------------------------------------------------------------------------------------------------------

    The saver's credit is in addition to any deduction or 
exclusion that would otherwise apply with respect to the 
contribution. The credit offsets alternative minimum tax 
liability as well as regular tax liability. The credit is 
available to individuals who are 18 years old or older, other 
than individuals who are full-time students or claimed as a 
dependent on another taxpayer's return.
    Qualified retirement savings contributions consist of (1) 
elective deferrals to a section 401(k) plan, a section 403(b) 
plan, a governmental section 457 plan, a SIMPLE plan, or a 
SARSEP; (2) contributions to a traditional or Roth IRA; and (3) 
voluntary after-tax employee contributions to a qualified 
retirement plan or section 403(b) plan. Under the rules 
governing these arrangements, an individual's contribution to 
the arrangement generally cannot exceed the lesser of an annual 
dollar amount (for example, in 2017, $5,500 in the case of an 
IRA of an individual under age 50) or the individual's 
compensation that is includible in income. In the case of IRA 
contributions of a married couple, the combined includible 
compensation of both spouses may be taken into account.
    The amount of any contribution eligible for the credit is 
reduced by distributions received by the taxpayer (or by the 
taxpayer's spouse if the taxpayer files a joint return with the 
spouse) from any retirement plan to which eligible 
contributions can be made during the taxable year for which the 
credit is claimed, during the two taxable years prior to the 
year for which the credit is claimed, and during the period 
after the end of the taxable year for which the credit is 
claimed and prior to the due date (including extensions) for 
filing the taxpayer's return for the year. Distributions that 
are rolled over to another retirement plan do not affect the 
credit.

                        Explanation of Provision

    The provision temporarily increases the contribution 
limitation to ABLE accounts under certain circumstances. While 
the annual limitation on contributions (the per-donee annual 
gift tax exclusion ($15,000 for 2018)) and the overall 
limitation remain the same, the limitation is increased with 
respect to contributions made by the designated beneficiary of 
the ABLE account. Under the provision, an ABLE account's 
designated beneficiary may contribute an additional amount each 
year, without regard to the annual limitation, up to the lesser 
of (a) the Federal poverty line for a one-person household; or 
(b) the individual's compensation for the taxable year.
    Additionally, the provision allows a designated beneficiary 
of an ABLE account to claim the saver's credit for 
contributions made to his or her ABLE account.
    The modifications described above do not apply to taxable 
years beginning after December 31, 2025.

                             Effective Date

    The provision is effective for taxable years beginning 
after the date of enactment (December 22, 2017).

E. Rollovers to ABLE Programs from 529 Programs (sec. 11025 of the Act 
                  and secs. 529 and 529A of the Code)


                               Prior Law


Qualified ABLE programs

    The Code provides for a tax-favored savings program 
intended to benefit disabled individuals, known as qualified 
ABLE programs.\257\ A qualified ABLE program is a program 
established and maintained by a State or agency or 
instrumentality thereof. A qualified ABLE program must meet the 
following conditions: (1) under the provisions of the program, 
contributions may be made to an account (an ``ABLE account''), 
established for the purpose of meeting the qualified disability 
expenses of the designated beneficiary of the account; (2) the 
program must limit a designated beneficiary to one ABLE 
account; and (3) the program must meet certain other 
requirements discussed below. A qualified ABLE program is 
generally exempt from income tax, but is otherwise subject to 
the taxes imposed on the unrelated business income of tax-
exempt organizations.
---------------------------------------------------------------------------
    \257\ Sec. 529A.
---------------------------------------------------------------------------
    A designated beneficiary of an ABLE account is the owner of 
the ABLE account. A designated beneficiary must be an eligible 
individual (defined below) who established the ABLE account and 
who is designated at the commencement of participation in the 
qualified ABLE program as the beneficiary of amounts paid (or 
to be paid) into and from the program.
    Contributions to an ABLE account must be made in cash and 
are not deductible for Federal income tax purposes. Except in 
the case of a rollover contribution from another ABLE account, 
an ABLE account must provide that it may not receive aggregate 
contributions during a taxable year in excess of the amount 
under section 2503(b) of the Code (the annual gift tax 
exclusion). For 2017, this is $14,000.\258\ Additionally, a 
qualified ABLE program must provide adequate safeguards to 
ensure that ABLE account contributions do not exceed the limit 
imposed on accounts under the qualified tuition program of the 
State maintaining the qualified ABLE program. Amounts in the 
account accumulate on a tax-deferred basis (i.e., income on 
accounts under the program is not subject to current income 
tax).
---------------------------------------------------------------------------
    \258\ The 2503(b) amount is indexed for inflation. In the case that 
contributions to an ABLE account exceed the annual limit, an excise tax 
in the amount of six percent of the excess contribution to such account 
is imposed on the designated beneficiary. Such tax does not apply in 
the event that the trustee of such account makes a corrective 
distribution of such excess amounts by the due date (including 
extensions) of the individual's tax return for the year in which the 
excess contribution was made.
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision temporarily allows for amounts from qualified 
tuition programs (also known as ``529 accounts''') to be rolled 
over to an ABLE account without penalty, provided that the ABLE 
account is owned by the designated beneficiary of that 529 
account, or a member of such designated beneficiary's 
family.\259\ Such rolled-over amounts count towards the annual 
limitation on amounts that can be contributed to an ABLE 
account within a taxable year.\260\ Any amount rolled over that 
is in excess of this limitation shall be includible in the 
gross income of the distributee in a manner provided by section 
72.\261\
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    \259\ For these purposes, a member of the family means, with 
respect to any designated beneficiary, the designated beneficiary's: 
(1) spouse; (2) child or descendant of a child; (3) brother, sister, 
stepbrother or stepsister; (4) father, mother or ancestor of either; 
(5) stepfather or stepmother; (6) niece or nephew; (7) aunt or uncle; 
(8) in-law; (9) the spouse of any individual described in (2)-(8); and 
(10) any first cousin.
    \260\ Sec. 529A(b)(2)(B)(i).
    \261\ Sec. 529(c)(3)(A).
---------------------------------------------------------------------------
    The provision does not apply to distributions made after 
December 31, 2025.

                             Effective Date

    The provision applies to distributions after the date of 
enactment (December 22, 2017).

 F. Treatment of Certain Individuals Performing Services in the Sinai 
Peninsula of Egypt (sec. 11026 of the Act and secs. 2, 112, 692, 2201, 
                3401, 4253, 6013, and 7508 of the Code)


                               Prior Law

    Members of the Armed Forces serving in a combat zone are 
afforded a number of tax benefits. These include:
    1. An exclusion from gross income of certain military pay 
received for any month during which the member served in a 
combat zone or was hospitalized as a result of serving in a 
combat zone; \262\
---------------------------------------------------------------------------
    \262\ Sec. 112; see also, sec. 3401(a)(1), exempting such income 
from wage withholding.
---------------------------------------------------------------------------
    2. An exemption from taxes on death while serving in a 
combat zone or dying as a result of wounds, disease, or injury 
incurred while so serving; \263\
---------------------------------------------------------------------------
    \263\ Sec. 692.
---------------------------------------------------------------------------
    3. Special estate tax rules where death occurs in a combat 
zone; \264\
---------------------------------------------------------------------------
    \264\ Sec. 2201.
---------------------------------------------------------------------------
    4. Special benefits to surviving spouses in the event of a 
service member's death or missing status; \265\
---------------------------------------------------------------------------
    \265\ Secs. 2(a)(3) and 6013(f)(1).
---------------------------------------------------------------------------
    5. An extension of time limits governing the filing of 
returns and other rules regarding timely compliance with 
Federal income tax rules; \266\ and
---------------------------------------------------------------------------
    \266\ Sec. 7508.
---------------------------------------------------------------------------
    6. An exclusion from telephone excise taxes.\267\
---------------------------------------------------------------------------
    \267\ Sec. 4253(d).
---------------------------------------------------------------------------
The land area (not including airspace) of Egypt has been 
designated as an imminent danger pay area since January 29, 
1997,\268\ but is not a designated combat zone.
---------------------------------------------------------------------------
    \268\ Dept. of Defense reg. sec. 7000.14-R, Vol. 7A, Chapter 10, 
Figure 10-1, November 2016.
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision temporarily identifies the Sinai Peninsula of 
Egypt as a ``qualified hazardous duty area'' that is to be 
treated in the same manner as a combat zone for purposes of 
determining eligibility for the benefits available to members 
of the Armed Forces. This qualified hazardous duty area 
designation applies only during periods in which a member of 
the Armed Forces is entitled to special pay under 37 U.S.C. 
sec. 310 for duty subject to hostile fire or imminent danger 
for services performed in the Sinai Peninsula of Egypt.
    The identification of the Sinai Peninsula of Egypt as a 
qualified hazardous duty area begins June 9, 2015, and includes 
the portion of the first taxable year ending after that date, 
as well as all subsequent taxable years beginning before 
January 1, 2026.\269\
---------------------------------------------------------------------------
    \269\ The IRS has provided guidance on how to claim these benefits 
retroactively in Publication 3, Armed Forces' Tax Guide, p. 13, 2017, 
and in the instructions for Form 1040X, rev. January 2018, p. 5.
---------------------------------------------------------------------------

                             Effective Date

    The provision is generally effective beginning June 9, 
2015. The portion of the provision that excludes qualified 
hazardous duty area pay from wage withholding applies to 
remuneration paid on or after the date of enactment (December 
22, 2017).

 G. Temporary Reduction in Medical Expense Deduction Floor (sec. 11027 
                  of the Act and sec. 213 of the Code)


                               Prior Law

    Individuals may claim an itemized deduction for 
unreimbursed medical expenses, but only to the extent that the 
expenses exceed 10 percent of adjusted gross income.\270\ For 
taxable years beginning before January 1, 2017, the 10-percent 
threshold was reduced to 7.5 percent in the case of a taxpayer 
who attained age 65 before the close of the taxable year. In 
the case of a married taxpayer, the 7.5-percent threshold 
applies if either the taxpayer or the taxpayer's spouse 
attained age 65 before the close of the taxable year.
---------------------------------------------------------------------------
    \270\ Sec. 213. The threshold was amended by the Patient Protection 
and Affordable Care Act (Pub. L. No. 111-118). For taxable years 
beginning before January 1, 2013, the threshold was 7.5 percent for 
regular tax purposes and 10 percent for AMT purposes.
---------------------------------------------------------------------------
    For all individuals the threshold is 10 percent for 
purposes of the alternative minimum tax (``AMT'').

                        Explanation of Provision

    Under the provision, for taxable years beginning after 
December 31, 2016, and ending before January 1, 2019, the 
threshold for deducting medical expenses is 7.5 percent of 
adjusted gross income for all individuals. For these years, 
this threshold applies for purposes of the AMT as well as the 
regular tax.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2016.

  H. Relief for 2016 Disaster Areas (sec. 11028 of the Act and secs. 
          72(t), 165, 401-403, 408, 457, and 3405 of the Code)


                               Prior Law


Distributions from tax-favored retirement plans

    A distribution from a qualified retirement plan, a tax-
sheltered annuity plan (a ``section 403(b) plan''), an eligible 
deferred compensation plan of a State or local government 
employer (a ``governmental section 457(b) plan''), or an 
individual retirement arrangement (an ``IRA'') generally is 
included in income for the year distributed.\271\ These plans 
are referred to collectively as ``eligible retirement plans.'' 
In addition, unless an exception applies, a distribution from a 
qualified retirement plan, a section 403(b) plan, or an IRA 
received before age 59\1/2\ is subject to a 10-percent 
additional tax (referred to as the ``early withdrawal tax'') on 
the amount includible in income.\272\
---------------------------------------------------------------------------
    \271\ Secs. 401(a), 403(a), 403(b), 457(b) and 408. Under section 
3405, distributions from these plans are generally subject to income 
tax withholding unless the recipient elects otherwise. In addition, 
certain distributions from a qualified retirement plan, a section 
403(b) plan, or a governmental section 457(b) plan are subject to 
mandatory income tax withholding at a 20-percent rate unless the 
distribution is rolled over.
    \272\ Sec. 72(t). The 10-percent early withdrawal tax does not 
apply to distributions from a governmental section 457(b) plan.
---------------------------------------------------------------------------
    In general, a distribution from an eligible retirement plan 
may be rolled over to another eligible retirement plan within 
60 days, in which case the amount rolled over generally is not 
includible in income. The IRS has the authority to waive the 
60-day requirement if failure to waive the requirement would be 
against equity or good conscience, including cases of casualty, 
disaster, or other events beyond the reasonable control of the 
individual.
    The terms of a qualified retirement plan, section 403(b) 
plan, or governmental section 457(b) plan generally determine 
when distributions are permitted. However, in some cases, 
restrictions may apply to distribution before an employee's 
termination of employment, referred to as ``in-service'' 
distributions. Despite such restrictions, an in-service 
distribution may be permitted in the case of financial hardship 
or an unforeseeable emergency.
    Tax-favored retirement plans are generally required to be 
operated in accordance with the terms of the plan document, and 
amendments to reflect changes to the plan generally must be 
adopted within a limited period.

Itemized deduction for casualty losses

    A taxpayer may generally claim a deduction for any loss 
sustained during the taxable year and not compensated by 
insurance or otherwise.\273\ For individual taxpayers, 
deductible losses must be incurred in a trade or business or 
other profit-seeking activity or consist of property losses 
arising from fire, storm, shipwreck, or other casualty, or from 
theft. Personal casualty or theft losses are deductible only if 
they exceed $100 per casualty or theft. In addition, aggregate 
net casualty and theft losses are deductible only to the extent 
they exceed 10 percent of an individual taxpayer's adjusted 
gross income.
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    \273\ Sec. 165.
---------------------------------------------------------------------------

                        Explanation of Provision


In general

    The provision provides tax relief, as described below, 
relating to any area with respect to which a major disaster was 
declared by the President under section 401 of the Robert T. 
Stafford Disaster Relief and Emergency Assistance Act during 
calendar year 2016 (a ``2016 disaster area'').

Distributions from eligible retirement plans

    Under the provision, an exception to the 10-percent early 
withdrawal tax applies in the case of a qualified 2016 disaster 
distribution from a qualified retirement plan, a section 403(b) 
plan, or an IRA. In addition, as discussed further, income 
attributable to a qualified 2016 disaster distribution may be 
included in income ratably over three years, and the amount of 
a qualified 2016 disaster distribution may be recontributed to 
an eligible retirement plan within three years.
    A qualified 2016 disaster distribution is a distribution 
from an eligible retirement plan made on or after January 1, 
2016, and before January 1, 2018, to an individual whose 
principal place of abode at any time during calendar year 2016 
was located in a 2016 disaster area and who has sustained an 
economic loss by reason of the events giving rise to the 
Presidential disaster declaration.
    The total amount of distributions to an individual from all 
eligible retirement plans that may be treated as qualified 2016 
disaster distributions is $100,000. Thus, any distributions in 
excess of $100,000 during the applicable period are not 
qualified 2016 disaster distributions.
    Any amount required to be included in income as a result of 
a qualified 2016 disaster is included in income ratably over 
the three-year period beginning with the year of distribution 
unless the individual elects not to have ratable inclusion 
apply.
    Any portion of a qualified 2016 disaster distribution may, 
at any time during the three-year period beginning the day 
after the date on which the distribution was received, be 
recontributed to an eligible retirement plan to which a 
rollover can be made. Any amount recontributed within the 
three-year period is treated as a rollover and thus is not 
includible in income. For example, if an individual receives a 
qualified 2016 disaster distribution in 2016, that amount is 
included in income, generally ratably over the year of the 
distribution and the following two years, but is not subject to 
the 10-percent early withdrawal tax. If, in 2018, the amount of 
the qualified 2016 disaster distribution is recontributed to an 
eligible retirement plan, the individual may file an amended 
return to claim a refund of the tax attributable to the amount 
previously included in income. In addition, if, under the 
ratable inclusion provision, a portion of the distribution has 
not yet been included in income at the time of the 
contribution, the remaining amount is not includible in income.
    A qualified 2016 disaster distribution is a permissible 
distribution from a qualified retirement plan, section 403(b) 
plan, or governmental section 457(b) plan, regardless of 
whether a distribution otherwise would be permissible.\274\ A 
plan is not treated as violating any Code requirement merely 
because it treats a distribution as a qualified 2016 disaster 
distribution, provided that the aggregate amount of such 
distributions from plans maintained by the employer and members 
of the employer's controlled group or affiliated service group 
does not exceed $100,000. Thus, a plan is not treated as 
violating any Code requirement merely because an individual 
might receive total distributions in excess of $100,000, taking 
into account distributions from plans of other employers or 
IRAs.
---------------------------------------------------------------------------
    \274\ A qualified 2016 disaster distribution is subject to income 
tax withholding unless the recipient elects otherwise. Mandatory 20-
percent withholding does not apply.
---------------------------------------------------------------------------
    A plan amendment made pursuant to the provision (or a 
regulation issued thereunder) may be retroactively effective 
if, in addition to the requirements described below, the 
amendment is made on or before the last day of the first plan 
year beginning after December 31, 2018 (or in the case of a 
governmental plan, December 31, 2020), or a later date 
prescribed by the Secretary. In addition, the plan will be 
treated as operated in accordance with plan terms during the 
period beginning with the date the provision or regulation 
takes effect (or the date specified by the plan if the 
amendment is not required by the provision or regulation) and 
ending on the last permissible date for the amendment (or, if 
earlier, the date the amendment is adopted). For an amendment 
to be retroactively effective, it must apply retroactively for 
that period, and the plan must be operated in accordance with 
the amendment during that period.

Modification of rules related to casualty losses

    Under the provision, in the case of a personal casualty 
loss which arose on or after January 1, 2016, in a 2016 
disaster area and was attributable to the events giving rise to 
the Presidential disaster declaration, such losses are 
deductible without regard to whether aggregate net losses 
exceed 10 percent of a taxpayer's adjusted gross income. Under 
the provision, to be deductible, the losses must exceed $500 
per casualty. Additionally, such losses may be claimed in 
addition to the standard deduction.

                             Effective Date

    The provision is effective on the date of enactment 
(December 22, 2017). The casualty loss relief under the 
provision applies to losses arising in taxable years beginning 
after December 31, 2015, and before January 1, 2018.

                           PART IV--EDUCATION

    A. Treatment of Student Loans Discharged on Account of Death or 
      Disability (sec. 11031 of the Act and sec. 108 of the Code)

                               Prior Law

    Gross income generally includes the discharge of 
indebtedness of the taxpayer. Under an exception to this 
general rule, gross income does not include any amount from the 
forgiveness (in whole or in part) of certain student loans, 
provided that the forgiveness is contingent on the student's 
working for a certain period of time in certain professions for 
any of a broad class of employers.\275\
---------------------------------------------------------------------------
    \275\ Sec. 108(f).
---------------------------------------------------------------------------
    Student loans eligible for this special rule must be made 
to an individual to assist the individual in attending an 
educational institution that normally maintains a regular 
faculty and curriculum and normally has a regularly enrolled 
body of students in attendance at the place where its education 
activities are regularly carried on. Loan proceeds may be used 
not only for tuition and required fees, but also to cover room 
and board expenses. The loan must be made by (1) the United 
States (or an instrumentality or agency thereof), (2) a State 
(or any political subdivision thereof), (3) certain tax-exempt 
public benefit corporations that control a State, county, or 
municipal hospital and whose employees have been deemed to be 
public employees under State law, or (4) an educational 
organization that originally received the funds from which the 
loan was made from the United States, a State, or a tax-exempt 
public benefit corporation.
    In addition, an individual's gross income does not include 
amounts from the forgiveness of loans made by educational 
organizations (and certain tax-exempt organizations in the case 
of refinancing loans) out of private, nongovernmental funds if 
the proceeds of such loans are used to pay costs of attendance 
at an educational institution or to refinance any outstanding 
student loans (not just loans made by educational 
organizations) and the student is not employed by the lender 
organization. In the case of such loans made or refinanced by 
educational organizations (or refinancing loans made by certain 
tax-exempt organizations), cancellation of the student loan 
must be contingent on the student working in an occupation or 
area with unmet needs and such work must be performed for, or 
under the direction of, a tax-exempt charitable organization or 
a governmental entity.
    Finally, an individual's gross income does not include any 
loan repayment amount received under the National Health 
Service Corps loan repayment program, certain State loan 
repayment programs, or any amount received by an individual 
under any State loan repayment or loan forgiveness program that 
is intended to provide for the increased availability of health 
care services in underserved or health professional shortage 
areas (as determined by the State).

                        Explanation of Provision

    The provision temporarily modifies the exclusion of student 
loan discharges from gross income by expanding the exclusion to 
include certain discharges on account of death or disability. 
Loans eligible for the exclusion under the provision are (1) 
loans made by the United States \276\ (or an instrumentality or 
agency thereof), (2) loans made by a State (or any political 
subdivision thereof), (3) loans made by certain tax-exempt 
public benefit corporations that control a State, county, or 
municipal hospital and whose employees have been deemed to be 
public employees under State law, (4) loans made by an 
educational organization that originally received the funds 
from which the loan was made from the United States, a State, 
or a tax-exempt public benefit corporation, or (5) private 
education loans (for this purpose, private education loan is 
defined in section 140(7) of the Consumer Credit Protection 
Act).\277\
---------------------------------------------------------------------------
    \276\ A technical correction may be needed to reflect the intent to 
include Parent PLUS loans.
    \277\ 15 U.S.C. sec. 1650(7).
---------------------------------------------------------------------------
    Under the provision, the discharge of a loan as described 
above is excluded from gross income if the discharge was 
pursuant to the death or total and permanent disability of the 
student.\278\ The provision does not apply to loans discharged 
after December 31, 2025.
---------------------------------------------------------------------------
    \278\ Although the provision makes specific reference to those 
provisions of the Higher Education Act of 1965 that discharge William 
D. Ford Federal Direct Loan Program loans, Federal Family Education 
Loan Program loans, and Federal Perkins Loan Program loans in the case 
of death and total and permanent disability, the provision also 
contains a catch-all exclusion in the case of a student loan discharged 
on account of the death or total and permanent disability of the 
student, in addition to those specific statutory references.
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to discharges of loans after December 
31, 2017.

  B. 529 Account Funding for Elementary and Secondary Education (sec. 
               11032 of the Act and sec. 529 of the Code)

                               Prior Law

            In general
    A qualified tuition program is a program established and 
maintained by a State or agency or instrumentality thereof, or 
by one or more eligible educational institutions, which 
satisfies certain requirements and under which a person may 
purchase tuition credits or certificates on behalf of a 
designated beneficiary that entitle the beneficiary to the 
waiver or payment of qualified higher education expenses of the 
beneficiary (a ``prepaid tuition program''). Section 529 
provides specified income tax and transfer tax rules for the 
treatment of accounts and contracts established under qualified 
tuition programs.\279\ In the case of a program established and 
maintained by a State or agency or instrumentality thereof, a 
qualified tuition program also includes a program under which a 
person may make contributions to an account that is established 
for the purpose of satisfying the qualified higher education 
expenses of the designated beneficiary of the account, provided 
it satisfies certain specified requirements (a ``savings 
account program''). Under both types of qualified tuition 
programs, a contributor establishes an account for the benefit 
of a particular designated beneficiary to provide for that 
beneficiary's higher education expenses.
---------------------------------------------------------------------------
    \279\ For purposes of this description, the term ``account'' is 
used interchangeably to refer to a prepaid tuition benefit contract or 
a tuition savings account established pursuant to a qualified tuition 
program.
---------------------------------------------------------------------------
    In general, prepaid tuition contracts and tuition savings 
accounts established under a qualified tuition program involve 
prepayments or contributions made by one or more individuals 
for the benefit of a designated beneficiary. Decisions with 
respect to the contract or account are typically made by an 
individual who is not the designated beneficiary. Qualified 
tuition accounts or contracts generally require the designation 
of a person (generally referred to as an ``account owner'') 
\280\ whom the program administrator (oftentimes a third-party 
administrator retained by the State or by the educational 
institution that established the program) may look to for 
decisions, recordkeeping, and reporting with respect to the 
account established for a designated beneficiary. The person or 
persons who make the contributions to the account need not be 
the same person who is regarded as the account owner for 
purposes of administering the account. Under many qualified 
tuition programs, the account owner generally has control over 
the account or contract, including the ability to change 
designated beneficiaries and to withdraw funds at any time and 
for any purpose. Thus, in practice, qualified tuition accounts 
or contracts generally involve a contributor, a designated 
beneficiary, an account owner (who oftentimes is not the 
contributor or the designated beneficiary), and an 
administrator of the account or contract.
---------------------------------------------------------------------------
    \280\ Section 529 refers to contributors and designated 
beneficiaries, but does not define or otherwise refer to the term 
``account owner,'' which is a commonly used term among qualified 
tuition programs.
---------------------------------------------------------------------------
            Qualified higher education expenses
    Distributions for the purpose of meeting the designated 
beneficiary's higher education expenses are generally not 
subject to tax. For purposes of receiving a distribution from a 
qualified tuition program that qualifies for this favorable tax 
treatment, qualified higher education expenses means tuition, 
fees, books, supplies, and equipment required for the 
enrollment or attendance of a designated beneficiary at an 
eligible educational institution, and expenses for special 
needs services in the case of a special needs beneficiary that 
are incurred in connection with such enrollment or attendance. 
Qualified higher education expenses generally also include room 
and board for students who are enrolled at least half-time. 
Qualified higher education expenses include the purchase of any 
computer technology or equipment, or Internet access or related 
services, if such technology or services were to be used 
primarily by the beneficiary during any of the years a 
beneficiary is enrolled at an eligible institution.
            Contributions to qualified tuition programs
    Contributions to a qualified tuition program must be made 
in cash. Section 529 does not impose a specific dollar limit on 
the amount of contributions, account balances, or prepaid 
tuition benefits relating to a qualified tuition account; 
however, the program is required to have adequate safeguards to 
prevent contributions in excess of amounts necessary to provide 
for the beneficiary's qualified higher education expenses. 
Contributions generally are treated as a completed gift 
eligible for the gift tax annual exclusion. Contributions are 
not tax deductible for Federal income tax purposes, although 
they may be deductible for State income tax purposes. Amounts 
in the account accumulate on a tax-free basis (i.e., income on 
accounts in the plan is not subject to current income tax).
    A qualified tuition program may not permit any contributor 
to, or designated beneficiary under, the program to direct 
(directly or indirectly) the investment of any contributions 
(or earnings thereon) more than two times in any calendar year, 
and must provide separate accounting for each designated 
beneficiary. A qualified tuition program may not allow any 
interest in an account or contract (or any portion thereof) to 
be used as security for a loan.

                        Explanation of Provision

    The provision modifies section 529 plans to allow such 
plans to distribute not more than $10,000 in expenses for 
tuition incurred during the taxable year in connection with the 
enrollment or attendance of the designated beneficiary at a 
public, private, or religious elementary or secondary 
school.\281\ This limitation applies on a per-student basis, 
rather than a per-account basis. Thus, under the provision, 
although an individual may be the designated beneficiary of 
multiple accounts, that individual may receive a maximum of 
$10,000 in distributions free of tax, regardless of whether the 
funds are distributed from multiple accounts. Any excess 
distributions received by the individual would be treated as a 
distribution subject to tax under the general rules of section 
529.
---------------------------------------------------------------------------
    \281\ This special treatment of elementary and secondary school 
tuition expenses is pursuant to section 529(c)(7), which provides that 
these expenses are treated as qualified higher education expenses for 
purposes of this subsection (i.e., sec. 529(c)). Thus, elementary and 
secondary school tuition is not treated as a qualified higher education 
expense for purposes of section 529 other than with respect to the tax 
treatment of distributions. For instance, for purposes of section 
529(b)(6), which requires that a 529 plan must provide adequate 
safeguards to prevent contributions on behalf of a designated 
beneficiary in excess of those necessary to provide for the qualified 
higher education expenses of such beneficiary, the maximum contribution 
amounts for purposes of such a prohibition should remain unchanged. See 
Prop. Treas. Reg. sec. 1.529-2(i)(2) (providing for a safe harbor under 
this requirement if the 529 plan limits the total account balance to 
actuarial estimates of the amount needed to pay tuition, required fees 
and room and board expenses of the designated beneficiary for five 
years of undergraduate enrollment at the highest cost institution 
allowed by the program).
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to distributions made after December 
31, 2017.

                   PART V--DEDUCTIONS AND EXCLUSIONS

 A. Suspension of Deduction for Personal Exemptions (sec. 11041 of the 
                     Act and sec. 151 of the Code)

                               Prior Law

    In determining taxable income, an individual reduces 
adjusted gross income by any personal exemption deductions and 
either the applicable standard deduction or his or her itemized 
deductions. Personal exemptions generally are allowed for the 
taxpayer (both taxpayers in the case of a joint return) and any 
dependents of the taxpayer.\282\ For 2017, the amount 
deductible for each personal exemption is $4,050. This amount 
is indexed annually for inflation. The personal exemption 
amount is phased out in the case of an individual with AGI in 
excess of $313,800 for married taxpayers filing jointly, 
$287,650 for heads of household, $156,900 for married taxpayers 
filing separately, and $261,500 for all other filers. In 
addition, no deduction for a personal exemption is allowed to a 
dependent if a personal exemption deduction for the dependent 
is allowable to another taxpayer or if an individual's TIN is 
not included on the return claiming the exemption.
---------------------------------------------------------------------------
    \282\ In addition, a married taxpayer filing a separate return may 
claim a personal exemption deduction for a spouse if the spouse has no 
gross income and is not a dependent of another taxpayer.
---------------------------------------------------------------------------
            Withholding rules
    The amount of tax required to be withheld by employers from 
a taxpayer's wages is based in part on the number of 
withholding exemptions a taxpayer claims on his Form W-4. An 
employee is entitled to the following exemptions: (1) an 
exemption for himself, unless he is allowed to be claimed as a 
dependent of another person; (2) an exemption to which the 
employee's spouse would be entitled, if that spouse does not 
file a Form W-4 for that taxable year claiming an exemption 
described in (1); (3) an exemption for each individual who is a 
dependent (but only if the employee's spouse has not also 
claimed such a withholding exemption on a Form W-4); (4) 
additional withholding allowances (taking into account 
estimated itemized deductions, estimated tax credits, and 
additional deductions as provided by the Secretary of the 
Treasury); and (5) a standard deduction allowance.
            Filing requirements
    An unmarried individual is required to file a tax return 
for a taxable year if the individual has gross income for the 
year which equals or exceeds the sum of the exemption amount 
plus the standard deduction applicable to such individual 
(i.e., single, head of household, or surviving spouse). An 
individual entitled to file a joint return is required to do so 
unless that individual's gross income, when combined with the 
individual's spouse's gross income for the taxable year, is 
less than the sum of twice the exemption amount plus the basic 
standard deduction applicable to a joint return, provided that 
the individual and his spouse, at the close of the taxable 
year, had the same household as their home, the individual's 
spouse did not make a separate return, and no other taxpayer is 
entitled to an exemption for the individual's spouse.
            Trusts and estates
    In lieu of the deduction for personal exemptions, an estate 
is allowed a deduction of $600. A trust is allowed a deduction 
of $100; $300 if required to distribute all its income 
currently; and an amount equal to the personal exemption of an 
individual in the case of a qualified disability trust.

                        Explanation of Provision

    Under the provision, for taxable years 2018 through 2025, 
the amount of a personal exemption is zero.\283\
---------------------------------------------------------------------------
    \283\ The provision also clarifies that, for purposes of taxable 
years in which the personal exemption is reduced to zero, this should 
not alter the operation of those provisions of the Code that refer to a 
taxpayer allowed a deduction (or an individual with respect to whom a 
taxpayer is allowed a deduction) under section 151. Thus, for instance, 
sec. 24(a) allows a credit against tax with respect to each qualifying 
child of the taxpayer for which the taxpayer is allowed a deduction 
under section 151. A qualifying child, as defined under section 152(c), 
remains eligible to be treated as such for purposes of the credit, 
notwithstanding that the deduction under section 151 has been reduced 
to zero.
---------------------------------------------------------------------------
    The Act modifies the provision relating to persons required 
to file an income tax return to take account of the reduction 
of the exemption amount to zero. Under the provision, as under 
prior law, every individual who has gross income for the 
taxable year is required to file an income tax return. However, 
an unmarried individual is exempt from the filing requirement 
if the individual's gross income for the taxable year is less 
than or equal to the individual's applicable standard 
deduction. A married individual is exempt from the filing 
requirement if the individual's gross income, when combined 
with the individual's spouse's gross income, for the taxable 
year, is more than the standard deduction applicable to the 
joint return of the individuals, provided that: (i) such 
individual and his spouse, at the close of the taxable year, 
had the same household as their home; (ii) the individual's 
spouse does not make a separate return; and (iii) neither the 
individual nor his spouse is a dependent of another taxpayer 
who has income (other than earned income) in excess of $500 
(indexed for inflation).
    Under the provision, the Secretary of the Treasury is to 
develop rules to determine the amount of tax required to be 
withheld by employers from a taxpayer's wages.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.
    Under the provision, the Secretary may administer the 
withholding rules under section 3402 for taxable years 
beginning before January 1, 2019, without regard to the 
provision. Thus, at the Secretary's discretion, wage 
withholding rules may remain the same as under prior law for 
2018.

B. Limitation on Deduction for State and Local, etc. Taxes (sec. 11042 
                  of the Act and sec. 164 of the Code)

                               Prior Law

    Individuals are permitted a deduction for certain taxes 
paid or accrued, whether or not incurred in a taxpayer's trade 
or business or activity for the production of income. These 
taxes are: (i) State and local, and foreign, real property 
taxes; \284\ (ii) State and local personal property taxes; 
\285\ and (iii) State and local, and foreign, income, war 
profits, and excess profits taxes.\286\ 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 for 
State and local income taxes.\287\ An individual may elect to 
claim a credit rather than a deduction for foreign income, war 
profits, and excess profits taxes.\288\
---------------------------------------------------------------------------
    \284\ Sec. 164(a)(1).
    \285\ Sec. 164(a)(2).
    \286\ Sec. 164(a)(3).
    \287\ Sec. 164(b)(5).
    \288\ Sec. 901.
---------------------------------------------------------------------------
    Property taxes may be allowed as a deduction in computing 
adjusted gross income if incurred in connection with property 
used in a trade or business; otherwise they are an itemized 
deduction. In the case of State and local income taxes, the 
deduction is an itemized deduction notwithstanding that the tax 
may be imposed on profits from a trade or business.\289\
---------------------------------------------------------------------------
    \289\ See H. Rep. No. 1365 to accompany Individual Income Tax Bill 
of 1944 (78th Cong., 2d. Sess.), reprinted at 19 C.B. 839 (1944); S. 
Rep. No. 884 to accompany Individual Income Tax Bill of 1944 (78th 
Cong, 2d Sess.), reprinted at 19 C.B. 878 (1944).
---------------------------------------------------------------------------
    Individuals also are permitted a deduction for Federal and 
State generation skipping transfer tax (``GST tax'') imposed on 
certain income distributions that are included in the gross 
income of the distributee.\290\ In addition, individuals are 
permitted a deduction for one-half of self-employment 
taxes.\291\
---------------------------------------------------------------------------
    \290\ Sec. 164(a)(4).
    \291\ Sec. 164(f).
---------------------------------------------------------------------------
    In determining an individual's alternative minimum taxable 
income, no itemized deduction for property, income, or sales 
tax is allowed.\292\
---------------------------------------------------------------------------
    \292\ Sec. 56(b)(1)(A)(ii).
---------------------------------------------------------------------------

                        Explanation of Provision

    Under the provision, in the case of an individual,\293\ the 
itemized deduction for the aggregate of (i) State and local 
property taxes not paid or accrued in carrying on a trade or 
business, or an activity described in section 212, and (ii) 
State and local income, war profits, and excess profits taxes 
(or sales taxes in lieu of income, etc. taxes) paid or accrued 
in the taxable year, is limited to $10,000 ($5,000 for a 
married taxpayer filing a separate return). It is intended that 
the limitation apply to the deduction for amounts paid or 
accrued to a cooperative housing corporation by a tenant-
stockholder under section 216(a)(1) (relating to real estate 
taxes) in the same manner as the limitation applies to real 
estate taxes under section 164.\294\ Under the provision, 
foreign real property taxes may not be deducted.
---------------------------------------------------------------------------
    \293\ The $10,000 limitation applies to all tax returns of 
individuals other than married taxpayers filing separate returns, for 
whom the limitation is $5,000. The use of the phrase ``in the case of 
an individual'' in the statute distinguishes those taxpayers to whom 
the limit applies from corporate taxpayers (for whom the limit is not 
applicable). The use of the term ``individual'' does not allow each 
spouse filing a joint return to deduct up to $10,000. Rather, the limit 
applies to the tax-filing unit. This is consistent with longstanding 
usage elsewhere in the Code. See, e.g., section 21 (limitations on 
child care credit understood to apply to the tax filing unit in the 
aggregate, notwithstanding the credit applying ``in the case of an 
individual''), section 36 (maximum allowable credit understood to apply 
to the tax filing unit in the aggregate, notwithstanding that the 
credit is provided ``in the case of an individual who is a first-time 
homebuyer''), section 67 (two-percent floor on miscellaneous itemized 
deductions understood to apply to the tax filing unit in the aggregate, 
notwithstanding that the floor is applied ``in the case of an 
individual''), section 165 (per-loss limitations understood to apply to 
the tax filing unit, notwithstanding that the limitations apply in the 
case of ``any loss of an individual''), and section 1411 (measurement 
of net investment income understood to apply to the tax-filing unit, 
notwithstanding that the adjusted gross income threshold upon which the 
tax is measured is stated ``in the case of an individual'').
    Many other Code sections use the term ``in the case of an 
individual'' to specify that a particular credit or deduction is not 
available to corporate taxpayers, and provide further evidence that 
limitations on those credits or deductions are meant to apply on a per-
tax filing units by describing limitations in terms of the 
``taxpayer.'' See, e.g., secs. 23, 25A, 25C, 25D, 32, 35, 151, 
170(b)(1)(A), 221, and 222. The Conference Report to the Act explicitly 
states ``Under the provision a taxpayer may claim an itemized deduction 
of up to $10,000 ($5,000 for married taxpayers filing a separate 
return) for the aggregate of . . .'' (emphasis added).
    The $5,000 limitation applicable to married taxpayers filing a 
separate return is consistent with a $10,000 limitation applying to 
married taxpayers filing jointly, with such limitation applying to the 
tax-filing unit. There is no Code provision wherein a specific 
limitation provided for married taxpayers who file separately is 
anything other than half of the limitation imposed on married taxpayers 
filing jointly (other than those instances in which married taxpayers 
filing separately are forbidden from claiming the benefit altogether).
    \294\ A technical correction may be needed to achieve this result.
---------------------------------------------------------------------------
    Thus, under the provision, in the case of an 
individual,\295\ as a general matter, State, local, and foreign 
property taxes and State and local sales taxes are not subject 
to the above-described limitation only when paid or accrued in 
carrying on a trade or business, or an activity described in 
section 212 (relating to expenses for the production of 
income).\296\ Thus, the provision does not limit those 
deductions for State, local, and foreign property taxes, and 
sales taxes which are taken into account in computing items of 
income on Schedule C, Schedule E, or Schedule F of the 
individual's income tax return. For instance, in the case of 
property taxes, an individual may deduct these taxes if imposed 
on business assets (such as residential rental property).
---------------------------------------------------------------------------
    \295\ See section 641(b) regarding the computation of taxable 
income of an estate or trust in the same manner as an individual.
    \296\ The provision does not modify the deductibility of GST tax 
imposed on certain income distributions. Additionally, taxes imposed at 
the entity level, such as a business tax imposed on pass-through 
entities, that are reflected in a partner's or S corporation 
shareholder's distributive or pro-rata share of income or loss on a 
Schedule K-1 (or similar form), will continue to reduce such partner's 
or shareholder's distributive or pro-rata share of income as under 
prior law.
---------------------------------------------------------------------------
    The limitation applies to taxable years beginning after 
December 31, 2017, and beginning before January 1, 2026.
    In the case of an amount paid in a taxable year beginning 
before January 1, 2018, with respect to a State or local income 
tax imposed for a taxable year beginning after December 31, 
2017, the payment shall be treated as paid on the last day of 
the taxable year for which such tax is so imposed for purposes 
of applying the provision limiting the dollar amount of the 
deduction. Thus, under the provision, an individual may not 
claim an itemized deduction in 2017 on a prepayment of income 
tax for a future taxable year in order to avoid the dollar 
limitation applicable for taxable years beginning after 2017.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2016.

C. Limitation on Deduction for Qualified Residence Interest (sec. 11043 
                of the Act and sec. 163(h) of the Code)


                               Prior Law

    As a general matter, personal interest is not 
deductible.\297\ Qualified residence interest is not treated as 
personal interest and is allowed as an itemized deduction, 
subject to limitations.\298\ Qualified residence interest means 
interest paid or accrued during the taxable year on either 
acquisition indebtedness or home equity indebtedness. A 
qualified residence means the taxpayer's principal residence 
and one other residence of the taxpayer selected to be a 
qualified residence. A qualified residence can be a house, 
condominium, cooperative, mobile home, house trailer, or boat.
---------------------------------------------------------------------------
    \297\ Sec. 163(h)(1).
    \298\ Sec. 163(h)(2)(D) and (h)(3).
---------------------------------------------------------------------------

Acquisition indebtedness

    Acquisition indebtedness is indebtedness that is incurred 
in acquiring, constructing, or substantially improving a 
qualified residence of the taxpayer and that secures the 
residence. The maximum amount treated as acquisition 
indebtedness is $1 million ($500,000 in the case of a married 
person filing a separate return).
    Acquisition indebtedness also includes indebtedness from 
the refinancing of other acquisition indebtedness but only to 
the extent of the amount (and term) of the refinanced 
indebtedness. Thus, for example, if the taxpayer incurs 
$200,000 of acquisition indebtedness to acquire a principal 
residence and pays down the debt to $150,000, the taxpayer's 
acquisition indebtedness with respect to the residence cannot 
thereafter be increased above $150,000 (except by indebtedness 
incurred to substantially improve the residence).
    Interest on acquisition indebtedness is deductible in 
computing alternative minimum taxable income. However, in the 
case of a second residence, the acquisition indebtedness may 
only be incurred with respect to a house, apartment, 
condominium, or a mobile home that is not used on a transient 
basis.

Home equity indebtedness

    Home equity indebtedness is indebtedness (other than 
acquisition indebtedness) secured by a qualified residence.
    The amount of home equity indebtedness may not exceed 
$100,000 ($50,000 in the case of a married individual filing a 
separate return) and may not exceed the fair market value of 
the residence reduced by the acquisition indebtedness.
    Interest on home equity indebtedness is not deductible in 
computing alternative minimum taxable income.
    Interest on qualifying home equity indebtedness is 
deductible, regardless of how the proceeds of the indebtedness 
are used. For example, personal expenditures may include health 
costs and education expenses for the taxpayer's family members 
or any other personal expenses such as vacations, furniture, or 
automobiles. A taxpayer and a mortgage company can contract for 
the home equity indebtedness loan proceeds to be transferred to 
the taxpayer in a lump sum payment (e.g., a traditional 
mortgage), a series of payments (e.g., a reverse mortgage), or 
the lender may extend the borrower a line of credit up to a 
fixed limit over the term of the loan (e.g., a home equity line 
of credit).
    Thus, the aggregate limitation on the total amount of a 
taxpayer's acquisition indebtedness and home equity 
indebtedness with respect to a taxpayer's principal residence 
and a second residence that may give rise to deductible 
interest is $1,100,000 ($550,000, for married persons filing a 
separate return).

                        Explanation of Provision

    Under the provision, in the case of taxable years beginning 
after December 31, 2017, and beginning before January 1, 2026, 
the maximum amount treated as acquisition indebtedness is 
$750,000 ($375,000 in the case of a married person filing a 
separate return). However, in the case of acquisition 
indebtedness incurred before December 15, 2017,\299\ the 
limitation remains at $1,000,000 ($500,000 in the case of 
married taxpayers filing separately).\300\ For taxable years 
beginning after December 31, 2025, a taxpayer may treat up to 
$1,000,000 ($500,000 in the case of married taxpayers filing 
separately) of indebtedness as acquisition indebtedness, 
regardless of when the indebtedness was incurred.
---------------------------------------------------------------------------
    \299\ Under the provision, a taxpayer who has entered into a 
binding written contract before December 15, 2017, to close on the 
purchase of a principal residence before January 1, 2018, and who 
purchases such residence before April 1, 2018, shall be considered to 
have incurred acquisition indebtedness prior to December 15, 2017.
    \300\ Special rules apply in the case of indebtedness from 
refinancing existing acquisition indebtedness. Specifically, the 
$1,000,000 ($500,000 in the case of married taxpayers filing 
separately) limitation continues to apply to any indebtedness incurred 
on or after December 15, 2017, to refinance qualified residence 
indebtedness incurred before that date to the extent the amount of the 
indebtedness resulting from the refinancing does not exceed the amount 
of the refinanced indebtedness, and the refinancing does not extend the 
term of indebtedness. Thus, the maximum dollar amount that may be 
treated as principal residence acquisition indebtedness will not 
decrease by reason of a refinancing.
---------------------------------------------------------------------------
    Additionally, the provision suspends the deduction for 
interest on home equity indebtedness. Thus, for taxable years 
beginning after December 31, 2017, a taxpayer may not claim a 
deduction for interest on home equity indebtedness. The 
suspension ends for taxable years beginning after December 31, 
2025.
    To illustrate the operation of the provision, assume a 
taxpayer incurred $700,000 acquisition indebtedness prior to 
December 15, 2017. On May 1, 2018, the taxpayer incurs a home 
equity loan of $100,000, none of the proceeds of which are used 
to finance a substantial improvement to the taxpayer's 
residence. Interest on the acquisition indebtedness remains 
deductible in 2018 and thereafter. No interest on the home 
equity loan is deductible. However, if the proceeds of the home 
equity loan are used to make substantial improvements on the 
taxpayer's residence, then the loan is considered acquisition 
indebtedness for purposes of the home mortgage interest 
deduction. Accordingly, the taxpayer may deduct interest on 
$50,000 of the $100,000 home equity loan ($50,000 equals 
$750,000 reduced by the pre-December 15 2017, acquisition 
indebtedness of $700,000). To the extent the principal of the 
old loan is reduced below $700,000, additional interest on the 
principal of the home equity loan becomes deductible.
    Assume however, the taxpayer incurred $800,000 acquisition 
indebtedness prior to December 15, 2017. Interest on the 
$800,000 indebtedness remains deductible in 2018 and 
thereafter. No interest on the home equity interest loan 
incurred in 2018 is deductible notwithstanding that the loan 
proceeds may have been used for substantial improvements to the 
taxpayer's home. This is because the $750,000 limitation on 
acquisition indebtedness incurred after December 15, 2017, is 
reduced (but not below zero) by the $800,000 acquisition 
indebtedness incurred before December 15, 2017. If the 
taxpayer's old acquisition indebtedness is reduced to less than 
$750,000, interest on the portion of the taxpayer's home equity 
indebtedness may be deductible (to the extent that $750,000 
exceeds the indebtedness of the old loan), assuming the 
indebtedness qualifies as acquisition indebtedness (i.e., the 
loan proceeds were used for substantial improvements on the 
home).

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

 D. Modification of Deduction for Personal Casualty Losses (sec. 11044 
                  of the Act and sec. 165 of the Code)


                               Prior Law

    A taxpayer may generally claim an itemized deduction for 
any loss sustained during the taxable year, not compensated by 
insurance or otherwise. For individual taxpayers, deductible 
losses must be incurred in a trade or business or other profit-
seeking activity or consist of property losses arising from 
fire, storm, shipwreck, or other casualty, or from theft.\301\ 
Personal casualty or theft losses are deductible only if they 
exceed $100 per casualty or theft. In addition, aggregate net 
casualty and theft losses are deductible only to the extent 
they exceed 10 percent of an individual taxpayer's adjusted 
gross income.
---------------------------------------------------------------------------
    \301\ Sec. 165(c).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision temporarily modifies the itemized deduction 
for personal casualty and theft losses. Under the provision, an 
individual may claim an itemized deduction for a personal 
casualty loss (subject to the limitations described above) only 
if such loss was attributable to a disaster declared by the 
President under section 401 of the Robert T. Stafford Disaster 
Relief and Emergency Assistance Act. An exception applies to 
the extent a loss of an individual does not exceed the 
individual's personal casualty gains.
    The above limitation does not apply with respect to losses 
incurred after December 31, 2025.

                             Effective Date

    The provision is effective for losses incurred in taxable 
years beginning after December 31, 2017.

 E. Suspension of Miscellaneous Itemized Deductions (sec. 11045 of the 
               Act and secs. 62, 67 and 212 of the Code)


                               Prior Law

    Individuals may deduct certain expenses in computing 
taxable income that do not reduce adjusted gross income 
(``AGI''). These deductions are referred to as ``itemized 
deductions''. Some of these expenses (``miscellaneous itemized 
deductions'') are deductible only if, in the aggregate, they 
exceed two percent of the taxpayer's AGI.\302\ The deductions 
listed below are miscellaneous itemized deductions subject to 
the two-percent floor.
---------------------------------------------------------------------------
    \302\ Sec. 67(a).
---------------------------------------------------------------------------

Expenses for the production or collection of income

    Individuals may deduct all ordinary and necessary expenses 
paid or incurred for the production or collection of income. 
These expenses are defined as ordinary and necessary expenses 
paid or incurred in a taxable year: (1) for the production or 
collection of income; \303\ (2) for the management, 
conservation, or maintenance of property held for the 
production of income; \304\ or (3) in connection with the 
determination, collection, or refund of any tax.\305\
---------------------------------------------------------------------------
    \303\ Sec. 212(1).
    \304\ Sec. 212(2).
    \305\ Sec. 212(3).
---------------------------------------------------------------------------
    IRS guidance provides examples of items that may be 
deducted under this provision. This non-exhaustive list 
includes: \306\
---------------------------------------------------------------------------
    \306\ See IRS Publication 529, Miscellaneous Deductions (2016), p. 
9.
---------------------------------------------------------------------------
           Appraisal fees for a casualty loss or 
        charitable contribution;
           Casualty and theft losses from property used 
        in performing services as an employee;
           Clerical help and office rent in caring for 
        investments;
           Depreciation on home computers used for 
        investments;
           Excess deductions (including administrative 
        expenses) allowed a beneficiary on termination of an 
        estate or trust;
           Fees to collect interest and dividends;
           Hobby expenses, but generally not more than 
        hobby income;
           Indirect miscellaneous deductions from pass-
        through entities;
           Investment fees and expenses;
           Loss on deposits in an insolvent or bankrupt 
        financial institution;
           Loss on traditional IRAs or Roth IRAs, when 
        all amounts have been distributed;
           Repayments of income;
           Safe deposit box rental fees, except for 
        storing jewelry and other personal effects;
           Service charges on dividend reinvestment 
        plans;
           Tax preparation fees; and
           Trustee's fees for an IRA, if separately 
        billed and paid.

Unreimbursed expenses attributable to the trade or business of being an 
        employee

    In general, unreimbursed business expenses incurred by an 
employee are deductible, but only as an itemized deduction and 
only to the extent the expenses exceed two percent of adjusted 
gross income.\307\
---------------------------------------------------------------------------
    \307\ Secs. 62(a)(1) and 67.
---------------------------------------------------------------------------
    IRS guidance provides examples of items that may be 
deducted under this provision. This non-exhaustive list 
includes: \308\
---------------------------------------------------------------------------
    \308\ See IRS Publication 529, Miscellaneous Deductions (2016), p. 
3.
---------------------------------------------------------------------------
           Business bad debt of an employee;
           Business liability insurance premiums;
           Damages paid to a former employer for breach 
        of an employment contract;
           Depreciation on a computer a taxpayer's 
        employer requires him to use in his work;
           Dues to a chamber of commerce if membership 
        helps the taxpayer perform his job;
           Dues to professional societies;
           Educator expenses; \309\
---------------------------------------------------------------------------
    \309\ Under a special provision, these expenses are deductible 
``above the line'' up to $250.
---------------------------------------------------------------------------
           Home office or part of a taxpayer's home 
        used regularly and exclusively in the taxpayer's work;
           Job search expenses in the taxpayer's 
        present occupation;
           Laboratory breakage fees;
           Legal fees related to the taxpayer's job;
           Licenses and regulatory fees;
           Malpractice insurance premiums;
           Medical examinations required by an 
        employer;
           Occupational taxes;
           Passport fees for a business trip;
           Repayment of an income aid payment received 
        under an employer's plan;
           Research expenses of a college professor;
           Rural mail carriers' vehicle expenses;
           Subscriptions to professional journals and 
        trade magazines related to the taxpayer's work;
           Tools and supplies used in the taxpayer's 
        work;
           Purchase of travel, transportation, meals, 
        entertainment, gifts, and local lodging related to the 
        taxpayer's work;
           Union dues and expenses;
           Work clothes and uniforms if required and 
        not suitable for everyday use; and
           Work-related education.

Other miscellaneous itemized deductions

    Other miscellaneous itemized deductions include:
           Repayments of income received under a claim 
        of right (only subject to the two-percent floor if less 
        than $3,000);
           Repayments of Social Security benefits; and
           The share of deductible investment expenses 
        from pass-through entities.

                        Explanation of Provision

    The provision temporarily eliminates all miscellaneous 
itemized deductions that were subject to the two-percent floor 
under prior law.\310\ Thus, under the provision, taxpayers may 
not claim an itemized deduction for any of the above-listed 
items. The provision does not apply for taxable years beginning 
after December 31, 2025.
---------------------------------------------------------------------------
    \310\ Notwithstanding the temporary repeal of miscellaneous 
itemized deductions, working condition fringes continue to be excluded 
under section 132(d). Because section 132(d) provides that a working 
condition fringe is excluded from an employee's gross income to the 
extent that had the employee paid for the benefit, such payment would 
be allowable as a deduction to the employee under section 162 or 167, 
the provision does not affect the exclusion. A deduction for these 
items would still be allowable under section 162, notwithstanding that 
the deduction may have been subsequently disallowed under section 67. A 
similar result is achieved under prior law, wherein a working condition 
fringe was excludable in its entirety, notwithstanding that a deduction 
under section 162 was limited by the prior-law section 67 two-percent 
haircut on miscellaneous itemized deductions.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

F. Suspension of Overall Limitation on Itemized Deductions (sec. 11046 
                  of the Act and sec. 68 of the Code)


                               Prior Law

    The total amount of most otherwise allowable itemized 
deductions (other than the deductions for medical expenses, 
investment interest and casualty, theft or gambling losses) is 
limited for certain upper-income individuals.\311\ All other 
limitations applicable to such deductions (such as the separate 
floors) are first applied and, then, the otherwise allowable 
total amount of itemized deductions is reduced by three percent 
of the amount by which the taxpayer's adjusted gross income 
exceeds a threshold amount.
---------------------------------------------------------------------------
    \311\ Sec. 68.
---------------------------------------------------------------------------
    For 2017, the threshold amounts are $261,500 for single 
taxpayers, $287,650 for heads of household, $313,800 for 
married couples filing jointly, and $156,900 for married 
taxpayers filing separately. These threshold amounts are 
indexed for inflation. The otherwise allowable itemized 
deductions may not be reduced by more than 80 percent by reason 
of the overall limit on itemized deductions.

                        Explanation of Provision

    The provision temporarily eliminates the overall limitation 
on itemized deductions. The provision does not apply to taxable 
years beginning after December 31, 2025.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

      G. Suspension of Exclusion for Qualified Bicycle Commuting 
   Reimbursement (sec. 11047 of the Act and sec. 132(f) of the Code)


                               Prior Law

    Qualified bicycle commuting reimbursements of up to $20 per 
qualifying bicycle commuting month in a calendar year are 
excludable from an employee's gross income.\312\ A qualifying 
bicycle commuting month is any month during which the employee 
regularly uses the bicycle for a substantial portion of the 
travel between the employee's residence and place of employment 
and during which the employee does not receive any qualified 
transportation fringe benefit for transportation in a commuter 
highway vehicle (in connection with travel between the 
employee's residence and place of employment), a transit pass, 
or qualified parking.\313\
---------------------------------------------------------------------------
    \312\ Secs. 132(a)(5), 132(f)(1)(D), and 132((f)(5)(F)(ii).
    \313\ Sec. 132(f)(5)(F)(iii).
---------------------------------------------------------------------------
    A qualified bicycle commuting reimbursement for a calendar 
year is an employer reimbursement during the 15-month period 
beginning with the first day of the calendar year for 
reasonable expenses incurred by the employee during such 
calendar year for the purchase of a bicycle and bicycle 
improvements, repair, and storage, if the bicycle is regularly 
used for travel between the employee's residence and place of 
employment.\314\
---------------------------------------------------------------------------
    \314\ Sec. 132(f)(5)(F)(i).
---------------------------------------------------------------------------
    Qualified bicycle commuting reimbursements that are 
excludable from gross income for income tax purposes are also 
excluded from wages for employment tax purposes.

                        Explanation of Provision

    The provision temporarily repeals the exclusion from gross 
income and wages for qualified bicycle commuting 
reimbursements.\315\ The exclusion does not apply to taxable 
years beginning after December 31, 2017, and before January 1, 
2026.
---------------------------------------------------------------------------
    \315\ A technical correction may be necessary to reflect that the 
suspension relates to the exclusion (under subsection (a)(5) of section 
132) rather than the definition of a qualified bicycle commuting 
reimbursement as a qualified transportation fringe, so that such 
taxable benefits are excepted from the deduction disallowance of 
section 274(a). See description of section 13304 of the Act (Limitation 
on Deduction by Employers of Expenses for Fringe Benefits) and related 
footnote, infra.

    The Treasury Department has issued published guidance 
addressing this provision.\316\
---------------------------------------------------------------------------
    \316\ IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits 
(revised Feb. 22, 2018), p. 21.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

 H. Suspension of Exclusion for Qualified Moving Expense Reimbursement 
          (sec. 11048 of the Act and sec. 132(g) of the Code)


                               Prior Law

    Qualified moving expense reimbursements are excluded from 
an employee's gross income,\317\ and are defined as any amount 
received (directly or indirectly) by an individual from an 
employer as a payment for (or reimbursement of) expenses which 
would be deductible as moving expenses under section 217 \318\ 
if directly paid or incurred by the individual. However, any 
such amount actually deducted by the individual is not eligible 
for this exclusion. Qualified moving expense reimbursements 
that are excludible from gross income for income tax purposes 
are also excluded from wages for employment tax purposes.
---------------------------------------------------------------------------
    \317\ Secs. 132(a)(6) and 132(g).
    \318\ Individuals are allowed an itemized deduction for moving 
expenses paid or incurred during the taxable year in connection with 
the commencement of work by the taxpayer as an employee or as a self-
employed individual at a new principal place of work. Such expenses are 
deductible only if the move meets certain conditions related to 
distance from the taxpayer's previous residence and the taxpayer's 
status as a full-time employee in the new location.
---------------------------------------------------------------------------

                        Explanation of Provision

    For taxable years beginning after December 31, 2017, and 
before January 1, 2026, the provision repeals the exclusion 
from gross income and wages for qualified moving expense 
reimbursements except in the case of a member of the Armed 
Forces of the United States on active duty who moves pursuant 
to a military order and incident to a permanent change of 
station.
    If an employee incurs moving expenses in a taxable year 
beginning before January 1, 2018, an employer payment for (or 
reimbursement of) such expenses that would otherwise be 
excludable under prior law is excludable from gross income for 
income tax purposes and from wages for employment tax purposes, 
notwithstanding that the payment (or reimbursement) may occur 
in a taxable year beginning on or after January 1, 2018. 
However, if an employee incurs expenses in a taxable year 
beginning after December 31, 2017, and before January 1, 2026, 
any reimbursement for such expenses is not excludable (other 
than to a member of the Armed Forces to whom the exclusion 
continues to apply).

    The Treasury Department has issued published guidance 
addressing this provision.\319\
---------------------------------------------------------------------------
    \319\ Notice 2018-75, 2018-41 I.R.B. 556.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

I. Suspension of Deduction for Moving Expenses (sec. 11049 of the Act, 
                       and sec. 217 of the Code)


                               Prior Law

    Individuals are permitted an above-the-line deduction for 
moving expenses paid or incurred during the taxable year in 
connection with the commencement of work by the taxpayer as an 
employee or as a self-employed individual at a new principal 
place of work.\320\ Such expenses are deductible only if the 
move meets certain conditions related to distance from the 
taxpayer's previous residence and the taxpayer's status as a 
full-time employee in the new location.
---------------------------------------------------------------------------
    \320\ Sec. 217(a).
---------------------------------------------------------------------------
    Special rules apply in the case of a member of the Armed 
Forces of the United States. In the case of any such individual 
who is on active duty, who moves pursuant to a military order 
and incident to a permanent change of station, the limitations 
related to distance from the taxpayer's previous residence and 
status as a full-time employee in the new location do not 
apply.\321\ Additionally, any moving and storage expenses that 
are furnished in kind to such an individual, spouse, or 
dependents, or if such expenses are reimbursed or an allowance 
for such expenses is provided, such amounts are excluded from 
gross income.\322\ Rules also apply to exclude amounts 
furnished to the spouse and dependents of such an individual in 
the event that such individuals move to a location other than 
to where the member of the Armed Forces is moving.
---------------------------------------------------------------------------
    \321\ Sec. 217(g).
    \322\ Sec. 217(g)(2).
---------------------------------------------------------------------------
    Income exclusions apply to various benefits provided to 
members of the Armed Forces.\323\
---------------------------------------------------------------------------
    \323\ Sec. 134.
---------------------------------------------------------------------------

                        Explanation of Provision

    Generally, the provision temporarily eliminates the 
deduction for moving expenses for taxable years 2018 through 
2025. However, during that period, the provision retains the 
deduction for moving expenses and the rules providing for 
exclusions of amounts attributable to in-kind moving and 
storage expenses (and reimbursements or allowances for these 
expenses) for members of the Armed Forces (or their spouses or 
dependents) on active duty who move pursuant to a military 
order and incident to a permanent change of station.
    The provision does not apply to taxable years beginning 
after December 31, 2025.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

J. Limitation on Wagering Losses (sec. 11050 of the Act and sec. 165(d) 
                              of the Code)


                               Prior Law

    Losses sustained during the taxable year on wagering 
transactions are allowed as a deduction only to the extent of 
the gains during the taxable year from such transactions.\324\
---------------------------------------------------------------------------
    \324\ Sec. 165(d).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision clarifies the scope of ``losses from wagering 
transactions'' as that term is used in section 165(d). Under 
the provision, this term includes any deduction otherwise 
allowable under chapter 1 of the Code incurred in carrying on 
any wagering transaction.
    The provision is intended to clarify that the limitation on 
losses from wagering transactions applies not only to the 
actual costs of wagers incurred by an individual, but to other 
expenses incurred by the individual in connection with the 
conduct of that individual's gambling activity.\325\ The 
provision clarifies, for instance, that an individual's 
otherwise deductible expenses in traveling to or from a casino 
are subject to the limitation under section 165(d).
---------------------------------------------------------------------------
    \325\ The provision thus reverses the result reached by the Tax 
Court in Ronald A. Mayo v. Commissioner, 136 T.C. 81 (2011). In that 
case, the Court held that a taxpayer's expenses incurred in the conduct 
of the trade or business of gambling, other than the cost of wagers, 
were not limited by sec. 165(d), and were thus deductible under sec. 
162(a).
---------------------------------------------------------------------------
    The provision does not apply to taxable years beginning 
after December 31, 2025.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

K. Repeal of Deduction for Alimony Payments (sec. 11051 of the Act and 
                secs. 61, 71, 215, and 682 of the Code)


                               Prior Law

    Alimony and separate maintenance payments are deductible by 
the payor spouse and includible in income by the recipient 
spouse.\326\ Child support payments are not treated as 
alimony.\327\ Also, certain income of an estate or trust in the 
case of a divorce, etc. are includible in the income of the 
recipient spouse.\328\
---------------------------------------------------------------------------
    \326\ Secs. 215(a), 61(a)(8) and 71(a).
    \327\ Sec. 71(c).
    \328\ Sec. 682.
---------------------------------------------------------------------------

                        Explanation of Provision

    Under the provision, alimony and separate maintenance 
payments are not deductible by the payor spouse. The provision 
also repeals the Code provisions that specify that alimony and 
separate maintenance payments are included in income. Thus, the 
intent of the provision is to adopt the approach reflected in 
the United States Supreme Court's holding in Gould v. 
Gould,\329\ in which the Court held that such payments are not 
income to the recipient (in the absence of a specific statutory 
rule providing for the inclusion of such payments in income). 
Income used for alimony payments is taxed at the rates 
applicable to the payor spouse rather than the recipient 
spouse. The treatment of child support is not changed. The 
provision treating income of an estate or trust as income of 
the recipient spouse in the case of a divorce, etc. is 
repealed.
---------------------------------------------------------------------------
    \329\ 245 U.S. 151 (1917).
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for any divorce or separation 
instrument executed after December 31, 2018, or for any divorce 
or separation instrument executed on or before December 31, 
2018, and modified after that date, if the modification 
expressly provides that the amendments made by this provision 
apply to such modification.

           PART VI--INCREASE IN ESTATE AND GIFT TAX EXEMPTION

A. Increase in Estate and Gift Tax Exemption (sec. 11061 of the Act and 
                    secs. 2001 and 2010 of the Code)

                               Prior Law

In general
    A gift tax is imposed on certain lifetime transfers, and an 
estate tax is imposed on certain transfers at death. A 
generation-skipping transfer tax generally is imposed on 
transfers, either directly or in trust or similar arrangement, 
to a ``skip person'' (i.e., a beneficiary in a generation more 
than one generation younger than that of the transferor). 
Transfers subject to the generation-skipping transfer tax 
include direct skips, taxable terminations, and taxable 
distributions.
    Income tax rules determine the recipient's tax basis in 
property acquired from a decedent or by gift. Gifts and 
bequests generally are excluded from the recipient's gross 
income.\330\
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    \330\ Sec. 102.
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Common features of the estate, gift and generation-skipping transfer 
        taxes
            Unified credit (exemption) and tax rates
    Unified credit.--A unified credit is available with respect 
to taxable transfers by gift and at death.\331\ The unified 
credit offsets tax, computed using the applicable estate and 
gift tax rates, on a specified amount of transfers, referred to 
as the applicable exclusion amount, or exemption amount. The 
exemption amount was set at $5 million for 2011 and is indexed 
for inflation for later years. For 2017, the inflation-indexed 
exemption amount is $5.49 million.\332\ Exemption used during 
life to offset taxable gifts reduces the amount of exemption 
that remains at death to offset the value of a decedent's 
estate. An election is available under which exemption that is 
not used by a decedent may be used by the decedent's surviving 
spouse (exemption portability).
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    \331\ Sec. 2010.
    \332\ For 2017, the $5.49 million exemption amount results in a 
unified credit of $2,141,800, after applying the applicable rates set 
forth in section 2001(c).
---------------------------------------------------------------------------
    Common tax rate table.--A common tax-rate table with a top 
marginal tax rate of 40 percent is used to compute gift tax and 
estate tax. The 40-percent rate applies to transfers in excess 
of $1 million (to the extent not exempt). Because the 2017 
exemption amount shields the first $5.49 million in gifts and 
bequests from tax, transfers in excess of the exemption amount 
generally are subject to tax at the highest marginal rate (40 
percent).
    Generation-skipping transfer tax exemption and rate.--The 
generation-skipping transfer tax is a separate tax that can 
apply in addition to either the gift tax or the estate tax. The 
tax rate and exemption amount for generation-skipping transfer 
tax purposes, however, are set by reference to the estate tax 
rules. Generation-skipping transfer tax is imposed using a flat 
rate equal to the highest estate tax rate (40 percent). Tax is 
imposed on cumulative generation-skipping transfers in excess 
of the generation-skipping transfer tax exemption amount in 
effect for the year of the transfer. The generation-skipping 
transfer tax exemption for a given year is equal to the estate 
tax exemption amount in effect for that year ($5.49 million for 
2017).
    Transfers between spouses.--A 100-percent marital deduction 
generally is permitted for the value of property transferred 
between spouses.\333\ In addition, transfers of ``qualified 
terminable interest property'' also are eligible for the 
marital deduction. Qualified terminable interest property is 
property (1) that passes from the decedent, (2) in which the 
surviving spouse has a ``qualifying income interest for life,'' 
and (3) to which an election under these rules applies. A 
qualifying income interest for life exists if (1) the surviving 
spouse is entitled to all the income from the property (payable 
annually or at more frequent intervals) or has the right to use 
the property during the spouse's life, and (2) no person has 
the power to appoint any part of the property to any person 
other than the surviving spouse.
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    \333\ Secs. 2056 and 2523.
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    A marital deduction generally is denied for property 
passing to a surviving spouse who is not a citizen of the 
United States. A marital deduction is permitted, however, for 
property passing to a qualified domestic trust of which the 
noncitizen surviving spouse is a beneficiary. A qualified 
domestic trust is a trust that has as its trustee at least one 
U.S. citizen or U.S. corporation. No corpus may be distributed 
from a qualified domestic trust unless the U.S. trustee has the 
right to withhold any estate tax imposed on the distribution.
    Tax is imposed on (1) any distribution from a qualified 
domestic trust before the date of the death of the noncitizen 
surviving spouse and (2) the value of the property remaining in 
a qualified domestic trust on the date of death of the 
noncitizen surviving spouse. The tax is computed as an 
additional estate tax on the estate of the first spouse to die.
    Transfers to charity.--Contributions to section 501(c)(3) 
charitable organizations and certain other organizations may be 
deducted from the value of a gift or from the value of the 
assets in an estate for Federal gift or estate tax 
purposes.\334\ The effect of the deduction generally is to 
remove the full fair market value of assets transferred to 
charity from the gift or estate tax base; unlike the income tax 
charitable deduction, there are no percentage limits on the 
deductible amount. For estate tax purposes, the charitable 
deduction is limited to the value of the transferred property 
that is required to be included in the gross estate.\335\ A 
charitable contribution of a partial interest in property, such 
as a remainder or future interest, generally is not deductible 
for gift or estate tax purposes.\336\
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    \334\ Secs. 2055 and 2522.
    \335\ Sec. 2055(d).
    \336\ Secs. 2055(e)(2) and 2522(c)(2).
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The estate tax
            Overview
    The Code imposes a tax on the transfer of the taxable 
estate of a decedent who is a citizen or resident of the United 
States.\337\ The taxable estate is determined by deducting from 
the value of the decedent's gross estate any deductions 
provided for in the Code. After applying tax rates to determine 
a tentative amount of estate tax, certain credits are 
subtracted to determine estate tax liability.\338\
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    \337\ Sec. 2001(a).
    \338\ The taxable estate is combined with the value of adjusted 
taxable gifts made during the decedent's life (generally, post-1976 
gifts), before applying tax rates to determine a tentative total amount 
of tax. The portion of the tentative tax attributable to lifetime gifts 
is then subtracted from the total tentative tax to determine the gross 
estate tax, i.e., the amount of estate tax before considering available 
credits. Credits are then subtracted to determine the estate tax 
liability.
    This method of computation was designed to ensure that a taxpayer 
only gets one run up through the rate brackets for all lifetime gifts 
and transfers at death, at a time when the thresholds for applying the 
higher marginal rates exceeded the exemption amount. However, the 
higher ($5.49 million) 2017 exemption amount effectively renders the 
lower rate brackets irrelevant, because the top marginal rate bracket 
applies to all transfers in excess of $1 million. In other words, all 
transfers that are not exempt by reason of the $5.49 million exemption 
amount are taxed at the highest marginal rate of 40 percent.
---------------------------------------------------------------------------
    Because the estate tax shares a common unified credit 
(exemption) and tax rate table with the gift tax, the exemption 
amounts and tax rates are described together above, along with 
certain other common features of these taxes.
            Gross estate
    A decedent's gross estate includes, to the extent provided 
for in other sections of the Code, the date-of-death value of 
all of a decedent's property, real or personal, tangible or 
intangible, wherever situated.\339\ In general, the value of 
property for this purpose is the fair market value of the 
property as of the date of the decedent's death, although an 
executor may elect to value certain property as of the date 
that is six months after the decedent's death (the alternate 
valuation date).\340\
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    \339\ Sec. 2031(a).
    \340\ Sec. 2032.
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    The gross estate includes not only property directly owned 
by the decedent, but also other property in which the decedent 
had a beneficial interest at the time of his or her death.\341\ 
The gross estate also includes certain transfers made by the 
decedent prior to his or her death, including (1) certain gifts 
made within three years prior to the decedent's death;\342\ (2) 
certain transfers of property in which the decedent retained a 
life estate;\343\ (3) certain transfers taking effect at 
death;\344\ and (4) revocable transfers.\345\ In addition, the 
gross estate includes property with respect to which the 
decedent had, at the time of death, a general power of 
appointment (generally, the right to determine who will have 
beneficial ownership).\346\ The value of a life insurance 
policy on the decedent's life is included in the gross estate 
if the proceeds are payable to the decedent's estate or the 
decedent had incidents of ownership with respect to the policy 
at the time of his or her death.\347\
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    \341\ Sec. 2033.
    \342\ Sec. 2035.
    \343\ Sec. 2036.
    \344\ Sec. 2037.
    \345\ Sec. 2038.
    \346\ Sec. 2041.
    \347\ Sec. 2042.
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            Deductions from the gross estate
    A decedent's taxable estate is determined by subtracting 
from the value of the gross estate any deductions provided for 
in the Code.
    Marital and charitable transfers.--As described above, 
transfers to a surviving spouse or to charity generally are 
deductible for estate tax purposes. The effect of the marital 
and charitable deductions generally is to remove assets 
transferred to a surviving spouse or to charity from the estate 
tax base.
    State death taxes.--An estate tax deduction is permitted 
for death taxes (e.g., any estate, inheritance, legacy, or 
succession taxes) actually paid to any State or the District of 
Columbia, in respect of property included in the gross estate 
of the decedent.\348\ Such State taxes must have been paid and 
claimed before the expiration of the applicable limitations 
period, which is generally four years after the filing of the 
estate tax return.\349\
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    \348\ Sec. 2058.
    \349\ Sec. 2058(b) provides that taxes must have been paid and 
deductions claimed before the later of (1) four years after the filing 
of the estate tax return; or (2) (a) 60 days after a decision of the 
U.S. Tax Court determining the estate tax liability becomes final, (b) 
the expiration of the period of extension to pay estate taxes over time 
under section 6166, or (c) the expiration of the period of limitations 
in which to file a claim for refund or 60 days after a decision of a 
court in which such refund suit has become final.
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    Other deductions.--A deduction is available for funeral 
expenses, estate administration expenses, and claims against 
the estate, including certain taxes.\350\ A deduction also is 
available for uninsured casualty and theft losses incurred 
during the settlement of the estate.\351\
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    \350\ Sec. 2053.
    \351\ Sec. 2054.
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            Credits against tax
    After accounting for allowable deductions, a gross amount 
of estate tax is computed. Estate tax liability is then 
determined by subtracting allowable credits from the gross 
estate tax.
    Unified credit.--The most significant credit allowed for 
estate tax purposes is the unified credit, which is discussed 
in greater detail above.\352\ For 2017, the value of the 
unified credit is $2,141,800, which has the effect of exempting 
$5.49 million in transfers from tax. The unified credit 
available at death is reduced by the amount of unified credit 
used to offset gift tax on gifts made during the decedent's 
life.
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    \352\ Sec. 2010.
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    Other credits.--Estate tax credits also are allowed for (1) 
gift tax paid on certain pre-1977 gifts (before the estate and 
gift tax computations were integrated); \353\ (2) estate tax 
paid on certain prior transfers (to limit the estate tax burden 
when estate tax is imposed on transfers of the same property in 
two estates by reason of deaths in rapid succession); \354\ and 
(3) certain foreign death taxes paid (generally, where the 
property is situated in a foreign country but included in the 
decedent's U.S. gross estate).\355\
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    \353\ Sec. 2012.
    \354\ Sec. 2013.
    \355\ Sec. 2014. In certain cases, an election may be made to 
deduct foreign death taxes. See section 2053(d).
---------------------------------------------------------------------------
            Provisions affecting small and family-owned businesses and 
                    farms
    Special-use valuation.--An executor can elect to value for 
estate tax purposes certain ``qualified real property'' used in 
farming or another qualifying closely-held trade or business at 
its current-use value, rather than its fair market value.\356\ 
The maximum reduction in value for such real property is 
$750,000 (adjusted for inflation occurring after 1997; the 
inflation-adjusted amount for 2017 is $1,120,000). In general, 
real property qualifies for special-use valuation only if (1) 
at least 50 percent of the adjusted value of the decedent's 
gross estate (including both real and personal property) 
consists of a farm or closely-held business property in the 
decedent's estate and (2) at least 25 percent of the adjusted 
value of the gross estate consists of farm or closely held 
business real property. In addition, the property must be used 
in a qualified use (e.g., farming) by the decedent or a member 
of the decedent's family for five of the eight years before the 
decedent's death.
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    \356\ Sec. 2032A.
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    If, after a special-use valuation election is made, the 
heir who acquired the real property ceases to use it in its 
qualified use within 10 years of the decedent's death, an 
additional estate tax is imposed to recapture the entire 
estate-tax benefit of the special-use valuation.
    Installment payment of estate tax for closely held 
businesses.--Under prior law, the estate tax generally is due 
within nine months of a decedent's death. However, an executor 
generally may elect to pay estate tax attributable to an 
interest in a closely held business in two or more installments 
(but no more than 10).\357\ An estate is eligible for payment 
of estate tax in installments if the value of the decedent's 
interest in a closely held business exceeds 35 percent of the 
decedent's adjusted gross estate (i.e., the gross estate less 
certain deductions). If the election is made, the estate may 
defer payment of principal and pay only interest for the first 
five years, followed by up to 10 annual installments of 
principal and interest.
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    \357\ Sec. 6166.
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    This provision effectively extends the time for paying 
estate tax by 14 years from the original due date of the estate 
tax. A special two-percent interest rate applies to the amount 
of deferred estate tax attributable to the first $1 million 
(adjusted annually for inflation occurring after 1998; the 
inflation-adjusted amount for 2017 is $1,490,000) in taxable 
value of a closely held business. The interest rate applicable 
to the amount of estate tax attributable to the taxable value 
of the closely held business in excess of $1 million (adjusted 
for inflation) is equal to 45 percent of the rate applicable to 
underpayments of tax under section 6621 of the Code (i.e., 45 
percent of the sum of the Federal short-term rate and three 
percentage points).\358\ Interest paid on deferred estate taxes 
is not deductible for estate or income tax purposes.
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    \358\ The interest rate on this portion adjusts with the Federal 
short-term rate.
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The gift tax

            Overview
    The Code imposes a tax for each calendar year on the 
transfer of property by gift during such year by any 
individual, whether a resident or nonresident of the United 
States.\359\ The amount of taxable gifts for a calendar year is 
determined by subtracting from the total amount of gifts made 
during the year: (1) the gift tax annual exclusion (described 
below); and (2) allowable deductions.
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    \359\ Sec. 2501(a). However, if the donor is neither a citizen nor 
a resident of the United States, the transfer is taxable only if the 
property is situated in the United States. Sec. 2511.
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    Gift tax for the current taxable year is determined by: (1) 
computing a tentative tax on the combined amount of all taxable 
gifts for the current and all prior calendar years using the 
common gift tax and estate tax rate table; (2) computing a 
tentative tax only on all prior-year gifts; (3) subtracting the 
tentative tax on prior-year gifts from the tentative tax 
computed for all years to arrive at the portion of the total 
tentative tax attributable to current-year gifts; and, finally, 
(4) subtracting the amount of unified credit not consumed by 
prior-year gifts.
    Because the gift tax shares a common unified credit 
(exemption) and tax rate table with the estate tax, the 
exemption amounts and tax rates are described together above, 
along with certain other common features of these taxes.
            Transfers by gift
    The gift tax applies to a transfer by gift regardless of 
whether (1) the transfer is made outright or in trust; (2) the 
gift is direct or indirect; or (3) the property is real or 
personal, tangible or intangible.\360\ For gift tax purposes, 
the value of a gift of property is the fair market value of the 
property at the time of the gift.\361\ Where property is 
transferred for less than full consideration, the amount by 
which the value of the property exceeds the value of the 
consideration is considered a gift and is included in computing 
the total amount of a taxpayer's gifts for a calendar 
year.\362\
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    \360\ Sec. 2511(a).
    \361\ Sec. 2512(a).
    \362\ Sec. 2512(b).
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    For a gift to occur, a donor generally must relinquish 
dominion and control over donated property. For example, if a 
taxpayer transfers assets to a trust established for the 
benefit of his or her children, but retains the right to revoke 
the trust, the taxpayer may not have made a completed gift, 
because the taxpayer has retained dominion and control over the 
transferred assets. A completed gift made in trust, on the 
other hand, often is treated as a gift to the trust 
beneficiaries.
    By reason of statute, certain transfers are not treated as 
transfers by gift for gift tax purposes. These include, for 
example, certain transfers for educational and medical 
purposes,\363\ transfers to section 527 political 
organizations,\364\ and transfers to tax-exempt organizations 
described in sections 501(c)(4), (5), or (6).\365\
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    \363\ Sec. 2503(e).
    \364\ Sec. 2501(a)(4).
    \365\ Sec. 2501(a)(6).
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            Taxable gifts
    As stated above, the amount of a taxpayer's taxable gifts 
for the year is determined by subtracting from the total amount 
of the taxpayer's gifts for the year the gift tax annual 
exclusion and any available deductions.
    Gift tax annual exclusion.--Under prior law, donors of 
lifetime gifts are provided an annual exclusion of $14,000 per 
donee in 2017 (indexed for inflation from the 1997 annual 
exclusion amount of $10,000) for gifts of present interests in 
property during the taxable year.\366\ If the non-donor spouse 
consents to split the gift with the donor spouse, then the 
annual exclusion is $28,000 per donee in 2017. In general, 
unlimited transfers between spouses are permitted without 
imposition of a gift tax. Special rules apply to the 
contributions to a qualified tuition program (``529 Plan'') 
including an election to treat a contribution that exceeds the 
annual exclusion as a contribution made ratably over a five-
year period beginning with the year of the contribution.\367\
---------------------------------------------------------------------------
    \366\ Sec. 2503(b).
    \367\ Sec. 529(c)(2).
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    Marital and charitable deductions.--As described above, 
transfers to a surviving spouse or to charity generally are 
deductible for gift tax purposes. The effect of the marital and 
charitable deductions generally is to remove assets transferred 
to a surviving spouse or to charity from the gift tax base.

The generation-skipping transfer tax

    A generation-skipping transfer tax generally is imposed (in 
addition to the gift tax or the estate tax) on transfers, 
either directly or in trust or similar arrangement, to a ``skip 
person'' (i.e., a beneficiary in a generation more than one 
generation below that of the transferor). Transfers subject to 
the generation-skipping transfer tax include direct skips, 
taxable terminations, and taxable distributions.
            Exemption and tax rate
    An exemption generally equal to the estate tax exemption 
amount ($5.49 million for 2017) is provided for each person 
making generation-skipping transfers. The exemption may be 
allocated by a transferor (or his or her executor) to 
transferred property, and in some cases is automatically 
allocated. The allocation of generation-skipping transfer tax 
exemption effectively reduces the tax rate on a generation-
skipping transfer.
    The tax rate on generation-skipping transfers is a flat 
rate of tax equal to the maximum estate and gift tax rate (40 
percent) multiplied by the ``inclusion ratio.'' The inclusion 
ratio with respect to any property transferred indicates the 
amount of ``generation-skipping transfer tax exemption'' 
allocated to a trust (or to property transferred in a direct 
skip) relative to the total value of property transferred.\368\ 
If, for example, a taxpayer transfers $5 million in property to 
a trust and allocates $5 million of exemption to the transfer, 
the inclusion ratio is zero, and the applicable tax rate on any 
subsequent generation-skipping transfers from the trust is zero 
percent (40 percent multiplied by the inclusion ratio of zero). 
If, however, the taxpayer allocated only $2.5 million of 
exemption to the transfer, the inclusion ratio is 0.5, and the 
applicable tax rate on any subsequent generation-skipping 
transfers from the trust is 20 percent (40 percent multiplied 
by the inclusion ratio of 0.5). If the taxpayer allocates no 
exemption to the transfer, the inclusion ratio is one, and the 
applicable tax rate on any subsequent generation-skipping 
transfers from the trust is 40 percent (40 percent multiplied 
by the inclusion ratio of one).
---------------------------------------------------------------------------
    \368\ The inclusion ratio is one minus the applicable fraction. The 
applicable fraction is the amount of exemption allocated to a trust (or 
to a direct skip) divided by the value of assets transferred.
---------------------------------------------------------------------------
            Generation-skipping transfers
    Generation-skipping transfer tax generally is imposed at 
the time of a generation-skipping transfer, i.e., a direct 
skip, a taxable termination, or a taxable distribution.
    A direct skip is any transfer subject to estate or gift tax 
of an interest in property to a skip person. A skip person may 
be a natural person or certain trusts. All persons assigned to 
the second or more remote generation below the transferor are 
skip persons (e.g., grandchildren and great-grandchildren). 
Trusts are skip persons if (1) all interests in the trust are 
held by skip persons, or (2) no person holds an interest in the 
trust and at no time after the transfer may a distribution 
(including distributions and terminations) be made to a non-
skip person.
    A taxable termination is a termination (by death, lapse of 
time, release of power, or otherwise) of an interest in 
property held in trust unless, immediately after such 
termination, a non-skip person has an interest in the property, 
or unless at no time after the termination may a distribution 
(including a distribution upon termination) be made from the 
trust to a skip person.
    A taxable distribution is a distribution from a trust to a 
skip person (other than a taxable termination or direct skip). 
If a transferor allocates generation-skipping transfer tax 
exemption to a trust prior to the taxable distribution, 
generation-skipping transfer tax may be avoided.

Income tax basis in property received

            In general
    Gain or loss, if any, on the disposition of property is 
measured by the taxpayer's amount realized on the disposition, 
less the taxpayer's basis in such property. Basis generally 
represents a taxpayer's investment in property with certain 
adjustments required after acquisition. For example, basis is 
increased by the cost of capital improvements made to the 
property and decreased by depreciation deductions taken with 
respect to the property.
    A gift or bequest of appreciated (or loss) property is not 
an income tax realization event for the transferor. The Code 
provides special rules for determining a recipient's basis in 
assets received by lifetime gift or from a decedent.
            Basis in property received by lifetime gift
    Under prior law, property received from a donor of a 
lifetime gift generally takes a carryover basis.\369\ 
``Carryover basis'' means that the basis in the hands of the 
donee is the same as it was in the hands of the donor. The 
basis of property transferred by lifetime gift also is 
increased, but not above fair market value, by any gift tax 
paid by the donor. The basis of a lifetime gift, however, 
generally cannot exceed the property's fair market value on the 
date of the gift. If a donor's basis in property is greater 
than the fair market value of the property on the date of the 
gift, then, for purposes of determining loss on a subsequent 
sale of the property, the donee's basis is the property's fair 
market value on the date of the gift.
---------------------------------------------------------------------------
    \369\ See sec. 1015.
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            Basis in property acquired from a decedent
    Property acquired from a decedent's estate generally takes 
a stepped-up basis.\370\ ``Stepped-up basis'' means that the 
basis of property acquired from a decedent's estate generally 
is the fair market value on the date of the decedent's death 
(or, if the alternate valuation date is elected, the earlier of 
six months after the decedent's death or the date the property 
is sold or distributed by the estate). Providing a fair market 
value basis eliminates the recognition of income on any 
appreciation of the property that occurred prior to the 
decedent's death and eliminates the tax benefit from any 
unrealized loss.
---------------------------------------------------------------------------
    \370\ See sec. 1014.
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    In community property states, a surviving spouse's one-half 
share of community property held by the decedent and the 
surviving spouse (under the community property laws of any 
State, U.S. possession, or foreign country) generally is 
treated as having passed from the decedent and, thus, is 
eligible for stepped-up basis. Thus, both the decedent's one-
half share and the surviving spouse's one-half share are 
stepped up to fair market value. This rule applies if at least 
one-half of the whole of the community interest is includible 
in the decedent's gross estate.
    Stepped-up basis treatment generally is denied to certain 
interests in foreign entities. Stock in a passive foreign 
investment company (including those for which a mark-to-market 
election has been made) generally takes a carryover basis, 
except that stock of a passive foreign investment company for 
which a decedent shareholder had made a qualified electing fund 
election is allowed a stepped-up basis. Stock owned by a 
decedent in a domestic international sales corporation (or 
former domestic international sales corporation) takes a 
stepped-up basis reduced by the amount (if any) which would 
have been included in gross income under section 995(c) as a 
dividend if the decedent had lived and sold the stock at its 
fair market value on the estate tax valuation date (i.e., 
generally the date of the decedent's death unless an alternate 
valuation date is elected).

                        Explanation of Provision

    The provision doubles the estate and gift tax exemption for 
estates of decedents dying and gifts made after December 31, 
2017, and before January 1, 2026. This is accomplished by 
increasing the basic exclusion amount provided in section 
2010(c)(3) of the Code from $5 million to $10 million. The $10 
million amount is indexed for inflation occurring after 2011. 
For 2018, the basic exclusion amount is $11,180,000 for 
determining the amount of the unified credit against estate 
tax.\371\ Because the generation-skipping transfer tax 
exemption under section 2631(c) is set by cross-reference to 
the basic exclusion amount in effect for estate tax purposes, 
this increase to the basic exclusion amount also increases the 
amount of generation-skipping transfer tax exemption available 
to be allocated from January 1, 2018, through December 31, 
2025.\372\
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    \371\ Rev. Proc. 2018-18, 2018-10 I.R.B. 392, p. 397 (March 5, 
2018).
    \372\ For example, assume that on March 15, 2016, T gave property 
with a value of $6,000,000 to a trust for the benefit of T's 
descendants (Trust A) and T's entire then-remaining generation-skipping 
transfer tax exemption of $5,400,000 was allocated to trust A on a 
timely filed 2016 gift tax return. As of the date of the 2016 gift, 
Trust A has an inclusion ratio of 0.100 [1 - ($5,400,000/$6,000,000)]. 
On July 1, 2018, when the property in Trust A has a fair market value 
of $7,000,000, T files a gift tax return and allocates $700,000 of 
generation-skipping transfer tax exemption to Trust A, reducing Trust 
A's inclusion ratio from 0.100 to zero [1 - (($700,000 + (90% x 
$7,000,000)) / $7,000,000))], effective on July 1, 2018. Absent 
additional contributions to Trust A, the generation-skipping transfer 
tax on taxable distributions from, or a taxable termination with 
respect to, Trust A on or after July 1, 2018, is determined using an 
inclusion ratio of zero.
---------------------------------------------------------------------------
    As a conforming amendment to section 2001(g) (regarding 
computation of estate tax), the provision provides that the 
Secretary shall prescribe regulations as may be necessary or 
appropriate to carry out the purposes of the section with 
respect to differences between the basic exclusion amount in 
effect at the time of the decedent's death and at the time of 
any gifts made by the decedent. It is intended that such 
regulations will address in particular the computation of the 
estate tax where (1) a decedent dies in a year in which the 
basic exclusion amount is lower than the basic exclusion amount 
that was in effect when the decedent made taxable gifts during 
his or her life, and (2) such taxable gifts exceeded the basic 
exclusion amount in effect at the time of the decedent's death. 
Because the increase in the basic exclusion amount does not 
apply for estates of decedents dying after December 31, 2025, 
it is expected that this guidance will prevent the estate tax 
computation under section 2001(g) from recapturing, or 
``clawing back,'' all or a portion of the benefit of the 
increased basic exclusion amount used to offset gift tax for 
certain decedents who make taxable gifts between January 1, 
2018, and December 31, 2025, and die after December 31, 2025.

                             Effective Date

    The provision is effective for estates of decedents dying 
and gifts made after December 31, 2017.

       PART VII--EXTENSION OF TIME LIMIT FOR CONTESTING IRS LEVY


 A. Extension of Time Limit for Contesting IRS Levy (sec. 11071 of the 
                Act and secs. 6343 and 6532 of the Code)


                               Prior Law

    The IRS is authorized to return property that has been 
wrongfully levied upon.\373\ In general, monetary proceeds from 
the sale of levied property may be returned within nine months 
of the date of the levy.
---------------------------------------------------------------------------
    \373\ Sec. 6343.
---------------------------------------------------------------------------
    Generally, any person (other than the person against whom 
is assessed the tax out of which such levy arose) who claims an 
interest in levied property and that such property was 
wrongfully levied upon may bring a civil action for wrongful 
levy in a district court of the United States.\374\ Generally, 
an action for wrongful levy must be brought within nine months 
from the date of levy.\375\
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    \374\ Sec. 7426.
    \375\ Sec. 6532.
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                        Explanation of Provision

    The provision extends from nine months to two years the 
period for returning the monetary proceeds from the sale of 
property that has been wrongfully levied upon.
    The provision also extends from nine months to two years 
the period for bringing a civil action for wrongful levy.

                             Effective Date

    The provision is effective with respect to: (1) levies made 
after the date of enactment (December 22, 2017); and (2) levies 
made on or before the date of enactment provided that the nine-
month period has not expired as of the date of enactment.

                     PART VIII--INDIVIDUAL MANDATE

A. Elimination of Shared Responsibility Payment for Individuals Failing 
to Maintain Minimum Essential Coverage (sec. 11081 of the Act and sec. 
                           5000A of the Code)

                               Prior Law

    Under the Affordable Care Act,\376\ individuals must have 
minimum essential coverage, qualify for an exemption, or make a 
shared responsibility payment (also referred to as a tax or 
penalty) for failure to maintain the coverage (commonly 
referred to as the ``individual mandate'').\377\ Minimum 
essential coverage includes government-sponsored programs 
(including Medicare, Medicaid, and CHIP, among others), 
eligible employer-sponsored plans, plans in the individual 
market, grandfathered group health plans and grandfathered 
health insurance coverage, and other coverage as recognized by 
the Secretary of Health and Human Services (``HHS'') in 
coordination with the Secretary of the Treasury.\378\ The tax 
is imposed for any month that an individual does not have 
minimum essential coverage unless the individual qualifies for 
an exemption for the month as described below.
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    \376\ Patient Protection and Affordable Care Act, Pub. L. No. 111-
148, and Health Care and Education Reconciliation Act of 2010, Pub. L. 
No. 111-152.
    \377\ Sec. 5000A. If an individual is a dependent, as defined in 
section 152, of another taxpayer, the other taxpayer is liable for any 
tax for failure to maintain the required coverage with respect to the 
individual. Sec. 5000A(b)(3)(A).
    \378\ Sec. 5000A(f)(1). Minimum essential coverage does not include 
coverage that consists of only certain excepted benefits, such as 
limited scope dental and vision benefits or long-term care insurance 
offered under a separate policy, certificate, or contract. Sec. 
5000A(f)(3).
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    The tax for any calendar month is one-twelfth of the tax 
calculated as an annual amount. The annual amount is equal to 
the greater of a flat dollar amount or an excess income amount. 
The flat dollar amount is the lesser of (1) the sum of the 
individual annual dollar amounts for the members of the 
taxpayer's family and (2) 300 percent of the adult individual 
dollar amount. The individual adult annual dollar amount is 
$695 for 2017 and 2018.\379\ For an individual who has not 
attained age 18, the individual annual dollar amount is one 
half of the adult amount. The excess income amount is 2.5 
percent of the excess of the taxpayer's household income for 
the taxable year over the threshold amount of income for 
requiring the taxpayer to file an income tax return.\380\ The 
total annual household payment may not exceed the national 
average annual premium for bronze level health plans for the 
applicable family size offered through Exchanges that 
year.\381\
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    \379\ For years after 2016, the $695 amount is indexed to CPI-U, 
rounded to the next lowest multiple of $50.
    \380\ The threshold amount is the amount of gross income specified 
in section 6012(a)(1) with respect to the taxpayer for the taxable 
year.
    \381\ Sec. 5000A(c).
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    Exemptions from the requirement to maintain minimum 
essential coverage are provided if an individual, with respect 
to any month, is: (1) an individual for whom coverage is 
unaffordable because the required contribution exceeds 8.16 
percent of household income,\382\ (2) an individual with 
household income below the income tax return filing threshold, 
(3) a member of an Indian tribe, (4) a member of certain 
recognized religious sects or a health care sharing ministry, 
(5) not a citizen or national of the United States or an alien 
not lawfully present in the United States,\383\ (6) 
incarcerated, other than incarceration pending the disposition 
of charges, (7) an individual with a coverage gap for a 
continuous period of less than three months, or (8) determined 
by the Secretary of HHS to have suffered a hardship with 
respect to the capability to obtain coverage.\384\
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    \382\ For 2017. The rate applicable for 2018 is 8.05 percent of 
household income.
    \383\ In addition, certain individuals present or residing outside 
of the United States and bona fide residents of United States 
territories are deemed to maintain minimum essential coverage for any 
month in which the applicable requirements are met. Sec. 5000A(f)(4).
    \384\ Secs. 5000A(d) and (e).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision reduces the amount of the individual shared 
responsibility payment, enacted as part of the Affordable Care 
Act, to zero.

                             Effective Date

    The provision is effective for months beginning after 
December 31, 2018.

                  SUBTITLE B--ALTERNATIVE MINIMUM TAX


 A. Repeal of Tax for Corporations; Credit for Prior Year Minimum Tax 
 Liability of Corporations; Increased Exemption for Individuals (secs. 
       12001-12003 of the Act and secs. 53 and 55-59 of the Code)


                               Prior Law


Corporate alternative minimum tax

            In general
    An alternative minimum tax (``AMT'') is imposed on a 
corporation to the extent the corporation's tentative minimum 
tax exceeds its regular tax. This tentative minimum tax is 
computed at the rate of 20 percent on the AMTI in excess of a 
$40,000 exemption amount that phases out. The exemption amount 
is phased out by an amount equal to 25 percent of the amount 
that the corporation's AMTI exceeds $150,000.
    AMTI is the taxpayer's taxable income increased by certain 
preference items and adjusted by determining the tax treatment 
of certain items in a manner that negates the deferral of 
income resulting from the regular tax treatment of those items.
    A corporation with average gross receipts of less than $7.5 
million for the prior three taxable years is exempt from the 
corporate minimum tax. The $7.5 million threshold is reduced to 
$5 million for the corporation's first three-taxable year 
period.
            Preference items in computing AMTI
    The corporate minimum tax preference items are:
    1. The excess of the deduction for percentage depletion 
over the adjusted basis of the property at the end of the 
taxable year. This preference does not apply to percentage 
depletion allowed with respect to oil and gas properties.
    2. The amount by which excess intangible drilling costs 
arising in the taxable year exceed 65 percent of the net income 
from oil, gas, and geothermal properties. This preference does 
not apply to an independent producer to the extent the 
preference would not reduce the producer's AMTI by more than 40 
percent.
    3. Tax-exempt interest income on private activity bonds 
(other than qualified 501(c)(3) bonds, certain housing bonds, 
and bonds issued in 2009 and 2010) issued after August 7, 1986.
    4. Accelerated depreciation or amortization on certain 
property placed in service before January 1, 1987.
            Adjustments in computing AMTI
    The adjustments that corporations must make in computing 
AMTI are:
    1. Depreciation on property placed in service after 1986 
and before January 1, 1999, must be computed by using the 
generally longer class lives prescribed by the alternative 
depreciation system of section 168(g) and either (a) the 
straight-line method in the case of property subject to the 
straight-line method under the regular tax or (b) the 150-
percent declining balance method in the case of other property. 
Depreciation on property placed in service after December 31, 
1998, is computed by using the regular tax recovery periods and 
the AMT methods described in the previous sentence. 
Depreciation on property which is allowed ``bonus 
depreciation'' for the regular tax is computed without regard 
to any AMT adjustments.
    2. Mining exploration and development costs must be 
capitalized and amortized over a 10-year period.
    3. Taxable income from a long-term contract (other than a 
home construction contract) must be computed using the 
percentage of completion method of accounting.
    4. The amortization deduction allowed for pollution control 
facilities placed in service before January 1, 1999 (generally 
determined using 60-month amortization for a portion of the 
cost of the facility under the regular tax), must be calculated 
under the alternative depreciation system (generally, using 
longer class lives and the straight-line method). The 
amortization deduction allowed for pollution control facilities 
placed in service after December 31, 1998, is calculated using 
the regular tax recovery periods and the straight-line method.
    5. The special rules applicable to Merchant Marine 
construction funds are not applicable.
    6. The special deduction allowable under section 833(b) for 
Blue Cross and Blue Shield organizations is not allowed.
    7. The adjusted current earnings adjustment applies, as 
described below.
            Adjusted current earning (``ACE'') adjustment
    The adjusted current earnings adjustment is the amount 
equal to 75 percent of the amount by which the adjusted current 
earnings of a corporation exceed its AMTI (determined without 
the ACE adjustment and the alternative tax net operating loss 
deduction). In determining ACE the following rules apply:
    1. For property placed in service before 1994, depreciation 
generally is determined using the straight-line method and the 
class life determined under the alternative depreciation 
system.
    2. Amounts excluded from gross income under the regular tax 
but included for purposes of determining earnings and profits 
are generally included in determining ACE.
    3. The inside build-up of a life insurance contract is 
included in ACE (and the related premiums are deductible).
    4. Intangible drilling costs of integrated oil companies 
must be capitalized and amortized over a 60-month period.
    5. The regular tax rules of section 173 (allowing 
circulation expenses to be amortized) and section 248 (allowing 
organizational expenses to be amortized) do not apply.
    6. Inventory must be calculated using the FIFO, rather than 
LIFO, method.
    7. The installment sales method generally may not be used.
    8. No loss may be recognized on the exchange of any pool of 
debt obligations for another pool of debt obligations having 
substantially the same effective interest rates and maturities.
    9. Depletion (other than for oil and gas properties) must 
be calculated using the cost, rather than the percentage, 
method.
    10. In certain cases, the assets of a corporation that has 
undergone an ownership change must be stepped down to their 
fair market values.
            Other rules
    The taxpayer's net operating loss carryover generally 
cannot reduce the taxpayer's AMT liability by more than 90 
percent of AMTI determined without this deduction.
    The various nonrefundable business credits allowed under 
the regular tax generally are not allowed against the AMT. 
Certain exceptions apply.
    If a corporation is subject to AMT in any year, the amount 
of AMT is allowed as an AMT credit in any subsequent taxable 
year to the extent the taxpayer's regular tax liability exceeds 
its tentative minimum tax in the subsequent year. Corporations 
are allowed to claim a limited amount of AMT credits in lieu of 
bonus depreciation.
    A corporation may elect to write off certain expenditures 
paid or incurred with respect of circulation expenses, research 
and experimental expenses, intangible drilling and development 
expenditures, development expenditures, and mining exploration 
expenditures over a specified period (three years in the case 
of circulation expenses, 60 months in the case of intangible 
drilling and development expenditures, and 10 years in case of 
other expenditures). The election applies for purposes of both 
the regular tax and the alternative minimum tax.

Individual alternative minimum tax

            In general
    An AMT is also imposed on an individual, estate, or trust 
in an amount by which the tentative minimum tax exceeds the 
regular income tax for the taxable year. For taxable years 
beginning in 2017, the tentative minimum tax is the sum of (1) 
26 percent of so much of the taxable excess as does not exceed 
$187,800 ($93,900 in the case of a married individual filing a 
separate return) and (2) 28 percent of the remaining taxable 
excess. The breakpoints are indexed for inflation. 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 taxable income adjusted to take account of 
specified tax preferences and adjustments.
    The exemption amounts for taxable years beginning in 2017 
are: (1) $84,500 in the case of married individuals filing a 
joint return and surviving spouses; (2) $54,300 in the case of 
other unmarried individuals; (3) $42,250 in the case of married 
individuals filing separate returns; and (4) $24,100 in the 
case of an estate or trust. For taxable years beginning in 
2017, the exemption amounts are phased out by an amount equal 
to 25 percent of the amount by which the individual's AMTI 
exceeds (1) $160,900 in the case of married individuals filing 
a joint return and surviving spouses, (2) $120,700 in the case 
of other unmarried individuals, and (3) $80,450 in the case of 
married individuals filing separate returns or an estate or a 
trust. The amounts are indexed for inflation.
    AMTI is the taxpayer's taxable income increased by certain 
preference items and adjusted by determining the tax treatment 
of certain items in a manner that negates the deferral of 
income resulting from the regular tax treatment of those items.
            Preference items in computing AMTI
    The minimum tax preference items are:
    1. The excess of the deduction for percentage depletion 
over the adjusted basis of each mineral property (other than 
oil and gas properties) at the end of the taxable year.
    2. The amount by which excess intangible drilling costs 
(i.e., expenses in excess the amount that would have been 
allowable if amortized over a 10-year period) exceed 65 percent 
of the net income from oil, gas, and geothermal properties. 
This preference applies to independent producers only to the 
extent it reduces the producer's AMTI (determined without 
regard to this preference and the net operating loss deduction) 
by more than 40 percent.
    3. Tax-exempt interest income on private activity bonds 
(other than qualified 501(c)(3) bonds, certain housing bonds, 
and bonds issued in 2009 and 2010) issued after August 7, 1986.
    4. Accelerated depreciation or amortization on certain 
property placed in service before January 1, 1987.
    5. Seven percent of the amount excluded from income under 
section 1202 (relating to gains on the sale of certain small 
business stock).
    In addition, losses from any tax shelter farm activity or 
passive activities are not taken into account in computing 
AMTI.
            Adjustments in computing AMTI
    The adjustments that individuals must make to compute AMTI 
are:
    1. Depreciation on property placed in service after 1986 
and before January 1, 1999, is computed by using the generally 
longer class lives prescribed by the alternative depreciation 
system of section 168(g) and either (a) the straight-line 
method in the case of property subject to the straight-line 
method under the regular tax or (b) the 150-percent declining 
balance method in the case of other property. Depreciation on 
property placed in service after December 31, 1998, is computed 
by using the regular tax recovery periods and the AMT methods 
described in the previous sentence. Depreciation on property 
acquired after September 10, 2001, which is allowed an 
additional allowance under section 168(k) for the regular tax 
is computed without regard to any AMT adjustments.
    2. Mining exploration and development costs are capitalized 
and amortized over a 10-year period.
    3. Taxable income from a long-term contract (other than a 
home construction contract) is computed using the percentage of 
completion method of accounting.
    4. The amortization deduction allowed for pollution control 
facilities placed in service before January 1, 1999 (generally 
determined using 60-month amortization for a portion of the 
cost of the facility under the regular tax), is calculated 
under the alternative depreciation system (generally, using 
longer class lives and the straight-line method). The 
amortization deduction allowed for pollution control facilities 
placed in service after December 31, 1998, is calculated using 
the regular tax recovery periods and the straight-line method.
    5. Miscellaneous itemized deductions are not allowed.
    6. Itemized deductions for State, local, and foreign real 
property taxes; State and local personal property taxes; State, 
local, and foreign income, war profits, and excess profits 
taxes; and State and local sales taxes are not allowed.
    7. Medical expenses are allowed only to the extent they 
exceed 10 percent of the taxpayer's adjusted gross income.
    8. Deductions for interest on home equity loans are not 
allowed.
    9. The standard deduction and the deduction for personal 
exemptions are not allowed.
    10. The amount allowable as a deduction for circulation 
expenditures is capitalized and amortized over a three-year 
period.
    11. The amount allowable as a deduction for research and 
experimentation expenditures from passive activities is 
capitalized and amortized over a 10-year period.
    12. The regular tax rules relating to incentive stock 
options do not apply.
            Other rules
    The taxpayer's net operating loss deduction generally 
cannot reduce the taxpayer's AMTI by more than 90 percent of 
the AMTI (determined without the net operating loss deduction).
    The alternative minimum tax foreign tax credit reduces the 
tentative minimum tax.
    The various nonrefundable business credits allowed under 
the regular tax generally are not allowed against the AMT. 
Certain exceptions apply.
    If an individual is subject to AMT in any year, the amount 
of tax exceeding the taxpayer's regular tax liability is 
allowed as a credit (the ``AMT credit'') in any subsequent 
taxable year to the extent the taxpayer's regular tax liability 
exceeds his or her tentative minimum tax liability in such 
subsequent year. The AMT credit is allowed only to the extent 
that the taxpayer's AMT liability is the result of adjustments 
that are timing in nature. The individual AMT adjustments 
relating to itemized deductions and personal exemptions are not 
timing in nature, and no minimum tax credit is allowed with 
respect to these items.
    An individual may elect to write off certain expenditures 
paid or incurred with respect of circulation expenses, research 
and experimental expenses, intangible drilling and development 
expenditures, development expenditures, and mining exploration 
expenditures over a specified period (three years in the case 
of circulation expenses, 60 months in the case of intangible 
drilling and development expenditures, and 10 years in case of 
other expenditures). The election applies for purposes of both 
the regular tax and the alternative minimum tax.

                        Explanation of Provision


Corporate alternative minimum tax

    The provision repeals the corporate alternative minimum 
tax.
    In the case of a corporation, the provision allows the AMT 
credit to offset the entire regular tax liability for a taxable 
year. In addition, the AMT credit is allowable and is 
refundable for a taxable year beginning after 2017 and before 
2022 in an amount equal to 50 percent (100 percent in the case 
of taxable years beginning in 2021) of the excess (if any) of 
the minimum tax credit for the taxable year over the amount of 
the credit allowed for the year against regular tax liability. 
For taxable years beginning after 2021, the amount of the 
minimum tax credit in the case of a corporation will be zero.

Individual alternative minimum tax

    The provision temporarily increases the exemption amounts 
and the exemption amount phase-out thresholds for the 
individual AMT. For taxable years beginning after December 31, 
2017, and beginning before January 1, 2026, the exemption 
amount is increased to $109,400 for married taxpayers filing a 
joint return and surviving spouses (half this amount for 
married taxpayers filing a separate return), and $70,300 for 
all other taxpayers (other than estates and trusts). The phase-
out threshold is increased to $1,000,000 for married taxpayers 
filing a joint return and surviving spouses, and $500,000 for 
all other taxpayers (other than estates and trusts). These 
amounts are indexed for inflation.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.
                SUBTITLE C--BUSINESS-RELATED PROVISIONS


                      PART I--CORPORATE PROVISIONS


A. 21-Percent Corporate Tax Rate (sec. 13001 of the Act and sec. 11 of 
                               the Code)


                               Prior Law

    Corporate taxable income is subject to tax under a four-
step graduated rate structure.\385\ The top corporate tax rate 
is 35 percent on taxable income in excess of $10 million. The 
corporate taxable income brackets and tax rates are as set 
forth in the table below.
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    \385\ Secs. 11(a) and (b)(1).

------------------------------------------------------------------------
                  Taxable income                     Tax rate (percent)
------------------------------------------------------------------------
Not over $50,000.................................                    15
Over $50,000 but not over $75,000................                    25
Over $75,000 but not over $10,000,000............                    34
Over $10,000,000.................................                    35
------------------------------------------------------------------------

    An additional five-percent tax is imposed on a 
corporation's taxable income in excess of $100,000. The maximum 
additional tax is $11,750. Also, a second additional three-
percent tax is imposed on a corporation's taxable income in 
excess of $15 million. The maximum second additional tax is 
$100,000.
    Certain personal service corporations pay tax on their 
entire taxable income at the rate of 35 percent.\386\
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    \386\ Sec. 11(b)(2).
---------------------------------------------------------------------------
    If the maximum corporate tax rate exceeds 35 percent, the 
maximum rate on a corporation's net capital gain will be 35 
percent.\387\
---------------------------------------------------------------------------
    \387\ Sec. 1201(a).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision taxes corporate taxable income at 21 percent, 
eliminating the graduated corporate rate structure and the 
special rate for personal service corporations.
    The provision repeals the maximum corporate tax rate on net 
capital gain as obsolete.
    In addition, for taxpayers subject to the normalization 
method of accounting (e.g., regulated public utilities), the 
provision clarifies the normalization of excess tax reserves 
resulting from the reduction of the corporate income tax rate 
(with respect to prior depreciation or recovery allowances 
taken on assets placed in service as of the day before the 
corporate rate reduction takes effect).
    The excess tax reserve is the excess of the reserve for 
deferred taxes as of the day before the corporate rate 
reduction takes effect over what the reserve for deferred taxes 
would be if the corporate rate reduction had been in effect for 
all prior periods. If an excess tax reserve is reduced more 
rapidly or to a greater extent than such reserve would be 
reduced under the average rate assumption method, the taxpayer 
will not be treated as using a normalization method with 
respect to the corporate rate reduction. If the taxpayer does 
not use a normalization method of accounting for the corporate 
rate reduction, the taxpayer's tax for the taxable year shall 
be increased by the amount by which it reduces its excess tax 
reserve more rapidly than permitted under a normalization 
method of accounting and the taxpayer will not be treated as 
using a normalization method of accounting for purposes of 
section 168(f)(2) and (i)(9)(C).\388\
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    \388\ Section 168(f)(2) and (i)(9)(C) provide that if a taxpayer is 
required to use a normalization method of accounting with respect to 
public utility property and does not do so, such taxpayer must compute 
its depreciation allowances for Federal income tax purposes using the 
depreciation method, useful life determination, averaging convention, 
and salvage value limitation used for purposes of setting rates and 
reflecting operating results in its regulated books of account.
---------------------------------------------------------------------------
    The average rate assumption method \389\ reduces the excess 
tax reserve over the remaining regulatory lives of the property 
that gave rise to the reserve for deferred taxes during the 
years in which the deferred tax reserve related to such 
property is reversing. Under this method, the excess tax 
reserve is reduced as the timing differences (i.e., differences 
between tax depreciation and regulatory depreciation with 
respect to the property) reverse over the remaining life of the 
asset. The reversal of timing differences generally occurs when 
the amount of the tax depreciation taken with respect to an 
asset is less than the amount of the regulatory depreciation 
taken with respect to the asset. To ensure that the deferred 
tax reserve, including the excess tax reserve, is reduced to 
zero at the end of the regulatory life of the asset that 
generated the reserve, the amount of the timing difference 
which reverses during a taxable year is multiplied by the ratio 
of (1) the aggregate deferred taxes as of the beginning of the 
period in question to (2) the aggregate timing differences for 
the property as of the beginning of the period in question.
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    \389\ See sec. 2.04 of Rev. Proc. 88-12, 1988-1 C.B. 637.
---------------------------------------------------------------------------
    The following example illustrates the application of the 
average rate assumption method. A calendar year regulated 
utility placed property costing $100 million in service in 
2016. For regulatory (book) purposes, the property is 
depreciated over 10 years on a straight line basis with a full 
year's allowance in the first year. For tax purposes, the 
property is depreciated over five years using the 200 percent 
declining balance method and a half-year placed in service 
convention.\390\
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    \390\ The five-year tax and 10-year book lives are used for 
illustration purposes only. In general, public utility property may be 
depreciated over various periods ranging from five to 20 years under 
MACRS. For regulatory purposes, public utility property may, in certain 
cases, have a useful life of 30 years or more.
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    The excess tax reserve as of December 31, 2017, the day 
before the corporate rate reduction takes effect, is $4.5 
million.\391\ The taxpayer will begin taking the excess tax 
reserve into account in the 2021 taxable year, which is the 
first year in which the tax depreciation taken with respect to 
the property is less than the depreciation reflected in the 
regulated books of account. The annual adjustment to the 
deferred tax reserve for the 2021 through 2025 taxable years is 
multiplied by 31.1 percent, which is the ratio of the aggregate 
deferred taxes as of the beginning of 2021 ($13.77 million) to 
the aggregate timing differences for the property as of the 
beginning of 2021 ($44.24 million).
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    \391\ The excess tax reserve of $4.5 million is equal to the 
cumulative deferred tax reserve as of December 31, 2017 ($11.2 million) 
minus the cumulative timing difference as of December 31, 2017 ($32 
million) multiplied by 21 percent.

                                                                     NORMALIZATION CALCULATION FOR CORPORATE RATE REDUCTION
                                                                                      [Millions of dollars]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                      Year(s)
                                                  ----------------------------------------------------------------------------------------------------------------------------------------------
                                                       2016         2017         2018         2019         2020         2021         2022         2023         2024         2025         Total
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
 Tax expense.....................................        20.00        32.00        19.20        11.52        11.52         5.76         0.00         0.00         0.00         0.00       100.00
 Book depreciation...............................        10.00        10.00        10.00        10.00        10.00        10.00        10.00        10.00        10.00        10.00       100.00
 Timing difference...............................        10.00        22.00         9.20         1.52         1.52        -4.24       -10.00       -10.00       -10.00       -10.00         0.00
 Tax rate........................................       35.00%       35.00%       21.00%       21.00%       21.00%       31.13%       31.13%       31.13%       31.13%       31.13%
 Annual adjustment to reserve....................         3.50         7.70         1.93         0.32         0.32        -1.32        -3.11        -3.11        -3.11        -3.11         0.00
 Cumulative deferred tax reserve.................         3.50        11.20        13.13        13.45        13.77        12.45         9.34         6.23         3.11         0.00         0.00
 Annual adjustment at 21%........................  ...........  ...........  ...........  ...........  ...........       (0.89)       (2.10)       (2.10)       (2.10)       (2.10)       (9.29)
 Annual adjustment at average rate...............  ...........  ...........  ...........  ...........  ...........       (1.32)       (3.11)       (3.11)       (3.11)       (3.11)      (13.77)
 Excess tax reserve..............................  ...........  ...........  ...........  ...........  ...........         0.43         1.01         1.01         1.01         1.01         4.48
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
* Details may not add to totals due to rounding.

    Instead of the average rate assumption method, a taxpayer 
may also use the alternative method as its normalization method 
if certain requirements are met. If, as of the first day of the 
taxable year that includes December 22, 2017 (i.e., the date of 
enactment of the Act), (i) the taxpayer was required by a 
regulatory agency to compute depreciation for public utility 
property on the basis of an average life or composite rate 
method, and (ii) the taxpayer's books and underlying records do 
not contain the vintage account data necessary to apply the 
average rate assumption method,\392\ the taxpayer is treated as 
using a normalization method of accounting if, with respect to 
such jurisdiction, the taxpayer uses the alternative method for 
public utility property that is subject to the regulatory 
authority for that jurisdiction.\393\ Under the alternative 
method, the taxpayer (i) computes the excess tax reserve on all 
public utility property included in the plant account based on 
the weighted average life or composite rate used to compute 
depreciation for regulatory purposes, and (ii) reduces the 
excess tax reserve ratably over the remaining regulatory life 
of the property.\394\
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    \392\ See sec. 2.05 of Rev. Proc. 88-12, 1988-1 C.B. 637.
    \393\ If a taxpayer is subject to the jurisdiction of more than one 
regulatory body, the determination of the adequacy of the vintage 
accounting records for each asset or group of assets shall be 
determined on a jurisdiction-by-jurisdiction basis. See sec. 3 of Rev. 
Proc. 88-12, 1988-1 C.B. 637.
    \394\ See, e.g., sec. 4 of Rev. Proc. 88-12, 1988-1 C.B. 637.
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

B. Reduction in Dividends-Received Deduction to Reflect Lower Corporate 
   Income Tax Rates (sec. 13002 of the Act and sec. 243 of the Code)


                               Prior Law

    Corporations are allowed a deduction with respect to 
dividends received from other taxable domestic 
corporations.\395\ The amount of the deduction is generally 
equal to 70 percent of the dividend received.
---------------------------------------------------------------------------
    \395\ Sec. 243(a). These dividends are taxed at a maximum rate of 
10.5 percent (30 percent of the top corporate tax rate of 35 percent).
---------------------------------------------------------------------------
    In the case of any dividend received from a 20-percent 
owned corporation, the amount of the deduction is equal to 80 
percent of the dividend received.\396\ The term ``20-percent 
owned corporation'' means any corporation if 20 percent or more 
of the stock of such corporation (by vote and value) is owned 
by the taxpayer. For this purpose, certain preferred stock is 
not taken into account.
---------------------------------------------------------------------------
    \396\ Sec. 243(c). These dividends are taxed at a maximum rate of 
seven percent (20 percent of the top corporate tax rate of 35 percent).
---------------------------------------------------------------------------
    In the case of a dividend received from a corporation that 
is a member of the same affiliated group, a corporation is 
generally allowed a deduction equal to 100 percent of the 
dividend received.\397\
---------------------------------------------------------------------------
    \397\ Secs. 243(a)(3) and (b)(1). For this purpose, the term 
``affiliated group'' generally has the meaning given such term by 
section 1504(a). Sec. 243(b)(2).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision reduces the 70 percent dividends-received 
deduction to 50 percent and the 80 percent dividends-received 
deduction to 65 percent.\398\
---------------------------------------------------------------------------
    \398\ These dividends would be taxed at a maximum rate of 10.5 
percent (50 percent of the top corporate tax rate of 21 percent) and 
7.35 percent (35 percent of the top corporate tax rate of 21 percent), 
respectively.
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                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

                    PART II--SMALL BUSINESS REFORMS

  A. Modifications of Rules for Expensing Depreciable Business Assets 
            (sec. 13101 of the Act and sec. 179 of the Code)

                               Prior Law

    A taxpayer generally must capitalize the cost of property 
used in a trade or business or held for the production of 
income and recover such cost over time through annual 
deductions for depreciation or amortization.\399\ The period 
for depreciation or amortization generally begins when the 
asset is placed in service by the taxpayer.\400\ Tangible 
property generally is depreciated under the modified 
accelerated cost recovery system (``MACRS''), which determines 
depreciation for different types of property based on an 
assigned applicable depreciation method, recovery period,\401\ 
and convention.\402\
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    \399\ See secs. 263(a) and 167. In general, only the tax owner of 
property (i.e., the taxpayer with the benefits and burdens of 
ownership) is entitled to claim tax benefits such as cost recovery 
deductions with respect to the property. In addition, where property is 
not used exclusively in a taxpayer's business, the amount eligible for 
a deduction must be reduced by the amount related to personal use. See, 
e.g., sec. 280A.
    \400\ See Treas. Reg. secs. 1.167(a)-10(b), -3, -14, and 1.197-
2(f). See also Treas. Reg. sec. 1.167(a)-11(e)(1)(i).
    \401\ The applicable recovery period for an asset is determined in 
part by statute and in part by historic Treasury guidance. Exercising 
authority granted by Congress, the Secretary issued Rev. Proc. 87-56, 
1987-2 C.B. 674, laying out the framework of recovery periods for 
enumerated classes of assets. The Secretary clarified and modified the 
list of asset classes in Rev. Proc. 88-22, 1988-1 C.B. 785. In November 
1988, Congress revoked the Secretary's authority to modify the class 
lives of depreciable property. Rev. Proc. 87-56, as modified, remains 
in effect except to the extent that the Congress has, since 1988, 
statutorily modified the recovery period for certain depreciable 
assets, effectively superseding any administrative guidance with regard 
to such property.
    \402\ Sec. 168.
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Election to expense certain depreciable business assets
    A taxpayer may elect under section 179 to deduct (or 
``expense'') the cost of qualifying property, rather than to 
recover such costs through depreciation deductions, subject to 
limitation. The maximum amount a taxpayer may expense is 
$500,000 of the cost of qualifying property placed in service 
for the taxable year.\403\ The $500,000 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 
$2,000,000.\404\ The $500,000 and $2,000,000 amounts are 
indexed for inflation for taxable years beginning after 
2015.\405\
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    \403\ Sec. 179(b)(1).
    \404\ Sec. 179(b)(2).
    \405\ Sec. 179(b)(6). For taxable years beginning in 2017, the 
total amount that may be expensed is $510,000 ($545,000 for qualified 
enterprise zone property under section 1397A), and the phase-out 
threshold amount is $2,030,000. See Section 3.25 of Rev. Proc. 2016-55, 
2016-45 I.R.B. 707. For example, assume that during 2017 a calendar 
year taxpayer purchases and places in service $2,500,000 of section 179 
property. The $510,000 section 179(b)(1) dollar amount for 2017 is 
reduced by the excess section 179 property cost amount of $470,000 
($2,500,000 - $2,030,000). The taxpayer's 2017 section 179 expensing 
limitation is $40,000 ($510,000 - $470,000). Note, however, that the 
taxpayer's remaining basis in the property may be eligible for bonus 
depreciation under section 168(k). See Treas. Reg. sec. 1.168(k)-
1(a)(2)(iii). For a discussion of changes made to section 168(k) by the 
Act, see the description of section 13201 of the Act (Temporary 100-
Percent Expensing for Certain Business Assets).
---------------------------------------------------------------------------
    In general, qualifying property is defined as depreciable 
tangible personal property \406\ that is purchased for use in 
the active conduct of a trade or business. Qualifying property 
also includes off-the-shelf computer software and qualified 
real property (i.e., qualified leasehold improvement property, 
qualified restaurant property, and qualified retail improvement 
property).\407\ Qualifying property excludes any property 
described in section 50(b) (i.e., certain property not eligible 
for the investment tax credit).\408\
---------------------------------------------------------------------------
    \406\ For example, qualifying property includes a portable air 
conditioning or heating unit (such as a window air conditioning unit or 
portable plug-in unit heater), but generally excludes any component of 
a central air conditioning or heating system of a building as such 
property represents real property (i.e., is a structural component of a 
building). See Treas. Reg. sec. 1.48-1(e)(2) and sec. 3.03(1) of Rev. 
Proc. 2017-33, 2017-19 I.R.B. 1236.
    \407\ Sec. 179(d)(1)(A)(ii) and (f), as in effect prior to the 
enactment of the Consolidated Appropriations Act, 2018, Pub. L. No. 
115-141, sec. 401(b)(15), March 23, 2018, which, as part of repealing 
general deadwood-related provisions, struck former subsection (e) 
(relating to special rules for qualified disaster assistance property) 
and redesignated ``subsection (f)'' as ``subsection (e)''. Thus, if a 
component of a central air conditioning or heating system of a building 
meets the definition of qualified real property under section 179 
(e.g., constitutes qualified restaurant property), the component may 
qualify as section 179 property if the taxpayer so elects. See sec. 
3.03(2) of Rev. Proc. 2017-33.
    \408\ Sec. 179(d)(1) flush language. Property described in section 
50(b) is generally property used outside the United States, certain 
property used for lodging, property used by certain tax-exempt 
organizations, and property used by governmental units and foreign 
persons or entities.
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    Passenger automobiles subject to the section 280F 
limitation are eligible for section 179 expensing only to the 
extent of the dollar limitations in section 280F.\409\ For 
sport utility vehicles above the 6,000 pound weight rating and 
not more than the 14,000 pound weight rating, which are not 
subject to the limitation under section 280F, the maximum cost 
that may be expensed for any taxable year under section 179 is 
$25,000 (the ``sport utility vehicle limitation'').\410\
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    \409\ For a discussion of changes made to section 280F by the Act, 
see the description of section 13202 of the Act (Modifications to 
Depreciation Limitations on Luxury Automobiles and Personal Use 
Property).
    \410\ Sec. 179(b)(5). 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.
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    The amount eligible to be expensed for a taxable year may 
not exceed the taxable income for such taxable year that is 
derived from the active conduct of a trade or business 
(determined without regard to this provision).\411\ 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 limitations).
---------------------------------------------------------------------------
    \411\ Sec. 179(b)(3).
---------------------------------------------------------------------------
    Amounts expensed under section 179 are allowed for both 
regular tax and the alternative minimum tax.\412\ However, no 
general business credit under section 38 is allowed with 
respect to any amount for which a deduction is allowed under 
section 179.\413\ In addition, if a corporation makes an 
election under section 179 to deduct expenditures, the full 
amount of the deduction does not reduce earnings and profits. 
Rather, the expenditures that are deducted under section 179 
reduce corporate earnings and profits ratably over a five-year 
period.\414\
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    \412\ See the Senate Finance Committee Report to Accompany H.R. 
3838, Tax Reform Act of 1986, S. Rep. No. 99-313, May 29, 1985, p. 522. 
See also the Instructions for Form 6251, Alternative Minimum Tax - 
Individuals (2017), p. 6.
    \413\ Sec. 179(d)(9).
    \414\ Sec. 312(k)(3)(B).
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    An expensing election is made under rules prescribed by the 
Secretary.\415\ In general, any election made under section 
179, and any specification contained therein, may be revoked by 
the taxpayer with respect to any property without the consent 
of the Commissioner.\416\ Such revocation, once made, is 
irrevocable.
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    \415\ Sec. 179(c)(1). Such election may be made on an amended 
return. See sec. 3.02 of Rev. Proc. 2017-33.
    \416\ Sec. 179(c)(2).
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                        Explanation of Provision

    The provision increases the maximum amount a taxpayer may 
expense under section 179 to $1,000,000, and increases the 
phase-out threshold amount to $2,500,000. Thus, the provision 
provides that the maximum amount a taxpayer may expense for 
taxable years beginning after 2017 is $1,000,000 of the cost of 
section 179 property placed in service for the taxable year. 
The $1,000,000 amount is reduced (but not below zero) by the 
amount by which the cost of section 179 property placed in 
service during the taxable year exceeds $2,500,000.\417\ The 
$1,000,000 and $2,500,000 amounts, as well as the $25,000 sport 
utility vehicle limitation (amount unchanged by the Act), are 
indexed for inflation for taxable years beginning after 2018.
---------------------------------------------------------------------------
    \417\ For example, assume that during 2018 a calendar-year taxpayer 
purchases and places in service $3,000,000 of section 179 property. The 
$1,000,000 section 179(b)(1) dollar amount for 2018 is reduced by the 
excess section 179 property cost amount of $500,000 ($3,000,000 - 
$2,500,000). The taxpayer's 2018 section 179 expensing limitation is 
$500,000 ($1,000,000 - $500,000). Note, however, that the taxpayer's 
remaining basis in the property may be eligible for bonus depreciation 
under section 168(k). See Treas. Reg. sec. 1.168(k)-1(a)(2)(iii). For a 
discussion of changes made to section 168(k) by the Act, see the 
description of section 13201 of the Act (Temporary 100-Percent 
Expensing for Certain Business Assets).
---------------------------------------------------------------------------
    The provision expands the definition of section 179 
property to include certain depreciable tangible personal 
property used predominantly to furnish lodging or in connection 
with furnishing lodging.\418\
---------------------------------------------------------------------------
    \418\ As defined in section 50(b)(2). Property used predominantly 
to furnish lodging or in connection with furnishing lodging generally 
includes, for example, beds and other furniture, refrigerators, ranges, 
and other equipment used in the living quarters of a lodging facility 
such as an apartment house, dormitory, or any other facility (or part 
of a facility) where sleeping accommodations are provided and let. See 
Treas. Reg. sec. 1.48-1(h).
---------------------------------------------------------------------------
    As a conforming amendment to the elimination by the Act of 
the separate definitions of qualified leasehold improvement 
property, qualified restaurant property, and qualified retail 
improvement property under section 168,\419\ the provision 
replaces the references in section 179(f) \420\ to qualified 
leasehold improvement property, qualified restaurant property, 
and qualified retail improvement property within the definition 
of qualified real property with a reference to qualified 
improvement property. Thus, for example, the provision allows 
section 179 expensing for qualified improvement property 
without regard to whether the improvements are property subject 
to a lease, placed in service more than three years after the 
date the building was first placed in service, or made to a 
restaurant building. Restaurant building property placed in 
service after December 31, 2017, that does not meet the 
definition of qualified improvement property is not eligible 
for section 179 expensing.
---------------------------------------------------------------------------
    \419\ See the description of section 13204 of the Act (Applicable 
Recovery Period for Real Property).
    \420\ As in effect prior to the enactment of the Consolidated 
Appropriations Act, 2018, Pub. L. No. 115-141, sec. 401(b)(15), March 
23, 2018, which, as part of repealing general deadwood-related 
provisions, struck former subsection (e) (relating to special rules for 
qualified disaster assistance property) and redesignated ``subsection 
(f)'' as ``subsection (e)''.
---------------------------------------------------------------------------
    The provision also expands the definition of qualified real 
property eligible for section 179 expensing to include any of 
the following improvements made by the taxpayer \421\ to 
nonresidential real property and placed in service after the 
date such nonresidential real property was first placed in 
service: roofs; heating, ventilation, and air-conditioning 
property; \422\ fire protection and alarm systems; and security 
systems. Thus, such improvements do not need to meet the 
definition of qualified improvement property to be eligible for 
section 179 expensing.
---------------------------------------------------------------------------
    \421\ A technical correction may be necessary to reflect this 
intent.
    \422\ Heating, ventilation, and air-conditioning property includes 
all components (whether in, on, or adjacent to the building) of a 
central air conditioning or heating system, including motors, 
compressors, pipes and ducts. Treas. Reg. sec. 1.48-1(e)(2).
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                             Effective Date

    The provision applies to property placed in service in 
taxable years beginning after December 31, 2017.

  B. Small Business Accounting Method Reform and Simplification (sec. 
    13102 of the Act and secs. 263A, 448, 460, and 471 of the Code)


                               Prior Law


General rule for methods of accounting

    Section 446 generally allows a taxpayer to select the 
method of accounting to be used to compute taxable income, 
provided that such method clearly reflects the income of the 
taxpayer. The term ``method of accounting'' includes not only 
the overall method of accounting used by the taxpayer, but also 
the accounting treatment of any one item.\423\ Permissible 
overall methods of accounting include the cash receipts and 
disbursements method (``cash method''), an accrual method, or 
any other method (including a hybrid method) permitted under 
regulations prescribed by the Secretary.\424\ Examples of any 
one item for which an accounting method may be adopted include 
cost recovery,\425\ revenue recognition,\426\ and the timing of 
deductions.\427\ For each separate trade or business, a 
taxpayer is entitled to adopt any permissible method, subject 
to certain restrictions.\428\
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    \423\ Treas. Reg. sec. 1.446-1(a)(1).
    \424\ Sec. 446(c).
    \425\ See, e.g., secs. 167 and 168.
    \426\ See, e.g., secs. 451 and 460.
    \427\ See, e.g., secs. 461 and 467.
    \428\ Sec. 446(d); Treas. Reg. sec. 1.446-1(d).
---------------------------------------------------------------------------
    A taxpayer filing its first return may adopt any 
permissible method of accounting in computing taxable income 
for such year.\429\ Except as otherwise provided, section 
446(e) requires taxpayers to secure the consent of the 
Secretary before changing a method of accounting. The 
regulations under this section provide rules for determining: 
(1) what a method of accounting is, (2) how a method of 
accounting is adopted,\430\ and (3) how a change in method of 
accounting is effectuated.\431\
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    \429\ Treas. Reg. sec. 1.446-1(e)(1).
    \430\ See also Rev. Rul. 90-38, 1990-1 C.B. 57 (holding that a 
taxpayer adopts a method of accounting (1) when it uses a permissible 
method of accounting on a single tax return, or (2) when it uses the 
same impermissible method of accounting on two or more consecutive tax 
returns).
    \431\ Treas. Reg. sec. 1.446-1(e).
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Cash and accrual methods 

    Taxpayers using the cash method generally recognize items 
of income when actually or constructively received and items of 
expense when paid. The cash method is administratively easy and 
provides the taxpayer flexibility in the timing of income 
recognition. It is the method generally used by most individual 
taxpayers, including farm and nonfarm sole proprietorships.
    Taxpayers using an accrual method generally accrue items of 
income when all the events have occurred that fix the right to 
receive the income and the amount of the income can be 
determined with reasonable accuracy.\432\ Taxpayers using an 
accrual method of accounting generally may not deduct items of 
expense prior to when all the events have occurred that fix the 
obligation to pay the liability, the amount of the liability 
can be determined with reasonable accuracy, and economic 
performance has occurred.\433\ Accrual methods of accounting 
generally result in a more accurate measure of economic income 
than does the cash method. The accrual method is often used by 
businesses for financial accounting purposes.
---------------------------------------------------------------------------
    \432\ See, e.g., sec. 451. For a discussion of changes made to 
section 451 by the Act, see the description of section 13221 of the Act 
(Certain Special Rules for Taxable Year of Inclusion).
    \433\ See, e.g., sec. 461.
---------------------------------------------------------------------------
    A C corporation, a partnership that has a C corporation as 
a partner, or a tax-exempt trust or corporation with unrelated 
business income generally may not use the cash method. 
Exceptions are made for farming businesses, qualified personal 
service corporations, and the aforementioned entities to the 
extent their average annual gross receipts \434\ do not exceed 
$5 million for all prior years (including the prior taxable 
years of any predecessor of the entity) (the ``gross receipts 
test''). The cash method may not be used by any tax 
shelter.\435\ In addition, the cash method generally may not be 
used if the purchase, production, or sale of merchandise is an 
income producing factor.\436\ Such taxpayers generally are 
required to keep inventories and use an accrual method with 
respect to inventory items.\437\
---------------------------------------------------------------------------
    \434\ For this purpose, gross receipts are taken into account in 
the taxable year in which they are properly recognized under the 
taxpayer's method of accounting used in that taxable year. Gross 
receipts include total sales (net of returns and allowances) and all 
amounts received for services. In addition, gross receipts include 
income from investments, income from incidental or outside sources, 
interest (including original issue discount and tax-exempt interest 
within the meaning of section 103), dividends, rents, royalties, and 
annuities, regardless of whether such amounts are derived in the 
ordinary course of the taxpayer's trade or business. Gross receipts are 
not reduced by cost of goods sold or by the cost of property sold if 
such property is described in section 1221(1), (3), (4), or (5). With 
respect to sales of capital assets as defined in section 1221, or sales 
of property described in section 1221(2) (relating to property used in 
a trade or business), gross receipts are reduced by the taxpayer's 
adjusted basis in such property. Gross receipts do not include the 
repayment of a loan or similar instrument (e.g., a repayment of the 
principal amount of a loan held by a commercial lender). Finally, gross 
receipts do not include amounts received by the taxpayer with respect 
to sales tax or other similar State and local taxes if, under the 
applicable State or local law, the tax is legally imposed on the 
purchaser of the good or service, and the taxpayer merely collects and 
remits the tax to the taxing authority. If, in contrast, the tax is 
imposed on the taxpayer under the applicable law, then gross receipts 
include the amounts received that are allocable to the payment of such 
tax. See section 448(c)(3)(C) and Treas. Reg. sec. 1.448-1T(f)(2)(iv).
    \435\ Secs. 448(a)(3) and (d)(3) and 461(i)(3) and (4). For this 
purpose, a tax shelter includes: (1) any enterprise (other than a C 
corporation) if at any time interests in such enterprise have been 
offered for sale in any offering required to be registered with any 
Federal or State agency having the authority to regulate the offering 
of securities for sale; (2) any syndicate (within the meaning of 
section 1256(e)(3)(B)); or (3) any tax shelter as defined in section 
6662(d)(2)(C)(ii). In the case of a farming trade or business, a tax 
shelter includes any tax shelter as defined in section 
6662(d)(2)(C)(ii) or any partnership or any other enterprise other than 
a corporation which is not an S corporation engaged in the trade or 
business of farming, (1) if at any time interests in such partnership 
or enterprise have been offered for sale in any offering required to be 
registered with any Federal or State agency having authority to 
regulate the offering of securities for sale or (2) if more than 35 
percent of the losses during any period are allocable to limited 
partners or limited entrepreneurs. For this purpose, certain holdings 
held directly by individuals that are attributable to active farm 
management activities are not treated as being held by a limited 
partner or a limited entrepreneur. See the second section 461(j) 
(relating to farming syndicate defined), as in effect prior to the 
enactment of the Consolidated Appropriations Act, 2018, Pub. L. No. 
115-141, section 401(a)(117), March 23, 2018, which, as part of 
repealing general deadwood-related provisions, redesignated the second 
``subsection (j)'' (relating to farming syndicate defined) as 
``subsection (k)''.
    \436\ Treas. Reg. secs. 1.446-1(c)(2) and 1.471-1.
    \437\ Sec. 471 and Treas. Reg. secs. 1.446-1(c)(2) and 1.471-1.
---------------------------------------------------------------------------
    A farming business is defined as a trade or business of 
farming, including operating a nursery or sod farm, or the 
raising or harvesting of trees bearing fruit, nuts, or other 
crops, timber, or ornamental trees (other than evergreen trees 
that are more than six years old at the time they are severed 
from their roots).\438\ Such farming businesses are not 
precluded from using the cash method regardless of whether they 
meet the gross receipts test. However, section 447 generally 
requires a farming C corporation (and any farming partnership 
if a corporation is a partner in such partnership) to use an 
accrual method of accounting. Section 447 does not apply to 
nursery or sod farms, to the raising or harvesting of trees 
(other than fruit and nut trees), nor to farming C corporations 
meeting a gross receipts test with a $1 million threshold. For 
family farm C corporations, the threshold under the gross 
receipts test is $25 million.
---------------------------------------------------------------------------
    \438\ Secs. 448(d)(1) and 263A(e)(4). See also Treas. Reg. sec. 
1.263A-4(a)(4).
---------------------------------------------------------------------------
    A qualified personal service corporation is a corporation: 
(1) substantially all of whose activities involve the 
performance of services in the fields of health, law, 
engineering, architecture, accounting, actuarial science, 
performing arts, or consulting, and (2) substantially all of 
the stock of which (by value) is owned by current or former 
employees performing such services, their estates, or 
heirs.\439\ Qualified personal service corporations are allowed 
to use the cash method without regard to whether they meet the 
gross receipts test.
---------------------------------------------------------------------------
    \439\ Sec. 448(d)(2).
---------------------------------------------------------------------------

Accounting for inventories

    In general, for Federal income tax purposes, taxpayers must 
account for inventories if the production, purchase, or sale of 
merchandise is an income-producing factor to the taxpayer.\440\ 
Treasury regulations also provide that in any case in which the 
use of inventories is necessary to clearly reflect income, the 
accrual method must be used with regard to purchases and 
sales.\441\ However, an exception is provided for taxpayers 
whose average annual gross receipts do not exceed $1 
million.\442\ A second exception is provided for taxpayers in 
certain industries whose average annual gross receipts do not 
exceed $10 million and that are not otherwise prohibited from 
using the cash method under section 448.\443\ Such taxpayers 
may account for inventory as materials and supplies that are 
not incidental (i.e., ``non-incidental materials and 
supplies''').\444\
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    \440\ Sec. 471(a) and Treas. Reg. sec. 1.471-1.
    \441\ Treas. Reg. sec. 1.446-1(c)(2).
    \442\ Rev. Proc. 2001-10, 2001-1 C.B. 272.
    \443\ Rev. Proc. 2002-28, 2002-1 C.B. 815.
    \444\ Treas. Reg. sec. 1.162-3(a)(1). A deduction is generally 
permitted for the cost of non-incidental materials and supplies in the 
taxable year in which they are first used or are consumed in the 
taxpayer's operations.
---------------------------------------------------------------------------
    In those circumstances in which a taxpayer is required to 
account for inventory, the taxpayer must maintain inventory 
records to determine the cost of goods sold during the taxable 
period. Cost of goods sold generally is determined by adding 
the taxpayer's inventory at the beginning of the period to the 
purchases made during the period and subtracting from that sum 
the taxpayer's inventory at the end of the period.
    Because of the difficulty of accounting for inventories on 
an item-by-item basis, taxpayers often use conventions that 
assume certain item or cost flows. Among these conventions are 
the first-in, first-out (``FIFO'') method, which assumes that 
the items in ending inventory are those most recently acquired 
by the taxpayer,\445\ and the last-in, first-out (``LIFO'') 
method, which assumes that the items in ending inventory are 
those earliest acquired by the taxpayer.\446\
---------------------------------------------------------------------------
    \445\ See Treas. Reg. sec. 1.471-2(d).
    \446\ See sec. 472.
---------------------------------------------------------------------------

Uniform capitalization 

    The uniform capitalization rules require certain direct and 
indirect costs allocable to real or tangible personal property 
produced by the taxpayer to be included in either inventory or 
capitalized into the basis of such property, as 
applicable.\447\ For real or personal property acquired by the 
taxpayer for resale, section 263A generally requires certain 
direct and indirect costs allocable to such property to be 
included in inventory.
---------------------------------------------------------------------------
    \447\ Sec. 263A.
---------------------------------------------------------------------------
    Section 263A provides a number of exceptions to the general 
uniform capitalization requirements. One such exception exists 
for certain small taxpayers who acquire property for resale and 
have $10 million or less of average annual gross receipts; 
\448\ such taxpayers are not required to include additional 
section 263A costs in inventory. Another exception exists for 
taxpayers who raise, harvest, or grow trees.\449\ Under this 
exception, section 263A does not apply to trees raised, 
harvested, or grown by the taxpayer (other than trees bearing 
fruit, nuts, or other crops, or ornamental trees) and any real 
property underlying such trees. Similarly, the uniform 
capitalization rules do not apply to any plant having a 
preproductive period of two years or less or to any animal, 
which is produced by a taxpayer in a farming business (unless 
the taxpayer is required to use an accrual method of accounting 
under section 447 or 448(a)(3)).\450\ Freelance authors, 
photographers, and artists also are exempt from section 263A 
for any qualified creative expenses.\451\
---------------------------------------------------------------------------
    \448\ Sec. 263A(b)(2)(B). No exception is available for small 
taxpayers who produce property subject to section 263A. However, a de 
minimis rule under Treasury regulations treats producers with total 
indirect costs of $200,000 or less as having no additional indirect 
costs beyond those normally capitalized for financial accounting 
purposes. Treas. Reg. sec. 1.263A-2(b)(3)(iv).
    \449\ Sec. 263A(c)(5).
    \450\ Sec. 263A(d).
    \451\ Sec. 263A(h). Qualified creative expenses are defined as 
amounts paid or incurred by an individual in the trade or business of 
being a writer, photographer, or artist (other than as an employee). 
However, such term does not include any expense related to printing, 
photographic plates, motion picture films, video tapes, or similar 
items.
---------------------------------------------------------------------------

Accounting for long-term contracts

    In general, in the case of a long-term contract, the 
taxable income from the contract is determined under the 
percentage-of-completion method.\452\ Under this method, the 
taxpayer must include in gross income for the taxable year an 
amount equal to the product of (1) the gross contract price and 
(2) the percentage of the contract completed during the taxable 
year.\453\ The percentage of the contract completed during the 
taxable year is determined by comparing costs allocated to the 
contract and incurred before the end of the taxable year with 
the estimated total contract costs.\454\ Costs allocated to the 
contract typically include all costs (including depreciation) 
that directly benefit or are incurred by reason of the 
taxpayer's long-term contract activities.\455\ The allocation 
of costs to a contract is made in accordance with 
regulations.\456\ Costs incurred with respect to the long-term 
contract are deductible in the year incurred, subject to 
general accrual method of accounting principles and 
limitations.\457\
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    \452\ Sec. 460(a).
    \453\ See Treas. Reg. sec. 1.460-4. This calculation is done on a 
cumulative basis. Thus, the amount included in gross income in a 
particular year is that proportion of the expected contract price that 
the amount of costs incurred through the end of the taxable year bears 
to the total expected costs, reduced by the amounts of gross contract 
price included in gross income in previous taxable years.
    \454\ Sec. 460(b)(1).
    \455\ Sec. 460(c).
    \456\ Treas. Reg. sec. 1.460-5.
    \457\ Treas. Reg. secs. 1.460-4(b)(2)(iv) and 1.460-1(b)(8).
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    There are a number of types of long-term contracts excepted 
from the requirements to use the percentage-of-completion 
method to compute taxable income. One such exception is 
provided for certain construction contracts performed by small 
contractors (``small construction contracts'').\458\ Contracts 
within this exception are those contracts for the construction 
or improvement of real property if the contract: (1) is 
expected (at the time such contract is entered into) to be 
completed within two years of commencement of the contract and 
(2) is performed by a taxpayer whose average annual gross 
receipts for the prior three taxable years do not exceed $10 
million.\459\ Thus, long-term contract income from small 
construction contracts must be reported consistently using the 
taxpayer's exempt contract method.\460\ Permissible exempt 
contract methods include the completed contract method, the 
exempt-contract percentage-of-completion method, the 
percentage-of-completion method, or any other permissible 
method.\461\
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    \458\ Other exceptions are provided for home construction 
contracts, residential construction contracts, qualified ship 
construction contracts, and qualified naval ship contracts. See sec. 
460(e); Treas. Reg. secs. 1.460-2(d), 1.460-3(b) and (c), and 1.460-
4(e); and sec. 708 of the American Jobs Creation Act of 2004, Pub. L. 
No. 108-357 (2004).
    \459\ Secs. 460(e)(1)(B) and (4).
    \460\ Since such contracts involve the construction of real 
property, they are subject to the interest capitalization rules without 
regard to their duration. See Treas. Reg. sec. 1.263A-8.
    \461\ Treas. Reg. sec. 1.460-4(c)(1).
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                        Explanation of Provision

    The provision expands the universe of taxpayers that may 
use the cash method of accounting. Under the provision, the 
cash method of accounting may be used by taxpayers, other than 
tax shelters, that satisfy the gross receipts test, regardless 
of whether the purchase, production, or sale of merchandise is 
an income-producing factor. The gross receipts test allows 
taxpayers with average annual gross receipts \462\ that do not 
exceed $25 million for the three prior taxable-year period (the 
``$25 million gross receipts test'') to use the cash method. 
The $25 million amount is indexed for inflation for taxable 
years beginning after 2018.
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    \462\ For purposes of the gross receipts test, items included in 
gross receipts are intended to be consistent with prior law. See 
section 448(c)(3)(C) and Treas. Reg. sec. 1.448-1T(f)(2)(iv).
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    The provision expands the universe of farming C 
corporations (and farming partnerships with a C corporation 
partner) that may use the cash method to include any farming C 
corporation (or farming partnership with a C corporation 
partner) that meets the $25 million gross receipts test.
    The provision retains the exceptions from the required use 
of the accrual method for qualified personal service 
corporations and taxpayers other than C corporations. Thus, 
qualified personal service corporations, partnerships without C 
corporation partners, S corporations, and other passthrough 
entities are allowed to use the cash method without regard to 
whether they meet the $25 million gross receipts test, so long 
as the use of such method clearly reflects income.\463\
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    \463\ Consistent with prior and present law, the cash method 
generally may not be used by taxpayers, other than those that meet the 
$25 million gross receipts test, if the purchase, production, or sale 
of merchandise is an income-producing factor.
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    In addition, the provision exempts certain taxpayers from 
the requirement to keep inventories. Specifically, taxpayers 
that meet the $25 million gross receipts test are not required 
to account for inventories under section 471,\464\ but rather 
may use a method of accounting for inventories that either (1) 
treats inventories as non-incidental materials and 
supplies,\465\ or (2) conforms to the taxpayer's financial 
accounting treatment of inventories.\466\
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    \464\ In the case of a sole proprietorship, the $25 million gross 
receipts test is applied as if the sole proprietorship is a corporation 
or partnership.
    \465\ Consistent with prior and present law, a deduction is 
generally permitted for the cost of non-incidental materials and 
supplies in the taxable year in which they are first used or are 
consumed in the taxpayer's operations. See Treas. Reg. sec. 1.162-
3(a)(1). As the provision allows a taxpayer to treat inventories as 
non-incidental materials and supplies, a taxpayer may also be able to 
elect to deduct such non-incidental materials and supplies in the 
taxable year the amount is paid under the de minimis safe harbor 
election of Treas. Reg. sec. 1.263(a)-1(f). Under such election, a 
taxpayer with an applicable financial statement that has written 
accounting procedures in place that treat as an expense amounts paid 
for property costing less than a specified dollar amount may deduct 
amounts paid for non-incidental materials and supplies at the time of 
payment if the amount paid for the property does not exceed $5,000 per 
invoice (or per item as substantiated by the invoice). In addition, a 
taxpayer without an applicable financial statement that has accounting 
procedures in place that treat as an expense amounts paid for property 
costing less than a specified dollar amount may deduct amounts paid for 
non-incidental materials and supplies at the time of payment if the 
amount paid for the property does not exceed $500 per invoice (or per 
item as substantiated by the invoice). However, in either case, the 
taxpayer is not eligible to deduct inventory treated as non-incidental 
materials and supplies under this provision under the de minimis safe 
harbor election unless the taxpayer is also treating the amounts paid 
for such items as an expense in its applicable financial statement or 
its books and records, if the taxpayer does not have an applicable 
financial statement (i.e., the taxpayer is not eligible to apply the de 
minimis safe harbor if the amounts paid for such items are treated as 
inventory for financial reporting purposes). See Treas. Reg. sec. 
1.263(a)-1(f)(1)(i)(C) and (ii)(C). If a taxpayer elects to apply the 
de minimis safe harbor, the taxpayer must apply such safe harbor to all 
materials and supplies that otherwise meet the requirements of Treas. 
Reg. sec. 1.263(a)-1(f).
    \466\ The taxpayer's financial accounting treatment of inventories 
is determined by reference to the method of accounting used in the 
taxpayer's applicable financial statement (as defined in section 13221 
of the Act (Certain Special Rules for Taxable Year of Inclusion)) or, 
if the taxpayer does not have an applicable financial statement, the 
method of accounting used in the taxpayer's books and records prepared 
in accordance with the taxpayer's accounting procedures.
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    The provision expands the exception for small taxpayers 
from the uniform capitalization rules. Under the provision, any 
producer or reseller that meets the $25 million gross receipts 
test is exempted from the application of section 263A.\467\ The 
provision retains the exemptions from the uniform 
capitalization rules that are not based on a taxpayer's gross 
receipts.
---------------------------------------------------------------------------
    \467\ In the case of a sole proprietorship, the $25 million gross 
receipts test is applied as if the sole proprietorship is a corporation 
or partnership.
---------------------------------------------------------------------------
    Finally, the provision expands the exception for small 
construction contracts from the requirement to use the 
percentage-of-completion method. Under the provision, contracts 
within this exception are those contracts for the construction 
or improvement of real property if the contract (1) is expected 
(at the time such contract is entered into) to be completed 
within two years of commencement of the contract, and (2) is 
performed by a taxpayer that (for the taxable year in which the 
contract was entered into) meets the $25 million gross receipts 
test.\468\
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    \468\ In the case of a sole proprietorship, the $25 million gross 
receipts test is applied as if the sole proprietorship is a corporation 
or partnership.
---------------------------------------------------------------------------
    Under the provision, a taxpayer who fails the $25 million 
gross receipts test for a taxable year is not eligible for any 
of the aforementioned exceptions (i.e., from the accrual 
method, from keeping inventories, from applying the uniform 
capitalization rules, or from using the percentage-of-
completion method) for such taxable year.
    Application of any of the above provisions is a change in 
the taxpayer's method of accounting for purposes of section 
481. Application of the exception for small construction 
contracts from the requirement to use the percentage-of-
completion method is implemented on a cutoff basis for all 
similarly classified contracts (hence there is no adjustment 
under section 481(a) for contracts entered into before January 
1, 2018). In addition, any change in method of accounting due 
to application of the above provisions is treated as initiated 
by the taxpayer and made with the consent of the 
Secretary.\469\ For example, such change is made with the 
consent of the Secretary for any taxable year in which the 
taxpayer fails to meet the gross receipts test if the taxpayer 
met such test in the prior taxable year, and the taxpayer is 
changing from the cash method to an accrual method. In 
addition, such change is made with the consent of the Secretary 
for any taxable year in which the taxpayer meets the gross 
receipts test if the taxpayer failed to meet such test in the 
prior taxable year and the taxpayer is changing from an accrual 
method to the cash method.
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    \469\ See sections 263A(i)(3), 448(d)(7), 460(e)(2)(B), and 
471(c)(4), all as amended by the Act.

    The Treasury Department has issued published guidance 
addressing this provision.\470\
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    \470\ See Rev. Proc. 2018-40, 2018-34 I.R.B. 320, August 20, 2018.
---------------------------------------------------------------------------

                             Effective Date

    The provisions to expand the universe of taxpayers, 
including farming C corporations, eligible to use the cash 
method, exempt certain taxpayers from the requirement to keep 
inventories, and expand the exception from the uniform 
capitalization rules apply to taxable years beginning after 
December 31, 2017. Application of these rules is a change in 
the taxpayer's method of accounting for purposes of section 
481.
    The provision to expand the exception for small 
construction contracts from the requirement to use the 
percentage-of-completion method applies to contracts entered 
into after December 31, 2017, in taxable years ending after 
such date. Application of this rule is a change in the 
taxpayer's method of accounting for purposes of section 481. 
Application of the exception for small construction contracts 
from the requirement to use the percentage-of-completion method 
is implemented on a cutoff basis for all similarly classified 
contracts (hence there is no adjustment under section 481(a) 
for contracts entered into before January 1, 2018).

             PART III--COST RECOVERY AND ACCOUNTING METHODS

                        SUBPART A--COST RECOVERY

 A. Temporary 100-Percent Expensing for Certain Business Assets (sec. 
             13201 of the Act and sec. 168(k) of the Code)

                               Prior Law

    A taxpayer generally must capitalize the cost of property 
used in a trade or business or held for the production of 
income and recover such cost over time through annual 
deductions for depreciation or amortization.\471\ The period 
for depreciation or amortization generally begins when the 
asset is placed in service by the taxpayer.\472\
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    \471\ See secs. 263(a) and 167. In general, only the tax owner of 
property (i.e., the taxpayer with the benefits and burdens of 
ownership) is entitled to claim tax benefits such as cost recovery 
deductions with respect to the property. In addition, where property is 
not used exclusively in a taxpayer's business, the amount eligible for 
a deduction must be reduced by the amount related to personal use. See, 
e.g., sec. 280A.
    \472\ See Treas. Reg. secs. 1.167(a)-10(b), -3, -14, and 1.197-
2(f). See also Treas. Reg. sec. 1.167(a)-11(e)(1)(i).
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Tangible property
    Tangible property generally is depreciated under the 
modified accelerated cost recovery system (``MACRS''), which 
determines depreciation for different types of property based 
on an assigned applicable depreciation method, recovery 
period,\473\ and convention.\474\
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    \473\ The applicable recovery period for an asset is determined in 
part by statute and in part by historic Treasury guidance. Exercising 
authority granted by Congress, the Secretary issued Rev. Proc. 87-56, 
1987-2 C.B. 674, laying out the framework of recovery periods for 
enumerated classes of assets. The Secretary clarified and modified the 
list of asset classes in Rev. Proc. 88-22, 1988-1 C.B. 785. In November 
1988, Congress revoked the Secretary's authority to modify the class 
lives of depreciable property. Rev. Proc. 87-56, as modified, remains 
in effect except to the extent that the Congress has, since 1988, 
statutorily modified the recovery period for certain depreciable 
assets, effectively superseding any administrative guidance with regard 
to such property.
    \474\ Sec. 168.
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            Bonus depreciation
    An additional first-year depreciation deduction is allowed 
equal to 50 percent of the adjusted basis of qualified property 
acquired and placed in service before January 1, 2020 (January 
1, 2021, for certain property with a recovery period of at 
least 10 years or certain transportation property,\475\ and 
certain aircraft \476\).\477\ The 50-percent allowance is 
phased down for property placed in service after December 31, 
2017 (after December 31, 2018, for longer production period 
property and certain aircraft). The bonus depreciation 
percentage rates are as follows.
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    \475\ Property qualifying for the extended placed-in-service date 
must have a recovery period of at least 10 years or constitute 
transportation property, have an estimated production period exceeding 
one year, and have a cost exceeding $1 million. Transportation property 
generally is defined as tangible personal property used in the trade or 
business of transporting persons or property. Section 168(k)(2)(B). 
Property defined in section 168(k)(2)(B) is hereinafter collectively 
referred to as ``longer production period property.''
    \476\ Certain aircraft which is not transportation property, other 
than for agricultural or firefighting uses, also qualifies for the 
extended placed-in-service date, if at the time of the contract for 
purchase, the purchaser made a nonrefundable deposit of the lesser of 
10 percent of the cost or $100,000, and which has an estimated 
production period exceeding four months and a cost exceeding $200,000. 
Sec. 168(k)(2)(C).
    \477\ Sec. 168(k). The additional first-year depreciation deduction 
is generally subject to the rules regarding whether a cost must be 
capitalized under section 263A. For a discussion of changes made to 
section 263A by the Act, see the description of section 13102 of the 
Act (Small Business Accounting Method Reform and Simplification).
    \478\ In the case of longer production period property placed in 
service in 2018, 50 percent applies to the entire adjusted basis. 
Similarly, in the case of longer production period property placed in 
service in 2019, 40 percent applies to the entire adjusted basis.
    \479\ In the case of longer production period property described in 
section 168(k)(2)(B) and placed in service in 2020, 30 percent applies 
to the adjusted basis attributable to manufacture, construction, or 
production before January 1, 2020, and the remaining adjusted basis 
does not qualify for bonus depreciation. Thirty percent applies to the 
entire adjusted basis of certain aircraft described in section 
168(k)(2)(C) and placed in service in 2020.

------------------------------------------------------------------------
                                       Bonus Depreciation Percentage
                                 ---------------------------------------
                                                       Longer Production
     Placed in Service Year       Qualified Property    Period Property
                                      in General          and Certain
                                                           Aircraft
------------------------------------------------------------------------
2017............................  50 percent........  50 percent
2018............................  40 percent........  50 percent \478\
2019............................  30 percent........  40 percent
2020............................  None..............  30 percent \479\
------------------------------------------------------------------------

    The additional first-year depreciation deduction is allowed 
for both the regular tax and the alternative minimum tax 
(``AMT''),\480\ but is not allowed in computing earnings and 
profits.\481\ 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.\482\ The amount of the additional 
first-year depreciation deduction is not affected by a short 
taxable year.\483\ The taxpayer may elect out of the additional 
first-year depreciation for any class of property for any 
taxable year.\484\
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    \480\ Sec. 168(k)(2)(G). See also Treas. Reg. sec. 1.168(k)-1(d).
    \481\ Sec. 312(k)(3) and Treas. Reg. sec. 1.168(k)-1(f)(7).
    \482\ Sec. 168(k)(1)(B).
    \483\ Ibid.
    \484\ Sec. 168(k)(7). For the definition of a class of property, 
see Treas. Reg. sec. 1.168(k)-1(e)(2).
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    The interaction of the additional first-year depreciation 
allowance with the otherwise applicable depreciation allowance 
may be illustrated as follows. Assume that in 2017 a taxpayer 
purchases new depreciable property and places it in 
service.\485\ The property's cost is $10,000, and it is five-
year property subject to the 200 percent declining balance 
method and half-year convention. The amount of additional 
first-year depreciation allowed is $5,000. The remaining $5,000 
of the cost of the property is depreciable under the rules 
applicable to five-year property. Thus, $1,000 also is allowed 
as a depreciation deduction in 2017.\486\ The total 
depreciation deduction with respect to the property for 2017 is 
$6,000. The remaining $4,000 adjusted basis of the property 
generally is recovered through otherwise applicable 
depreciation rules.
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    \485\ Assume that the cost of the property is not eligible for 
expensing under section 179 or Treas. Reg. sec. 1.263(a)-1(f).
    \486\ $1,000 results from the application of the half-year 
convention and the 200 percent declining balance method to the 
remaining $5,000.
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            Qualified property
    Property qualifying for the additional first-year 
depreciation deduction must meet all of the following 
requirements: \487\
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    \487\ Requirements relating to actions taken before 2008 are not 
described herein since they have little (if any) remaining effect. For 
a description of these actions, see Joint Committee on Taxation, 
General Explanation of Tax Legislation Enacted in the 110th Congress 
(JCS-1-09), March 2009, pp. 81-84.
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           The property must be: (1) property to which 
        MACRS applies with an applicable recovery period of 20 
        years or less; (2) water utility property; \488\ (3) 
        computer software other than computer software covered 
        by section 197; or (4) qualified improvement property; 
        \489\
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    \488\ As defined in section 168(e)(5).
    \489\ The additional first-year depreciation deduction is not 
available for any property that is required to be depreciated under the 
alternative depreciation system of MACRS. Sec. 168(k)(2)(D)(i).
---------------------------------------------------------------------------
           The original use \490\ of the property must 
        commence with the taxpayer; \491\ and
---------------------------------------------------------------------------
    \490\ 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). Treas. Reg. sec. 1.168(k)-1(b)(3).
    \491\ 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, 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. Sec. 168(k)(2)(E)(ii) and (iii).
---------------------------------------------------------------------------
           The property must be placed in service 
        before January 1, 2020. However, as noted above, an 
        extension of the placed-in-service date of one year 
        (i.e., before January 1, 2021) is provided for longer 
        production period property and certain aircraft.
    In the case of longer production period property and 
certain aircraft, the property must also be acquired (1) before 
January 1, 2020, or (2) pursuant to a written binding contract 
which was entered into before January 1, 2020. With respect to 
such 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 
before January 1, 2020.\492\ Additionally, 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, 2020 (``progress expenditures'') is 
eligible for the additional first-year depreciation 
deduction.\493\
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    \492\ Sec. 168(k)(2)(E)(i).
    \493\ Sec. 168(k)(2)(B)(ii). For purposes of determining the amount 
of eligible progress expenditures, rules similar to section 46(d)(3) as 
in effect prior to the Tax Reform Act of 1986 apply.
---------------------------------------------------------------------------
    For purposes of identifying qualified property, qualified 
improvement property is any improvement to an interior portion 
of a building that is nonresidential real property if such 
improvement is placed in service by the taxpayer after the date 
such building was first placed in service by any taxpayer.\494\ 
Qualified improvement property does not include any improvement 
for which the expenditure is attributable to the enlargement of 
the building, any elevator or escalator, or the internal 
structural framework of the building.
---------------------------------------------------------------------------
    \494\ Sec. 168(k)(3). See also section 4.02 of Rev. Proc. 2017-33, 
2017-19 I.R.B. 1236. Qualified improvement property must also meet the 
requirements of section 168(k)(2)(A)(ii) and (iii) (i.e., the original 
use and placed in service date requirements) to be eligible for bonus 
depreciation.
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            Election to accelerate AMT credits in lieu of bonus 
                    depreciation
    A corporation otherwise eligible for additional first-year 
depreciation may elect to claim additional AMT credits in lieu 
of claiming additional depreciation with respect to qualified 
property.\495\ In the case of a corporation making this 
election, the straight line method is used for the regular tax 
and the AMT with respect to qualified property.\496\
---------------------------------------------------------------------------
    \495\ Sec. 168(k)(4).
    \496\ Sec. 168(k)(4)(A)(ii).
---------------------------------------------------------------------------
    A corporation making an election increases the tax 
liability limitation on the use of minimum tax credits under 
section 53(c) by the bonus depreciation amount. The aggregate 
increase in credits allowable by reason of the increased 
limitation is treated as refundable.
    The bonus depreciation amount generally is equal to 20 
percent of bonus depreciation for qualified property that could 
be claimed as a deduction absent an election under this 
provision.\497\ As originally enacted, the bonus depreciation 
amount for all taxable years was limited to the lesser of (1) 
$30 million or (2) six percent of the minimum tax credits 
allowable to the adjusted net minimum tax imposed for taxable 
years beginning before January 1, 2006. However, extensions of 
this provision have provided that this limitation applies 
separately to property subject to each extension.
---------------------------------------------------------------------------
    \497\ For this purpose, bonus depreciation is the difference 
between (i) the aggregate amount of depreciation determined if section 
168(k)(1) applied to all qualified property placed in service during 
the taxable year and (ii) the amount of depreciation that would be so 
determined if section 168(k)(1) did not so apply. This determination is 
made using the most accelerated depreciation method and the shortest 
life otherwise allowable for each property.
---------------------------------------------------------------------------
    For taxable years ending after December 31, 2015, the bonus 
depreciation amount for a taxable year (as defined under prior 
law with respect to all qualified property) is limited to the 
lesser of (1) 50 percent of the minimum tax credit for the 
first taxable year ending after December 31, 2015 (determined 
before the application of any tax liability limitation) or (2) 
the minimum tax credit for the taxable year allowable to the 
adjusted net minimum tax imposed for taxable years ending 
before January 1, 2016 (determined before the application of 
any tax liability limitation and determined on a first-in, 
first-out basis).
    All corporations treated as a single employer under section 
52(a) are treated as one taxpayer for purposes of the 
limitation, as well as for electing the application of this 
provision.\498\
---------------------------------------------------------------------------
    \498\ Sec. 168(k)(4)(B)(iii).
---------------------------------------------------------------------------
    In the case of a corporation making an election which is a 
partner in a partnership, for purposes of determining the 
electing partner's distributive share of partnership items, 
bonus depreciation does not apply to any qualified property and 
the straight line method is used with respect to that 
property.\499\
---------------------------------------------------------------------------
    \499\ Sec. 168(k)(4)(D)(ii).
---------------------------------------------------------------------------
    In the case of a partnership having a single corporate 
partner owning (directly or indirectly) more than 50 percent of 
the capital and profits interests in the partnership, each 
partner takes into account its distributive share of 
partnership depreciation in determining its bonus depreciation 
amount.\500\
---------------------------------------------------------------------------
    \500\ Sec. 168(k)(4)(D)(iii).
---------------------------------------------------------------------------
            Special rules
                Passenger automobiles
    The limitation under section 280F on the amount of 
depreciation deductions allowed with respect to certain 
passenger automobiles is increased in the first year by $8,000 
for automobiles that qualify (and for which the taxpayer does 
not elect out of the additional first-year deduction).\501\ The 
$8,000 amount is phased down from $8,000 by $1,600 per calendar 
year beginning in 2018. Thus, the section 280F increase amount 
for property placed in service during 2018 is $6,400, and 
during 2019 is $4,800. While the underlying section 280F 
limitation is indexed for inflation,\502\ the section 280F 
increase amount is not indexed for inflation. The increase does 
not apply to a taxpayer who elects to accelerate AMT credits in 
lieu of bonus depreciation for a taxable year.
---------------------------------------------------------------------------
    \501\ Sec. 168(k)(2)(F).
    \502\ Sec. 280F(d)(7).
---------------------------------------------------------------------------
                Certain plants bearing fruits and nuts
    A special election is provided for certain plants bearing 
fruits and nuts.\503\ Under the election, the applicable 
percentage of the adjusted basis of a specified plant which is 
planted or grafted after December 31, 2015, and before January 
1, 2020, is deductible for regular tax and AMT purposes in the 
year planted or grafted by the taxpayer (rather than in the 
year the specified plant is placed in service by the taxpayer 
\504\), and the adjusted basis is reduced by the amount of the 
deduction.\505\ The percentage is 50 percent for 2017, 40 
percent for 2018, and 30 percent for 2019. A specified plant is 
any tree or vine that bears fruits or nuts, and any other plant 
that will have more than one crop or yield of fruits or nuts 
and generally has a preproductive period of more than two years 
from the time of planting or grafting to the time it begins 
bearing a marketable crop or yield of fruits or nuts.\506\ If 
the election is made with respect to any specified plant, such 
plant is not treated as qualified property eligible for bonus 
depreciation in the subsequent taxable year in which it is 
placed in service.\507\ Once made, the election is revocable 
only with the consent of the Secretary.\508\
---------------------------------------------------------------------------
    \503\ See sec. 168(k)(5). Section 4.05 of Rev. Proc. 2017-33 
provides the procedures for making a section 168(k)(5) election.
    \504\ In the case of any tree or vine bearing fruits or nuts, the 
placed in service date generally does not occur until the tree or vine 
first reaches an income-producing stage. See Treas. Reg. sec. 1.46-
3(d)(2). See also, Rev. Rul. 80-25, 1980-1 C.B. 65; and Rev. Rul. 69-
249, 1969-1 C.B. 31.
    \505\ Any amount deducted under this election is not subject to 
capitalization under section 263A.
    \506\ A specified plant does not include any property that is 
planted or grafted outside of the United States.
    \507\ However, when placed in service, the remaining adjusted basis 
of the specified plant may be eligible for expensing under section 179. 
See section 4.05(3) of Rev. Proc. 2017-33. For a discussion of changes 
made to section 179 by the Act, see the description of section 13101 of 
the Act (Modification of Rules for Expensing).
    \508\ See section 4.05(2) of Rev. Proc. 2017-33 for guidance on 
revoking a section 168(k)(5) election.
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                Long-term contracts
    In general, in the case of a long-term contract, the 
taxable income from the contract is determined under the 
percentage-of-completion method.\509\ Solely for purposes of 
determining the percentage-of-completion under section 
460(b)(1)(A), the cost of qualified property with a MACRS 
recovery period of seven years or less is taken into account as 
a cost allocated to the contract as if bonus depreciation had 
not been enacted for property placed in service before January 
1, 2020 (January 1, 2021, in the case of longer production 
period property).\510\
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    \509\ Sec. 460.
    \510\ Sec. 460(c)(6). Other dates involving prior years are not 
described herein.
---------------------------------------------------------------------------

Intangible property

            Section 197 intangibles
    Under section 197, when a taxpayer acquires intangible 
assets held in connection with a trade or business, any value 
properly attributable to a ``section 197 intangible'' is 
amortizable on a straight-line basis over 15 years.\511\ No 
other depreciation or amortization deduction (such as bonus 
depreciation under section 168(k)) is allowable with respect to 
any section 197 intangible.\512\ Such intangibles include: 
goodwill; going concern value; workforce in place including its 
composition and terms and conditions (contractual or otherwise) 
of its employment; business books and records, operating 
systems, or other information base; any patent, copyright, 
formula, process, design, pattern, knowhow, format, or similar 
item; customer-based intangibles; supplier-based intangibles; 
and any other similar item.\513\ The definition of a section 
197 intangible also includes: any license, permit, or other 
rights granted by governmental units (even if the right is 
granted for an indefinite period or is reasonably expected to 
be renewed indefinitely); \514\ any covenant not to compete; 
and any franchise,\515\ trademark, or trade name.\516\
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    \511\ Secs. 197(a) and (c).
    \512\ Sec. 197(b).
    \513\ Sec. 197(d)(1).
    \514\ Sec. 197(d)(1)(D). Examples include a liquor license, a taxi-
cab medallion, an airport landing or take-off right, a regulated 
airline route, or a television or radio broadcasting license. Renewals 
of such governmental rights are treated as the acquisition of a new 15-
year asset. Treas. Reg. sec. 1.197-2(b)(8). A license, permit, or other 
right granted by a governmental unit is a franchise if it otherwise 
meets the definition of a franchise. Treas. Reg. sec. 1.197-2(b)(10). 
Section 197 intangibles do not include certain rights granted by a 
government not considered part of the acquisition of a trade or 
business. Sec. 197(e)(4)(B) and Treas. Reg. sec. 1.197-2(c)(13).
    \515\ A franchise is defined as ``an agreement which gives one of 
the parties to the agreement the right to distribute, sell, or provide 
goods, services, or facilities, within a specified area.'' Secs. 
197(f)(4) and 1253(b)(1). Thus, for example, 15-year amortization under 
section 197 generally applies to acquired sports franchises, including 
any intangible assets acquired in connection with the acquisition of 
such a franchise (including player contracts). See Joint Committee on 
Taxation, General Explanation of Tax Legislation Enacted in the 108th 
Congress (JCS-5-05), May 2005, pp. 479-480. As section 197 intangibles, 
such assets are not eligible for bonus depreciation under section 
168(k).
    \516\ Sec. 197(d)(1)(F).
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    Section 197 does not apply to certain intangible property, 
including certain 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.\517\
---------------------------------------------------------------------------
    \517\ Secs. 197(c)(2) and (e)(4)(A).
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            Films, videos, and sound recordings
    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.\518\ 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 is determined 
under section 167, which allows a depreciation deduction for 
the reasonable allowance for the exhaustion, wear and tear, or 
obsolescence of the property if it is used in a trade or 
business or held for the production of income. In addition, the 
costs of motion picture films, video tapes, sound recordings, 
copyrights, books, and patents are eligible to be recovered 
using the income forecast method of depreciation once the 
property is placed in service.\519\
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    \518\ Secs. 168(f)(1), (3) and (4).
    \519\ Sec. 167(g)(6).
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    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 gross income generated by the property during the 
year, and the denominator of which is the total forecasted or 
estimated gross income expected to be generated prior to the 
close of the tenth taxable year after the year the property is 
placed in service. Any costs that are not recovered by the end 
of the tenth taxable year after the property is placed in 
service may be taken into account as depreciation in that 
year.\520\
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    \520\ Sec. 167(g)(1). In general, the adjusted basis of property 
that may be taken into account under the income forecast method only 
includes amounts that have been incurred under the economic performance 
requirements of section 461(h). An exception to this rule applies to 
participations and residuals. Specifically, 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 (even if economic performance has 
not yet occurred) 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. For this 
purpose, 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. See sec. 167(g)(7).
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            Expensing of certain qualified film, television, and live 
                    theatrical productions
    Under section 181, a taxpayer may elect \521\ to deduct up 
to $15 million of the aggregate production costs of any 
qualified film, television, or live theatrical production, 
commencing prior to January 1, 2017,\522\ in the year the costs 
are paid or incurred by the taxpayer, in lieu of capitalizing 
the costs and recovering them through depreciation allowances 
once the production is placed in service.\523\ The dollar 
limitation is increased to $20 million if a significant amount 
of the production costs 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.\524\
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    \521\ See Treas. Reg. sec. 1.181-2 for rules on making (and 
revoking) an election under section 181.
    \522\ Subsequent to the enactment of Pub. L. No. 115-97, section 
181 was extended for productions commencing after December 31, 2016, 
and before January 1, 2018, by the Bipartisan Budget Act of 2018, Pub. 
L. No. 115-123, sec. 40308, February 9, 2018. For purposes of 
determining whether a production is eligible for section 181 expensing, 
a qualified film or television production is treated as commencing on 
the first date of principal photography. See the Conference Report to 
accompany H.R. 4520, American Jobs Creation Act of 2004, H.R. Rep. No. 
108-755, October 7, 2004, p. 372. See also Joint Committee on Taxation, 
General Explanation of Tax Legislation Enacted in the 108th Congress 
(JCS-5-05), May 2005, p. 210. The date on which a qualified live 
theatrical production commences is the date of the first public 
performance of such production for a paying audience. See the 
Protecting Americans from Tax Hikes Act of 2015, Pub. L. No. 114-113, 
sec. 169(d), December 18, 2015. See also Joint Committee on Taxation, 
General Explanation of Tax Legislation Enacted in 2015 (JCS-1-16), 
March 2016, p. 187.
    \523\ Sec. 181(a)(2)(A). See Treas. Reg. sec. 1.181-1 for rules on 
determining eligible production costs. Eligible production costs under 
section 181 include participations and residuals paid or incurred. 
Treas. Reg. sec. 1.181-1(a)(3)(i). The special rule in section 
167(g)(7) that allows taxpayers using the income forecast method of 
depreciation to include participations and residuals that have not met 
the economic performance requirements in the adjusted basis of the 
property for the taxable year the property is placed in service does 
not apply for purposes of section 181. Treas. Reg. sec. 1.181-1(a)(8). 
Thus, under section 181, a taxpayer may only include participations and 
residuals actually paid or incurred in eligible production costs. 
Further, production costs do not include the cost of obtaining a 
production after its initial release or broadcast. See Treas. Reg. sec. 
1.181-1(a)(3). For this purpose, ``initial release or broadcast'' means 
the first commercial exhibition or broadcast of a production to an 
audience. Treas. Reg. sec. 1.181-1(a)(7). Thus, for example, a taxpayer 
may not expense the purchase of an existing film library under section 
181. See T.D. 9551, 76 Fed. Reg. 64816, October 19, 2011.
    \524\ Sec. 181(a)(2)(B).
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    A section 181 election may only be made by an owner of the 
production.\525\ An owner of a production is any person that is 
required under section 263A to capitalize the costs of 
producing the production into the cost basis of the production, 
or that would be required to do so if section 263A applied to 
that person.\526\ In addition, the aggregate production costs 
of a qualified production that is co-produced include all 
production costs, regardless of funding source, in determining 
if the applicable dollar limit is exceeded. Thus, the term 
``aggregate production costs'' means all production costs paid 
or incurred by any person, whether paid or incurred directly by 
an owner or indirectly on behalf of an owner.\527\ The costs of 
the production in excess of the applicable dollar limitation 
are capitalized and recovered under the taxpayer's method of 
accounting for the recovery of such property once placed in 
service.\528\
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    \525\ Treas. Reg. sec. 1.181-1(a).
    \526\ Treas. Reg. sec. 1.181-1(a)(2)(i). For a discussion of the 
changes made to section 263A by the Act, see the description of section 
13102 of the Act (Small Business Accounting Method Reform and 
Simplification).
    \527\ Treas. Reg. sec. 1.181-1(a)(4). See Treas. Reg. sec. 1.181-
2(c)(3) for the information required to be provided to the Internal 
Revenue Service when more than one person will claim deductions under 
section 181 for a production (to ensure that the applicable deduction 
limitation is not exceeded).
    \528\ See Joint Committee on Taxation, General Explanation of Tax 
Legislation Enacted in the 110th Congress (JCS-1-09), March 2009, p. 
448; and Treas. Reg. sec. 1.181-1(c)(2). A production is generally 
considered to be placed in service at the time of initial release, 
broadcast, or live staged performance (i.e., at the time of the first 
commercial exhibition, broadcast, or live staged performance of a 
production to an audience). See, e.g., Rev. Rul. 79-285, 1979-2 C.B. 
91; and Priv. Ltr. Rul. 9010011, March 9, 1990. See also, Treas. Reg. 
sec. 1.181-1(a)(7). However, a production generally may not be 
considered to be placed in service if it is only exhibited, 
broadcasted, or performed for a limited test audience in advance of the 
commercial exhibition, broadcast, or performance to general audiences. 
See Priv. Ltr. Rul. 9010011 and Treas. Reg. sec. 1.181-1(a)(7).
---------------------------------------------------------------------------
    A qualified film, television, or live theatrical production 
means any production of a motion picture (whether released 
theatrically or directly to video cassette or any other 
format), television program, or live staged play if at least 75 
percent of the total compensation expended on the production is 
for services performed in the United States by actors, 
directors, producers, and other relevant production 
personnel.\529\ Solely for purposes of this rule, the term 
``compensation'' does not include participations and residuals 
(as defined in section 167(g)(7)(B)).\530\
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    \529\ Sec. 181(d)(3)(A).
    \530\ Sec. 181(d)(3)(B). Participations and residuals are defined 
as, with respect to any property, costs the amount of which by contract 
varies with the amount of income earned in connection with such 
property. See also Treas. Reg. sec. 1.181-3(c).
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    Each episode of a television series is treated as a 
separate production, and only the first 44 episodes of a 
particular series qualify under the provision.\531\ Qualified 
productions do not include sexually explicit productions as 
referenced by section 2257 of title 18 of the U.S. Code.\532\
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    \531\ Sec. 181(d)(2)(B).
    \532\ Sec. 181(d)(2)(C).
---------------------------------------------------------------------------
    A qualified live theatrical production is defined as a live 
staged production of a play (with or without music) which is 
derived from a written book or script and is produced or 
presented by a commercial entity in any venue which has an 
audience capacity of not more than 3,000, or a series of venues 
the majority of which have an audience capacity of not more 
than 3,000.\533\ In addition, qualified live theatrical 
productions include any live staged production which is 
produced or presented by a taxable entity no more than 10 weeks 
annually in any venue which has an audience capacity of not 
more than 6,500.\534\ In general, in the case of multiple live-
staged productions, each such live-staged production is treated 
as a separate production. Similar to the exclusion for sexually 
explicit productions from the definition of qualified film or 
television productions, qualified live theatrical productions 
do not include stage performances that would be excluded by 
section 2257(h)(1) of title 18 of the U.S. Code, if such 
provision were extended to live stage performances.\535\
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    \533\ Sec. 181(e)(2)(A).
    \534\ Sec. 181(e)(2)(D).
    \535\ Sec. 181(e)(2)(E).
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    For purposes of recapture under section 1245, any deduction 
allowed under section 181 is treated as if it were a deduction 
allowable for amortization.\536\ Thus, the deduction under 
section 181 may be subject to recapture as ordinary income in 
the taxable year in which (i) the taxpayer revokes a section 
181 election, (ii) the production fails to meet the 
requirements of section 181, or (iii) the taxpayer sells or 
otherwise disposes of the production.\537\
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    \536\ Sec. 1245(a)(2)(C). For a discussion of the recapture rules 
applicable to depreciation and amortization deductions, see Joint 
Committee on Taxation, Background and Present Law Relating to Cost 
Recovery and Domestic Production Activities (JCX-19-12), February 27, 
2012, pp. 45-46.
    \537\ See Treas. Reg. sec. 1.181-4.
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                        Explanation of Provision


In general

    The provision extends and modifies the additional first-
year depreciation deduction through 2026 (through 2027 for 
longer production period property and certain aircraft). The 
50-percent allowance is increased to 100 percent for property 
acquired and placed in service after September 27, 2017, and 
before January 1, 2023 (January 1, 2024, for longer production 
period property and certain aircraft), as well as for specified 
plants planted or grafted after September 27, 2017, and before 
January 1, 2023. The 100-percent allowance is phased down by 20 
percent per calendar year for property acquired after September 
27, 2017, and placed in service, and specified plants planted 
or grafted, in taxable years beginning after 2022 (after 2023 
for longer production period property and certain aircraft).
    The provision retains the prior-law phase down of bonus 
depreciation for property acquired before September 28, 2017, 
and placed in service after September 27, 2017.\538\
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    \538\ A technical correction may be necessary to reflect this 
intent due to the effective date of the provision.
    \539\ In the case of specified plants, this is the year of planting 
or grafting.
    \540\ Thirty percent applies to the adjusted basis attributable to 
manufacture, construction, or production before January 1, 2020, and 
the remaining adjusted basis does not qualify for bonus depreciation. 
Thirty percent applies to the entire adjusted basis of certain aircraft 
described in section 168(k)(2)(C) and placed in service in 2020.
---------------------------------------------------------------------------
    Under the provision, the bonus depreciation percentage 
rates are as follows.

------------------------------------------------------------------------
                                       Bonus Depreciation Percentage
                                 ---------------------------------------
                                                       Longer Production
  Placed in Service Year \539\    Qualified Property   Period  Property
                                      in General/         and Certain
                                   Specified Plants        Aircraft
------------------------------------------------------------------------
  Portion of Basis of Qualified Property Acquired before Sept. 28, 2017
 
Sept. 28, 2017-Dec. 31, 2017....  50 percent........  50 percent
2018............................  40 percent........  50 percent
2019............................  30 percent........  40 percent
2020............................  None..............  30 percent \540\
2021 and thereafter.............  None..............  None
------------------------------------------------------------------------


  Portion of Basis of Qualified Property Acquired after Sept. 27, 2017
 
Sept. 28, 2017-Dec. 31, 2022....  100 percent.......  100 percent
2023............................  80 percent........  100 percent
2024............................  60 percent........  80 percent
2025............................  40 percent........  60 percent
2026............................  20 percent........  40 percent
2027............................  None..............  20 percent \541\
2028 and thereafter.............  None..............  None
------------------------------------------------------------------------

                Special rules
---------------------------------------------------------------------------
    \541\ Twenty percent applies to the adjusted basis attributable to 
manufacture, construction, or production before January 1, 2027, and 
the remaining adjusted basis does not qualify for bonus depreciation. 
Twenty percent applies to the entire adjusted basis of certain aircraft 
described in section 168(k)(2)(C) and placed in service in 2027.
---------------------------------------------------------------------------
    The provision maintains the prior-law section 280F increase 
amount of $8,000 for passenger automobiles placed in service 
after December 31, 2017. However, the provision also maintains 
the prior-law phase down of the section 280F increase amount 
for passenger automobiles acquired before September 28, 2017, 
and placed in service after September 27, 2017. Thus, the 
section 280F increase amount for passenger automobiles acquired 
before September 28, 2017, and placed in service after 
September 27, 2017, is $8,000 for 2017, $6,400 for 2018, and 
$4,800 for 2019.
    The provision extends the special rule under the 
percentage-of-completion method for the allocation of bonus 
depreciation to a long-term contract for property placed in 
service before January 1, 2027 (January 1, 2028, in the case of 
longer production period property).

Application to used property

    The provision expands the definition of qualified property 
to include certain qualified property for which the original 
use did not commence with the taxpayer. Thus, the provision 
applies to purchases of used as well as new items. However, 
qualified property only includes used property if such property 
was not previously used by the taxpayer prior to 
acquisition.\542\ To avoid potential abuses, the additional 
first-year depreciation deduction applies only to property 
purchased in an arm's-length transaction. It does not apply to 
property received as a gift or from a decedent.\543\ In the 
case of trade-ins, like-kind exchanges, or involuntary 
conversions, it applies only to any money paid in addition to 
the traded-in property or in excess of the adjusted basis of 
the replaced property.\544\ It does not apply to property 
acquired in a nontaxable exchange such as a reorganization, to 
property acquired from a member of the taxpayer's family, 
including a spouse, ancestors, and lineal descendants, or from 
another related entity as defined in section 267, nor to 
property acquired from a person who controls, is controlled by, 
or is under common control with, the taxpayer.\545\ Thus it 
does not apply, for example, if one member of an affiliated 
group of corporations purchases property from another member, 
or if an individual who controls a corporation purchases 
property from that corporation.
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    \542\ For purposes of determining whether an asset has been 
previously used by a taxpayer, it is intended that the term ``used'' 
means that the taxpayer previously had a depreciable interest in the 
asset (as determined for purposes of sections 167 and 168).
    \543\ By reference to section 179(d)(2)(C). See also Treas. Reg. 
sec. 1.179-4(c)(1)(iv).
    \544\ By reference to section 179(d)(3). See also Treas. Reg. sec. 
1.179-4(d).
    \545\ By reference to section 179(d)(2)(A) and (B). See also Treas. 
Reg. sec. 1.179-4(c).
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Application to qualified film, television, and live theatrical 
        productions

    The provision expands the definition of qualified property 
eligible for the additional first-year depreciation allowance 
to include the production costs of qualified film, television, 
and live theatrical productions \546\ placed in service after 
September 27, 2017, and before January 1, 2027, for which a 
deduction otherwise would have been allowable under section 181 
without regard to the dollar limitation or termination of such 
section.\547\ For purposes of this provision, a qualified 
production is considered placed in service, and thus eligible 
for the additional first-year depreciation allowance, at the 
time of initial release, broadcast, or live staged performance 
(i.e., at the time of the first commercial exhibition, 
broadcast, or live staged performance of a production to an 
audience).
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    \546\ As defined in section 181(d) and (e).
    \547\ For example, similar to section 181, participations and 
residuals are only included in eligible production costs under section 
168(k) to the extent such amounts are actually paid or incurred. 
Similarly, the taxpayer must be the owner of the qualified production 
to be eligible to claim the additional first-year depreciation 
allowance. Thus, for example, a taxpayer that acquires only a limited 
license or right to exploit a production prior to its initial release, 
broadcast, or live staged performance is not eligible to claim the 
additional first-year depreciation allowance for any production costs 
attributable to such production. See Treas. Reg. sec. 1.181-1(a)(2).
---------------------------------------------------------------------------

Election to accelerate AMT credits in lieu of bonus depreciation

    As a conforming amendment to the repeal of the corporate 
AMT, the election to accelerate AMT credits in lieu of bonus 
depreciation is repealed.\548\
---------------------------------------------------------------------------
    \548\ See the description of section 12001 of the Act (Repeal of 
Tax for Corporations).
---------------------------------------------------------------------------

Exception for certain businesses not subject to limitation on interest 
        expense

    The provision excludes from the definition of qualified 
property any property placed in service in taxable years 
beginning after December 31, 2017,\549\ which is primarily used 
in the trade or business of the furnishing \550\ or sale of (1) 
electrical energy, water, or sewage disposal services, (2) gas 
or steam through a local distribution system, or (3) 
transportation of gas or steam by pipeline, if the rates for 
such furnishing or sale, as the case may be, have been 
established or approved by a State or political subdivision 
thereof, by any agency or instrumentality of the United States, 
by a public service or public utility commission or other 
similar body of any State or political subdivision thereof, or 
by the governing or ratemaking body of an electric 
cooperative.\551\
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    \549\ A technical correction may be necessary to reflect this 
intent.
    \550\ The term ``furnishing'' includes generation, transmission, 
and distribution activities.
    \551\ See section 163(j)(7)(A)(iv) and the description of section 
13301 of the Act (Limitation on Deduction for Interest). It is intended 
that this exception only apply to regulated public utility or electric 
cooperative trades or businesses excluded from the interest limitation 
under section 163(j)(7)(A)(iv). For example, property leased by a 
leasing trade or business to a regulated public utility would not be 
precluded by section 168(k)(9)(A) from claiming bonus depreciation on 
its qualified property because the leasing trade or business is not 
excluded from the interest limitation by section 163(j)(7)(A)(iv). 
However, if the leasing trade or business qualifies as an electing real 
property trade or business described in section 163(j)(7)(B), and the 
taxpayer elects to have such business excluded from the interest 
limitation, then the leasing trade or business is required to use ADS 
recovery periods, instead of MACRS recovery periods, for certain real 
property. See the description of section 13204 of the Act (Applicable 
Recovery Period for Real Property).
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    In addition, the provision excludes from the definition of 
qualified property any property used in a trade or business 
that has had floor plan financing indebtedness \552\ if the 
floor plan financing interest related to such indebtedness was 
taken into account to increase the taxpayer's interest 
limitation under section 163(j)(1)(C),\553\ unless the taxpayer 
with such trade or business is not a tax shelter prohibited 
from using the cash method and is exempt from the interest 
limitation rules in section 13301 of the Act by meeting the $25 
million gross receipts test of section 448(c).\554\ Once a 
trade or business has taken floor plan financing interest into 
account under section 163(j)(1)(C) for a taxable year, any 
qualified property placed in service by that trade or business 
in such taxable year and subsequent taxable years is not 
eligible for bonus depreciation.
---------------------------------------------------------------------------
    \552\ As defined in section 163(j)(9). See the description of 
section 13301 of the Act (Limitation on Deduction for Interest).
    \553\ As modified by section 13301 of the Act (Limitation on 
Deduction for Interest).
    \554\ As modified by section 13102 of the Act (Small Business 
Accounting Method Reform and Simplification).
---------------------------------------------------------------------------
    For example, assume that for 2018 a motor vehicle dealer 
does not meet the $25 million gross receipts test and has $20 
of business interest income, $150 of business interest, $50 of 
floor plan financing interest, and $650 of adjusted taxable 
income.\555\ Because the $150 of business interest is less than 
the $215 interest limitation ($20 + ($650 * 30 percent)) 
determined without regard to the floor plan financing interest, 
the floor plan financing interest need not be taken into 
account under section 163(j)(1)(C) to increase the interest 
limitation because all business interest is deductible based on 
the interest limitation otherwise applicable. As a result, 
qualified property placed in service by the motor vehicle 
dealer's trade or business during 2018 is eligible for bonus 
depreciation.
---------------------------------------------------------------------------
    \555\ Determined as provided under section 13301 of the Act 
(Limitation on Deduction for Interest).
---------------------------------------------------------------------------
    Alternatively, assume the same facts as previously stated, 
except that the motor vehicle dealer has adjusted taxable 
income of $50. The interest limitation, determined without 
taking into account floor plan financing interest under section 
163(j)(1)(C), is $35 ($20 + ($50 * 30 percent)). If the 
taxpayer limits the business interest deduction to $35 for 
2018, qualified property placed in service during 2018 remains 
eligible for bonus depreciation. However, if the taxpayer 
increases the interest limitation by taking into account the 
$50 floor plan financing interest under section 163(j)(1)(C) 
and deducts $85 of business interest for 2018, any property 
placed in service by the motor vehicle dealer's trade or 
business during 2018 and subsequent taxable years is not 
eligible for bonus depreciation.\556\
---------------------------------------------------------------------------
    \556\ Note, however, that the motor vehicle dealer's property may 
be eligible for expensing under section 179. For a discussion of 
changes made to section 179 by the Act, see the description of section 
13101 of the Act (Modification of Rules for Expensing).

    The Treasury Department has issued proposed regulations 
addressing this provision.\557\
---------------------------------------------------------------------------
    \557\ See REG-104397-18, 83 Fed. Reg. 39292, August 8, 2018.
---------------------------------------------------------------------------

                             Effective Date

    The provision generally applies to property acquired and 
placed in service after September 27, 2017, and to specified 
plants planted or grafted after such date. The provision 
retaining the prior-law phase down of bonus depreciation 
applies to property acquired before September 28, 2017, and 
placed in service after September 27, 2017.\558\ To determine 
the date of acquisition for purposes of applying these 
effective dates, any property acquired pursuant to a written 
binding contract (including property that is manufactured, 
constructed, or produced for the taxpayer by another person 
under a written binding contract) may not be treated as 
acquired after the date on which such contract is entered into. 
For example, property acquired by a taxpayer pursuant to a 
written binding contract that was entered into on September 1, 
2017, will be subject to prior law when placed in service.
---------------------------------------------------------------------------
    \558\ A technical correction may be necessary to reflect this 
intent.
---------------------------------------------------------------------------
    A transition rule provides that for a taxpayer's first 
taxable year ending after September 27, 2017, and beginning 
before January 1, 2018,\559\ the taxpayer may elect to apply a 
50-percent allowance instead of the 100-percent allowance.\560\
---------------------------------------------------------------------------
    \559\ A technical correction may be necessary to reflect this 
intent.
    \560\ Such election shall be made at such time and in such form and 
manner as prescribed by the Secretary.
---------------------------------------------------------------------------

B. Modifications to Depreciation Limitations on Luxury Automobiles and 
Personal Use Property (sec. 13202 of the Act and sec. 280F of the Code)


                               Prior Law

    Section 280F(a) limits the annual cost recovery deduction 
with respect to certain passenger automobiles. This limitation 
is commonly referred to as the ``luxury automobile depreciation 
limitation'' or the ``section 280F limitation.'' For passenger 
automobiles placed in service in 2017, and for which the 
additional first-year depreciation deduction under section 
168(k) is not claimed, the maximum amount of allowable 
depreciation is $3,160 for the year in which the vehicle is 
placed in service, $5,100 for the second year, $3,050 for the 
third year, and $1,875 for the fourth and later years in the 
recovery period.\561\ This limitation is indexed for inflation 
and applies to the aggregate deduction provided for 
depreciation and section 179 expensing. Hence, passenger 
automobiles subject to section 280F are eligible for section 
179 expensing only to the extent of the applicable limits 
contained in section 280F.\562\ For passenger automobiles 
eligible for the additional first-year depreciation allowance 
in 2017, the first-year limitation is increased by an 
additional $8,000.\563\
---------------------------------------------------------------------------
    \561\ Rev. Proc. 2017-29, Table 3, 2017-14 I.R.B. 1065.
    \562\ For a discussion of changes made to section 179 by the Act, 
see the description of section 13101 of the Act (Modifications of Rules 
for Expensing Depreciable Business Assets).
    \563\ Sec. 168(k)(2)(F). For a discussion of changes made to 
section 168(k) by the Act, see the description of section 13201 of the 
Act (Temporary 100-Percent Expensing for Certain Business Assets).
---------------------------------------------------------------------------
    For purposes of the section 280F 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.\564\ In the case 
of a truck or a van, the section 280F limitation applies to 
vehicles that are rated at 6,000 pounds gross vehicle weight or 
less. Sport utility vehicles are treated as a truck for the 
purpose of applying the section 280F limitation.
---------------------------------------------------------------------------
    \564\ Sec. 280F(d)(5). Exceptions are provided for any ambulance, 
hearse, or combination ambulance-hearse used by the taxpayer directly 
in a trade or business, or any vehicle used by the taxpayer directly in 
the trade or business of transporting persons or property for 
compensation or hire.
---------------------------------------------------------------------------
    Basis not recovered in the recovery period of a passenger 
automobile is allowable as an expense in subsequent taxable 
years.\565\ The expensed amount is limited in each such 
subsequent taxable year to the amount of the limitation in the 
fourth year in the recovery period.
---------------------------------------------------------------------------
    \565\ Sec. 280F(a)(1)(B).
---------------------------------------------------------------------------

Listed property

    In the case of certain listed property, special rules 
apply. Listed property generally is defined as: (1) any 
passenger automobile; (2) any other property used as a means of 
transportation; \566\ (3) any property of a type generally used 
for purposes of entertainment, recreation, or amusement; (4) 
any computer or peripheral equipment; \567\ and (5) any other 
property of a type specified in Treasury regulations.\568\
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    \566\ Property substantially all of the use of which is in a trade 
or business of providing transportation to unrelated persons for hire 
is not considered other property used as a means of transportation. 
Sec. 280F(d)(4)(C).
    \567\ Computer or peripheral equipment used exclusively at a 
regular business establishment and owned or leased by the person 
operating such establishment, however, is not listed property. Sec. 
280F(d)(4)(B).
    \568\ Sec. 280F(d)(4)(A).
---------------------------------------------------------------------------
    First, if for the taxable year in which the property is 
placed in service, the use of the property for trade or 
business purposes does not exceed 50 percent of the total use 
of the property, then the depreciation deduction with respect 
to such property is determined under the alternative 
depreciation system.\569\ The alternative depreciation system 
generally requires the use of the straight-line method and a 
recovery period equal to the class life of the property.\570\ 
Second, if an individual owns or leases listed property that is 
used by the individual in connection with the performance of 
services as an employee, no depreciation deduction, expensing 
allowance, or deduction for lease payments is available with 
respect to such use unless the use of the property is for the 
convenience of the employer and required as a condition of 
employment.\571\ Both limitations apply for purposes of section 
179 expensing.
---------------------------------------------------------------------------
    \569\ Sec. 280F(b)(1). If for any taxable year after the year in 
which the property is placed in service the use of the property for 
trade or business purposes decreases to 50 percent or less of the total 
use of the property, then the amount of depreciation allowed in prior 
years in excess of the amount of depreciation that would have been 
allowed for such prior years under the alternative depreciation system 
is recaptured (i.e., included in gross income) for such taxable year.
    \570\ Sec. 168(g).
    \571\ Sec. 280F(d)(3).
---------------------------------------------------------------------------
    For listed property, no deduction is allowed unless the 
taxpayer adequately substantiates the expense and business 
usage of the property.\572\ A taxpayer must substantiate the 
elements of each expenditure or use of listed property, 
including (1) the amount (e.g., cost) of each separate 
expenditure and the amount of business or investment use, based 
on the appropriate measure (e.g., mileage for automobiles), and 
the total use of the property for the taxable period, (2) the 
date of the expenditure or use, and (3) the business purposes 
for the expenditure or use.\573\ The level of substantiation 
for business or investment use of listed property varies 
depending on the facts and circumstances. In general, the 
substantiation must contain sufficient information as to each 
element of every business or investment use.\574\
---------------------------------------------------------------------------
    \572\ Sec. 274(d)(4).
    \573\ Temp. Treas. Reg. sec. 1.274-5T(b)(6).
    \574\ Temp. Treas. Reg. sec. 1.274-5T(c)(2)(ii)(C).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision increases the depreciation limitations under 
section 280F that apply to passenger automobiles. Specifically, 
for passenger automobiles placed in service after December 31, 
2017, and for which the additional first-year depreciation 
deduction under section 168(k) is not claimed, the maximum 
amount of allowable depreciation is $10,000 for the year in 
which the vehicle is placed in service, $16,000 for the second 
year, $9,600 for the third year, and $5,760 for the fourth and 
later years in the recovery period. The limitations are indexed 
for inflation for passenger automobiles placed in service after 
2018.
    The provision also removes computer or peripheral equipment 
from the definition of listed property. Such property is 
therefore not subject to the heightened substantiation 
requirements that apply to listed property.

    The Treasury Department has issued published guidance 
addressing this provision for passenger automobiles placed in 
service during calendar year 2018.\575\
---------------------------------------------------------------------------
    \575\ See Rev. Proc. 2018-25, 2018-18 I.R.B. 543.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for property placed in service 
after December 31, 2017, in taxable years ending after such 
date.

 C. Modifications of Treatment of Certain Farm Property (sec. 13203 of 
                   the Act and sec. 168 of the Code)


                               Prior Law


In general

    A taxpayer generally must capitalize the cost of property 
used in a trade or business or held for the production of 
income and recover such cost over time through annual 
deductions for depreciation or amortization.\576\ The period 
for depreciation or amortization generally begins when the 
asset is placed in service by the taxpayer.\577\ Tangible 
property generally is depreciated under the modified 
accelerated cost recovery system (``MACRS''), which determines 
depreciation for different types of property based on an 
assigned applicable depreciation method, recovery period, and 
convention.\578\
---------------------------------------------------------------------------
    \576\ See secs. 263(a) and 167. In general, only the tax owner of 
property (i.e., the taxpayer with the benefits and burdens of 
ownership) is entitled to claim tax benefits such as cost recovery 
deductions with respect to the property. In addition, where property is 
not used exclusively in a taxpayer's business, the amount eligible for 
a deduction must be reduced by the amount related to personal use. See, 
e.g., sec. 280A.
    \577\ See Treas. Reg. secs. 1.167(a)-10(b), -3, -14, and 1.197-
2(f). See also Treas. Reg. sec. 1.167(a)-11(e)(1)(i). In the case of 
any tree or vine bearing fruits or nuts, the placed in service date 
generally does not occur until the tree or vine first reaches an 
income-producing stage. See Treas. Reg. sec. 1.46-3(d)(2). See also 
Rev. Rul. 80-25, 1980-1 C.B. 65; and Rev. Rul. 69-249, 1969-1 C.B. 31.
    \578\ Sec. 168.
---------------------------------------------------------------------------
    The applicable recovery period for an asset is determined 
in part by statute and in part by historic Treasury 
guidance.\579\ The ``type of property'' of an asset is used to 
determine the ``class life'' of the asset, which in turn 
dictates the applicable recovery period for the asset.
---------------------------------------------------------------------------
    \579\ Exercising authority granted by Congress, the Secretary 
issued Rev. Proc. 87-56, 1987-2 C.B. 674, laying out the framework of 
recovery periods for enumerated classes of assets. The Secretary 
clarified and modified the list of asset classes in Rev. Proc. 88-22, 
1988-1 C.B. 785. In November 1988, Congress revoked the Secretary's 
authority to modify the class lives of depreciable property. Rev. Proc. 
87-56, as modified, remains in effect except to the extent that the 
Congress has, since 1988, statutorily modified the recovery period for 
certain depreciable assets, effectively superseding any administrative 
guidance with regard to such property.
---------------------------------------------------------------------------
    The MACRS recovery periods applicable to most tangible 
personal property range from three to 20 years. The 
depreciation methods generally applicable to tangible personal 
property are the 200-percent and 150-percent declining balance 
methods,\580\ switching to the straight line method for the 
first taxable year where using the straight line method with 
respect to the adjusted basis as of the beginning of that year 
yields a larger depreciation allowance. The recovery periods 
for most real property are 39 years for nonresidential real 
property and 27.5 years for residential rental property. The 
straight line depreciation method is required for the 
aforementioned real property.
---------------------------------------------------------------------------
    \580\ Under the declining balance method the depreciation rate is 
determined by dividing the appropriate percentage (here 150 or 200) by 
the appropriate recovery period. This leads to accelerated depreciation 
when the declining balance percentage is greater than 100. The table 
below illustrates depreciation for an asset with a cost of $1,000 and a 
seven-year recovery period under the 200-percent declining balance 
method, the 150-percent declining balance method, and the straight line 
method.

    Recovery method              Year 1 Year 2 Year 3 Year 4 Year 5 
Year 6 Year 7  Total
    200-percent declining balance   285.71 204.08 145.77 104.12 86.77  
86.77 86.77   1,000.00
    150-percent declining balance   214.29 168.37 132.29 121.26 121.26 
121.26  121.26 1,000.00
    Straight-line                142.86 142.86 142.86 142.86 142.86 
142.86 142.86 1,000.00
    * Details may not add to totals due to rounding.
---------------------------------------------------------------------------

Farm property

    Property used in a farming business is assigned various 
recovery periods in the same manner as other business property. 
For these purposes, the term ``farming business'' means a trade 
or business involving the cultivation of land or the raising or 
harvesting of any agricultural or horticultural commodity 
(e.g., the trade or business of operating a nursery or sod 
farm; the raising or harvesting of trees bearing fruit, nuts, 
or other crops; the raising of ornamental trees (other than 
evergreen trees that are more than six years old at the time 
they are severed from their roots); and the raising, shearing, 
feeding, caring for, training, and management of animals).\581\ 
A farming business includes processing activities that are 
normally incident to the growing, raising, or harvesting of 
agricultural or horticultural products.\582\ A farming business 
does not include contract harvesting of an agricultural or 
horticultural commodity grown or raised by another taxpayer, or 
merely buying and reselling plants or animals grown or raised 
by another taxpayer.\583\
---------------------------------------------------------------------------
    \581\ Sec. 263A(e)(4) and Treas. Reg. sec. 1.263A-4(a)(4)(i).
    \582\ Sec. 263A(e)(4) and Treas. Reg. sec. 1.263A-4(a)(4)(ii).
    \583\ Sec. 263A(e)(4) and Treas. Reg. sec. 1.263A-4(a)(4)(i).
---------------------------------------------------------------------------
            Farm recovery periods
    Farm property that is generally assigned a three-year 
recovery period includes, for example, breeding hogs, breeding 
and working horses more than 12 years old when placed in 
service, and over-the-road tractor units.\584\ Examples of 
five-year farm property include dairy or breeding cattle, 
breeding goats and sheep, and trucks.\585\ Farm property 
assigned a recovery period of seven years includes machinery 
and equipment, grain bins, and fences (but no other land 
improvements), that are used in the production of crops or 
plants, vines, and trees; livestock; the operation of farm 
dairies, nurseries, greenhouses, sod farms, mushrooms cellars, 
cranberry bogs, apiaries, and fur farms; and the performance of 
agriculture, animal husbandry, and horticultural services.\586\ 
Cotton ginning assets and breeding and working horses 12 years 
old or less when placed in service are also assigned a recovery 
period of seven years.\587\ Any single purpose agricultural or 
horticultural structure,\588\ and any tree or vine bearing 
fruit or nuts are assigned a recovery period of 10 years.\589\ 
Land improvements such as drainage facilities, paved lots, and 
water wells are assigned a recovery period of 15 years.\590\ 
Farm buildings that do not meet the definition of a single 
purpose agricultural or horticultural structure are assigned a 
recovery period of 20 years.\591\
---------------------------------------------------------------------------
    \584\ See Rev. Proc. 87-56, asset class 01.23, Hogs, Breeding; 
asset class 01.222, any breeding or work horse that is more than 12 
years old at the time it is placed in service; and asset class 00.26, 
Tractor Units for Use Over-the-Road.
    \585\ See Rev. Proc. 87-56, asset class 01.21, Cattle, Breeding or 
Dairy; asset class 01.24, Sheep and Goats, Breeding; asset class 
00.241, Light General Purpose Trucks; and asset class 00.242, Heavy 
General Purpose Trucks.
    \586\ Rev. Proc. 87-56, asset class 01.1, Agriculture.
    \587\ Rev. Proc. 87-56, asset class 01.11, Cotton ginning assets; 
and asset class 01.221, any breeding or work horse that is 12 years old 
or less at the time it is placed in service.
    \588\ A single purpose agricultural (livestock) structure is any 
enclosure or structure specifically designed, constructed, and used for 
(i) housing, raising, and feeding a particular type of livestock 
(including poultry) and their produce, and (ii) housing the equipment 
(including any replacements) necessary for the housing, raising, and 
feeding of such livestock. Sec. 168(i)(13)(B)(i) and (iv). For example, 
a single purpose agricultural structure includes a structure used to 
breed chicken or hogs, produce milk from dairy cattle, or produce 
feeder cattle or pigs, broiler chickens, or eggs, if an integral part 
of the structure is the equipment necessary to house, raise, and feed 
the livestock. See IRS Publication 225, Farmer's Tax Guide (2017). A 
single purpose horticultural structure is (i) a greenhouse specifically 
designed, constructed and used for the commercial production of plants, 
and (ii) a structure specifically designed, constructed, and used for 
the commercial production of mushrooms. Sec. 168(i)(13)(B)(ii). If a 
structure includes work space, the work space must be solely for (i) 
the stocking, caring for, or collecting of livestock or plants (as the 
case may be) or their produce, (ii) the maintenance of the enclosure or 
structure, and (iii) the maintenance or replacement of the equipment or 
stock enclosed or housed therein. Sec. 168(i)(13)(B)(iii). See also 
Rev. Proc. 87-56, asset class 01.4, Single purpose agricultural or 
horticultural structures.
    \589\ Sec. 168(e)(3)(D)(i) and (ii).
    \590\ Rev. Proc. 87-56, asset class 00.3, Land improvements. See 
also IRS Publication 225, Farmer's Tax Guide (2017).
    \591\ Rev. Proc. 87-56, asset class 01.3, Farm buildings except 
structures included in asset class 01.4.
---------------------------------------------------------------------------
    A five-year recovery period was assigned to new farm 
machinery or equipment (other than any grain bin, cotton 
ginning asset, fence, or other land improvement) which was used 
in a farming business (as defined above), the original use of 
which commenced with the taxpayer after December 31, 2008, and 
which was placed in service before January 1, 2010.\592\
---------------------------------------------------------------------------
    \592\ Sec. 168(e)(3)(B)(vii).
---------------------------------------------------------------------------
    Any property used in a farming business (other than 
nonresidential real property,\593\ residential rental 
property,\594\ and trees or vines bearing fruits or nuts \595\) 
is subject to the 150-percent declining balance method.\596\
---------------------------------------------------------------------------
    \593\ Sec. 168(b)(3)(A).
    \594\ Sec. 168(b)(3)(B).
    \595\ Sec. 168(b)(3)(E).
    \596\ Sec. 168(b)(2)(B).
---------------------------------------------------------------------------
    Under a special accounting rule, certain taxpayers engaged 
in the business of farming who elect to deduct preproductive 
period expenditures of plants produced in such business are 
required to depreciate all farming assets using the alternative 
depreciation system (i.e., using longer recovery periods and 
the straight line method).\597\
---------------------------------------------------------------------------
    \597\ Secs. 263A(d)(3) and (e)(2), and 168(g)(2). For a discussion 
of changes made to the applicability of section 263A by the Act, see 
the description of section 13102 of the Act (Small Business Accounting 
Method Reform and Simplification).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision shortens the recovery period from seven to 
five years for any machinery or equipment (other than any grain 
bin, cotton ginning asset, fence, or other land improvement) 
used in a farming business,\598\ the original use of which 
commences with the taxpayer and which is placed in service 
after December 31, 2017.
---------------------------------------------------------------------------
    \598\ For purposes of the provision, ``farming business'' is 
defined consistent with prior law (i.e., under section 263A(e)(4)).
---------------------------------------------------------------------------
    The provision also repeals the required use of the 150-
percent declining balance method for certain property used in a 
farming business (i.e., for three-, five-, seven-, and 10-year 
property), allowing such property to use the 200-percent 
declining balance method. The 150-percent declining balance 
method will continue to apply to any 15-year or 20-year 
property used in a farming business to which the straight line 
method does not apply, or to property for which the taxpayer 
elects the use of the 150-percent declining balance method.

                             Effective Date

    The provision is effective for property placed in service 
after December 31, 2017, in taxable years ending after such 
date.

D. Applicable Recovery Period for Real Property (sec. 13204 of the Act 
                       and sec. 168 of the Code)


                               Prior Law


In general

    A taxpayer generally must capitalize the cost of property 
used in a trade or business or held for the production of 
income and recover such cost over time through annual 
deductions for depreciation or amortization.\599\ The period 
for depreciation or amortization generally begins when the 
asset is placed in service by the taxpayer.\600\ Tangible 
property generally is depreciated under the modified 
accelerated cost recovery system (``MACRS''), which determines 
depreciation for different types of property based on an 
assigned applicable depreciation method, recovery period, and 
convention.\601\
---------------------------------------------------------------------------
    \599\ See secs. 263(a) and 167. In general, only the tax owner of 
property (i.e., the taxpayer with the benefits and burdens of 
ownership) is entitled to claim tax benefits such as cost recovery 
deductions with respect to the property. In addition, where property is 
not used exclusively in a taxpayer's business, the amount eligible for 
a deduction must be reduced by the amount related to personal use. See, 
e.g., sec. 280A.
    \600\ See Treas. Reg. secs. 1.167(a)-10(b), -3, -14, and 1.197-
2(f). See also Treas. Reg. sec. 1.167(a)-11(e)(1)(i).
    \601\ Sec. 168.
---------------------------------------------------------------------------
            Recovery periods and depreciation methods
    The applicable recovery period for an asset is determined 
in part by statute and in part by historic Treasury 
guidance.\602\ The ``type of property'' of an asset is used to 
determine the ``class life'' of the asset, which in turn 
dictates the applicable recovery period for the asset.
---------------------------------------------------------------------------
    \602\ Exercising authority granted by Congress, the Secretary 
issued Rev. Proc. 87-56, 1987-2 C.B. 674, laying out the framework of 
recovery periods for enumerated classes of assets. The Secretary 
clarified and modified the list of asset classes in Rev. Proc. 88-22, 
1988-1 C.B. 785. In November 1988, Congress revoked the Secretary's 
authority to modify the class lives of depreciable property. Rev. Proc. 
87-56, as modified, remains in effect except to the extent that the 
Congress has, since 1988, statutorily modified the recovery period for 
certain depreciable assets, effectively superseding any administrative 
guidance with regard to such property.
---------------------------------------------------------------------------
    The MACRS recovery periods applicable to most tangible 
personal property range from three to 20 years. The 
depreciation methods generally applicable to tangible personal 
property are the 200-percent and 150-percent declining balance 
methods,\603\ switching to the straight line method for the 
first taxable year where using the straight line method with 
respect to the adjusted basis as of the beginning of that year 
yields a larger depreciation allowance. The recovery periods 
for most real property are 39 years for nonresidential real 
property and 27.5 years for residential rental property. The 
straight line depreciation method is required for the 
aforementioned real property.
---------------------------------------------------------------------------
    \603\ Under the declining balance method the depreciation rate is 
determined by dividing the appropriate percentage (here 150 or 200) by 
the appropriate recovery period. This leads to accelerated depreciation 
when the declining balance percentage is greater than 100. The table 
below illustrates depreciation for an asset with a cost of $1,000 and a 
seven-year recovery period under the 200-percent declining balance 
method, the 150-percent declining balance method, and the straight line 
method.

    Recovery method              Year 1 Year 2 Year 3 Year 4 Year 5 
Year 6 Year 7  Total
    200-percent declining balance   285.71 204.08 145.77 104.12 86.77  
86.77 86.77   1,000.00
    150-percent declining balance   214.29 168.37 132.29 121.26 121.26 
121.26  121.26 1,000.00
    Straight-line                142.86 142.86 142.86 142.86 142.86 
142.86 142.86 1,000.00
    * Details may not add to totals due to rounding.
---------------------------------------------------------------------------
            Placed-in-service conventions
    Depreciation of an asset begins when the asset is deemed to 
be placed in service under the applicable convention.\604\ 
Under MACRS, nonresidential real property, residential rental 
property, and any railroad grading or tunnel bore generally are 
subject to the mid-month convention, which treats all property 
placed in service during any month (or disposed of during any 
month) as placed in service (or disposed of) on the mid-point 
of such month.\605\ All other property generally is subject to 
the half-year convention, which treats all property placed in 
service during any taxable year (or disposed of during any 
taxable year) as placed in service (or disposed of) on the mid-
point of such taxable year to reflect the assumption that 
assets are placed in service ratably throughout the year.\606\ 
However, if substantial property is placed in service during 
the last three months of a taxable year, a special rule 
requires use of the mid-quarter convention,\607\ designed to 
prevent the recognition of disproportionately large amounts of 
first-year depreciation under the half-year convention.
---------------------------------------------------------------------------
    \604\ Treas. Reg. sec. 1.167(a)-10(b).
    \605\ Secs. 168(d)(2) and (4)(B).
    \606\ Secs. 168(d)(1) and (4)(A).
    \607\ The mid-quarter convention treats all property placed in 
service (or disposed of) during any quarter as placed in service (or 
disposed of) on the mid-point of such quarter. Sec. 168(d)(3) and 
(4)(C).
---------------------------------------------------------------------------

Depreciation of additions or improvements to property

    The recovery period for any addition or improvement to real 
or personal property begins on the later of (1) the date on 
which the addition or improvement is placed in service, or (2) 
the date on which the property with respect to which such 
addition or improvement is made is placed in service.\608\ Any 
MACRS deduction for an addition or improvement to any property 
is to be computed in the same manner as the deduction for the 
underlying property would be if such property were placed in 
service at the same time as such addition or improvement. Thus, 
for example, the cost of an improvement to a building that 
constitutes nonresidential real property is recovered over 39 
years using the straight line method and mid-month convention. 
However, exceptions apply to certain leasehold improvements.
---------------------------------------------------------------------------
    \608\ Sec. 168(i)(6).
---------------------------------------------------------------------------
            Depreciation of leasehold improvements
    Generally, 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.\609\ This rule applies regardless of whether 
the lessor or the lessee places the leasehold improvements in 
service. If a leasehold improvement constitutes an addition or 
improvement to nonresidential real property already placed in 
service, the improvement generally 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. 
However, exceptions to the 39-year recovery period exist for 
certain qualified leasehold improvement property, qualified 
restaurant property, and qualified retail improvement property.
---------------------------------------------------------------------------
    \609\ Sec. 168(i)(8).
---------------------------------------------------------------------------
            Qualified leasehold improvement property
    Section 168(e)(3)(E)(iv) provides a statutory 15-year 
recovery period for qualified leasehold improvement property. 
Qualified leasehold improvement property is any improvement to 
an interior portion of a building that is nonresidential real 
property, provided certain requirements are met.\610\ 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. 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 nonrecognition treatment.
---------------------------------------------------------------------------
    \610\ Sec. 168(e)(6).
---------------------------------------------------------------------------
    Qualified leasehold improvement property is generally 
recovered using the straight-line method and a half-year 
convention,\611\ and is eligible for the additional first-year 
depreciation deduction if the other requirements of section 
168(k) are met.\612\
---------------------------------------------------------------------------
    \611\ Secs. 168(b)(3)(G) and (d).
    \612\ Secs. 168(k)(2)(A)(i)(IV) and (3), prior to amendment by 
section 13201 of the Act (Temporary 100-Percent Expensing for Certain 
Business Assets).
---------------------------------------------------------------------------
            Qualified restaurant property
    Section 168(e)(3)(E)(v) provides a statutory 15-year 
recovery period for qualified restaurant property. Qualified 
restaurant property is any section 1250 property \613\ that is 
a building or an improvement to a building, if 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.\614\ Qualified restaurant property is recovered 
using the straight-line method and a half-year convention.\615\ 
Additionally, qualified restaurant property is not eligible for 
the additional first-year depreciation deduction unless it also 
satisfies the definition of qualified improvement 
property.\616\
---------------------------------------------------------------------------
    \613\ Depreciable real property, other than that included within 
the definition of section 1245 property, is known as section 1250 
property. Sec. 1250(c). Section 1250 property includes, for example, a 
building or its structural components. Treas. Reg. sec. 1.1250-1(e)(3). 
Depreciable real property that may be classified as section 1245 
property includes, for example, real property that performs specific 
functions in a business, but does not include buildings or structural 
components of buildings. Sec. 1245(a)(3).
    \614\ Sec. 168(e)(7).
    \615\ Secs. 168(b)(3)(H) and (d).
    \616\ Sec. 168(e)(7)(B).
---------------------------------------------------------------------------
            Qualified retail improvement property
    Section 168(e)(3)(E)(ix) provides a statutory 15-year 
recovery period for qualified retail improvement property. 
Qualified retail improvement property is any improvement to an 
interior portion of a building which is nonresidential real 
property if such portion is open to the general public \617\ 
and is used in the retail trade or business of selling tangible 
personal property to the general public, and such improvement 
is placed in service more than three years after the date the 
building was first placed in service.\618\ Qualified retail 
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.\619\ In the case of an improvement made by the 
owner of such improvement, the improvement is a qualified 
retail improvement only so long as the improvement is held by 
such owner.\620\
---------------------------------------------------------------------------
    \617\ Improvements to portions of a building not open to the 
general public (e.g., stock room in back of retail space) do not 
qualify under the provision.
    \618\ Sec. 168(e)(8).
    \619\ Sec. 168(e)(8)(C).
    \620\ Sec. 168(e)(8)(B). Rules similar to section 168(e)(6)(B) 
apply in the case of death and certain transfers of property that 
qualify for nonrecognition treatment.
---------------------------------------------------------------------------
    Retail establishments that qualify for the 15-year recovery 
period include those primarily engaged in the sale of goods. 
Examples of these retail establishments include, but are not 
limited to, grocery stores, clothing stores, hardware stores, 
and convenience stores. Establishments primarily engaged in 
providing services, such as professional services, financial 
services, personal services, health services, and 
entertainment, do not qualify. Generally, it is intended that 
businesses defined as a store retailer under the current North 
American Industry Classification System (industry subsectors 
441 through 453) qualify while those in other industry classes 
do not qualify.\621\
---------------------------------------------------------------------------
    \621\ Joint Committee on Taxation, General Explanation of Tax 
Legislation Enacted in the 110th Congress (JCS-1-09), March 2009, p. 
402.
---------------------------------------------------------------------------
    Qualified retail improvement property is recovered using 
the straight-line method and a half-year convention,\622\ and 
is eligible for the additional first-year depreciation 
deduction if the other requirements of section 168(k) are 
met.\623\
---------------------------------------------------------------------------
    \622\ Secs. 168(b)(3)(I) and (d).
    \623\ Secs. 168(k)(2)(A)(i)(IV) and (3), prior to amendment by 
section 13301 of the Act (Temporary 100-Percent Expensing for Certain 
Business Assets).
---------------------------------------------------------------------------

Expensing of certain improvements

    Improvements that meet the definition of qualified 
leasehold improvement property, qualified restaurant property, 
or qualified retail improvement property (as defined above) are 
eligible for section 179 expensing.\624\ Similarly, 
improvements that constitute ``qualified improvement property'' 
are eligible for the additional first-year depreciation 
deduction if the other requirements of section 168(k) are 
met.\625\
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    \624\ Sec. 179(f), as in effect prior to amendment by section 13101 
of the Act (Modifications of Rules for Expensing) and the enactment of 
the Consolidated Appropriations Act, 2018, Pub. L. No. 115-141, sec. 
401(b)(15), March 23, 2018, which, as part of repealing general 
deadwood-related provisions, struck former subsection (e) (relating to 
special rules for qualified disaster assistance property) and 
redesignated ``subsection (f)'' as ``subsection (e)''.
    \625\ Secs. 168(k)(2)(A)(i)(IV) and (3), prior to amendment by 
section 13201 of the Act (Temporary 100-Percent Expensing for Certain 
Business Assets). Note that the amount of the additional first-year 
depreciation deduction is determined after basis adjustments for any 
section 179 expensing. See Treas. Reg. sec. 1.168(k)-1(a)(2)(iii).
---------------------------------------------------------------------------
    Qualified improvement property is any improvement to an 
interior portion of a building that is nonresidential real 
property if such improvement is placed in service by the 
taxpayer after the date such building was first placed in 
service by any taxpayer.\626\ Qualified improvement property 
does not include any improvement for which the expenditure is 
attributable to the enlargement of the building, any elevator 
or escalator, or the internal structural framework of the 
building.
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    \626\ Sec. 168(k)(3). See also section 4.02 of Rev. Proc. 2017-33, 
2017-19 I.R.B. 1236. Qualified improvement property must also meet the 
requirements of section 168(k)(2)(A)(ii) and (iii) (i.e., the original 
use and placed in service date requirements) to be eligible for the 
additional first-year depreciation deduction.
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Alternative depreciation system

    The alternative depreciation system (``ADS'') is required 
to be used for tangible property used predominantly outside the 
United States, certain tax-exempt use property, tax-exempt bond 
financed property, and certain imported property covered by an 
Executive order.\627\ An election to use ADS is available to 
taxpayers for any class of property for any taxable year.\628\ 
Under ADS, all property is depreciated using the straight line 
method over recovery periods which generally are equal to the 
class life of the property, with certain exceptions.\629\ For 
example nonresidential real and residential rental property 
have a 40-year ADS recovery period, while qualified leasehold 
improvement property, qualified restaurant property, and 
qualified retail improvement property have a 39-year ADS 
recovery period.\630\
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    \627\ Sec. 168(g).
    \628\ Sec. 168(g)(7).
    \629\ Secs. 168(g)(2) and (3).
    \630\ Sec. 168(g)(3).
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                        Explanation of Provision

    The provision eliminates the separate definitions of 
qualified leasehold improvement property, qualified restaurant 
property, and qualified retail improvement property,\631\ and 
provides a general 15-year recovery period \632\ for qualified 
improvement property made by the taxpayer \633\ and a 20-year 
ADS recovery period for such property.\634\ Thus, for example, 
qualified improvement property placed in service after December 
31, 2017, is generally depreciable over 15 years using the 
straight line method and half-year convention, without regard 
to whether the improvements are property subject to a lease, 
placed in service more than three years after the date the 
building was first placed in service, or made to a restaurant 
building. Restaurant building property placed in service after 
December 31, 2017, that does not meet the definition of 
qualified improvement property is depreciable over 39 years as 
nonresidential real property, using the straight line method 
and the mid-month convention.
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    \631\ For a description of a conforming amendment made to section 
179 to provide that qualified improvement property (in lieu of 
qualified leasehold improvement property, qualified restaurant 
property, and qualified retail improvement property) is eligible for 
section 179 expensing, see the description of section 13101 of the Act 
(Modifications of Rules for Expensing Depreciable Business Assets).
    \632\ A technical correction may be necessary to reflect this 
intent. Note that as 15-year property, qualified improvement property 
is generally eligible for the additional first-year depreciation 
deduction under section 168(k). For a discussion of changes made to 
section 168(k) by the Act, see the description of section 13201 of the 
Act (Temporary 100-Percent Expensing for Certain Business Assets).
    \633\ A technical correction may be necessary to reflect this 
intent.
    \634\ A technical correction may be necessary to reflect this 
intent.
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    The provision also requires a real property trade or 
business \635\ electing out of the interest limitation under 
section 163(j) to use ADS to depreciate any of its 
nonresidential real property, residential rental property, 
qualified improvement property, qualified leasehold improvement 
property, qualified restaurant property, and qualified retail 
improvement property.\636\
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    \635\ As defined in section 163(j)(7)(B), by cross reference to 
section 469(c)(7)(C) (i.e., any real property development, 
redevelopment, construction, reconstruction, acquisition, conversion, 
rental, operation, management, leasing, or brokerage trade or 
business). Note that a mortgage broker who is a broker of financial 
instruments is not in a real property trade or business for this 
purpose. See, e.g., CCA 201504010 (December 17, 2014). For a discussion 
of changes made to section 163(j) by the Act, see the description of 
section 13301 of the Act (Limitation on Deduction for Interest).
    \636\ A technical correction may be necessary to reflect that an 
electing real property trade or business is also required to use ADS to 
depreciate its qualified leasehold improvement property, qualified 
restaurant property, and qualified retail improvement property (as 
defined under prior law) that was placed in service prior to 2018 and 
is owned by the taxpayer as of the beginning of the year of the 
election out of the interest limitation. Congress intends that an 
election out of the interest limitation and resulting required use of 
ADS be treated as a change in use of the property. See sec. 168(i)(5) 
and Treas. Reg. sec. 1.168(i)-4.
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    In addition, the provision shortens the ADS recovery period 
for residential rental property from 40 years to 30 years.

                             Effective Date

    The provision is generally effective for property placed in 
service after December 31, 2017.
    The provision relating to electing real property trades or 
businesses applies to taxable years beginning after December 
31, 2017.

    E. Use of Alternative Depreciation System for Electing Farming 
      Businesses (sec. 13205 of the Act and sec. 168 of the Code)


                               Prior Law


In general

    A taxpayer generally must capitalize the cost of property 
used in a trade or business or held for the production of 
income and recover such cost over time through annual 
deductions for depreciation or amortization.\637\ The period 
for depreciation or amortization generally begins when the 
asset is placed in service by the taxpayer.\638\ Tangible 
property generally is depreciated under the modified 
accelerated cost recovery system (``MACRS''), which determines 
depreciation for different types of property based on an 
assigned applicable depreciation method, recovery period, and 
convention.\639\
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    \637\ See secs. 263(a) and 167. In general, only the tax owner of 
property (i.e., the taxpayer with the benefits and burdens of 
ownership) is entitled to claim tax benefits such as cost recovery 
deductions with respect to the property. In addition, where property is 
not used exclusively in a taxpayer's business, the amount eligible for 
a deduction must be reduced by the amount related to personal use. See, 
e.g., sec. 280A.
    \638\ See Treas. Reg. secs. 1.167(a)-10(b), -3, -14, and 1.197-
2(f). See also Treas. Reg. sec. 1.167(a)-11(e)(1)(i). In the case of 
any tree or vine bearing fruits or nuts, the placed in service date 
generally does not occur until the tree or vine first reaches an 
income-producing stage. See Treas. Reg. sec. 1.46-3(d)(2). See also, 
Rev. Rul. 80-25, 1980-1 C.B. 65; and Rev. Rul. 69-249, 1969-1 C.B. 31.
    \639\ Sec. 168.
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    The applicable recovery period for an asset is determined 
in part by statute and in part by historic Treasury 
guidance.\640\ The ``type of property'' of an asset is used to 
determine the ``class life'' of the asset, which in turn 
dictates the applicable recovery period for the asset.
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    \640\ Exercising authority granted by Congress, the Secretary 
issued Rev. Proc. 87-56, 1987-2 C.B. 674, laying out the framework of 
recovery periods for enumerated classes of assets. The Secretary 
clarified and modified the list of asset classes in Rev. Proc. 88-22, 
1988-1 C.B. 785. In November 1988, Congress revoked the Secretary's 
authority to modify the class lives of depreciable property. Rev. Proc. 
87-56, as modified, remains in effect except to the extent that the 
Congress has, since 1988, statutorily modified the recovery period for 
certain depreciable assets, effectively superseding any administrative 
guidance with regard to such property.
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    The MACRS recovery periods applicable to most tangible 
personal property range from three to 20 years. The 
depreciation methods generally applicable to tangible personal 
property are the 200-percent and 150-percent declining balance 
methods,\641\ switching to the straight line method for the 
first taxable year where using the straight line method with 
respect to the adjusted basis as of the beginning of that year 
yields a larger depreciation allowance. The recovery periods 
for most real property are 39 years for nonresidential real 
property and 27.5 years for residential rental property. The 
straight line depreciation method is required for the 
aforementioned real property.
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    \641\ Under the declining balance method the depreciation rate is 
determined by dividing the appropriate percentage (here 150 or 200) by 
the appropriate recovery period. This leads to accelerated depreciation 
when the declining balance percentage is greater than 100. The table 
below illustrates depreciation for an asset with a cost of $1,000 and a 
seven-year recovery period under the 200-percent declining balance 
method, the 150-percent declining balance method, and the straight line 
method.
      

    Recovery method              Year  1 Year 2  Year 3 Year 4 Year 5 
Year 6 Year 7  Total
    200-percent declining balance   285.71 204.08 145.77 104.12 86.77  
86.77 86.77   1,000.00
    150-percent declining balance   214.29 168.37 132.29 121.26 121.26 
121.26  121.26 1,000.00
    Straight-line                142.86 142.86 142.86 142.86 142.86 
142.86 142.86 1,000.00
    * Details may not add to totals due to rounding.
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Farm property

    Property used in a farming business is assigned various 
recovery periods in the same manner as other business property. 
For these purposes, the term ``farming business'' means a trade 
or business involving the cultivation of land or the raising or 
harvesting of any agricultural or horticultural commodity 
(e.g., the trade or business of operating a nursery or sod 
farm; the raising or harvesting of trees bearing fruit, nuts, 
or other crops; the raising of ornamental trees (other than 
evergreen trees that are more than six years old at the time 
they are severed from their roots); and the raising, shearing, 
feeding, caring for, training, and management of animals).\642\ 
A farming business includes processing activities that are 
normally incident to the growing, raising, or harvesting of 
agricultural or horticultural products.\643\ A farming business 
does not include contract harvesting of an agricultural or 
horticultural commodity grown or raised by another taxpayer, or 
merely buying and reselling plants or animals grown or raised 
by another taxpayer.\644\
---------------------------------------------------------------------------
    \642\ Sec. 263A(e)(4) and Treas. Reg. sec. 1.263A-4(a)(4)(i).
    \643\ Sec. 263A(e)(4) and Treas. Reg. sec. 1.263A-4(a)(4)(ii).
    \644\ Sec. 263A(e)(4) and Treas. Reg. sec. 1.263A-4(a)(4)(i).
---------------------------------------------------------------------------
            Farm property recovery periods
    Farm property that is generally assigned a three-year 
recovery period includes, for example, breeding hogs, breeding 
and working horses more than 12 years old when placed in 
service, and over-the-road tractor units.\645\ Examples of 
five-year farm property include dairy or breeding cattle, 
breeding goats and sheep, and trucks.\646\ Farm property 
assigned a recovery period of seven years includes machinery 
and equipment, grain bins, and fences (but no other land 
improvements), that are used in the production of crops or 
plants, vines, and trees; livestock; the operation of farm 
dairies, nurseries, greenhouses, sod farms, mushrooms cellars, 
cranberry bogs, apiaries, and fur farms; and the performance of 
agriculture, animal husbandry, and horticultural services.\647\ 
Cotton ginning assets and breeding and working horses 12 years 
old or less when placed in service are also assigned a recovery 
period of seven years.\648\ Any single purpose agricultural or 
horticultural structure,\649\ and any tree or vine bearing 
fruit or nuts are assigned a recovery period of 10 years.\650\ 
Land improvements such as drainage facilities, paved lots, and 
water wells are assigned a recovery period of 15 years.\651\ 
Farm buildings that do not meet the definition of a single 
purpose agricultural or horticultural structure are assigned a 
recovery period of 20 years.\652\
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    \645\ See Rev. Proc. 87-56, asset class 01.23, Hogs, Breeding; 
asset class 01.222, any breeding or work horse that is more than 12 
years old at the time it is placed in service; and asset class 00.26, 
Tractor Units for Use Over-the-Road.
    \646\ See Rev. Proc. 87-56, asset class 01.21, Cattle, Breeding or 
Dairy; asset class 01.24, Sheep and Goats, Breeding; asset class 
00.241, Light General Purpose Trucks; and asset class 00.242, Heavy 
General Purpose Trucks.
    \647\ Rev. Proc. 87-56, asset class 01.1, Agriculture.
    \648\ Rev. Proc. 87-56, asset class 01.11, Cotton ginning assets; 
and asset class 01.221, Any breeding or work horse that is 12 years old 
or less at the time it is placed in service.
    \649\ A single purpose agricultural (livestock) structure is any 
enclosure or structure specifically designed, constructed, and used for 
(i) housing, raising, and feeding a particular type of livestock 
(including poultry) and their produce, and (ii) housing the equipment 
(including any replacements) necessary for the housing, raising, and 
feeding of such livestock. Sec. 168(i)(13)(B)(i) and (iv). For example, 
a single purpose agricultural structure includes a structure used to 
breed chicken or hogs, produce milk from dairy cattle, or produce 
feeder cattle or pigs, broiler chickens, or eggs, if an integral part 
of the structure is the equipment necessary to house, raise, and feed 
the livestock. See IRS Publication 225, Farmer's Tax Guide (2017). A 
single purpose horticultural structure is (i) a greenhouse specifically 
designed, constructed and used for the commercial production of plants, 
and (ii) a structure specifically designed, constructed, and used for 
the commercial production of mushrooms. Sec. 168(i)(13)(B)(ii). If a 
structure includes work space, the work space must be solely for (i) 
the stocking, caring for, or collecting of livestock or plants (as the 
case may be) or their produce, (ii) the maintenance of the enclosure or 
structure, and (iii) the maintenance or replacement of the equipment or 
stock enclosed or housed therein. Sec. 168(i)(13)(B)(iii). See also 
Rev. Proc. 87-56, asset class 01.4, Single purpose agricultural or 
horticultural structures.
    \650\ Secs. 168(e)(3)(D)(i) and (ii).
    \651\ Rev. Proc. 87-56, asset class 00.3, Land improvements. See 
also IRS Publication 225, Farmer's Tax Guide (2017).
    \652\ Rev. Proc. 87-56, asset class 01.3, Farm buildings except 
structures included in asset class 01.4.
---------------------------------------------------------------------------
    A five-year recovery period was assigned to new farm 
machinery or equipment (other than any grain bin, cotton 
ginning asset, fence, or other land improvement) which was used 
in a farming business (as defined above), the original use of 
which commenced with the taxpayer after December 31, 2008, and 
which was placed in service before January 1, 2010.\653\
---------------------------------------------------------------------------
    \653\ Sec. 168(e)(3)(B)(vii). However, section 13203 of the Act 
(Modifications of Treatment of Certain Farm Property) also shortens the 
recovery period from seven to five years for any machinery or equipment 
(other than any grain bin, cotton ginning asset, fence, or other land 
improvement) which is used in a farming business, the original use of 
which commences with the taxpayer and is placed in service after 
December 31, 2017.
---------------------------------------------------------------------------
    Any property used in a farming business (other than 
nonresidential real property,\654\ residential rental 
property,\655\ and trees or vines bearing fruits or nuts \656\) 
is subject to the 150-percent declining balance method.\657\
---------------------------------------------------------------------------
    \654\ Sec. 168(b)(3)(A).
    \655\ Sec. 168(b)(3)(B).
    \656\ Sec. 168(b)(3)(E).
    \657\ Sec. 168(b)(2)(B). However, section 13203 of the Act 
(Modifications of Treatment of Certain Farm Property) repeals the 
required use of the 150-percent declining balance method for property 
used in a farming business (i.e., for three-, five-, seven-, and 10-
year property). The 150-percent declining balance method will continue 
to apply to any 15-year or 20-year property used in the farming 
business to which the straight line method does not apply, or to 
property for which the taxpayer elects the use of the 150-percent 
declining balance method.
---------------------------------------------------------------------------

Alternative depreciation system

    The alternative depreciation system (``ADS'') is required 
to be used for tangible property used predominantly outside the 
United States, certain tax-exempt use property, tax-exempt bond 
financed property, and certain imported property covered by an 
executive order.\658\ An election to use ADS is available to 
taxpayers for any class of property for any taxable year.\659\ 
Under ADS, all property is depreciated using the straight line 
method over recovery periods which generally are equal to the 
class life of the property, with certain exceptions.\660\ For 
example, any single purpose agricultural or horticultural 
structure has a 15-year ADS recovery period,\661\ while any 
tree or vine bearing fruit or nuts has a 20-year ADS recovery 
period.\662\ Similarly, land improvements such as drainage 
facilities, paved lots, and water wells have an ADS recovery 
period of 20 years.\663\ Farm buildings that do not meet the 
definition of a single purpose agricultural or horticultural 
structure have an ADS recovery period of 25 years.\664\
---------------------------------------------------------------------------
    \658\ Sec. 168(g).
    \659\ Sec. 168(g)(7).
    \660\ Secs. 168(g)(2) and (3).
    \661\ Sec. 168(g)(3)(B).
    \662\ Sec. 168(g)(3)(B).
    \663\ Rev. Proc. 87-56, asset class 00.3, Land improvements.
    \664\ Rev. Proc. 87-56, asset class 01.3, Farm buildings except 
structures included in asset class 01.4.
---------------------------------------------------------------------------
    Under a special accounting rule, certain taxpayers engaged 
in the business of farming who elect to deduct preproductive 
period expenditures of plants produced in such business are 
required to depreciate all farming assets using ADS.\665\
---------------------------------------------------------------------------
    \665\ Secs. 263A(d)(3) and (e)(2), and 168(g)(2). For a discussion 
of changes made to the applicability of section 263A by the Act, see 
the description of section 13102 of the Act (Small Business Accounting 
Method Reform and Simplification).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision requires an electing farming business \666\ 
(i.e., a farming business electing out of the limitation on the 
deduction for interest) \667\ to use ADS to depreciate any 
property with a MACRS recovery period of 10 years or more 
(e.g., property such as single purpose agricultural or 
horticultural structures, trees or vines bearing fruit or nuts, 
farm buildings, and certain land improvements).\668\
---------------------------------------------------------------------------
    \666\ As defined in section 163(j)(7)(C), which defines an electing 
farming business as (i) a farming business as defined in section 
263A(e)(4), or (ii) any trade or business of a specified agricultural 
or horticultural cooperative as defined in section 199A(g)(4) (a 
clerical correction may be necessary to correct this reference). See 
the description of section 13301 of the Act (Limitation on Deduction 
for Interest). Note that the treatment of income relating to 
cooperatives under section 199A (as originally enacted December 22, 
2017) was modified by the Consolidated Appropriations Act, 2018, Pub. 
L. No. 115-141, enacted March 23, 2018. The description of the 
modification was originally published as Joint Committee on Taxation, 
Technical Explanation of the Revenue Provisions of the House Amendment 
to the Senate Amendment to H.R. 1625 (Rules Committee Print 115-66) 
(JCX-6-18), March 22, 2018, pages 5-27, which is reproduced in the 
Appendix.
    \667\ See section 13301 of the Act (Limitation on Deduction for 
Interest). Section 13301 of the Act also includes an exception from the 
limitation on the deduction for interest for taxpayers meeting the $25 
million gross receipts test.
    \668\ Congress intends that an election out of the interest 
limitation and resulting required use of ADS be treated as a change in 
use of the property. See sec. 168(i)(5) and Treas. Reg. sec. 1.168(i)-
4.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

 F. Amortization of Research and Experimental Expenditures (sec. 13206 
                  of the Act and sec. 174 of the Code)


                               Prior Law

    Business expenses associated with the development or 
creation of an asset having a useful life extending beyond the 
current year generally must be capitalized and depreciated over 
such useful life.\669\ Taxpayers, however, may elect to deduct 
currently the amount of certain reasonable research or 
experimental expenditures paid or incurred in connection with a 
trade or business.\670\ Taxpayers may elect to forgo a current 
deduction, capitalize their research or experimental 
expenditures, and recover them ratably over the useful life of 
the research, but in no case over a period of less than 60 
months.\671\ Taxpayers, alternatively, may elect to amortize 
their research or experimental expenditures over a period of 10 
years.\672\ Research and experimental expenditures deductible 
under section 174 are not subject to capitalization under 
either section 263(a) \673\ or section 263A.\674\ In addition, 
section 174 deductions are generally reduced by the amount of 
the taxpayer's research credit under section 41.\675\
---------------------------------------------------------------------------
    \669\ Secs. 167 and 263(a).
    \670\ Secs. 174(a) and (e).
    \671\ Sec. 174(b). Taxpayers generating significant short-term 
losses often choose to defer the deduction for their research and 
experimental expenditures under this section. Additionally, section 174 
amounts are excluded from the definition of ``start-up expenditures'' 
under section 195 (section 195 generally provides that start-up 
expenditures in excess of $5,000 either are not deductible or are 
amortizable over a period of not less than 180 months once an active 
trade or business begins). So as not to generate significant losses 
before beginning its trade or business, a taxpayer may choose to defer 
the deduction and amortize its section 174 costs beginning with the 
month in which the taxpayer first realizes benefits from the 
expenditures (i.e., the month in which its active trade or business 
begins).
    \672\ Secs. 174(f)(2) and 59(e). This special 10-year election is 
available to mitigate the effect of the alternative minimum tax 
(``AMT'') adjustment for research expenditures set forth in section 
56(b)(2) (for a discussion of the repeal of the corporate AMT, see the 
description of section 12001 of the Act (Repeal of Tax for 
Corporations)). Taxpayers with significant losses also may elect to 
amortize their otherwise deductible research and experimental 
expenditures to reduce amounts that could be subject to expiration 
under the net operating loss carryforward regime (for changes to 
section 172 made by the Act, see the description of section 13302 of 
the Act (Modification of Net Operating Loss Deduction)).
    \673\ Sec. 263(a)(1)(B).
    \674\ Sec. 263A(c)(2).
    \675\ Sec. 280C(c). Taxpayers may alternatively elect to claim a 
reduced research credit amount under section 41 in lieu of reducing 
deductions otherwise allowed. Sec. 280C(c)(3).
---------------------------------------------------------------------------
    Amounts defined as research or experimental expenditures 
under section 174 generally include all costs incurred in the 
experimental or laboratory sense related to the development or 
improvement of a product.\676\ In particular, qualifying costs 
are those incurred for activities intended to discover 
information that would eliminate uncertainty concerning the 
development or improvement of a product.\677\ Uncertainty 
exists when information available to the taxpayer is not 
sufficient to ascertain the capability or method for 
developing, improving, and/or appropriately designing the 
product.\678\ The determination of whether expenditures qualify 
as deductible research expenses depends on the nature of the 
activity to which the costs relate, not the nature of the 
product or improvement being developed or the level of 
technological advancement the product or improvement 
represents. Examples of qualifying costs include salaries for 
those engaged in research or experimentation efforts, amounts 
incurred to operate and maintain research facilities (e.g., 
utilities, depreciation, rent, etc.), and expenditures for 
materials and supplies used and consumed in the course of 
research or experimentation (including amounts incurred in 
conducting trials).\679\ In addition, under administrative 
guidance, the costs of developing computer software have been 
accorded treatment similar to research and experimental 
expenditures.\680\
---------------------------------------------------------------------------
    \676\ Treas. Reg. sec. 1.174-2(a)(1) and (2). Product is defined to 
include any pilot model, process, formula, invention, technique, 
patent, or similar property, and includes products to be used by the 
taxpayer in its trade or business as well as products to be held for 
sale, lease, or license. Treas. Reg. sec. 1.174-2(a)(11), Example 10, 
provides an example of new process development costs eligible for 
section 174 treatment.
    \677\ Treas. Reg. sec. 1.174-2(a)(1).
    \678\ Ibid.
    \679\ See Treas. Reg. sec. 1.174-4(c). The definition of research 
and experimental expenditures also includes the costs of obtaining a 
patent, such as attorneys' fees incurred in making and perfecting a 
patent application. Treas. Reg. sec. 1.174-2(a)(1).
    \680\ Rev. Proc. 2000-50, 2000-2 C.B. 601.
---------------------------------------------------------------------------
    Research or experimental expenditures under section 174 do 
not include expenditures for quality control testing; 
efficiency surveys; management studies; consumer surveys; 
advertising or promotions; the acquisition of another's patent, 
model, production or process; or research in connection with 
literary, historical, or similar projects.\681\ For purposes of 
section 174, quality control testing means testing to determine 
whether particular units of materials or products conform to 
specified parameters, but does not include testing to determine 
if the design of the product is appropriate.\682\
---------------------------------------------------------------------------
    \681\ Treas. Reg. sec. 1.174-2(a)(6).
    \682\ Treas. Reg. sec. 1.174-2(a)(7).
---------------------------------------------------------------------------
    Generally, no current deduction under section 174 is 
allowable for expenditures for the acquisition or improvement 
of land or of depreciable or depletable property used in 
connection with any research or experimentation.\683\ In 
addition, no current deduction is allowed for any expenditure 
incurred for the purpose of ascertaining the existence, 
location, extent, or quality of any deposit of ore or other 
mineral, including oil and gas.\684\
---------------------------------------------------------------------------
    \683\ Sec. 174(c). However, depreciation and depletion allowances 
may be considered section 174 expenditures. Ibid.
    \684\ Sec. 174(d). Special rules apply with respect to geological 
and geophysical costs (section 167(h)), qualified tertiary injectant 
expenses (section 193), intangible drilling costs (sections 263(c) and 
291(b)), and mining exploration and development costs (sections 616 and 
617).
---------------------------------------------------------------------------

                        Explanation of Provision

    Under the provision, amounts defined as specified research 
or experimental expenditures are required to be capitalized and 
amortized ratably over a five-year period beginning with the 
midpoint of the taxable year in which the specified research or 
experimental expenditures were paid or incurred. Specified 
research or experimental expenditures that are attributable to 
research that is conducted outside of the United States \685\ 
are required to be capitalized and amortized ratably over the 
15-year period beginning with the midpoint of the taxable year 
in which such expenditures were paid or incurred. Specified 
research or experimental expenditures subject to capitalization 
include expenditures for software development.
---------------------------------------------------------------------------
    \685\ For this purpose, the term ``United States'' includes the 
United States, the Commonwealth of Puerto Rico, and any possession of 
the United States.
---------------------------------------------------------------------------
    Specified research or experimental expenditures do not 
include expenditures for the acquisition or improvement of land 
or for depreciable or depletable property used in connection 
with the research or experimentation, but do include the 
depreciation and depletion allowances of such property. Also 
excluded are exploration expenditures incurred for ore or other 
minerals (including oil and gas).
    In the case of retired, abandoned, or disposed property 
with respect to which specified research or experimental 
expenditures are paid or incurred, any remaining basis may not 
be recovered in the year of retirement, abandonment, or 
disposal, but instead must continue to be amortized over the 
remaining amortization period.
    The application of this rule is treated as a change in the 
taxpayer's method of accounting for purposes of section 481 
initiated by the taxpayer and made with the consent of the 
Secretary. This rule is applied on a cutoff basis to research 
or experimental expenditures paid or incurred in taxable years 
beginning after December 31, 2021 (hence there is no adjustment 
under section 481(a) for research or experimental expenditures 
paid or incurred in taxable years beginning before January 1, 
2022).
    The provision makes conforming changes to sections 41 and 
280C.\686\
---------------------------------------------------------------------------
    \686\ Thus, if a taxpayer's research credit under section 41 for a 
taxable year beginning after 2021 exceeds the amount allowed as an 
amortization deduction under the provision for such taxable year, the 
amount chargeable to capital account under the provision for such 
taxable year must be reduced by that excess amount. A taxpayer may 
alternatively elect to claim a reduced research credit amount under 
section 41 in lieu of reducing its section 174 expenditures for the 
taxable year. If such an election is made, the research credit is 
reduced by an amount equal to that credit multiplied by the highest 
corporate tax rate.
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                             Effective Date

    The provision applies to amounts paid or incurred in 
taxable years beginning after December 31, 2021.

   G. Expensing of Certain Costs of Replanting Citrus Plants Lost by 
  Reason of Casualty (sec. 13207 of the Act and sec. 263A of the Code)


                               Prior Law


In general

    The uniform capitalization rules require certain direct and 
indirect costs allocable to real or tangible personal property 
produced by the taxpayer to be either capitalized into the 
basis of such property or included in inventory, as 
applicable.\687\ For real or personal property acquired by the 
taxpayer for resale, section 263A generally requires certain 
direct and indirect costs allocable to such property to be 
either capitalized into the basis of such property or included 
in inventory, as applicable.
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    \687\ Sec. 263A. For a discussion of the changes made by the Act to 
the applicability of section 263A, see the description of section 13102 
of the Act (Small Business Accounting Method Reform and 
Simplification).
---------------------------------------------------------------------------
    Section 263A generally requires the capitalization of the 
direct and indirect costs allocable to the production of any 
property in a farming business,\688\ including animals and 
plants without regard to the length of their preproductive 
period.\689\ The costs of a plant generally required to be 
capitalized under section 263(a) include preparatory costs 
incurred so that the plant's growing process may begin, such as 
the acquisition costs of the seed, seedling, or plant. Under 
section 263A, the costs of producing a plant generally required 
to be capitalized also include the preproductive period costs 
of planting, cultivating, maintaining, and developing the plant 
during the preproductive period.\690\ Preproductive period 
costs may include management, irrigation, pruning, soil and 
water conservation, fertilizing, frost protection, spraying, 
harvesting, storage and handling, upkeep, electricity, tax 
depreciation and repairs on buildings and equipment used in 
raising the plants, farm overhead, taxes, and interest, as 
applicable.\691\
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    \688\ For purposes of section 263A, the term ``farming business'' 
means a trade or business involving the cultivation of land or the 
raising or harvesting of any agricultural or horticultural commodity 
(e.g., the trade or business of operating a nursery or sod farm; the 
raising or harvesting of trees bearing fruit, nuts, or other crops; the 
raising of ornamental trees (other than evergreen trees that are more 
than six years old at the time they are severed from their roots); and 
the raising, shearing, feeding, caring for, training, and management of 
animals). A farming business includes processing activities that are 
normally incident to the growing, raising, or harvesting of 
agricultural or horticultural products. A farming business does not 
include contract harvesting of an agricultural or horticultural 
commodity grown or raised by another taxpayer, or merely buying and 
reselling plants or animals grown or raised by another taxpayer. See 
sec. 263A(e)(4) and Treas. Reg. sec. 1.263A-4(a)(4).
    \689\ Treas. Reg. sec. 1.263A-4(b)(1).
    \690\ Treas. Reg. sec. 1.263A-4(b)(1)(i).
    \691\ Ibid.
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Special rules for plant farmers

    Section 263A provides an exception to the general 
capitalization requirements for taxpayers who raise, harvest, 
or grow trees.\692\ Under this exception, section 263A does not 
apply to trees raised, harvested, or grown by the taxpayer 
(other than trees bearing fruit, nuts, or other crops, or 
ornamental trees) and any real property underlying such trees. 
Similarly, the section 263A rules do not apply to any plant 
having a preproductive period of two years or less, that is 
produced by a taxpayer in a farming business (unless the 
taxpayer is required to use an accrual method of accounting 
under section 447 or 448(a)(3)).\693\ Hence, in general, the 
section 263A rules apply to the production of plants that have 
a preproductive period of more than two years, and to taxpayers 
required to use an accrual method of accounting.
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    \692\ Sec. 263A(c)(5).
    \693\ Sec. 263A(d). For a discussion of the changes made by the Act 
to taxpayers allowed to use the cash method rather than an accrual 
method, see the description of section 13102 of the Act (Small Business 
Accounting Method Reform and Simplification).
---------------------------------------------------------------------------
    Plant farmers otherwise required to capitalize 
preproductive period costs may elect to deduct such costs 
currently, provided the alternative depreciation system 
described in section 168(g)(2) is used on all farm assets and 
the preproductive period costs are recaptured upon disposition 
of the product.\694\ The election is not available to taxpayers 
required to use the accrual method of accounting. Moreover, the 
election is not available with respect to certain costs 
attributable to planting, cultivating, maintaining, or 
developing citrus or almond groves.
---------------------------------------------------------------------------
    \694\ Sec. 263A(d)(3), (e)(1), and (e)(2).
---------------------------------------------------------------------------
    Section 263A does not apply to costs incurred in replanting 
edible crops for human consumption following loss or damage due 
to freezing temperatures, disease, drought, pests, or 
casualty.\695\ The same type of crop as the lost or damaged 
crop must be replanted. However, the exception to 
capitalization still applies if the replanting occurs on a 
parcel of land other than the land on which the damage occurred 
provided the acreage of the new land does not exceed that of 
the land to which the damage occurred and the new land is 
located in the United States. This exception may also apply to 
costs incurred by persons other than the taxpayer who incurred 
the loss or damage, provided (1) the taxpayer who incurred the 
loss or damage retains an equity interest of more than 50 
percent in the plants for which the loss or damage occurred at 
all times during the taxable year in which the replanting costs 
are paid or incurred, and (2) such other person claiming the 
deduction holds a minority equity interest and materially 
participates in the planting, maintenance, cultivation, or 
development of such plants during the taxable year in which the 
replanting costs are paid or incurred.\696\
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    \695\ Sec. 263A(d)(2). Such replanting costs generally include 
costs attributable to the replanting, cultivating, maintaining, and 
developing of the plants that were lost or damaged that are incurred 
during the preproductive period. Treas. Reg. sec. 1.263A-4(e)(1). The 
acquisition costs of the replacement trees or seedlings must still be 
capitalized under section 263(a) (see, e.g., T.D. 8897, 65 FR 50638, 
Treas. Reg. sec. 1.263A-4(e)(3), Examples 1-3, and TAM 9547002 (July 
18, 1995)), potentially subject to the special additional first-year 
depreciation deduction in the year of planting under section 168(k)(5). 
For a discussion of changes made by the Act to section 168(k), see the 
description of section 13201 of the Act (Temporary 100-Percent 
Expensing for Certain Business Assets).
    \696\ Sec. 263A(d)(2)(B). Material participation for this purpose 
is determined in a similar manner as under section 2032A(e)(6) 
(relating to qualified use valuation of farm property upon death of the 
taxpayer).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision expands the special rule for costs incurred 
by persons (other than the taxpayer who incurred the loss or 
damage) in connection with replanting an edible crop for human 
consumption following loss or damage due to casualty. Under the 
provision, with respect to replanting costs paid or incurred 
after December 22, 2017 (i.e., incurred after the date of 
enactment), but no later than December 22, 2027 (i.e., the date 
which is 10 years after such date of enactment), for citrus 
plants lost or damaged due to casualty, such replanting costs 
may also be deducted by a person (other than the taxpayer who 
incurred the loss or damage) if (1) the taxpayer has an equity 
interest of not less than 50 percent in the replanted citrus 
plants at all times during the taxable year in which the 
replanting costs are paid or incurred and such other person 
holds any part of the remaining equity interest, or (2) such 
other person acquires all of the taxpayer's equity interest in 
the land on which the lost or damaged citrus plants were 
located at the time of such loss or damage, and the replanting 
is on such land.

    The Treasury Department has issued published guidance 
addressing this provision.\697\
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    \697\ See Rev. Proc. 2018-31, 2018-22 I.R.B. 637.
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                             Effective Date

    The provision is effective for costs paid or incurred after 
December 22, 2017 (i.e., after the date of enactment).

                     SUBPART B--ACCOUNTING METHODS


 A. Certain Special Rules for Taxable Year of Inclusion (sec. 13221 of 
                   the Act and sec. 451 of the Code)


                               Prior Law


Realization of gross income

            In general
    Under section 61(a), gross income generally includes all 
income from whatever source derived, except as otherwise 
provided in Subtitle A of the Code.\698\ Gross income generally 
includes all items that are clearly realized accessions to 
wealth in any form.\699\ Gross income is clearly realized when 
an item is sufficiently fixed and definite to be treated as 
gross income.\700\ Realization generally occurs when a taxpayer 
takes the last step by which the economic gain comes to 
fruition.\701\ Generally, there must be a transaction involving 
the taxpayer for there to be a clearly realized accession to 
wealth.\702\ For a transaction involving a capital asset, gross 
income is realized at the time the asset is sold, exchanged, or 
otherwise disposed.\703\
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    \698\ See sections 101 through 140 for items specifically excluded 
from gross income.
    \699\ Treas. Reg. sec. 1.61-1 and Commissioner v. Glenshaw Glass 
Co., 348 U.S. 426, 429-430 (1955).
    \700\ Eisner v. Macomber, 252 U.S. 189, 207 (1920).
    \701\ Helvering v. Horst, 311 U.S. 112, 115 (1940).
    \702\ Baldwin Locomotive Works v. McCoach, 221 Fed. 59, 60 (3d Cir. 
1915).
    \703\ Sec. 1001.
---------------------------------------------------------------------------
    Gross income generally includes income realized in any 
form, whether in money, property, services, payment of the 
taxpayer's indebtedness, or relief from a liability, except to 
the extent provided in other sections of the Code.\704\
---------------------------------------------------------------------------
    \704\ Treas. Reg. sec. 1.61-1. See also Helvering v. Bruun, 309 
U.S. 461, 469 (1940).
---------------------------------------------------------------------------
    If the consideration to be received by the taxpayer cannot 
be valued at the time of the transaction, a taxpayer is not 
required to include any gain in income at that time.\705\ 
Instead, the transaction remains open until such consideration 
is received or can be valued. As a result, open transactions 
generally arise in connection with sales or property in 
exchange for contingent payments. However, only in rare and 
extraordinary circumstances will property be considered not to 
have an ascertainable fair market value.\706\ In addition, 
Congress has limited a taxpayer's ability to treat a 
transaction as an open transaction by enacting rules addressing 
the realization and recognition of income from installment 
sales, in particular contingent payment installment sales for 
which the aggregate selling price cannot be determined by the 
close of the taxable year in which such sale or other 
disposition occurs.\707\ Under these rules, the taxpayer has a 
closed transaction and has realized income at the time the sale 
or disposition of the property occurs.
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    \705\ Burnet v. Logan, 283 U.S. 404 (1931).
    \706\ Simmonds Precision Prods. v. Commissioner, 75 T.C. 103 
(1980). See also Treas. Reg. sec. 15A.453-1(d)(2)(iii). In the case of 
an arm's-length transaction, an asset with an unascertainable value is 
presumed to have a value equal to that of the property for which it was 
exchanged. See United States v. Davis, 370 U.S. 65 (1962).
    \707\ See section 453 and Treas. Reg. sec. 15A.453-1(c). A taxpayer 
may elect out of the installment sale rules under section 453(d).
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            Constructive realization
    In certain situations, Congress has prescribed the time at 
which realization is deemed to occur by requiring taxpayers, or 
allowing taxpayers to elect, to include in gross income amounts 
that may otherwise be unrealized income or gain. For example, 
under the mark to market rules, a taxpayer that is a dealer in 
securities who holds as of the end of a taxable year a security 
that is not inventory in the hands of the taxpayer must realize 
and recognize gain or loss during the year on that security, 
even though the taxpayer has not yet sold or disposed of the 
security.\708\ To determine the amount of gain or loss, the 
taxpayer is deemed to have sold the security for its fair 
market value on the last day of the taxable year.\709\ Dealers 
in commodities and traders in securities or commodities may 
elect to mark to market the commodities or securities they 
hold.\710\ Similarly, under the mark to market rules applicable 
to a section 1256 contract,\711\ a taxpayer must treat each 
section 1256 contract as if it were sold for its fair market 
value on the last business day of the taxable year, with any 
gain or loss taken into account for the taxable year, even 
though the taxpayer has not yet sold or disposed of the 
contract.\712\ In addition, in certain situations, a taxpayer 
is treated as having made a constructive sale of an appreciated 
financial position.\713\ In that case, the taxpayer must 
realize and recognize gain as if such position were sold, 
assigned, or otherwise terminated at its fair market value on 
the date of such constructive sale.\714\
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    \708\ Sec. 475(a)(2).
    \709\ Sec. 475(a)(2)(A). Adjustments are made in subsequent years 
for the amount of any gain or loss previously realized and recognized 
by the taxpayer.
    \710\ Sec. 475(e) and (f).
    \711\ A section 1256 contract is any regulated futures contract, 
any foreign currency contract, any nonequity option, any dealer equity 
option, and any dealer securities futures contract. Sec. 1256(b)(1). A 
section 1256 contract does not include any securities future contract 
or option on such a contract unless such contract or option is a dealer 
securities futures contract or any interest rate swap, currency swap, 
basis swap, interest rate cap, interest rate floor, commodity swap, 
equity swap, equity index swap, credit default swap, or similar 
agreement. Sec. 1256(b)(2).
    \712\ Sec. 1256(a). As under the mark to market rules under section 
475, adjustments are made in subsequent years for the amount of any 
gain or loss previously realized and recognized by the taxpayer on the 
contract.
    \713\ Sec. 1259(c).
    \714\ Sec. 1259(a). As under sections 475 and 1256, adjustments are 
made in subsequent years for the amount of any gain previously realized 
and recognized by the taxpayer on the position.
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    Special rules govern the timing of realization with respect 
to income from debt instruments. For example, amounts received 
by a holder upon retirement of any debt instrument are 
considered amounts received in exchange therefor.\715\ Such 
amounts are not realized any earlier than when the debt 
instrument is retired, sold, or exchanged. In addition, gain on 
the disposition of any market discount bond is treated as 
ordinary income to the extent it does not exceed the accrued 
market discount on such bond.\716\ A taxpayer does not realize 
such gain, including market discount, until disposition of the 
bond or receipt of partial principal payments on the bond.\717\ 
However, a taxpayer may elect out of these default realization 
rules for market discount and instead realize market discount 
currently as it accrues.\718\
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    \715\ Sec. 1271(a)(1).
    \716\ Sec. 1276(a).
    \717\ Sec. 1276(a).
    \718\ Sec. 1278(b).
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            Gross income derived from certain businesses
    For businesses involving the sale of property to others 
(e.g., manufacturing, merchandising, mining, etc.), gross 
income is total sales less the cost of goods sold, plus any 
income from investment and from incidental or outside 
sources.\719\ Gross income is determined on an annual or 
taxable year basis with the amount of each item of gross income 
(e.g., total sales) for the taxable year determined under the 
taxpayer's method of accounting for each item.\720\ In 
determining gross income, the amount of total sales included as 
an item of gross income is determined in accordance with the 
taxpayer's method of accounting under the income recognition 
rules.\721\
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    \719\ Treas. Reg. sec. 1.61-3(a).
    \720\ See Automobile Club of New York, Inc. v. Commissioner, 32 
T.C. 906, 914 (1959), aff'd 304 F.2d 781 (2nd Cir. 1962) (``. . . net 
income under the statute is computed on an annual basis, and . . . 
there is no necessary correlation in any given year between receipts 
and expenses. Expenses with respect to income not yet earned are 
deductible when paid or accrued; and conversely, income is reportable 
when received or accrued, notwithstanding that some, or even all, 
expenses allocable thereto have not yet been incurred''); and Hagen 
Advertising Displays, Inc. v. Commissioner, 47 T.C. 139 (1966), aff'd 
407 F.2d 1105 (6th Cir. 1969) (``Nothing in [Treas. Reg. sec. 1.61-
3(a)] suggests that an attempt must be made to match a particular 
purchase with a particular sale or a particular item in inventory'').
    \721\ See, e.g., sec. 451. See discussion below of the income 
recognition rules. See also, e.g., line 1a of Form 1120, Form 1120S, or 
Form 1065, or line 1 of Schedule C (Form 1040).
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    The amount of cost of goods sold included as a subtraction 
from total sales is determined in accordance with the 
taxpayer's methods of accounting for items included in cost of 
goods sold.\722\ An amount may not be taken into account in the 
computation of cost of goods sold, and thus reduce total sales, 
any earlier than the taxable year in which economic performance 
occurs with respect to such amount.\723\ Once economic 
performance occurs, amounts may only be taken into account in 
the computation of cost of goods sold if they are not required 
to be capitalized and are not subject to any other provision of 
the Code that requires the deduction to be taken in a taxable 
year later than the year when economic performance occurs.\724\ 
For example, generally a taxpayer must maintain inventories 
whenever the production, purchase, or sale of merchandise is an 
income-producing factor.\725\ In addition, such merchandise 
remains in inventory, and is not included in cost of goods 
sold, if title thereto is still vested in the taxpayer.\726\ 
Section 263A and the regulations thereunder also require that 
direct costs and certain indirect costs incurred by the 
taxpayer (i.e., costs for which economic performance has 
occurred) must be capitalized and included in the basis of 
property produced or acquired for resale by the taxpayer with 
the capitalized costs recovered by including such amounts in 
cost of goods sold when the underlying inventory or property is 
sold.\727\
---------------------------------------------------------------------------
    \722\ Treas. Reg. sec. 1.61-3(a). See, e.g., sections 263A, 461(h), 
and 471. See also, e.g., line 2 of Form 1120, Form 1120S, or Form 1065, 
or line 4 of Schedule C (Form 1040), as well as Form 1125-A. A 
taxpayer's gross profit is generally determined by subtracting returns 
and allowances and cost of goods sold from gross receipts or sales. See 
line 3 of Form 1120, Form 1120S, or Form 1065, or line 5 of Schedule C 
(Form 1040).
    \723\ Treas. Reg. secs. 1.61-3(a), 1.263A-1(c)(2)(ii), and 1.446-
1(c)(1)(ii). For a liability that arises out of the provision of 
services or property to the taxpayer by another person, economic 
performance occurs as the other person provides such services, as the 
other person provides such property, or as the taxpayer uses such 
property. For a liability that requires the taxpayer to provide 
property to others, economic performance occurs as the taxpayer 
provides the property to the other person. Sec. 461(h)(2)(A) and (B). A 
liability includes any item allowable as a deduction, cost, or expense 
for Federal income tax purposes. In addition to allowable deductions, 
the term includes any amount otherwise allowable as a capitalized cost, 
as a cost taken into account in computing cost of goods sold, as a cost 
allocable to a long-term contract, or as any other cost or expense. See 
Treas. Reg. secs. 1.446-1(c)(1)(ii)(B) and 1.461-4(c)(1) and T.D. 8408, 
1992-1 C.B. 155.
    \724\ Conference Report to accompany H.R. 4170, Deficit Reduction 
Act of 1984, H.R. Rep. No. 98-861, June 23, 1984, p. 871.
    \725\ Sec. 471 and Treas. Reg. sec. 1.471-1.
    \726\ Sec. 471 and Treas. Reg. sec. 1.471-1. Whether the 
requirement that title be vested in the taxpayer has been met is 
generally determined based on whether the taxpayer has the benefits and 
burdens of ownership.
    \727\ Sec. 263A and Treas. Reg. sec. 1.263A-1(c)(4).
---------------------------------------------------------------------------

Income recognition

            In general
    Once it is determined that gross income is clearly realized 
for Federal income tax purposes, section 451 and the 
regulations thereunder provide the general rules as to the 
timing of when sales, gross receipts, and other items of income 
are recognized by including such items in gross income under 
the taxpayer's method of accounting.\728\
---------------------------------------------------------------------------
    \728\ Treas. Reg. sec. 1.61-1(b)(3).
---------------------------------------------------------------------------
    A taxpayer generally is required to include sales, gross 
receipts, or other items of income in gross income no later 
than the time of its actual or constructive receipt, unless the 
item \729\ is properly accounted for in a different period 
under the taxpayer's method of accounting.\730\ If a taxpayer 
has an unrestricted right to demand the payment of an amount, 
the taxpayer is in constructive receipt of that amount whether 
or not the taxpayer makes the demand and actually receives the 
payment.\731\
---------------------------------------------------------------------------
    \729\ Methods of accounting include both the taxpayer's overall 
method of accounting (e.g., the cash method and an accrual method), as 
well as any special methods of accounting for any ``item'' of income or 
expense. See Treas. Reg. sec. 1.446-1(a)(1). Generally, an item is any 
income or expense that differs in some way that is relevant to the 
determination of taxable income. For example, late fee income is 
treated as a separate item from interchange fee income, over-limit 
fees, finance charges, and cash advance fees because late fee income is 
earned for different reasons than the other types of income. See 
Capital One Financial Corp. and Subsidiaries v. Commissioner, 133 T.C. 
No. 8 (2009).
    \730\ Sec. 451(a).
    \731\ See Treas. Reg. sec. 1.451-2.
---------------------------------------------------------------------------
    In general, for a cash basis taxpayer, sales, gross 
receipts, and other items of income are included in gross 
income when actually or constructively received.\732\ For an 
accrual basis taxpayer, sales, gross receipts, and other items 
of income are included in gross income when all the events have 
occurred that fix the right to receive such income and the 
amount thereof can be determined with reasonable accuracy 
(i.e., when the ``all events test'' is met), unless an 
exception permits deferral or exclusion or a special method of 
accounting applies.\733\ Generally, all the events that fix the 
right to receive income occur upon the earlier of when (i) 
payment is earned through performance, (ii) payment is due to 
the taxpayer, or (iii) payment is received by the 
taxpayer.\734\ Amounts are earned upon performance by the 
taxpayer. For example, performance takes place when all 
services are provided (except for ministerial duties),\735\ the 
sale takes place, or, in the case of interest and rent, the use 
of money or property is provided. An amount is considered due 
based on the terms of the arrangement between the taxpayer and 
the other party. The taxpayer does not have to have a legally 
enforceable right for an amount to be considered due for 
purposes of the all events test.
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    \732\ Treas. Reg. secs. 1.446-1(c)(1)(i) and 1.451-1(a).
    \733\ Treas. Reg. secs. 1.446-1(c)(1)(ii) and 1.451-1(a).
    \734\ See Rev. Rul. 2003-10, 2003-1 C.B. 288.
    \735\ With respect to whether a taxpayer earned income from 
unbilled receivables, income from the provision of services generally 
accrues when performance is complete, not as the taxpayer engages in 
the activity. See, e.g., Decision, Inc. v. Commissioner, 47 T.C. 58, 63 
(1966), acq. 1967-2 C.B. 2. However, if services are severable, a 
portion of the income is proportionally allocated to each service 
provided under the contract. See Rev. Rul. 79-195, 1979-1 C.B. 177, and 
Tech. Adv. Mem. 200803017, January 18, 2008, and 200903079, January 16, 
2009.
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                Advance payments
            In general
    Various methods of accounting are provided to address 
situations in which an accrual method taxpayer receives an 
advance payment for goods, services, or other items of income. 
An advance payment generally occurs when a taxpayer receives 
payment before the taxpayer provides goods, services, or other 
items to its customer. These methods of accounting generally 
allow taxpayers to either (i) include the advance payment in 
gross income in the year of receipt, or (ii) defer the 
recognition of the advance payment under various methods of 
accounting, with the cost of satisfying the taxpayer's future 
obligation to provide goods, services, or other items taken 
into account when such costs are incurred at a later date. 
However, special rules were also historically provided that 
allowed taxpayers to instead accelerate the deduction or 
adjustment to gross income for the estimated cost of the goods 
or property to be provided in the future and take such 
deduction or adjustment generally in the same taxable year for 
which the related advance payment was included in gross income 
(i.e., generally in the taxable year the advance payment was 
received).
            Inclusion in gross income in year of receipt
    A taxpayer that receives an advance payment for goods, 
services, or other items of income may include such amount in 
gross income in the year of receipt (i.e., the ``full inclusion 
method'').\736\ A taxpayer using the full inclusion method to 
account for an advance payment for services does not take an 
offsetting deduction for the cost of providing such services 
until the taxable year in which the taxpayer provides such 
services to the customer and economic performance occurs for 
such costs.\737\ Similarly, a taxpayer using the full inclusion 
method to account for an advance payment for goods does not 
take an offsetting adjustment for its actual or estimated basis 
in the goods to be sold until such time that economic 
performance occurs for the cost to acquire or produce the goods 
and the goods in question have been provided to the 
customer.\738\
---------------------------------------------------------------------------
    \736\ See, e.g., sec. 451(a), Treas. Reg. sec. 1.451-5(b)(1)(i), 
and Rev. Proc. 2004-34, 2004-1 C.B. 991, as modified and clarified by 
Rev. Proc. 2011-18, 2011-5 I.R.B. 443, and Rev. Proc. 2013-29, 2013-33 
I.R.B. 141.
    \737\ See sec. 461(h)(2)(B).
    \738\ See secs. 263A, 461(h)(2)(B), and 471. See also PLR 
200638015, September 22, 2006.
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            Deferral of advance payments
    A number of exceptions exist that allow taxpayers to defer 
the recognition of advance payments from goods, services, and 
other items in gross income. These exceptions often allow tax 
deferral of the advance payments to mirror the financial 
accounting deferral of such payments \739\ (e.g., the advance 
payments are included in gross income as the goods are provided 
or the services are performed) or limit the initial tax 
deferral of the advance payments to the financial accounting 
deferral of such payments.\740\ Under each of these exceptions, 
a taxpayer receiving an advance payment for services does not 
take an offsetting deduction for the cost of providing such 
services until the taxable year in which the taxpayer provides 
such services to the customer and economic performance occurs 
for such costs.\741\ In addition, a taxpayer receiving an 
advance payment for goods does not take an offsetting 
adjustment for its actual or estimated basis in the goods to be 
sold until such time that economic performance occurs for the 
cost to acquire or produce the goods and the goods in question 
have been provided to the customer.\742\
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    \739\ See Treas. Reg. sec. 1.451-5.
    \740\ See Rev. Proc. 2004-34, 2004-1 C.B. 991, as modified and 
clarified by Rev. Proc. 2011-18, 2011-5 I.R.B. 443, and Rev. Proc. 
2013-29, 2013-33 I.R.B. 141.
    \741\ See sec. 461(h)(2)(B).
    \742\ See secs. 263A, 461(h)(2)(B), and 471. See also Announcement 
2004-48, 2004-1 C.B. 998 (``Taxpayers that use the deferral method in 
[Rev. Proc. 2004-34] must use the general rules under section 461 and 
the regulations thereunder for determining when a liability (including 
cost of goods sold) is incurred.''). However, see discussion below for 
a limited exception to this treatment for a taxpayer electing a two-
year deferral of an advance payment for inventoriable goods.
---------------------------------------------------------------------------
    A taxpayer receiving an advance payment for goods, 
services, and other items \743\ may elect to include in gross 
income in the year of receipt \744\ only the portion of the 
advance payment that is included in revenue in the taxpayer's 
applicable financial statement \745\ and include the remaining 
amount in gross income in the next succeeding taxable year 
(i.e., a one-year deferral of the advance payment). If the 
taxpayer dies or ceases to exist, or the taxpayer's obligation 
with respect to the advance payment is satisfied or otherwise 
ends, the taxpayer must include in gross income any portion of 
the advance payment not previously recognized.\746\
---------------------------------------------------------------------------
    \743\ Such other items include advance payments for the use 
(including by license or lease) of intellectual property; the occupancy 
or use of property if the occupancy or use is ancillary to the 
provision of services; the sale, lease or license of computer software; 
guaranty or warranty contracts ancillary to any of the preceding items, 
as well as services or the sale of goods; subscriptions, whether or not 
provided in a tangible or intangible format; memberships in an 
organization; or any combination of the preceding items. See sec. 4.01 
of Rev. Proc. 2004-34, 2004-1 C.B. 991, as modified and clarified by 
Rev. Proc. 2011-18, 2011-5 I.R.B. 443, and Rev. Proc. 2013-29, 2013-33 
I.R.B. 141.
    \744\ An advance payment is considered received by a taxpayer if it 
is actually or constructively received, or if it is due or payable to 
the taxpayer. See sec. 4.04 of Rev. Proc. 2004-34, 2004-1 C.B. 991, as 
modified and clarified by Rev. Proc. 2011-18, 2011-5 I.R.B. 443, and 
Rev. Proc. 2013-29, 2013-33 I.R.B. 141.
    \745\ Alternatively, if the taxpayer does not have an applicable 
financial statement, the taxpayer includes in gross income in the year 
of receipt only the portion of such advance payment that is earned in 
that taxable year. See sec. 5.02(3)(b) of Rev. Proc. 2004-34, 2004-1 
C.B. 991, as modified and clarified by Rev. Proc. 2011-18, 2011-5 
I.R.B. 443, and Rev. Proc. 2013-29, 2013-33 I.R.B. 141.
    \746\ See sec. 5.02(5) of Rev. Proc. 2004-34, 2004-1 C.B. 991, as 
modified and clarified by Rev. Proc. 2011-18, 2011-5 I.R.B. 443, and 
Rev. Proc. 2013-29, 2013-33 I.R.B. 141.
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    Taxpayers receiving substantial advance payments for 
inventoriable goods may also elect a two-year deferral of the 
advance payment.\747\ A taxpayer has received a substantial 
advance payment with respect to an agreement if the advance 
payments received during the taxable year and preceding taxable 
years equal or exceed the total costs and expenditures 
reasonably estimated as includible in inventory with respect to 
the agreement.\748\ Advance payments for which the goods or 
type of goods to be sold are not identifiable in the year the 
payment is received, such as gift certificates and gift cards, 
are treated as substantial advance payments.\749\ If the 
taxpayer (i) receives a substantial advance payment during the 
taxable year and (ii) has on hand (or available through the 
normal source of supply) goods of substantially similar kind 
and in sufficient quantity to satisfy the agreement in such 
taxable year, then any advance payments received by the last 
day of the second taxable year following the year in which the 
substantial advance payment is received are included in gross 
income no later than such second taxable year (adjusted for any 
amounts previously included in gross income as goods are 
provided to customers).\750\ Any additional advance payments 
received with respect to the agreement in taxable years 
following the second taxable year are included in gross income 
in the year of receipt.\751\
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    \747\ See Treas. Reg. sec. 1.451-5(c). If the taxpayer receives an 
advance payment under an agreement to provide both goods and services, 
where the services are not performed as an integral part of providing 
the goods, only the portion of the advance payment properly allocable 
to the provision of goods is eligible for the two-year deferral. 
However, if the portion of the advance payment allocable to the 
provision of services is less than five percent of the total contract 
price, the advance payment is also eligible for the two year-deferral. 
See Treas. Reg. sec. 1.451-5(a)(3).
    \748\ Treas. Reg. sec. 1.451-5(c)(3).
    \749\ Ibid.
    \750\ Treas. Reg. sec. 1.451-5(c)(1)(i).
    \751\ Treas. Reg. sec. 1.451-5(c)(2).
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    Taxpayers receiving an advance payment for goods may also 
apply a multiyear deferral of the advance payment.\752\ For 
this purpose, an advance payment for goods includes any amount 
received during the taxable year which is (i) for the sale or 
other disposition in a future taxable year of goods held by the 
taxpayer primarily for sale to customers in the ordinary course 
of the trade or business, or (ii) for the building, installing, 
constructing, or manufacturing by the taxpayer of items where 
the agreement is not completed within such taxable year.\753\ 
The taxpayer includes such amounts in gross income in (i) the 
taxable year in which such amounts are properly included in 
gross income under the taxpayer's accrual method of accounting, 
or (ii) the taxable year in which such amounts are included in 
revenue in the taxpayer's financial statements, whichever 
occurs first.\754\ If the taxpayer dies or ceases to exist, or 
the taxpayer's obligation with respect to the advance payment 
is satisfied or otherwise ends, the taxpayer must include in 
gross income any portion of the advance payment not previously 
recognized.\755\
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    \752\ Treas. Reg. sec. 1.451-5(b)(1)(ii). If the taxpayer receives 
an advance payment under an agreement to provide both goods and 
services, where the services are not performed as an integral part of 
providing the goods, only the portion of the advance payment properly 
allocable to the provision of goods is eligible for the multiyear 
deferral. However, if the portion of the advance payment allocable to 
the provision of services is less than five percent of the total 
contract price, such advance payments are also eligible for the 
multiyear deferral. See Treas. Reg. sec. 1.451-5(a)(3).
    \753\ Treas. Reg. sec. 1.451-5(a)(1).
    \754\ Treas. Reg. sec. 1.451-5(b)(1).
    \755\ Treas. Reg. sec. 1.451-5(f).
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            Acceleration of related deductions or adjustments to gross 
                    income
    As noted above, special rules were also historically 
provided that allowed taxpayers to instead accelerate the 
deduction for the estimated cost of the goods or property to be 
provided in the future and take such deduction, or adjustment 
to gross income, generally in the same taxable year for which 
the related advance payment was included in gross income (i.e., 
generally in the taxable year the advance payment was 
received). If an accrual method taxpayer issued trading stamps 
or premium coupons with sales, or if an accrual method taxpayer 
engaged in the business of selling trading stamps or premium 
coupons (i.e., a ``trading stamp company''), and such stamps or 
coupons were redeemable by such taxpayer in merchandise, cash, 
or other property, the taxpayer was allowed to reduce gross 
receipts by the estimated cost of future redemptions of trading 
stamps or premium coupons outstanding as of the close of the 
taxable year.\756\ To be eligible to use such method, the 
taxpayer must have satisfied a book conformity requirement 
under which the taxpayer's estimated future redemptions and 
estimated average cost of redeeming each stamp or coupon could 
be no greater than the estimates that the taxpayer used for 
purposes of all reports (including consolidated financial 
statements) to shareholders, partners, beneficiaries, other 
proprietors, and for credit purposes.\757\
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    \756\ Treas. Reg. sec. 1.451-4.
    \757\ Treas. Reg. sec. 1.451-4(d). Under prior generally accepted 
accounting principles, two approaches were available to account for 
customer loyalty programs: (i) incremental cost accrual method (revenue 
is generally recognized at the time of initial sale along with the 
estimated expense for the anticipated costs of satisfying the award 
credits) or (ii) multiple-element revenue model (revenue is allocated 
between the goods or services sold and the award credits based on their 
relative fair value, with revenue allocable to the award credits 
deferred until they are redeemed or expire, with any costs of 
redemption also taken into account at the time redemption takes place). 
See ASC 605-25, Revenue Recognition--Multiple-Element Arrangements, and 
605-50, Revenue Recognition--Customer Payments and Incentives, prior to 
their repeal by Accounting Standards Update (``ASU'') No. 2014-09, 
Revenue from Contracts with Customers. Accordingly, only taxpayers 
using the incremental cost accrual method for financial statement 
purposes were previously eligible to use the method provided in Treas. 
Reg. sec. 1.451-4 for Federal income tax purposes. Under current 
generally accepted accounting principles in ASC 606, Revenue from 
Contracts with Customers, if the taxpayer is acting as a principal, 
customer loyalty programs are accounted for in a manner similar to the 
multiple-element revenue model, with any costs of redemption taken into 
account at the time redemption takes place. However, if the taxpayer is 
acting as an agent, the taxpayer recognizes fee or commission income 
from the exchange at the time redemption takes place. The amount of the 
fee or commission is deemed to be equal to the net amount that the 
taxpayer retains in the exchange (i.e., the revenue deferred from the 
prior sale or issuance of the points less any costs of redemption 
incurred at the time redemption takes place). See ASC 606-10-55-36 
through 55-40, Revenue from Contracts with Customers--Overall--
Implementation Guidance and Illustrations--Principal versus Agent 
Considerations, and ASC 606-10-55-353 through 55-356, Revenue from 
Contracts with Customers--Overall--Implementation Guidance and 
Illustrations--Example 52-Customer Loyalty Program. As the incremental 
cost accrual method is no longer allowed for financial statement 
purposes, taxpayers may not be able to meet the book conformity 
requirement contained in Treas. Reg. sec. 1.451-4(d) and may no longer 
be eligible for the method provided in Treas. Reg. sec. 1.451-4.
---------------------------------------------------------------------------
    Similarly, section 466 previously allowed taxpayers that 
issue discount coupons to deduct the estimated cost of future 
redemptions that occurred during the six-month period after the 
end of a taxable year.
    In addition, a taxpayer electing a two-year deferral of 
advance payments for inventoriable goods was provided with a 
one-time acceleration of its adjustment to gross income for 
estimated cost of goods sold. In particular, a taxpayer 
electing a two-year deferral was allowed to reduce gross income 
for the second taxable year following the year in which the 
substantial advance payment is received (i.e., the taxable year 
in which any remaining advance payment is included in gross 
income) by the costs and expenditures included in inventory 
with respect to the goods to which the remaining advance 
payment relates, even though such goods had not yet been 
provided to the customer.\758\ In addition, if all or a portion 
of the goods to which the remaining advance payment relates are 
not on hand by the last day of such taxable year, the taxpayer 
could also reduce gross income for such taxable year for the 
estimated cost of the goods necessary to satisfy the agreement, 
even though such goods had not yet been acquired or produced by 
the taxpayer and had not yet been provided to the 
customer.\759\ However, the reduction of gross income in such 
taxable year by actual or estimated cost of goods to be 
provided to the customer in the future was not permitted if the 
goods or type of goods with respect to which the advance 
payment was received were not identified in the year the 
advance payments are required to be included in gross income 
(e.g., gift certificates and gift cards).\760\ In addition, if 
the taxpayer receives additional advance payments after the 
second taxable year following the year in which the substantial 
advance payment is received, the reduction of gross income by 
actual or estimated cost of goods to be provided to the 
customer in the future was also not permitted for estimated 
cost of goods sold related to such additional advance payments, 
even though the taxpayer is required under the two-year 
deferral method to include such advance payments in gross 
income in the year received.
---------------------------------------------------------------------------
    \758\ Treas. Reg. sec. 1.451-5(c)(1)(ii).
    \759\ Ibid.
    \760\ Treas. Reg. sec. 1.451-5(c)(1)(iii).
---------------------------------------------------------------------------
    Each of these methods allowing the acceleration of 
deductions or adjustments to gross income for the estimated 
future costs of providing goods, property, or other items 
related to advance payments included in gross income predates 
and is inconsistent with the economic performance rules in 
section 461(h) \761\ enacted in 1984 and the related repeal of 
section 466 \762\ in 1986.\763\ Congress enacted the economic 
performance rules in section 461(h) and repealed section 466 to 
ensure that no liability is treated as incurred any earlier 
than when economic performance takes place.\764\ The economic 
performance rules provide that a liability \765\ that requires 
the taxpayer to provide property or services to others not be 
taken into account any earlier than as the taxpayer provides 
the property or services to the other person.\766\ For a 
liability that arises out of the provision of services or 
property to the taxpayer by another person, economic 
performance occurs as the other person provides such services, 
as the other person provides such property, or as the taxpayer 
uses such property.\767\ If the liability is to pay a rebate, 
refund, or similar payment to another person (whether paid in 
property, money, or as a reduction in the price of goods or 
services to be provided in the future by the taxpayer), 
economic performance occurs as payment is made to the person to 
which the liability is owed.\768\
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    \761\ Deficit Reduction Act of 1984, Pub. L. No. 98-369, sec. 91, 
July 18, 1984.
    \762\ Tax Reform Act of 1986, Pub. L. No. 99-514, sec. 823, October 
22, 1986.
    \763\ In addition, the acceleration of adjustments to gross income 
for costs and expenditures included in inventory as part of the two-
year deferral method is inconsistent with the requirement to maintain 
inventories under section 471 and the requirements of the uniform 
capitalization rules under section 263A to capitalize direct costs and 
certain indirect costs related to goods produced or acquired for resale 
by the taxpayer until such time that the goods are sold to customers 
and the benefits and burdens of ownership of such goods are transferred 
to the customer.
    \764\ Joint Committee on Taxation, General Explanation of the 
Revenue Provisions of The Deficit Reduction Act of 1984 (JCS-41-84), 
December 1984, pp. 260-261. See also Report to accompany H.R. 3838, Tax 
Reform Act of 1986, S. Rpt. No. 99-313, May 29, 1985, pp. 158-159.
    \765\ A liability includes any item allowable as a deduction, cost, 
or expense for Federal income tax purposes. In addition to allowable 
deductions, the term includes any amount otherwise allowable as a 
capitalized cost, as a cost taken into account in computing cost of 
goods sold, as a cost allocable to a long-term contract, or as any 
other cost or expense. See Treas. Reg. secs. 1.446-1(c)(1)(ii)(B) and 
1.461-4(c)(1) and T.D. 8408, 1992-1 C.B. 155.
    \766\ Sec. 461(h)(2)(B).
    \767\ Sec. 461(h)(2)(A).
    \768\ Treas. Reg. sec. 1.461-4(g)(3). This rule applies to all 
rebates, refunds, and payments or transfers in the nature of a rebate 
or refund regardless of whether they are characterized as a deduction 
from gross income, an adjustment to gross receipts or total sales, or 
an adjustment or addition to cost of goods sold. In the case of a 
rebate or refund made as a reduction in the price of goods or services 
to be provided in the future by the taxpayer ``payment'' is deemed to 
occur as the taxpayer would otherwise be required to recognize income 
resulting from a disposition at an unreduced price.
---------------------------------------------------------------------------
    The economic performance rules were enacted to address 
Congressional concerns regarding court decisions that, in some 
cases, permitted accrual method taxpayers to deduct expenses 
that were not yet economically incurred (i.e., that were 
attributable to activities to be performed or amounts to be 
paid in the future).\769\ In particular, Congress observed that 
allowing a taxpayer to take deductions currently for an amount 
to be paid in the future overstates the true cost of the 
expense to the extent that the time value of money is not taken 
into account.\770\ Accordingly, in order to prevent deductions 
for future expenses in excess of their true cost, while 
avoiding the complexity of a system of discounted valuation, 
Congress believed that expenses should be treated as incurred 
only when economic performance occurs.\771\
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    \769\ Joint Committee on Taxation, General Explanation of the 
Revenue Provisions of The Deficit Reduction Act of 1984 (JCS-41-84), 
December 1984, pp. 260-261.
    \770\ Ibid.
    \771\ Ibid.
---------------------------------------------------------------------------
    In addition, in repealing section 466 two years later, 
Congress noted that ``the provision of prior law allowing a 
deduction for discount coupons received for redemption after 
the close of the taxable year resulted in an incorrect 
measurement of taxable income'' and that prior law

          ``provided an unwarranted exception to the general 
        rules of tax accounting. An accrual basis taxpayer 
        normally is allowed to recognize an expense only when 
        all events establishing its obligation to pay the 
        amount claimed as a deduction have occurred, the amount 
        thereof can be determined with reasonable accuracy, and 
        there has been economic performance with respect to the 
        item. Absent the special provision of prior law for 
        discount coupons, such costs would not have been 
        considered deductible until the coupons actually were 
        redeemed.'' \772\
---------------------------------------------------------------------------
    \772\ Report to accompany H.R. 3838, Tax Reform Act of 1986, S. 
Rpt. No. 99-313, May 29, 1985, pp. 158-159.

    As a result of the enactment of section 461(h) and the 
repeal of section 466 the deduction acceleration provisions 
discussed above are no longer consistent with the Code. Under 
prior law, taxpayers receiving advance payments could either 
account for such items by including the advanced payment in 
gross income in the year of receipt or by applying the one-
year, two-year, or multiyear deferral method discussed 
above.\773\
---------------------------------------------------------------------------
    \773\ Upon the enactment of the economic performance rules, 
Congress noted that it ``expected that the Treasury Department would 
review existing regulations and rulings to determine whether they are 
consistent with the policies and principles set forth [in section 
461(h)]. Until new regulations are issued under these provisions or the 
existing rulings are revoked or clarified, taxpayers may continue to 
rely on these rulings to the extent they are not inconsistent with the 
general principles of economic performance.'' See Joint Committee on 
Taxation, General Explanation of the Revenue Provisions of The Deficit 
Reduction Act of 1984 (JCS-41-84), December 1984, p. 266.
---------------------------------------------------------------------------
            Special methods of accounting
    In a number of situations, Congress has prescribed the 
proper time for including sales, gross receipts, and other 
items of income in gross income by providing special methods of 
accounting \774\ for such items in the Code. For example, 
Congress has provided special methods of accounting for (i) 
amounts received by accrual method taxpayers in the year of the 
taxpayer's death, (ii) employee tips, (iii) crop insurance 
proceeds and disaster payments, (iv) proceeds from livestock 
sold on account of drought, flood, or other weather-related 
conditions, (v) income from the sale or furnishing of utility 
services, (vi) interest on frozen deposits in certain financial 
institutions, (vii) qualified prizes including a cash option, 
and (viii) sales or dispositions to implement Federal energy 
regulatory commission or State electric restructuring 
policy.\775\ Congress has also prescribed the proper time for 
including gross profit from installment sales, \776\ prepaid 
subscription income, \777\ prepaid membership dues, \778\ and 
adjustments for certain returned merchandise \779\ in gross 
income. In addition, Congress has prescribed the proper time 
for including in gross income any income from certain long-term 
contracts \780\ and rental income from certain arrangements for 
the use of property or services.\781\
---------------------------------------------------------------------------
    \774\ Methods of accounting include both the taxpayer's overall 
method of accounting, as well as any special methods of accounting for 
any ``item'' of income or expense. Examples of overall methods are the 
cash receipts and disbursements method, an accrual method, and 
combinations of the foregoing with various special methods provided for 
the accounting treatment of items of income or expense. Except for 
deviations permitted or required by special methods of accounting, 
taxable income is computed under the taxpayer's overall method of 
accounting (i.e., the cash receipts and disbursements method or an 
accrual method). See Treas. Reg. sec. 1.446-1(a)(1).
    \775\ See sec. 451(d)-(k), as redesignated by the Act.
    \776\ See sec. 453.
    \777\ See sec. 455.
    \778\ See sec. 456.
    \779\ See sec. 458.
    \780\ See sec. 460.
    \781\ See sec. 467.
---------------------------------------------------------------------------
            Interest income
    A taxpayer generally must include in gross income the 
amount of interest received or accrued within the taxable year 
on indebtedness held by the taxpayer.\782\
---------------------------------------------------------------------------
    \782\ Secs. 61(a)(4) and 451.
---------------------------------------------------------------------------
            Original issue discount
    The holder of a debt instrument with original issue 
discount (``OID'') generally accrues and includes the OID in 
gross income as interest over the term of the instrument, 
regardless of when the stated interest (if any) is paid.\783\
---------------------------------------------------------------------------
    \783\ Sec. 1272.
---------------------------------------------------------------------------
    The amount of OID with respect to a debt instrument is the 
excess of the stated redemption price at maturity over the 
adjusted issue price of the debt instrument.\784\ The stated 
redemption price at maturity is the sum of all payments 
provided by the debt instrument other than qualified stated 
interest payments.\785\ The holder includes in gross income an 
amount equal to the sum of the daily portions of the OID for 
each day during the taxable year the holder held such debt 
instrument. The daily portion is determined by allocating to 
each day in any accrual period its ratable portion of the 
increase during such accrual period in the adjusted issue price 
of the debt instrument.\786\ The adjustment to the issue price 
is determined by multiplying the adjusted issue price (i.e., 
the issue price increased by adjustments prior to the accrual 
period) by the instrument's yield to maturity, and then 
subtracting the interest payable during the accrual period. 
Thus, to compute the amount of OID and the portion of OID 
allocable to a period, the stated redemption price at maturity 
and the term must be known. Issuers of OID instruments accrue 
and deduct the amount of OID as interest expense in the same 
manner as the holder.\787\
---------------------------------------------------------------------------
    \784\ Sec. 1273(a)(1).
    \785\ Sec. 1273(a)(2) and Treas. Reg. sec. 1.1273-1(b).
    \786\ Secs. 1272(a)(1) and (3).
    \787\ Sec. 163(e).
---------------------------------------------------------------------------
            Debt instruments subject to acceleration
    Special rules for determining the amount of OID allocated 
to a period apply to certain instruments that may be subject to 
prepayment. If a borrower can reduce the yield on a debt by 
exercising a prepayment option, the OID rules assume that the 
borrower will prepay the debt.\788\ In addition, in the case of 
(1) any regular interest in a real estate mortgage investment 
conduit (``REMIC'') or qualified mortgages held by a REMIC, or 
(2) any other debt instrument if payments under the instrument 
may be accelerated by reason of prepayments of other 
obligations securing the instrument, the daily portions of the 
OID on such debt instruments are determined by taking into 
account an assumption regarding the prepayment of principal for 
such instruments.\789\
---------------------------------------------------------------------------
    \788\ Treas. Reg. sec. 1.1272-1(c)(5).
    \789\ Sec. 1272(a)(6).
---------------------------------------------------------------------------
    The Taxpayer Relief Act of 1997 \790\ extended these rules 
to any pool of debt instruments the payments on which may be 
accelerated by reason of prepayments.\791\ Thus, if a taxpayer 
holds a pool of credit card receivables that require interest 
to be paid only if the borrowers do not pay their accounts by a 
specified date (``grace-period interest''), the taxpayer is 
required to accrue interest or OID on such pool based upon a 
reasonable assumption regarding the timing of the payments of 
the accounts in the pool. Under these rules, certain amounts 
(other than grace-period interest) related to credit card 
transactions, such as late-payment fees,\792\ cash-advance 
fees,\793\ and interchange fees,\794\ have been determined to 
create OID or increase the amount of OID on the pool of credit 
card receivables to which the amounts relate.\795\
---------------------------------------------------------------------------
    \790\ Pub. L. No. 105-34, sec. 1004(a).
    \791\ Sec. 1272(a)(6)(C)(iii).
    \792\ Rev. Proc. 2004-33, 2004-1 C.B. 989.
    \793\ Rev. Proc. 2005-47, 2005-2 C.B. 269.
    \794\ Capital One Financial Corp. and Subsidiaries v. Commissioner, 
133 T.C. No. 8 (2009); IRS Chief Counsel Notice CC-2010-018, September 
27, 2010.
    \795\ See also Rev. Proc. 2013-26, 2013-22 I.R.B. 1160, for a safe 
harbor method of accounting for OID on a pool of credit card 
receivables for purposes of section 1272(a)(6).
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            Stripped bonds
    Special rules are provided with respect to the buyer and 
seller of stripped bonds.\796\ 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.\797\ 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 are each treated as a new bond that 
is purchased at a discount and is payable at a fixed amount on 
a future date. Accordingly, both the stripped bond and the 
detached interest coupons are treated as individual bonds that 
are newly issued with OID on the date of disposition.
---------------------------------------------------------------------------
    \796\ Sec. 1286.
    \797\ Sec. 1286(d)(2), as redesignated by the Consolidated 
Appropriations Act, 2018, Pub. L. No. 115-141, March 23, 2018.
---------------------------------------------------------------------------
    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.\798\ The OID on the stripped bond or coupon is includible 
in gross income under the general OID periodic income inclusion 
rules.
---------------------------------------------------------------------------
    \798\ 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.\799\ Special rules require that interest or 
market discount accrued on the bond before such disposition 
must be included in the taxpayer's gross income (to the extent 
not previously included in gross income) at the time the 
stripping occurs, and the taxpayer increases the pre-
disposition 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 rules.\800\
---------------------------------------------------------------------------
    \799\ 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.
    \800\ 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 debt instrument that is not tax-exempt (sec. 
1286(c), as redesignated by the Consolidated Appropriations Act, 2018, 
Pub. L. No. 115-141, March 23, 2018).
---------------------------------------------------------------------------
            Mortgage servicing rights
    Income from ``normal'' mortgage servicing rights is 
included in income upon the earlier of when earned or received 
under the all events test of section 451 (i.e., not averaged 
over the life of the mortgage).\801\ Income from ``excess'' 
mortgage servicing rights is treated as income from stripped 
coupons under section 1286 and therefore subject to the OID 
rules.\802\
---------------------------------------------------------------------------
    \801\ See Rev. Rul. 70-142, 1970-1 C.B. 115.
    \802\ See Rev. Rul. 91-46, 1991-2 C.B. 358, and Rev. Proc. 91-50, 
1991-2 C.B. 778.
---------------------------------------------------------------------------
            Nonrecognition rules
    Congress has provided that, in certain situations in which 
income or gain has been clearly realized by the taxpayer, such 
income or gain realized is nonetheless excluded either in whole 
or in part from gross income.\803\ To receive nonrecognition 
treatment for such income or gain, taxpayers generally must 
meet certain requirements and comply with any applicable 
restrictions or adjustments to basis.
---------------------------------------------------------------------------
    \803\ See, e.g., secs. 247(f)(2), 267(d), 311, 332, 336(e)(2), 351, 
354, 355, 361, 721, 731, and 1031 through 1045.
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                        Explanation of Provision


Modification to the all events test for income recognition

    The provision revises the rules associated with the timing 
of income recognition under the all events test of section 451. 
Specifically, the provision requires an accrual method taxpayer 
with an applicable or other specified financial statement \804\ 
that is subject to the all events test to include sales, gross 
receipts, and other items of income in gross income no later 
than the taxable year in which such income is taken into 
account as revenue \805\ in an applicable financial statement 
or another financial statement under rules specified by the 
Secretary. Under the provision, an accrual method taxpayer with 
an applicable or other specified financial statement includes 
sales, gross receipts, and other items of income in gross 
income upon the earlier of when the all events test is met or 
when the taxpayer includes such item in revenue in an 
applicable or other specified financial statement (i.e., upon 
the earlier of when due, paid, earned, or included in an 
applicable or other specified financial statement).
---------------------------------------------------------------------------
    \804\ For purposes of the provision, the term ``applicable 
financial statement'' means: (A) a financial statement which is 
certified as being prepared in accordance with generally accepted 
accounting principles and which is (i) a 10-K (or successor form), or 
annual statement to shareholders, required to be filed by the taxpayer 
with the United States Securities and Exchange Commission (``SEC''), 
(ii) an audited financial statement of the taxpayer which is used for 
(I) credit purposes, (II) reporting to shareholders, partners, or other 
proprietors, or to beneficiaries, or (III) any other substantial nontax 
purpose, but only if there is no statement of the taxpayer described in 
clause (i), or (iii) filed by the taxpayer with any other Federal 
agency for purposes other than Federal tax purposes, but only if there 
is no statement of the taxpayer described in clause (i) or (ii); (B) a 
financial statement which is made on the basis of international 
financial reporting standards and is filed by the taxpayer with an 
agency of a foreign government which is equivalent to the SEC and which 
has reporting standards not less stringent than the standards required 
by such Commission, but only if there is no statement of the taxpayer 
described in subparagraph (A); or (C) a financial statement filed by 
the taxpayer with any other regulatory or governmental body specified 
by the Secretary, but only if there is no statement of the taxpayer 
described in subparagraph (A) or (B). If the financial results of a 
taxpayer are reported on the applicable financial statement for a group 
of entities, such statement is treated as the applicable financial 
statement of the taxpayer. See sec. 451(b)(3) and (5), as modified by 
the Act.
    \805\ Accounting Standards Codification (``ASC'') Topics 605, 
Revenue Recognition, and 606, Revenue from Contracts with Customers, 
provide the accounting rules for determining the amount of revenue to 
which a company expects to be entitled (i.e., realization) and the 
timing of when such amount is included in revenue in the company's 
financial statements (i.e., recognition). The timing of when costs 
incurred to fulfill a contract with a customer are included in the 
company's financial statements is determined separately from the 
inclusion timing of the associated revenue under various ASC topics, 
including ASC 330, Inventory, ASC 340-10-25-1 through 25-4, Other 
Assets and Deferred Costs-Overall-Recognition-Preproduction Costs 
Related to Long-Term Supply Arrangements, ASC 340-40, Other Assets and 
Deferred Costs-Contracts with Customers, ASC 350-40, Intangibles--
Goodwill and Other-Internal-Use Software, ASC 360, Property, Plant, and 
Equipment, and ASC 985-20, Software--Costs of Software to be Sold, 
Leased, or Marketed. See ASC 340-40-15-3.
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    In the case of a contract which contains multiple 
performance obligations, the provision requires the taxpayer to 
allocate the transaction price to each performance obligation 
in accordance with the allocation made in the taxpayer's 
applicable financial statement.\806\
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    \806\ Congress expects that Treasury will provide guidance 
regarding whether and how to allocate the transaction price (i) to 
performance obligations that are not contractually based (e.g., the 
provision of free goods or services to a customer or the provision of a 
customary amount of training or support), (ii) for arrangements that 
include both income subject to section 451 and long-term contracts 
subject to section 460, and (iii) when the income realization event for 
Federal income tax purposes differs from the income realization event 
for financial statement purposes.
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    The provision does not apply to taxpayers without an 
applicable or other specified financial statement.\807\
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    \807\ See below for further discussion.
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            Examples
    Example 1.--A taxpayer enters into a one-year contract with 
a customer to provide cleaning services twice a month for $100 
per cleaning service. The taxpayer invoices the customer and 
receives payment of $200 after the end of each month. The 
taxpayer provides cleaning services to the customer 10 times 
during the last five months of year one and 14 times during the 
first seven months of year two. The taxpayer receives payments 
from the customer of $800 in year one and $1,600 in year two. 
The taxpayer includes in revenue in its financial statements 
$1,000 in year one and $1,400 in year two.\808\ Under prior 
law, the taxpayer would have included in gross income $1,000 in 
year one and $1,400 in year two.\809\ Under the provision, the 
taxpayer includes in gross income $1,000 in year one and $1,400 
in year two.
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    \808\ Because the customer simultaneously receives and consumes the 
benefits provided by the taxpayer's performance as the taxpayer 
performs the cleaning services, the taxpayer recognizes revenue over 
time as it satisfies its performance obligation to provide cleaning 
services. See ASC 606-10-25-27(a) and 606-10-55-5.
    \809\ Under the all events test, the taxpayer includes amounts in 
gross income upon the earlier of when due (i.e., after the end of each 
month), earned (i.e., each time cleaning services are provided as such 
services are severable), or paid (i.e., after the end of each month).
---------------------------------------------------------------------------
    Example 2.--A taxpayer provides construction services to a 
customer to expand the customer's warehouse facility for 
$100,000. The taxpayer begins providing the construction 
services in year one and construction is completed during year 
two. Under the contract, the taxpayer bills the customer 
$50,000 in year one when construction begins and $50,000 in 
year two when construction is complete. In addition, the 
performance of the construction services is non-severable 
(i.e., there are no milestones that have to be met before 
payment is due).\810\ While the construction services are being 
provided, the customer retains control of the original 
warehouse facility and the expansion. The taxpayer includes in 
revenue in its financial statements $60,000 in year one and 
$40,000 in year two.\811\ Under prior law, the taxpayer would 
have included in gross income $50,000 in year one and $50,000 
in year two.\812\ Under the provision, the taxpayer includes in 
gross income $60,000 in year one and $40,000 in year two.
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    \810\ See, e.g., Tech. Adv. Mem. 200903079, October 8, 2008.
    \811\ Because the taxpayer's performance creates or enhances an 
asset that the customer controls as the asset is created or enhanced, 
the taxpayer recognizes revenue over time as it satisfies its 
performance obligation to provide construction services. See ASC 606-
10-25-27(b) and 606-10-55-7.
    \812\ Under the all events test, the taxpayer includes $50,000 in 
gross income for year one upon the earlier of when due (i.e., when 
construction begins), earned (i.e., when performance of the 
nonseverable services is complete in year two), or paid (i.e., upon 
receipt of payment in year one after construction begins). Under the 
all events test, the taxpayer includes $50,000 in gross income for year 
two (adjusted for amounts previously included in gross income during 
year one) upon the earlier of when due (i.e., when construction is 
complete), earned (i.e., when performance of the non-severable services 
is complete in year two), or paid (i.e., upon receipt of payment in 
year two after construction is complete).
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    Example 3.--Assume the same facts as in Example 2 except 
that, under the contract, the taxpayer bills the customer, and 
the customer pays, $75,000 in year one when construction begins 
and $25,000 in year two when construction is complete. The 
taxpayer includes in revenue in its financial statements 
$60,000 in year one and $40,000 in year two.\813\ Under prior 
law, the taxpayer would have included in gross income $75,000 
in year one and $25,000 in year two.\814\ Under the provision, 
the taxpayer includes in gross income $75,000 in year one and 
$25,000 in year two.
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    \813\ Because the taxpayer's performance creates or enhances an 
asset that the customer controls as the asset is created or enhanced, 
the taxpayer recognizes revenue over time as it satisfies its 
performance obligation to provide construction services. See ASC 606-
10-25-27(b) and 606-10-55-7.
    \814\ Under the all events test, the taxpayer includes $75,000 in 
gross income for year one upon the earlier of when due (i.e., when 
construction begins), earned (i.e., when performance of the non-
severable services is complete in year two), or paid (i.e., upon 
receipt of payment in year one after construction begins). Under the 
all events test, the taxpayer includes $25,000 in gross income for year 
two (adjusted for amounts previously included in gross income during 
year one) upon the earlier of when due (i.e., when construction is 
complete), earned (i.e., when performance of the non-severable services 
is complete in year two), or paid (i.e., upon receipt of payment in 
year two after construction is complete). This example assumes that the 
taxpayer has not elected to defer advance payments under prior law or 
the provision. See below for further discussion of an election to defer 
advance payments under the provision.
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    Example 4.--A taxpayer enters into a contract with a 
customer to build a customized piece of machinery for $50,000. 
Because of the customized nature of the machinery, the taxpayer 
is unable to sell the machinery to any of its other customers 
if the customer defaults or withdraws from the contract. Under 
the contract, taxpayer and the customer agree that the taxpayer 
will not invoice the customer until the item is delivered to 
the customer, the customer accepts the machinery, and title to 
the machinery has transferred to the customer. However, the 
contract also provides that, if the customer withdraws from the 
agreement, the taxpayer has an enforceable right to payment as 
the work is performed, even if the contract is not completed 
(for reasons other than a failure to perform by the taxpayer). 
The taxpayer begins producing the machinery in year one and the 
item is delivered to the customer in year two. The taxpayer 
invoices the customer for $50,000 and is paid such amount in 
year two. The taxpayer includes in revenue in its financial 
statements $30,000 in year one and $20,000 in year two.\815\ 
Under prior law, the taxpayer would not have included any 
portion of the $50,000 in gross income in year one and would 
have included $50,000 in gross income in year two.\816\ Under 
the provision, the taxpayer incudes in gross income $30,000 in 
year one and $20,000 in year two.
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    \815\ Because the taxpayer's performance does not create an asset 
with an alternative use to the taxpayer (i.e., the machinery cannot be 
sold to other customers) and the taxpayer has an enforceable right to 
payment for performance completed to date, the taxpayer recognizes 
revenue over time as it satisfies its performance obligation to 
manufacture the item of machinery. See ASC 606-10-25-27(c) and 25-28 
through 25-29, as well as ASC 606-10-55-8 through 55-15.
    \816\ Under the all events test, the taxpayer includes $50,000 in 
gross income for year two upon the earlier of when due (i.e., when the 
taxpayer invoices the customer), earned (i.e., when the machinery is 
delivered to and accepted by the customer), or paid (i.e., when the 
taxpayer receives payment).
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    Example 5.--A taxpayer enters into a contract with a 
customer to manufacture 500 widgets at a price of $10 each. The 
taxpayer receives a prepayment of $5,000 from the customer in 
year one. The taxpayer manufactures the widgets during year two 
and the widgets are delivered to the customer throughout year 
two as production of each widget is complete. The taxpayer does 
not include any portion of the prepayment in revenue in its 
financial statements in year one and, instead, includes the 
$5,000 in revenue in its financial statements in year two.\817\ 
Under prior law, the taxpayer would have included in gross 
income $5,000 in year one and zero in year two.\818\ Under the 
provision, the taxpayer includes in gross income $5,000 in year 
one and zero in year two.\819\
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    \817\ Because the customer simultaneously receives and consumes the 
benefits provided by the taxpayer's performance as the taxpayer 
delivers the widgets to the customer, the taxpayer recognizes revenue 
in year two as it satisfies its performance obligation to provide the 
widgets to the customer. See ASC 606-10-25-27(a) and 606-10-55-5.
    \818\ Under the all events test, the taxpayer includes $5,000 in 
gross income for year one upon the earlier of when due (i.e., when the 
widgets are delivered to the customer), earned (i.e., when the widgets 
are delivered to the customer), or paid (i.e., when paid by the 
customer). This example assumes that the taxpayer accounts for sales of 
its product when the product is delivered (see Treas. Reg. sec. 1.446-
1(c)(1)(ii)(C)), and has not elected to defer advance payments under 
prior law.
    \819\ This example assumes that the taxpayer has not elected to 
defer advance payments under the provision. See below for further 
discussion of an election to defer advance payments under the 
provision.
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Prior law principles which are unchanged by the provision

    Congress intends that the provision apply to items of gross 
income, such as sales, gross receipts, or other items of 
income, for which the timing of income recognition was 
determined using the all events test under prior law. Thus, the 
provision does not apply to items of gross income the timing of 
which is determined under a special method of accounting 
provided elsewhere in the Code, including special rules 
regarding items of gross income in connection with a mortgage 
servicing contract (contained in section 1286 of part V of 
subchapter P (special rules for bonds and other debt 
instruments)). However, the exception for special methods of 
accounting does not apply, and thus the provision is 
applicable, to any other income recognition timing rule 
contained in part V of subchapter P (special rules for bonds 
and other debt instruments).\820\
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    \820\ See prior law discussion above regarding special methods of 
accounting. See also the discussion below regarding the interaction of 
the provision with the special rules for bonds and other debt 
instruments in part V of subchapter P.
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    Consistent with prior law, the amount of cost of goods sold 
included as a subtraction from total sales is determined in 
accordance with the taxpayer's methods of accounting for items 
included in cost of goods sold.\821\ An amount may not be taken 
into account in the computation of cost of goods sold, and thus 
reduce total sales, any earlier than the taxable year in which 
economic performance occurs with respect to such amount.\822\ 
Once economic performance occurs, amounts may only be taken 
into account in the computation of cost of goods sold if they 
are not required to be capitalized and are not subject to any 
other provision of the Code that requires the deduction to be 
taken in a taxable year later than the year when economic 
performance occurs.\823\ For example, generally taxpayers must 
maintain inventories whenever the production, purchase, or sale 
of merchandise is an income-producing factor.\824\ In addition, 
such merchandise remains in inventory and is not included in 
cost of goods sold if title thereto is still vested in the 
taxpayer.\825\ Section 263A and the regulations thereunder also 
require that direct costs and certain indirect costs incurred 
by the taxpayer (i.e., costs for which economic performance has 
occurred) must be capitalized and included in the basis of 
property produced or acquired for resale by the taxpayer with 
the capitalized costs recovered by including such amounts in 
cost of goods sold when the underlying inventory or property is 
sold.\826\
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    \821\ Treas. Reg. sec. 1.61-3(a). See, e.g., sections 263A, 461(h), 
and 471. See also, e.g., line 2 of Form 1120, Form 1120S, or Form 1065, 
or line 4 of Schedule C (Form 1040), as well as Form 1125-A. A 
taxpayer's gross profit is generally determined by subtracting returns 
and allowances and cost of goods sold from gross receipts or sales. See 
line 3 of Form 1120, Form 1120S, or Form 1065, or line 5 of Schedule C 
(Form 1040).
    \822\ Treas. Reg. secs. 1.61-3(a), 1.263A-1(c)(2)(ii), and 1.446-
1(c)(1)(ii). For a liability that arises out of the provision of 
services or property to the taxpayer by another person, economic 
performance occurs as the other person provides such services, as the 
other person provides such property, or as the taxpayer uses such 
property. For a liability that requires the taxpayer to provide 
property to others, economic performance occurs as the taxpayer 
provides the property to the other person. Sec. 461(h)(2)(A) and (B). A 
liability includes any item allowable as a deduction, cost, or expense 
for Federal income tax purposes. In addition to allowable deductions, 
the term includes any amount otherwise allowable as a capitalized cost, 
as a cost taken into account in computing cost of goods sold, as a cost 
allocable to a long-term contract, or as any other cost or expense. See 
Treas. Reg. secs. 1.446-1(c)(1)(ii)(B) and 1.461-4(c)(1) and T.D. 8408, 
1992-1 C.B. 155.
    \823\ Conference Report to accompany H.R. 4170, Deficit Reduction 
Act of 1984, H.R. Rep. No. 98-861, June 23, 1984, p. 871.
    \824\ Sec. 471 and Treas. Reg. sec. 1.471-1.
    \825\ Sec. 471 and Treas. Reg. sec. 1.471-1. Whether the 
requirement that title be vested in the taxpayer has been met is 
generally determined based on whether the taxpayer has the benefits and 
burdens of ownership.
    \826\ Sec. 263A and Treas. Reg. sec. 1.263A-1(c)(4).
---------------------------------------------------------------------------
    Consistent with prior law, the provision does not apply to 
an item of gross income subject to the nonrecognition rules 
provided elsewhere in the Code.\827\
---------------------------------------------------------------------------
    \827\ See prior law discussion above regarding nonrecognition 
rules.
---------------------------------------------------------------------------
    The provision does not revise the rules regarding when an 
item is realized for Federal income tax purposes and, 
accordingly, does not require the recognition of income in 
situations where the Federal income tax realization event has 
not yet occurred.\828\ For example, the provision does not 
require the recognition of gain or loss from securities that 
are marked to market for financial reporting purposes if the 
gain or loss from such securities is not realized for Federal 
income tax purposes until such time that the taxpayer sells or 
otherwise disposes of the investment (because the taxpayer has 
not elected to apply, and is thus not subject to, the tax mark 
to market rules under section 475). In addition, the provision 
does not change any Federal income tax realization rule 
prescribed by the Code. For example, the provision does not 
apply to the Federal income tax treatment of amounts received 
upon the retirement, sale, or exchange of debt instruments 
which is governed by section 1271, or to the character of bond 
disposition gain where realization does not occur until the 
bond has been sold or otherwise disposed of by reason of 
section 1276.\829\
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    \828\ For example, the provision does not require the 
recharacterization of a transaction from sale to lease, or vice versa, 
for Federal income tax purposes to conform to how the transaction is 
reported in the taxpayer's applicable financial statement. In addition, 
income from investments in corporations or partnerships that are 
accounted for under the equity method for financial reporting purposes 
will not result in the recognition of income for Federal income tax 
purposes until such time that the Federal income tax realization event 
has occurred (e.g., when the taxpayer receives a dividend from the 
corporation in which it owns less than a controlling interest or when 
the taxpayer receives its allocable share of income, deductions, gains, 
and losses on its Schedule K-1 from the partnership).
    \829\ However, see further discussion below for taxpayers that 
elect under section 1278(b) to have deemed realization of market 
discount as it ratably accrues over the number of days the taxpayer 
holds the bond.
---------------------------------------------------------------------------
            Examples
    Example 6.--A taxpayer enters into a three-year contract to 
provide consulting services to a customer and receives payment 
as such services are provided. The contract also includes a 
performance bonus of $4,500 at the end of year three if certain 
material conditions and requirements are met. Because the 
taxpayer expects, at the time the contract is entered into, 
that all necessary conditions and requirements will be met at 
the end of the contract in year three, the taxpayer includes 
the $4,500 performance bonus in revenues in its financial 
statements ratably over the three-year contract, resulting in 
$1,500 included in revenue each year. At the end of the three-
year contract, the taxpayer and the customer agree that the 
necessary conditions and requirements were met and the taxpayer 
receives the $4,500 performance bonus. For Federal income tax 
purposes, the performance bonus is not realized until year 
three when the necessary material conditions and requirements 
for receipt of the performance bonus have been met and the 
taxpayer has a fixed and definite right to receive the income. 
Accordingly, the taxpayer includes the $4,500 performance bonus 
in gross income in year three.
    Example 7.--The taxpayer, an insurance agent, is engaged by 
an insurance carrier to sell insurance. For each policy sold to 
customers, the taxpayer receives a $50 commission from the 
insurance carrier at the time of purchase. The taxpayer also 
receives an additional $25 commission each time the policy is 
renewed. The taxpayer sells 1,000 one-year policies in year 
one, of which 800 are renewed in year two and 700 are renewed 
in year three. The taxpayer does not have any ongoing 
obligation to provide additional services to the insurance 
carrier or the customers after the initial sale of the policy. 
The taxpayer includes $86,000 in revenue in its financial 
statements for year one, which includes $50,000 of fixed 
consideration for policies sold in year one and $36,000 of 
variable consideration for the policies expected to be renewed 
in years two and three.\830\ For Federal income tax purposes, 
the commissions related to policy renewals are not realized 
until year two and year three as the customers renew the 
policies. Accordingly, under the provision, the taxpayer 
includes in gross income commissions of $50,000 ($50 * 1,000) 
in year one, $20,000 ($25 * 800) in year two, and $17,500 ($25 
* 700) in year three.
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    \830\ Under ASC 606-10-32-2, a transaction price includes both 
fixed and variable consideration. ASC 606-10-32-5 provides that if 
consideration promised in a contract includes a variable amount, the 
transaction price includes an estimate of the amount of consideration 
expected to be received in exchange for transferring the promised goods 
or services to a customer. However, such variable consideration may 
only be included in the transaction price to the extent that it is 
probable that a significant reversal in the amount of cumulative 
revenue recognition will not occur when uncertainty associated with the 
variable consideration is subsequently resolved. See ASC 606-10-32-11. 
For purposes of this example, at the time the contract is entered into 
in year one, the taxpayer estimates that the variable consideration to 
be received from policy renewals in year two and year three will be 
$36,000.
---------------------------------------------------------------------------

Interaction with special rules for bonds and other debt instruments

    In addition, the provision directs accrual method taxpayers 
with an applicable or other specified financial statement to 
apply the income recognition rules under section 451 before 
applying any income recognition rules applicable under part V 
of subchapter P,\831\ which include the OID rules contained in 
section 1272 (including the related provisions contained in 
sections 1273 through 1275), the election to include market 
discount in income as it ratably accrues,\832\ and the stripped 
bond rules contained in section 1286 (including the related 
provisions in section 1288). Thus, for example, if a taxpayer 
has realized interchange fees on credit card loans that the OID 
rules would permit the taxpayer to recognize over time, but the 
taxpayer has included those fees in revenue for financial 
statement purposes when received (e.g., late-payment fees, 
cash-advance fees, or interchange fees), this provision 
requires the taxpayer to apply the income recognition 
principles under section 451 before applying the OID rules.
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    \831\ Secs. 1271-1288. The provisions of part V of subchapter P 
provide special rules regarding the income realization and income 
recognition for bonds and other debt instruments, as well as the timing 
of certain related interest deductions.
    \832\ See sec. 1278(b).
---------------------------------------------------------------------------
    However, the provision provides an exception for income in 
connection with a mortgage servicing contract.\833\ Thus, under 
the provision, income from mortgage servicing rights continues 
to be recognized in accordance with the rules for such items of 
gross income (i.e., ``normal'' mortgage servicing rights are 
included in income upon the earlier of when earned or received 
under the all events test of section 451 (i.e., not averaged 
over the life of the mortgage),\834\ and ``excess''' mortgage 
servicing rights are treated as stripped coupons under section 
1286 and therefore subject to the OID rules).\835\
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    \833\ Sec. 451(b)(1)(B)(ii).
    \834\ See Rev. Rul. 70-142, 1970-2 C.B. 115.
    \835\ See Rev. Rul. 91-46, 1991-2 C.B. 358, and Rev. Proc. 91-50, 
1991-2 C.B. 778.
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Advance payments

    The provision also codifies the one-year deferral method of 
accounting for advance payments for goods, services, and other 
specified items provided by the IRS under Revenue Procedure 
2004-34.\836\ That is, the provision allows accrual method 
taxpayers with an applicable or other specified financial 
statement to elect \837\ to defer the inclusion of income 
associated with certain advance payments to the end of the tax 
year following the tax year of receipt if such income also is 
deferred for financial statement purposes.\838\ For purposes of 
the provision, an advance payment includes any payment received 
\839\ during the taxable year (i) the full inclusion of which 
in the gross income of the taxpayer for the taxable year of 
receipt is a permissible method of accounting under section 451 
(determined without regard to the provision), (ii) any portion 
of which is included in revenue by the taxpayer in an 
applicable or other specified financial statement for a 
subsequent taxable year, and (iii) which is for any goods, 
services, or such other items as may be identified by the 
Secretary.\840\ However, the provision excludes from eligible 
advance payments any payments that are received for certain 
items.\841\ Thus, the provision is intended to override the 
two-year deferral and multiyear deferral methods of accounting 
for advance payments received for goods provided by Treasury 
Regulation section 1.451-5.
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    \836\ 2004-1 C.B. 991, as modified and clarified by Rev. Proc. 
2011-18, 2011-5 I.R.B. 443, and Rev. Proc. 2013-29, 2013-33 I.R.B. 141.
    \837\ The election shall be made at such time, in such form and 
manner, and with respect to such categories of advance payments as the 
Secretary may provide. For these purposes, the recognition of income 
under such election is treated as a method of accounting. See sec. 
451(c)(2).
    \838\ Consistent with prior law, an accrual method taxpayer with an 
applicable or other specified financial statement may instead include 
the amount of the advance payment in gross income in the year of 
receipt under the full inclusion method.
    \839\ For purposes of the provision, a payment is received by the 
taxpayer if it is actually or constructively received, or if it is due 
and payable to the taxpayer. See sec. 451(c)(4)(C).
    \840\ Sec. 451(c)(4). See sec. 4.01 of Rev. Proc. 2004-34, 2004-1 
C.B. 991, as modified and clarified by Rev. Proc. 2011-18, 2011-5 
I.R.B. 443, and Rev. Proc. 2013-29, 2013-33 I.R.B. 141.
    \841\ Sec. 451(c)(4)(B). Consistent with prior law, the following 
payments are excluded from advance payments: rent, insurance premiums 
governed by subchapter L, payments with respect to financial 
instruments, payments with respect to warranty or guarantee contracts 
under which a third party is the primary obligor, payments subject to 
section 871(a), 881, 1441, or 1442, payments in property to which 
section 83 applies, and any other payment identified by the Secretary. 
For prior law, see sec. 4.02 of Rev. Proc. 2004-34, 2004-1 C.B. 991, as 
modified and clarified by Rev. Proc. 2011-18, 2011-5 I.R.B. 443, and 
Rev. Proc. 2013-29, 2013-33 I.R.B. 141.
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    In the case of advance payments received for a combination 
of services, goods, or other specified items, the provision 
requires the taxpayer to allocate the transaction price in 
accordance with the allocation made in the taxpayer's 
applicable financial statement.\842\
---------------------------------------------------------------------------
    \842\ Sec. 451(c)(4)(D). Congress expects that Treasury will 
provide guidance regarding whether and how to allocate the transaction 
price (i) to performance obligations that are not contractually based 
(e.g., the provision of free goods or services to a customer or the 
provision of a customary amount of training or support), (ii) for 
arrangements that include both income subject to section 451 and long-
term contracts subject to section 460, and (iii) when the income 
realization event for Federal income tax purposes differ from the 
income realization event for financial statement purposes.
---------------------------------------------------------------------------
    The provision requires the inclusion of a deferred advance 
payment in gross income if the taxpayer ceases to exist.\843\
---------------------------------------------------------------------------
    \843\ Sec. 451(c)(3).
---------------------------------------------------------------------------
    Consistent with prior law and consistent with the methods 
of accounting previously followed by taxpayers applying the 
full inclusion method or the one-year deferral method in 
Revenue Procedure 2004-34, the amount of cost of goods sold 
included as a subtraction from total sales is determined in 
accordance with the taxpayer's methods of accounting for items 
included in cost of goods sold.\844\ An amount may not be taken 
into account in the computation of cost of goods sold, and thus 
reduce total sales, any earlier than the taxable year in which 
economic performance occurs with respect to such amount.\845\ 
Once economic performance occurs, amounts may only be taken 
into account in the computation of cost of goods sold if they 
are not required to be capitalized and are not subject to any 
other provision of the Code that requires the deduction to be 
taken in a taxable year later than the year when economic 
performance occurs.\846\ For example, generally taxpayers must 
maintain inventories whenever the production, purchase, or sale 
of merchandise is an income-producing factor.\847\ In addition, 
such merchandise remains in inventory, and is not included in 
cost of goods sold, if title thereto is still vested in the 
taxpayer.\848\ Section 263A and the regulations thereunder also 
require that direct costs and certain indirect costs incurred 
by the taxpayer (i.e., costs for which economic performance has 
occurred) must be capitalized and included in the basis of 
property produced or acquired for resale by the taxpayer with 
the capitalized costs recovered by including such amounts in 
cost of goods sold when the underlying inventory or property is 
sold.\849\
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    \844\ Treas. Reg. sec. 1.61-3(a). See, e.g., sections 263A, 461(h), 
and 471. See also, e.g., line 2 of Form 1120, Form 1120S, or Form 1065, 
or line 4 of Schedule C (Form 1040), as well as Form 1125-A. A 
taxpayer's gross profit is generally determined by subtracting returns 
and allowances and cost of goods sold from gross receipts or sales. See 
line 3 of Form 1120, Form 1120S, or Form 1065, or line 5 of Schedule C 
(Form 1040).
    \845\ Treas. Reg. secs. 1.61-3(a), 1.263A-1(c)(2)(ii), and 1.446-
1(c)(1)(ii). For a liability that arises out of the provision of 
services or property to the taxpayer by another person, economic 
performance occurs as the other person provides such services, as the 
other person provides such property, or as the taxpayer uses such 
property. For a liability that requires the taxpayer to provide 
property to others, economic performance occurs as the taxpayer 
provides the property to the other person. Sec. 461(h)(2)(A) and (B). A 
liability includes any item allowable as a deduction, cost, or expense 
for Federal income tax purposes. In addition to allowable deductions, 
the term includes any amount otherwise allowable as a capitalized cost, 
as a cost taken into account in computing cost of goods sold, as a cost 
allocable to a long-term contract, or as any other cost or expense. See 
Treas. Reg. secs. 1.446-1(c)(1)(ii)(B) and 1.461-4(c)(1) and T.D. 8408, 
1992-1 C.B. 155.
    \846\ Conference Report to accompany H.R. 4170, Deficit Reduction 
Act of 1984, H.R. Rep. No. 98-861, June 23, 1984, p. 871.
    \847\ Sec. 471 and Treas. Reg. sec. 1.471-1.
    \848\ Sec. 471 and Treas. Reg. sec. 1.471-1. Whether the 
requirement that title be vested in the taxpayer has been met is 
generally determined based on whether the taxpayer has the benefits and 
burdens of ownership.
    \849\ Sec. 263A and Treas. Reg. sec. 1.263A-1(c)(4).
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            Examples
    Example 8.--Assume the same facts as Example 3, except that 
the taxpayer elects to defer advance payments under section 
451(c). Under the provision, the taxpayer includes in gross 
income $60,000 in year one and $40,000 in year two.
    Example 9.--Assume the same facts as Example 5, except that 
the taxpayer elects to defer advance payments under section 
451(c). Under the provision, the taxpayer does not include any 
portion of the advance payment in gross income in year one and, 
instead, includes $5,000 in gross income in year two.
    Example 10.--A taxpayer enters into a contract with a 
customer to build a customized piece of machinery for $50,000. 
The taxpayer receives an advance payment of $35,000 in year one 
for which it elected to apply a two-year deferral under prior 
law. In addition, the taxpayer elects to defer advance payments 
under section 451(c). Due to the customized nature of the 
machinery, the taxpayer is unable to sell the good to any of 
its other customers if the customer defaults or withdraws from 
the contract. Under the contract, the taxpayer and the customer 
agree that the taxpayer will not invoice the customer for the 
remaining $15,000 until the machinery is delivered to the 
customer, the customer accepts the machinery, and title to the 
machinery has transferred to the customer. However, if the 
customer withdraws from the agreement, the contract also 
provides that the taxpayer has an enforceable right to payment 
as the work is performed, even if the contract is not completed 
(for reasons other than a failure to perform by the taxpayer). 
The taxpayer begins producing the machinery in year two and the 
machinery is delivered to the customer in year three. The 
taxpayer invoices the customer and receives payment for the 
remaining $15,000 in year three. The taxpayer includes in 
revenue in its financial statements $30,000 in year two and 
$20,000 in year three.\850\ Under prior law, the taxpayer would 
have not included any portion of the $50,000 in gross income in 
year one or year two and would have included $50,000 in gross 
income in year three.\851\ Under the provision, the taxpayer 
defers including the $35,000 advance payment in gross income 
from year one to year two. Accordingly, under the provision, 
the taxpayer incudes in gross income $35,000 in year two and 
$15,000 in year three.
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    \850\ Because the taxpayer's performance does not create an asset 
with an alternative use to the taxpayer (i.e., the machinery cannot be 
sold to other customers) and the taxpayer has an enforceable right to 
payment for performance completed to date, the taxpayer recognizes 
revenue over time as it satisfies its performance obligation to 
manufacture the item of machinery. See ASC 606-10-25-27(c) and 25-28 
through 25-29, as well as ASC 606-10-55-8 through 55-15.
    \851\ The $50,000 included in gross income for year three includes 
(i) the remaining $15,000 included in gross income under the all events 
test in year three upon the earlier of when due (i.e., when the 
taxpayer invoices the customer), earned (i.e., when the machinery is 
delivered to and accepted by the customer), or paid (i.e., when 
taxpayer receives payment) plus (ii) the $35,000 advance payment 
deferred from year one and included in gross income for year three 
under the two-year deferral method of Treas. Reg. sec. 1.451-5. At the 
time prior law was in effect, ASC 606, Revenue from Contracts with 
Customers, was not yet applicable to financial statements. Under the 
accounting standards previously in effect, the taxpayer would have 
included the $50,000 in revenue in its financial statements entirely in 
year three; thus, allowing the taxpayer to defer the $35,000 advance 
payment to year three under the two-year deferral method of Treas. Reg. 
sec. 1.451-5.
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    Example 11.--A taxpayer enters into a contract with a 
customer to manufacture 500 widgets at a price of $10 each. 
Taxpayer receives a prepayment of $5,000 from the customer in 
year one for which it elected to apply a two-year deferral 
under prior law. In addition, the taxpayer elects to defer 
advance payments under section 451(c). Taxpayer manufactures 
the widgets during year two and year three and the widgets are 
delivered to the customer during year three. The taxpayer does 
not include any portion of the advance payment in revenue in 
its financial statements in year one or year two and, instead, 
includes the $5,000 in revenue in its financial statements in 
year three.\852\ Under prior law, the taxpayer would have not 
have included any portion of the advance payment in gross 
income for year one or year two and, instead, would have 
included the entire amount in gross income in year three.\853\ 
Under the provision, the taxpayer defers including the $5,000 
advance payment in gross income from year one to year two. 
Accordingly, under the provision, the taxpayer includes the 
$5,000 advance payment in gross income in year two.
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    \852\ Because the taxpayer's performance obligation is satisfied at 
a point in time (i.e., at the time control of the widgets is 
transferred to the customer), the taxpayer recognizes revenue at such 
point in time. See ASC 606-10-25-23 and 25-30.
    \853\ At the time prior law was in effect, ASC 606, Revenue from 
Contracts with Customers, was not yet applicable to financial 
statements. Under the accounting standards previously in effect, the 
taxpayer would have included the $5,000 in revenue in its financial 
statements entirely in year three, which allowed the taxpayer to defer 
the $5,000 advance payment to year three under the two-year deferral 
method of Treas. Reg. sec. 1.451-5.
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Taxpayers without an applicable financial statement

    These provisions do not apply to taxpayers that do not have 
an applicable or other specified financial statement. Accrual 
method taxpayers without an applicable or other specified 
financial statement continue to determine the timing for when 
sales, gross receipts, and other income are included in gross 
income under the all events test (i.e., upon the earlier of 
when (i) payment is earned through performance, (ii) payment is 
due to the taxpayer, or (iii) payment is received by the 
taxpayer),\854\ unless an exception permits deferral or a 
special method of accounting applies. In addition, such 
taxpayers generally may continue to defer advance payments for 
goods, services, and other items using a permissible method of 
deferral.\855\
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    \854\ See Rev. Rul. 2003-10, 2003-1 C.B. 288.
    \855\ As of the date of enactment, taxpayers without an applicable 
or other specified financial statement could continue to defer advance 
payments using either the one-year, two-year, or multiyear deferral 
methods (if the taxpayer is otherwise eligible to use such methods and 
to the extent that such methods are consistent with the Code and 
subsequent published guidance issued by the Treasury Department). 
Consistent with prior law, the related liabilities to provide goods, 
services, or other items to customers in exchange for the advance 
payments received by the taxpayer are included as an item of gross 
income (i.e., as a cost of goods sold adjustment) or as a deduction 
taken into account in determining the taxpayer's taxable income in 
accordance with the taxpayer's methods of accounting for such items. 
See, e.g., secs. 263A, 461(h), and 471. See also Treas. Reg. secs. 
1.61-3(a) and 1.446-1(c)(1)(ii)(A).

    The Treasury Department has issued published guidance 
addressing this provision.\856\
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    \856\ REG-104872-18, 83 Fed. Reg. 51904, October 15, 2018; Notice 
2018-35, 2018-18 I.R.B. 520, April 30, 2018; Notice 2018-80, 2018-42 
I.R.B. 609, October 15, 2018; and Rev. Proc. 2018-60, available at 
https://www.irs.gov/pub/irs-drop/rp-18-60.pdf.
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                             Effective Date

    The provision generally applies to taxable years beginning 
after December 31, 2017, and the application of these rules is 
a change in the taxpayer's method of accounting for purposes of 
section 481. In the case of any taxpayer required by this 
provision to change its method of accounting for its first 
taxable year beginning after December 31, 2017, such change is 
treated as initiated by the taxpayer and made with the consent 
of the Secretary.
    In the case of income from a debt instrument having OID, 
the provision applies to taxable years beginning after December 
31, 2018, and the related section 481(a) adjustment is taken 
into account over six taxable years.

          PART IV--BUSINESS-RELATED EXCLUSIONS AND DEDUCTIONS

A. Limitation on Deduction for Interest (sec. 13301 of the Act and sec. 
                          163(j) of the Code)

                               Prior Law

Interest deduction
    Interest paid or accrued by a business generally is 
deductible in the computation of taxable income subject to a 
number of limitations.\857\
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    \857\ Sec. 163(a). In addition to the limitations discussed herein, 
other limitations include: denial of the deduction for the disqualified 
portion of the original issue discount on an applicable high yield 
discount obligation (sec. 163(e)(5)), denial of deduction for interest 
on certain obligations not in registered form (sec. 163(f)), reduction 
of the deduction for interest on indebtedness with respect to which a 
mortgage credit certificate has been issued under section 25 (sec. 
163(g)), disallowance of deduction for personal interest (sec. 163(h)), 
disallowance of deduction for interest on debt with respect to certain 
life insurance contracts (sec. 264), and disallowance of deduction for 
interest relating to tax-exempt income (sec. 265). Interest may also be 
subject to capitalization. See, e.g., sections 263A(f) and 461(g).
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    Interest is generally deducted by a taxpayer as it is paid 
or accrued, depending on the taxpayer's method of accounting. 
For all taxpayers, if an obligation is issued with original 
issue discount (``OID''), a deduction for interest is allowable 
over the life of the obligation on a yield to maturity 
basis.\858\ Generally, OID arises where interest on a debt 
instrument is not calculated based on a qualified rate and 
required to be paid at least annually.
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    \858\ Sec. 163(e). But see section 267 (dealing in part with 
interest paid to a related or foreign party).
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Investment interest expense
    In the case of a taxpayer other than a corporation, the 
deduction for interest on indebtedness that is allocable to 
property held for investment (``investment interest'') is 
limited to the taxpayer's net investment income for the taxable 
year.\859\ Disallowed investment interest is carried forward to 
the next taxable year.
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    \859\ Sec. 163(d).
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    Net investment income is investment income net of 
investment expenses. Investment income generally consists of 
gross income from property held for investment, and investment 
expense includes all deductions directly connected with the 
production of investment income (e.g., deductions for 
investment management fees) other than deductions for interest.
    The two-percent floor on miscellaneous itemized deductions 
allows taxpayers to deduct investment expenses connected with 
investment income only to the extent such deductions exceed two 
percent of the taxpayer's adjusted gross income.\860\ 
Miscellaneous itemized deductions \861\ that are not investment 
expenses are disallowed first before any investment expenses 
are disallowed.\862\
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    \860\ Sec. 67(a). For a discussion of changes made to the deduction 
of miscellaneous itemized deductions by the Act, see the description of 
section 11045 of the Act (Suspension of Miscellaneous Itemized 
Deductions).
    \861\ Miscellaneous itemized deductions include itemized deductions 
of individuals other than certain specific itemized deductions. Sec. 
67(b). Miscellaneous itemized deductions generally include, for 
example, investment management fees and certain employee business 
expenses, but specifically do not include, for example, interest, 
taxes, casualty and theft losses, charitable contributions, medical 
expenses, or other listed itemized deductions.
    \862\ H.R. Rep. No. 841, 99th Cong., 2d Sess., p. II-154, Sept. 18, 
1986 (Conf. Rep.) (``In computing the amount of expenses that exceed 
the 2-percent floor, expenses that are not investment expenses are 
intended to be disallowed before any investment expenses are 
disallowed.'').
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Earnings stripping
    Section 163(j) may disallow a deduction for disqualified 
interest paid or accrued by a corporation in a taxable year if 
two threshold tests are satisfied: (1) the payor's debt-to-
equity ratio exceeds 1.5 to 1.0, and (2) the payor's net 
interest expense exceeds the sum of 50 percent of its adjusted 
taxable income (generally, taxable income computed without 
regard to deductions for net interest expense, net operating 
losses, domestic production activities under section 199, 
depreciation, amortization, and depletion) plus any excess 
limitation carryforward (defined below).\863\ Disqualified 
interest includes interest paid or accrued to: (1) related 
parties when no Federal income tax is imposed with respect to 
such interest; \864\ (2) unrelated parties in certain instances 
in which a related party guarantees the debt; and (3) a real 
estate investment trust (``REIT'') by a taxable REIT subsidiary 
of that trust.\865\ The amount disallowed may not exceed the 
amount by which the corporation's net interest expense exceeds 
50 percent of the corporation's adjusted taxable income.\866\ 
Interest amounts disallowed under these rules can be carried 
forward indefinitely.\867\ In addition, any excess limitation 
(i.e., the excess, if any, of 50 percent of the adjusted 
taxable income of the payor over the payor's net interest 
expense) can be carried forward three years (the ``excess 
limitation carryforward'').\868\
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    \863\ Secs. 163(j)(2)(A), (2)(B) and (6)(A). For a brief 
description of the legislative background of section 163(j), see Joint 
Committee on Taxation, Present Law and Background Relating to Tax 
Treatment of Business Debt (JCS-41-11), July 11, 2011, pp. 21-23.
    \864\ If a tax treaty reduces the rate of tax on interest paid or 
accrued by the taxpayer, the interest is treated as interest on which 
no Federal income tax is imposed to the extent of the same proportion 
of such interest as the rate of tax imposed without regard to the 
treaty, reduced by the rate of tax imposed by the treaty, bears to the 
rate of tax imposed without regard to the treaty. Sec. 163(j)(5)(B).
    \865\ Sec. 163(j)(3).
    \866\ Sec. 163(j)(1)(A).
    \867\ Sec. 163(j)(1)(B).
    \868\ Sec. 163(j)(2)(B)(ii).
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                        Explanation of Provision

In general
    In the case of any taxpayer for any taxable year, the 
deduction for business interest is limited to the sum of (1) 
business interest income of the taxpayer for the taxable year, 
(2) 30 percent of the adjusted taxable income of the taxpayer 
for the taxable year (not less than zero), and (3) the floor 
plan financing interest of the taxpayer for the taxable year. 
The amount of any business interest not allowed as a deduction 
for any taxable year may be carried forward indefinitely. The 
limitation applies at the taxpayer level (but see a special 
carryforward rule for partnerships, described below). In the 
case of a group of affiliated corporations that file a 
consolidated return, the limitation applies at the consolidated 
tax return filing level.
    Business interest means any interest paid or accrued on 
indebtedness properly allocable to a trade or business. Any 
amount treated as interest for purposes of the Code is interest 
for purposes of the provision. Business interest income means 
the amount of interest includible in the gross income of the 
taxpayer for the taxable year which is properly allocable to a 
trade or business. Business interest does not include 
investment interest, and business interest income does not 
include investment income, within the meaning of section 
163(d).\869\
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    \869\ Section 163(d) applies in the case of a taxpayer other than a 
corporation; a corporation has neither investment interest nor 
investment income within the meaning of section 163(d). Thus, interest 
income and interest expense of a corporation is properly allocable to a 
trade or business, unless such trade or business is otherwise 
explicitly excluded from the application of the provision. For example, 
in the case of an insurance company that for regulatory (i.e., 
statutory accounting) purposes has both underwriting income and expense 
and investment interest income and expense, any interest income is 
business interest income and any interest expense is business interest 
for purposes of section 163(j).
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    Adjusted taxable income means the taxable income of the 
taxpayer computed without regard to: (1) any item of income, 
gain, deduction, or loss that is not properly allocable to a 
trade or business; (2) any business interest or business 
interest income; (3) the amount of any net operating loss 
deduction; and (4) the amount of any deduction allowed under 
section 199A.\870\ Additionally, for taxable years beginning 
after December 31, 2017 and before January 1, 2022, adjusted 
taxable income is computed without regard to any deduction 
allowable for depreciation, amortization, or depletion.\871\ 
For taxable years beginning after December 31, 2021, adjusted 
taxable income is computed with regard to deductions allowable 
for depreciation, amortization, or depletion. The Secretary may 
provide for other adjustments to the computation of adjusted 
taxable income.
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    \870\ For a discussion of section 199A, see the description of 
section 11011 of the Act (Deduction for Qualified Business Income) and 
the Appendix.
    \871\ Any deduction allowable for depreciation, amortization, or 
depletion includes any deduction allowable for any amount treated as 
depreciation, amortization, or depletion.
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    Floor plan financing interest means interest paid or 
accrued on floor plan financing indebtedness. Floor plan 
financing indebtedness means indebtedness used to finance the 
acquisition of motor vehicles held for sale or lease to retail 
customers and secured by the inventory so acquired.\872\ A 
motor vehicle means a motor vehicle that is: (1) any self-
propelled vehicle designed for transporting person or property 
on a public street, highway, or road; (2) a boat; or (3) farm 
machinery or equipment.
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    \872\ Property that is held exclusively for lease is not inventory, 
but rather property used in a trade or business under section 
1221(a)(2). Property simultaneously held for sale or lease is treated 
as inventory until such time as it first becomes leased, at which point 
it is no longer treated as inventory. See, e.g., Notice 2013-13, 2013-
12 I.R.B. 659, March 18, 2013.
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    By including business interest income and floor plan 
financing interest in the limitation, the rule operates to 
allow (1) business interest up to the amount of business 
interest income and (2) floor plan financing interest to be 
fully deductible. That is, a deduction for business interest is 
permitted to the full extent of business interest income and 
any floor plan financing interest.\873\ The deduction for any 
remaining business interest is limited to 30 percent of 
adjusted taxable income.
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    \873\ Note, however, that if the taxpayer takes floor plan 
financing interest into account to increase the taxpayer's interest 
limitation under section 163(j) for a taxable year, property placed in 
service by the taxpayer during such year and subsequent taxable years 
is not eligible for the additional first-year depreciation deduction 
under section 168(k), as modified by the Act. For a discussion of 
changes made to section 168(k) by the Act, including an example of the 
interaction of sections 168(k) and 163(j) with regard to taxpayers with 
floor plan financing interest, see the description of section 13201 of 
the Act (Temporary 100-Percent Expensing for Certain Business Assets).
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    It is generally intended that, similar to prior law, 
section 163(j) apply after the application of provisions that 
subject interest to deferral, capitalization, or other 
limitation. Thus, as with prior-law section 163(j), the 
provision applies to interest deductions that are deferred, for 
example under section 163(e) or section 267(a)(3)(B), in the 
taxable year to which such deductions are deferred.\874\ Also 
as with prior-law section 163(j), the provision applies after 
section 263A is applied to capitalize interest \875\ and after, 
for example, section 265 or section 279 is applied to disallow 
any interest deduction.\876\ However, the provision applies 
before the application of sections 465 and 469 (again, similar 
to prior-law section 163(j)(7)).
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    \874\ See, e.g., Prop. Treas. Reg. sec. 1.163(j)-7(b)(2) under 
prior section 163(j).
    \875\ See, e.g., Treas. Reg. sec. 1.263A-9(g)(1)(i).
    \876\ See, e.g., Prop. Treas. Reg. sec. 1.163(j)-7(b)(1) under 
prior section 163(j).
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Carryforward of disallowed business interest

    The amount of any business interest not allowed as a 
deduction for any taxable year is treated as business interest 
paid or accrued in the succeeding taxable year. Business 
interest may be carried forward indefinitely. The provision 
contains rules (described below) intended to prevent 
trafficking in carryforwards, and it is intended that the 
provision be administered consistent with that intent.
    With respect to corporations, any carryforward of 
disallowed business interest of the corporation is an item 
taken into account in the case of certain corporate 
acquisitions described in section 381 and is subject to 
limitation under section 382.

Application to passthrough entities \877\
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    \877\ Technical corrections may be necessary to achieve the 
provision's application to passthrough entities as described herein.
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            In general
    In the case of any partnership, the limitation is applied 
at the partnership level. To prevent double counting, there are 
special rules for the determination of the business interest 
income and adjusted taxable income of each partner of the 
partnership. Similarly, to allow for additional interest 
deduction by a partner in the case of an excess amount of 
either business interest income of the partnership or adjusted 
taxable income of the partnership, special rules apply. Similar 
rules apply with respect to any S corporation and its 
shareholders. Additionally, there is a special rule for 
carryforward of disallowed partnership interest that applies 
only to partnerships.
            Double counting rule
    The business interest income and adjusted taxable income of 
each partner (or shareholder, as the case may be) is determined 
without regard to such partner's distributive share of any 
items of income, gain, deduction, or loss of the partnership. 
In the absence of such rules, items of business interest income 
or adjusted taxable income of a partnership might be viewed as 
generating additional interest deductions as the items are 
passed through to the partners.
    Example 1.--ABC is a partnership owned 50-50 by XYZ 
Corporation and an individual. ABC generates $200 of 
noninterest income. Its only expense is $60 of business 
interest. Under the provision the deduction for business 
interest is limited to 30 percent of adjusted taxable income, 
that is, 30 percent * $200 = $60. ABC deducts $60 of business 
interest and reports ordinary business income of $140. XYZ 
Corporation's distributive share of the ordinary business 
income of ABC is $70. XYZ Corporation has net taxable income of 
zero from its other operations, none of which is attributable 
to business interest income, and without regard to its business 
interest. XYZ Corporation has business interest of $25. In the 
absence of any special rule, the $70 of taxable income from its 
interest in ABC might permit the deduction of up to an 
additional $21 of interest (30 percent * $70 = $21), resulting 
in a deduction disallowance of $4. That is, XYZ Corporation's 
$100 share of ABC's adjusted taxable income would generate $51 
of interest deductions (i.e., XYZ Corporation's $30 share of 
ABC's interest deduction plus XYZ Corporation's interest 
deduction of $21). If XYZ Corporation were instead a 
passthrough entity, additional deductions might be available at 
each tier.
    The double counting rule provides that XYZ Corporation has 
adjusted taxable income computed without regard to the $70 
distributive share of the income of ABC. As a result, XYZ 
Corporation has adjusted taxable income of $0. XYZ 
Corporation's deduction for business interest is limited to 30 
percent * $0 = $0, resulting in a deduction disallowance of 
$25.
            Additional deduction limit
    For purposes of determining the allowable interest 
deduction of a partner in a partnership, the partner's business 
interest deduction limitation calculated under the provision is 
increased to reflect the partner's distributive share of any 
business interest income or adjusted taxable income of the 
partnership that was not used to generate a business interest 
deduction at the partnership level. Specifically, in the 
absence of disallowed business interest attributable to the 
partnership (see discussion of the partnership carryforward 
rule, below), the partner's business interest deduction 
limitation is increased by the sum of the partner's 
distributive share of the partnership's excess business 
interest income and 30 percent of the partnership's excess 
taxable income. Excess business interest income with respect to 
any partnership is the excess of the business interest income 
of the partnership over the business interest, reduced by floor 
plan financing interest,\878\ of the partnership. Excess 
taxable income with respect to any partnership is the amount 
which bears the same ratio to the partnership's adjusted 
taxable income as (1) the excess (if any) of (a) 30 percent of 
the adjusted taxable income of the partnership over (b) the 
amount (if any) by which the business interest of the 
partnership, reduced by floor plan financing interest,\879\ 
exceeds the business interest income of the partnership bears 
to (2) 30 percent of the adjusted taxable income of the 
partnership. These rules allow a partner of a partnership to 
deduct additional business interest that the partner may have 
paid or incurred to the extent the partnership could have 
deducted more business interest.
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    \878\ To the extent the partnership takes floor plan financing 
interest into account to increase the amount of interest permitted to 
be deducted under section 163(j)(1).
    \879\ Again, to the extent the partnership takes floor plan 
financing interest into account to increase the amount of interest 
permitted to be deducted under section 163(j)(1).
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    Example 2.--The facts are the same as in Example 1 except 
ABC has only $40 of business interest. As in Example 1, ABC has 
a limit on its business interest deduction of $60. The excess 
taxable income for ABC is $66.67 ($20/$60 * $200). XYZ 
Corporation's distributive share of the excess taxable income 
from ABC is $33.33. XYZ Corporation's deduction for business 
interest is limited to 30 percent of its adjusted taxable 
income plus its distributive share of the excess taxable income 
from ABC (30 percent * ($0 + $33.33) = $10). As a result of the 
excess taxable income, XYZ Corporation may deduct $10 of 
business interest and has a business interest deduction 
disallowance of $15 ($25-$10).
            Carryforward rule
    In the case of a partnership, the general entity-level 
carryforward rule does not apply. Instead, any business 
interest that is not allowed as a deduction to the partnership 
for the taxable year (referred to as ``disallowed business 
interest'') is allocated to the partners. Each partner may 
deduct its share of the partnership's disallowed business 
interest in any future year, but only to the extent of the 
partner's distributive share of excess business interest income 
and 30 percent of the partner's distributive share of excess 
taxable income of the partnership the activities of which gave 
rise to the disallowed business interest carryforward. Any 
amount that is not allowed as a deduction is carried forward. 
For example, if a partner's disallowed business interest from a 
prior year of Partnership X is $100, and in the current year 
the partner is allocated $100 of excess taxable income and $10 
of excess business interest income from X and has $200 of 
adjusted taxable income from other sources, the partner may 
only deduct $40 of the disallowed business interest in the 
current year ($10 excess business interest income + (30 percent 
* $100 excess taxable income)). The remaining $60 of disallowed 
business interest is carried forward to the subsequent year. To 
prevent double counting, any deduction by the partner of 
disallowed business interest requires a corresponding reduction 
in the partner's distributive share of current-year excess 
business interest income and excess taxable income used to 
determine the partner's current-year interest limitation.
    Additionally, when disallowed business interest is 
allocated to a partner, the partner's basis in its partnership 
interest is reduced (but not below zero) by the amount of such 
allocation, even though the carryforward does not give rise to 
a partner deduction in the year of the basis reduction. 
However, the partner's deduction in a subsequent year for 
disallowed business interest does not reduce the partner's 
basis in its partnership interest. In the event the partner 
disposes of a partnership interest the basis of which has been 
so reduced, the partner's basis in such interest shall be 
increased, immediately before such disposition, by the amount 
that any such basis reductions exceed any amount of disallowed 
business interest that has been deducted by the partner against 
excess business interest income or excess taxable income of the 
same partnership.\880\
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    \880\ The special rule for dispositions also applies to transfers 
of a partnership interest (including by reason of death) in 
transactions in which gain is not recognized in whole or in part. No 
deduction is allowed to the transferor or transferee for any disallowed 
business interest resulting in a basis increase under this rule.
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    This special carryforward rule does not apply to S 
corporations and their shareholders.

Exceptions

    The limitation does not apply to any taxpayer (other than a 
tax shelter prohibited from using the cash method under section 
448(a)(3)) that meets the $25 million gross receipts test of 
section 448(c) (i.e., if the average annual gross receipts for 
the three-taxable-year period ending with the prior taxable 
year does not exceed $25 million).\881\ Aggregation rules apply 
to determine the amount of a taxpayer's gross receipts under 
the $25 million gross receipts test.
---------------------------------------------------------------------------
    \881\ In the case of a sole proprietorship, the $25 million gross 
receipts test is applied as if the sole proprietorship were a 
corporation or partnership. For a discussion of changes made to section 
448 by the Act, see the description of section 13102 of the Act (Small 
Business Accounting Method Reform and Simplification).
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    The trade or business of performing services as an employee 
is not treated as a trade or business for purposes of the 
limitation.\882\ As a result, for example, the wages of an 
employee are not counted in the adjusted taxable income of the 
taxpayer for purposes of determining the limitation.
---------------------------------------------------------------------------
    \882\ The trade or business of performing services as an employee 
is also mentioned in section 62(a)(1), among other places, and has the 
same meaning here as there.
---------------------------------------------------------------------------
    At the taxpayer's election, any real property development, 
redevelopment, construction, reconstruction, acquisition, 
conversion, rental, operation, management, leasing, or 
brokerage trade or business (i.e., any electing real property 
trade or business) is not treated as a trade or business for 
purposes of the limitation, and therefore the limitation does 
not apply to such trades or businesses.\883\ Similarly, at the 
taxpayer's election, any farming business \884\ or any business 
engaged in the trade or business of a specified agricultural or 
horticultural cooperative,\885\ is not treated as a trade or 
business for purposes of the limitation, and therefore the 
limitation does not apply to any such trade or business.\886\
---------------------------------------------------------------------------
    \883\ Congress intends that any such real property trade or 
business, including such a trade or business conducted by a corporation 
or REIT, be included. Because this description of a real property trade 
or business refers only to the section 469(c)(7)(C) description, and 
not to other rules of section 469 (such as the rule of section 
469(c)(2) that passive activities include rental activities or the rule 
of section 469(a) that a passive activity loss is limited under section 
469), the other rules of section 469 are not made applicable by this 
reference. It is further intended that a real property operation or a 
real property management trade or business includes the operation or 
management of a lodging facility, including a lodging facility that 
provides some supplemental services, such as an assisted living 
facility. In addition, an electing real property trade or business is 
required to use the alternative depreciation system (``ADS'') to 
depreciate any of its nonresidential real property, residential rental 
property, qualified improvement property, qualified leasehold 
improvement property, qualified retail improvement property, and 
qualified restaurant property. See the description of section 13204 of 
the Act (Applicable Recovery Period for Real Property).
    \884\ As defined in section 263A(e)(4) (i.e., farming business 
means the trade or business of farming and includes the trade or 
business of operating a nursery or sod farm, or the raising or 
harvesting of trees bearing fruit, nuts, or other crops, or ornamental 
trees (other than evergreen trees that are more than six years old at 
the time they are severed from their roots)). Treas. Reg. sec. 1.263A-
4(a)(4) further defines a farming business as a trade or business 
involving the cultivation of land or the raising or harvesting of any 
agricultural or horticultural commodity. Examples of a farming business 
include the trade or business of operating a nursery or sod farm; the 
raising or harvesting of trees bearing fruit, nuts, or other crops; the 
raising of ornamental trees (other than evergreen trees that are more 
than six years old at the time they are severed from their roots); and 
the raising, shearing, feeding, caring for, training, and management of 
animals. A farming business also includes processing activities that 
are normally incident to the growing, raising, or harvesting of 
agricultural or horticultural products. See Treas. Reg. sec. 1.263A-
4(a)(4)(i) and (ii). A farming business does not include contract 
harvesting of an agricultural or horticultural commodity grown or 
raised by another taxpayer, or merely buying and reselling plants or 
animals grown or raised by another taxpayer. See Treas. Reg. sec. 
1.263A-4(a)(4)(i).
    \885\ As defined in section 199A(g)(4).
    \886\ An electing farming business is required to use ADS to 
depreciate any property with a recovery period of 10 years or more. See 
the description of section 13205 of the Act (Use of Alternative 
Depreciation System for Electing Farming Businesses).
---------------------------------------------------------------------------
    The limitation does not apply to certain regulated public 
utilities. Specifically, the trade or business of the 
furnishing or sale of (1) electrical energy, water, or sewage 
disposal services, (2) gas or steam through a local 
distribution system, or (3) transportation of gas or steam by 
pipeline, if the rates for such furnishing or sale, as the case 
may be, have been established or approved by a State \887\ or 
political subdivision thereof, by any agency or instrumentality 
of the United States, by a public service or public utility 
commission or other similar body of any State or political 
subdivision thereof, or by the governing or ratemaking body of 
an electric cooperative is not treated as a trade or business 
for purposes of the limitation, and thus any interest paid or 
accrued on indebtedness properly allocable to such trades or 
businesses is not business interest.\888\
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    \887\ The term ``State'' includes the District of Columbia. See 
sec. 7701(a)(10) (``The term `State' shall be construed to include the 
District of Columbia where such construction is necessary to carry out 
provisions of this title'').
    \888\ Note, however, that any property primarily used by a 
regulated public utility trade or business with a depreciable interest 
in the property is not eligible for the additional first-year 
depreciation deduction by such utility business under section 168(k), 
as modified by the Act. For a discussion of changes made to section 
168(k) by the Act, see the description of section 13201 of the Act 
(Temporary 100-Percent Expensing for Certain Business Assets).

    The Treasury Department and IRS have issued published 
guidance addressing this provision.\889\
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    \889\ REG-106089-18, November 26, 2018, available at https://
www.irs.gov/pub/irs-drop/REG-106089-18-NPRM.pdf; Rev. Proc. 2018-59, 
2018-50 I.R.B. (Nov. 26, 2018); Notice 2018-28, 2018-16 IRB 492 (Apr. 
2, 2018).
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                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017. Congress intends that taxpayers with 
disqualified interest disallowed under prior-law section 
163(j)(1)(A) for the last taxable year beginning before January 
1, 2018, may carry such interest forward as business interest 
to the taxpayer's first taxable year beginning after December 
31, 2017, and that such business interest carried forward will 
be subject to potential disallowance under the provision in the 
same manner as any other business interest otherwise paid or 
accrued in a taxable year beginning after December 31, 2017.

B. Modification of Net Operating Loss Deduction (sec. 13302 of the Act 
                       and sec. 172 of the Code)


                               Prior Law

    A net operating loss (``NOL'') generally means the amount 
by which a taxpayer's business deductions exceed its gross 
income.\890\ In general, an NOL may be carried back two taxable 
years and carried over 20 taxable years to offset taxable 
income in such years (referred to as the ``NOL 
deduction'').\891\ NOLs offset taxable income in the order of 
the taxable years to which the NOL may be carried.\892\
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    \890\ Sec. 172(c).
    \891\ Sec. 172(b)(1)(A).
    \892\ Sec. 172(b)(2). The amount of the NOL which may be carried to 
a taxable year is reduced by the taxable income for prior taxable years 
to which the NOL may be carried.
---------------------------------------------------------------------------
    Different carryback periods apply with respect to NOLs 
arising in different circumstances. Extended carryback periods 
are allowed for NOLs attributable to specified liability 
losses, certain casualty and disaster losses, and farming 
losses.\893\ The carryback of excess interest losses 
attributable to corporate equity reduction transactions is 
limited.\894\ Special rules prohibit carrybacks to or from any 
taxable year in which a taxpayer is a real estate investment 
trust (a ``REIT'').\895\
---------------------------------------------------------------------------
    \893\ Sec. 172(b)(1)(C) (10-year carryback for specified liability 
losses), (E) (three-year carryback for individual casualty losses, 
small business disaster losses, and farming disaster losses), and (F) 
(five-year carryback for farming losses).
    \894\ Sec. 172(b)(1)(D).
    \895\ Sec. 172(b)(1)(B).
---------------------------------------------------------------------------
    For purposes of the alternative minimum tax, a taxpayer's 
NOL deduction generally is limited to 90 percent of alternative 
minimum taxable income (determined without regard to the NOL 
deduction).\896\
---------------------------------------------------------------------------
    \896\ Secs. 55 and 56(a)(4) and (d). For a description of the 
alternative minimum tax, see the description of sections 12001-12003 of 
the Act (Alternative Minimum Tax).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision makes a number of changes with respect to 
losses arising in taxable years beginning after December 31, 
2017.\897\ First, the provision limits the NOL deduction to 80 
percent of taxable income (determined without regard to the NOL 
deduction).\898\ Carryovers of such NOLs to other years are 
adjusted to take account of this limitation, and may be carried 
over indefinitely.
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    \897\ In calculating the amount of the NOL arising in a taxable 
year, certain deductions are excluded. For example, deductions under 
sections 199A and 250 are not allowed. For a description of section 
199A, see the description of section 11011 of the Act (Deduction for 
Qualified Business Income). For a description of section 250, see the 
description of section 14202 of the Act (Deduction for Foreign-Derived 
Intangible Income and Global Intangible Low-Taxed Income).
    \898\ For this purpose, a REIT is subject to a limit based on 80 
percent of its real estate investment trust taxable income (as defined 
in section 857(b)(2) but without regard to the deduction for dividends 
paid (as defined in section 561). See sec. 172(d)(6)(C).
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    In addition, the provision \899\ repeals the two-year 
carryback \900\ and the special carryback provisions for 
specified liability losses, individual casualty losses, and 
small business and farming disaster losses.\901\ In the case of 
certain farming losses, the provision shortens the carryback 
period from five years to two years.\902\ Finally, a special 
rule provides a two-year carryback and 20-year carryover for 
NOLs of a property and casualty insurance company (i.e., an 
insurance company (as defined in section 816(a)) other than a 
life insurance company). Further, the 80-percent limitation 
does not apply to the NOLs of such insurance companies.
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    \899\ A technical correction may be necessary to reflect that the 
changes to carryovers and carrybacks apply to losses arising in taxable 
years beginning after December 31, 2017.
    \900\ In light of the general repeal of the two-year carryback, the 
special rules limiting carrybacks for REITs are repealed.
    \901\ Thus, specified liability losses are no longer eligible for a 
10-year carryback, and certain individual casualty losses, as well as 
small business and farming disaster losses, are no longer eligible for 
a three-year carryback under section 172. Under section 165(i), 
however, a taxpayer may elect to take certain disaster losses into 
account for the taxable year immediately preceding the taxable year in 
which the disaster occurred.
    \902\ For this purpose, the term ``farming loss'' means the lesser 
of (1) the amount which would be the NOL for the taxable year if only 
income and deductions attributable to farming businesses (as defined in 
section 263A(e)(4)) are taken into account, or (2) the amount of the 
NOL for such taxable year. For any loss year, a farming business may 
irrevocably elect out of the two-year carryback. Such election must be 
made in the manner as prescribed by the Secretary by the due date 
(including extensions) of the taxpayer's return for the taxable year of 
the NOL.
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    NOLs arising in taxable years beginning before January 1, 
2018, remain subject to prior law. Accordingly, such NOLs are 
not subject to the 80-percent limitation, and remain subject to 
the 20-year carryover limitation and to the prior-law carryback 
rules.
    A taxpayer with NOL carryovers to a taxable year from both 
taxable years beginning before 2018 (``pre-2018 NOL 
carryovers'') and taxable years beginning after 2017 (``post-
2017 NOL carryovers'') computes its tax liability as follows. 
First, the taxpayer is entitled to an NOL deduction in the 
amount of its pre-2018 NOL carryovers without limitation. 
Second, the taxpayer is entitled to an additional NOL deduction 
equal to the lesser of (1) its post-2017 NOL carryovers, or (2) 
80 percent of the excess (if any) of the taxpayer's taxable 
income (before any NOL deduction attributable to post-2017 NOL 
carryovers) over the NOL deduction attributable to pre-2018 NOL 
carryovers.\903\
---------------------------------------------------------------------------
    \903\ A technical correction may be necessary to reflect this 
intent.
---------------------------------------------------------------------------

Examples

    Example 1.--The following example illustrates the rules for 
carryovers of pre-2018 NOLs and post-2017 NOLs.
    Suppose a taxpayer (a calendar-year corporation) has $120 
of pre-2018 NOL carryovers and $70 of post-2017 NOL carryovers 
to 2019. In 2019, the taxpayer has $100 of taxable income 
(before any NOL deduction). The taxpayer is entitled to an NOL 
deduction equal to the sum of (i) its pre-2018 NOL carryovers 
and (ii) the lesser of its post-2017 carryovers or 80 percent 
of its taxable income in 2019 (determined without regard to the 
NOL deduction attributable to post-2017 NOL carryovers). In 
this case, the taxpayer's pre-2018 NOL carryovers ($120) exceed 
its pre-NOL taxable income ($100), so the taxpayer is entitled 
to an NOL deduction fully offsetting its taxable income. The 
taxpayer will have $20 \904\ of pre-2018 NOL carryovers and $70 
of post-2017 NOL carryovers to 2020.
---------------------------------------------------------------------------
    \904\ $20 is the excess of the $120 of pre-2018 NOL carryovers to 
2019 over $100 taxable income for 2019 as computed under section 
172(b)(2).
---------------------------------------------------------------------------
    Suppose, in 2020, the taxpayer again has $100 of taxable 
income (before any NOL deduction). The taxpayer is entitled to 
an NOL deduction equal to the sum of (i) its pre-2018 NOL 
carryovers and (ii) the lesser of its post-2017 carryovers or 
80 percent of its taxable income in 2020 (determined without 
regard to the NOL deduction attributable to post-2017 NOL 
carryovers). In this case, the taxpayer's NOL deduction is $20 
plus the lesser of $70 or 80 percent of the taxpayer's taxable 
income (before any NOL deduction attributable to post-2017 NOL 
carryovers). In this case, 80 percent of taxable income 
computed without regard to post-2017 NOL carryovers is $64 (80 
percent of $80 ($100 taxable income less the NOL deduction of 
$20 attributable to pre-2018 NOL carryovers)). Thus, for 2020, 
the taxpayer is entitled to an NOL deduction of $84 ($20 plus 
$64). The taxpayer will have $6 ($70 less $64) of post-2017 NOL 
carryovers to 2021.
    Example 2.--The following example illustrates the 
interaction of the 80-percent limitation and the two-year 
carryback of certain farming losses.
    Suppose, in 2018, a calendar-year taxpayer has a $300 
farming loss. The taxpayer has no other NOLs and is not limited 
by section 461(l).\905\ Because the provision allows a special 
two-year carryback in the case of certain farming losses, the 
taxpayer may carry back the farming loss to 2016 or 2017. 
However, the NOL deduction for such carryback year will be 
limited to 80 percent of taxable income (determined without 
regard to the NOL deduction) for such taxable year. If the 
taxpayer had $100 of taxable income in 2016 and $200 of taxable 
income in 2017 (both without regard to any NOL deduction), the 
taxpayer is entitled to an $80 NOL deduction in 2016 (80 
percent of $100) and a $160 NOL deduction in 2017 (80 percent 
of $200). The taxpayer will have $60 of post-2017 NOL 
carryovers to 2019 (i.e., the $300 2018 NOL less (1) the $80 
2016 NOL carryback and (2) the $160 2017 NOL carryback).
---------------------------------------------------------------------------
    \905\ For a discussion of section 461(l), see the description of 
section 11012 of the Act (Limitation on Losses for Taxpayers Other Than 
Corporations).
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                             Effective Date

    The provision limiting the NOL deduction applies to losses 
arising in taxable years beginning after December 31, 2017.
    The provision allowing indefinite carryovers and modifying 
carrybacks applies to losses arising in taxable years beginning 
\906\ after December 31, 2017.
---------------------------------------------------------------------------
    \906\ A technical correction may be necessary to reflect this 
intent.
---------------------------------------------------------------------------

C. Like-Kind Exchanges of Real Property (sec. 13303 of the Act and sec. 
                           1031 of the Code)


                               Prior Law

    An exchange of property, like a sale, generally is a 
taxable event. However, no gain or loss is recognized if 
property held for productive use in a trade or business or for 
investment is exchanged for property of a ``like kind'' which 
is to be held for productive use in a trade or business or for 
investment.\907\ In general, section 1031 does not apply to any 
exchange of stock in trade (i.e., inventory) or other property 
held primarily for sale; stocks, bonds, or notes; other 
securities or evidences of indebtedness or interest; interests 
in a partnership; certificates of trust or beneficial 
interests; or choses in action.\908\ Section 1031 also does not 
apply to certain exchanges involving livestock \909\ or foreign 
property.\910\
---------------------------------------------------------------------------
    \907\ Sec. 1031(a)(1).
    \908\ Sec. 1031(a)(2). A chose in action is a right that can be 
enforced by legal action.
    \909\ Sec. 1031(e).
    \910\ Sec. 1031(h).
---------------------------------------------------------------------------
    For purposes of section 1031, the determination of whether 
property is of a ``like kind'' relates to the nature or 
character of the property and not its grade or quality, i.e., 
the nonrecognition rules do not apply to an exchange of one 
class or kind of property for property of a different class or 
kind (e.g., section 1031 does not apply to an exchange of real 
property for personal property).\911\ The different classes of 
property are: (1) depreciable tangible personal property; \912\ 
(2) intangible or nondepreciable personal property; \913\ and 
(3) real property.\914\ However, the rules with respect to 
whether real estate is ``like kind'' are applied more liberally 
than the rules governing like-kind exchanges of depreciable, 
intangible, or nondepreciable personal property. For example, 
improved real estate and unimproved real estate generally are 
considered to be property of a ``like kind'' as this 
distinction relates to the grade or quality of the real 
estate,\915\ while depreciable tangible personal properties 
must be either within the same General Asset Class \916\ or 
within the same Product Class.\917\
---------------------------------------------------------------------------
    \911\ Treas. Reg. sec. 1.1031(a)-1(b).
    \912\ For example, an exchange of a personal computer classified 
under asset class 00.12 of Rev. Proc. 87-56, 1987-2 C.B. 674, for a 
printer classified under the same asset class of Rev. Proc. 87-56 would 
be treated as property of a like kind. However, an exchange of an 
airplane classified under asset class 00.21 of Rev. Proc. 87-56 for a 
heavy general purpose truck classified under asset class 00.242 of Rev. 
Proc. 87-56 would not be treated as property of a like kind. See Treas. 
Reg. sec. 1.1031(a)-2(b)(7).
    \913\ For example, an exchange of a copyright on a novel for a 
copyright on a different novel would be treated as property of a like 
kind. See Treas. Reg. sec. 1.1031(a)-2(c)(3). However, the goodwill or 
going concern value of one business is not of a like kind to the 
goodwill or going concern value of a different business. See Treas. 
Reg. sec. 1.1031(a)-2(c)(2). The IRS has ruled that intangible assets 
such as trademarks, trade names, mastheads, and customer-based 
intangibles that can be separately described and valued apart from 
goodwill qualify as property of a like kind under section 1031. See 
Chief Counsel Advice 200911006, February 12, 2009.
    \914\ Treas. Reg. sec. 1.1031(a)-1(b) and (c).
    \915\ Treas. Reg. sec. 1.1031(a)-1(b).
    \916\ Treasury Regulation section 1.1031(a)-2(b)(2) provides the 
following list of General Asset Classes, based on asset classes 00.11 
through 00.28 and 00.4 of Rev. Proc. 87-56, 1987-2 C.B. 674: (i) Office 
furniture, fixtures, and equipment (asset class 00.11), (ii) 
Information systems (computers and peripheral equipment) (asset class 
00.12), (iii) Data handling equipment, except computers (asset class 
00.13), (iv) Airplanes (airframes and engines), except those used in 
commercial or contract carrying of passengers or freight, and all 
helicopters (airframes and engines) (asset class 00.21), (v) 
Automobiles, taxis (asset class 00.22), (vi) Buses (asset class 00.23), 
(vii) Light general purpose trucks (asset class 00.241), (viii) Heavy 
general purpose trucks (asset class 00.242), (ix) Railroad cars and 
locomotives, except those owned by railroad transportation companies 
(asset class 00.25), (x) Tractor units for use over-the-road (asset 
class 00.26), (xi) Trailers and trailer-mounted containers (asset class 
00.27), (xii) Vessels, barges, tugs, and similar water-transportation 
equipment, except those used in marine construction (asset class 
00.28), and (xiii) Industrial steam and electric generation and/or 
distribution systems (asset class 00.4).
    \917\ Property within a product class consists of depreciable 
tangible personal property that is described in a 6-digit product class 
within Sectors 31, 32, and 33 (pertaining to manufacturing industries) 
of the North American Industry Classification System (``NAICS''), set 
forth in Executive Office of the President, Office of Management and 
Budget, North American Industry Classification System, United States, 
2002 (NAICS Manual), as periodically updated. Treas. Reg. sec. 
1.1031(a)-2(b)(3).
---------------------------------------------------------------------------
    The nonrecognition of gain in a like-kind exchange applies 
only to the extent that like-kind property is received in the 
exchange. Thus, if an exchange of property would meet the 
requirements of section 1031, but for the fact that the 
property received in the transaction consists not only of the 
property that would be permitted to be exchanged on a tax-free 
basis, but also other non-qualifying property or money 
(``additional consideration''), then the gain to the recipient 
of the other property or money is required to be recognized, 
but not in an amount exceeding the fair market value of such 
other property or money.\918\ Additionally, any such gain 
realized on a section 1031 exchange as a result of additional 
consideration being involved constitutes ordinary income to the 
extent that the gain is subject to the recapture provisions of 
sections 1245 and 1250.\919\ No losses may be recognized from a 
like-kind exchange.\920\
---------------------------------------------------------------------------
    \918\ Sec. 1031(b). For example, if a taxpayer holding land A 
having a basis of $40,000 and a fair market value of $100,000 exchanges 
the property for land B worth $90,000 plus $10,000 in cash, the 
taxpayer would recognize $10,000 of gain on the transaction, which 
would be includable in income. The remaining $50,000 of gain would be 
deferred until the taxpayer disposes of land B in a taxable sale or 
exchange.
    \919\ Secs. 1245(b)(4) and 1250(d)(4). For example, if a taxpayer 
holding section 1245 property A with an original cost basis of $11,000, 
an adjusted basis of $10,000, and a fair market value of $15,000 
exchanges the property for section 1245 property B with a fair market 
value of $14,000 plus $1,000 in cash, the taxpayer would recognize 
$1,000 of ordinary income on the transaction. The remaining $4,000 of 
gain would be deferred until the taxpayer disposes of section 1245 
property B in a taxable sale or exchange.
    \920\ Sec. 1031(c).
---------------------------------------------------------------------------
    If section 1031 applies to an exchange of properties, the 
basis of the property received in the exchange is equal to the 
basis of the property transferred. This basis is increased to 
the extent of any gain recognized as a result of the receipt of 
other property or money in the like-kind exchange, and 
decreased to the extent of any money received by the 
taxpayer.\921\ The holding period of qualifying property 
received includes the holding period of the qualifying property 
transferred, but the nonqualifying property received is 
required to begin a new holding period.\922\
---------------------------------------------------------------------------
    \921\ Sec. 1031(d). Thus, in the example noted above, the 
taxpayer's basis in B would be $40,000 (the taxpayer's transferred 
basis of $40,000, increased by $10,000 in gain recognized, and 
decreased by $10,000 in money received).
    \922\ Sec. 1223(1).
---------------------------------------------------------------------------
    A like-kind exchange also does not require that the 
properties be exchanged simultaneously. Rather, the property to 
be received in the exchange must be received not more than 180 
days after the date on which the taxpayer relinquishes the 
original property (but in no event later than the due date 
(including extensions) of the taxpayer's income tax return for 
the taxable year in which the transfer of the relinquished 
property occurs). In addition, the taxpayer must identify the 
property to be received within 45 days after the date on which 
the taxpayer transfers the property relinquished in the 
exchange.\923\
---------------------------------------------------------------------------
    \923\ Sec. 1031(a)(3).

    The Treasury Department has issued regulations \924\ and 
revenue procedures \925\ providing guidance and safe harbors 
for taxpayers engaging in deferred like-kind exchanges.
---------------------------------------------------------------------------
    \924\ Treas. Reg. sec. 1.1031(k)-1(a) through (o).
    \925\ See Rev. Proc. 2000-37, 2000-40 I.R.B. 308, as modified by 
Rev. Proc. 2004-51, 2004-33 I.R.B. 294.
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision limits the provision providing for 
nonrecognition of gain or loss in the case of like-kind 
exchanges to exchanges of real property not held primarily for 
sale.\926\
---------------------------------------------------------------------------
    \926\ It is intended that real property eligible for like-kind 
exchange treatment under prior law will continue to be eligible for 
like-kind exchange treatment under the provision. For example, a like-
kind exchange of real property includes an exchange of shares in a 
mutual ditch, reservoir, or irrigation company described in section 
501(c)(12)(A) if at the time of the exchange such shares have been 
recognized by the highest court or statute of the State in which the 
company is organized as constituting or representing real property or 
an interest in real property. Similarly, improved real estate and 
unimproved real estate are generally considered to be property of a 
like kind. See Treas. Reg. sec. 1.1031(a)-1(b).
---------------------------------------------------------------------------

                             Effective Date

    The provision generally applies to exchanges completed 
after December 31, 2017. However, an exception is provided for 
any exchange if the property disposed of by the taxpayer in the 
exchange is disposed of on or before December 31, 2017, or the 
property received by the taxpayer in the exchange is received 
on or before such date.

D. Limitation on Deduction by Employers of Expenses for Fringe Benefits 
            (sec. 13304 of the Act and sec. 274 of the Code)


                               Prior Law


Limitations on employer deductions

    No deduction is allowed with respect to (1) an activity 
generally considered to be entertainment, amusement, or 
recreation (``entertainment''), 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.\927\ If the taxpayer establishes 
that entertainment expenses are directly related to (or 
associated with) the active conduct of its trade or business, 
the deduction generally is limited to 50 percent of the amount 
otherwise deductible.\928\ Similarly, a deduction for any 
expense for food or beverages generally is limited to 50 
percent of the amount otherwise deductible.\929\ In addition, 
no deduction is allowed for membership dues with respect to any 
club organized for business, pleasure, recreation, or other 
social purpose.\930\
---------------------------------------------------------------------------
    \927\ Sec. 274(a)(1).
    \928\ Sec. 274(n)(1)(B).
    \929\ Sec. 274(n)(1)(A). This includes expenses for food or 
beverages (and facilities used in connection therewith) furnished on 
the business premises of the taxpayer primarily for the taxpayer's 
employees under section 274(e)(1).
    \930\ Sec. 274(a)(3).
---------------------------------------------------------------------------
    There are a number of exceptions to the general rule 
disallowing the deduction of entertainment expenses and the 
rules limiting deductions to 50 percent of the otherwise 
deductible amount. One such exception applies to expenses for 
goods, services, and facilities to the extent that the expenses 
are reported by the taxpayer as compensation and as wages to an 
employee.\931\ Another exception applies to expenses 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.\932\ 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 taxpayer's actual cost, even if a greater 
amount (i.e., fair market value) is includible in income.\933\
---------------------------------------------------------------------------
    \931\ Sec. 274(e)(2)(A). See below for a discussion of the 
modification of this rule for certain individuals.
    \932\ Sec. 274(e)(9).
    \933\ Treas. Reg. sec. 1.162-25T(a).
---------------------------------------------------------------------------
    Other exceptions to the deduction disallowance rules 
include the following: expenses paid or incurred by the 
taxpayer, in connection with the performance of services for 
another person (other than an employer), under a reimbursement 
or other expense allowance arrangement if the taxpayer accounts 
for the expenses to such person; \934\ expenses for 
recreational, social, or similar activities primarily for the 
benefit of employees other than certain owners and highly 
compensated employees; \935\ entertainment expenses directly 
related to business meetings of a taxpayer's employees, 
stockholders, agents or directors,\936\ or directly related and 
necessary to attendance at business meetings or conventions of 
organizations described in section 501(c)(6) and exempt from 
taxation under section 501(a); \937\ expenses for goods, 
services, and facilities made available by the taxpayer to the 
general public; \938\ and expenses for goods or services 
(including the use of facilities) which are sold by the 
taxpayer in a bona fide transaction for an adequate and full 
consideration in money or money's worth.\939\ Other exceptions 
from the 50-percent deduction limit include exceptions for food 
or beverage expenses excludable from the gross income of the 
recipient under section 132(e) (relating to de minimis fringes) 
and for food or beverages provided to crew members of certain 
commercial vessels and certain oil or gas platform or drilling 
rig workers.\940\
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    \934\ Sec. 274(e)(3).
    \935\ Sec. 274(e)(4).
    \936\ Sec. 274(e)(5).
    \937\ Sec. 274(e)(6).
    \938\ Sec. 274(e)(7).
    \939\ Sec. 274(e)(8).
    \940\ Secs. 274(n)(2)(B) and (E). The legislative history to the 
Tax Reform Act of 1986 (Pub. L. No. 99-514) further provides that a 
restaurant or catering firm may deduct 100 percent (rather than the 80-
percent limitation that would otherwise have applied under the Tax 
Reform Act of 1986) of its costs for food and beverage items, purchased 
in connection with preparing and providing meals to its paying 
customers, that are consumed at the worksite by employees of the 
restaurant or caterer. Conference Report to accompany H.R. 3838, Tax 
Reform Act of 1986, H.R. Rep. No. 99-841, September 18, 1986, p. II-25. 
See also Joint Committee on Taxation, General Explanation of the Tax 
Reform Act of 1986 (JCS-10-87), May 1987, p. 68, clarifying that this 
exception only applies to employees who work in the employer's 
restaurant or catering business.
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Employee compensation

            Expenses treated as compensation
    Except as otherwise provided, gross income includes 
compensation for services, including fees, commissions, fringe 
benefits, and similar items.\941\ In general, an employee (or 
other service provider) must include in gross income the amount 
by which the fair market value of a fringe benefit exceeds the 
sum of the amount (if any) paid by the individual and the 
amount (if any) specifically excluded from gross income.\942\ 
Treasury regulations provide detailed rules regarding the 
valuation of certain fringe benefits, including flights on an 
employer-provided aircraft. In general, the value of a 
noncommercial flight generally is determined under the base 
aircraft valuation formula, also known as the Standard Industry 
Fare Level formula (``SIFL'').\943\ If the SIFL valuation rules 
do not apply, the value of a flight on an employer-provided 
aircraft generally is 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.\944\
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    \941\ Sec. 61(a)(1).
    \942\ Treas. Reg. sec. 1.61-21(b)(1).
    \943\ Treas. Reg. sec. 1.61-21(g)(5).
    \944\ 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 has been 
interpreted as not limiting the company's deduction for 
expenses attributable to the operation of the aircraft to the 
amount of compensation reportable to its employees.\945\ The 
result of that interpretation is often a deduction several 
times larger than the amount required to be included in income. 
Further, 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.
---------------------------------------------------------------------------
    \945\ Sutherland Lumber-Southwest, Inc. v. Commissioner, 114 T.C. 
197 (2000), aff'd 255 F.3d 495 (8th Cir. 2001) (the ``Sutherland 
Lumber-Southwest decision'').
---------------------------------------------------------------------------
    Subsequent to the Sutherland Lumber-Southwest decision, the 
exceptions for expenses treated as compensation or otherwise 
includible income were modified by the American Jobs Creation 
Act \946\ for specified individuals such that the exceptions 
apply only to the extent of the amount of expenses treated as 
compensation or includible in income of the specified 
individual.\947\ Specified individuals are individuals who, 
with respect to an employer or other service recipient (or a 
related party), are subject to the requirements of section 
16(a) of the Securities Exchange Act of 1934, or would be 
subject to such requirements if the employer or service 
recipient (or related party) were an issuer of equity 
securities referred to in section 16(a).\948\
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    \946\ Pub. L. No. 108-357. See also Conference Report to accompany 
H.R. 4520, American Jobs Creation Act of 2004, H.R. Rep. No. 108-755, 
October 7, 2004, pp. 797-798.
    \947\ Sec. 274(e)(2)(B)(i). See also Treas. Reg. sec. 1.274-9(a).
    \948\ Sec. 274(e)(2)(B)(ii). See also Treas. Reg. sec. 1.274-9(b).
---------------------------------------------------------------------------
    As a result, in the case of specified individuals, 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 individual. For example, 
a company's deduction attributable to aircraft operating costs 
and other expenses for a specified individual's vacation use of 
a company aircraft is limited to the amount reported as 
compensation to the specified individual. However, in the case 
of other employees or service providers, the company's 
deduction is not limited to the amount treated as compensation 
or includible in income.\949\
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    \949\ See Treas. Reg. sec. 1.274-10(a)(2).
---------------------------------------------------------------------------
            Excludable fringe benefits
    Certain employer-provided fringe benefits are excluded from 
an employee's gross income and wages for employment tax 
purposes, including, but not limited to, de minimis fringes, 
qualified transportation fringes, on-premises athletic 
facilities, and meals provided for the ``convenience of the 
employer.'' \950\
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    \950\ Secs. 132(a), 119(a), 3121(a)(19) and (20), 3231(e)(5) and 
(9), 3306(b)(14) and (16), and 3401(a)(19).
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    A de minimis fringe generally means any property or service 
the value of which is (taking into account the frequency with 
which similar fringes are provided by the employer) so small as 
to make accounting for it unreasonable or administratively 
impracticable,\951\ and also includes food or beverages 
provided to employees through an eating facility operated by 
the employer that is located on or near the employer's business 
premises and meets certain requirements.\952\
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    \951\ Sec. 132(e)(1). Examples include occasional personal use of 
an employer's copying machine, occasional parties or meals for 
employees and their guests, local telephone calls, and coffee, 
doughnuts and soft drinks. Treas. Reg. sec. 1.132-6(e)(1).
    \952\ Sec. 132(e)(2). Revenue derived from such a facility must 
normally equal or exceed the direct operating costs of the facility. 
Employees who are entitled, under section 119, to exclude the value of 
a meal provided at such a facility are treated as having paid an amount 
for the meal equal to the direct operating costs of the facility 
attributable to such meal.
---------------------------------------------------------------------------
    Qualified transportation fringes provided by an employer 
include qualified parking (parking on or near the employer's 
business premises or parking on or near a location from which 
the employee commutes to work by transit pass, vanpool, or 
carpool), transit passes, vanpool benefits (commuter highway 
vehicles for travel between the employee's residence and place 
of employment), and qualified bicycle commuting 
reimbursements.\953\
---------------------------------------------------------------------------
    \953\ Secs. 132(f)(1) and (5). The qualified transportation fringe 
exclusions are subject to monthly limits. Sec. 132(f)(2).
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    On-premises athletic facilities are gyms or other athletic 
facilities located on the employer's premises, operated by the 
employer, and substantially all the use of which is by 
employees of the employer, their spouses, and their dependent 
children.\954\
---------------------------------------------------------------------------
    \954\ Sec. 132(j)(4).
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    The value of meals furnished to an employee or the 
employee's spouse or dependents by or on behalf of an employer 
for the convenience of the employer is excludible from the 
employee's gross income, but only if such meals are provided on 
the employer's business premises.\955\
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    \955\ Sec. 119(a).
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                        Explanation of Provision


In general

    The provision eliminates the deduction permitted under 
prior law with respect to entertainment, amusement, or 
recreation. It also eliminates the deduction permitted to an 
employer under prior law for items with respect to qualified 
transportation fringes and employer-provided commuting. In 
addition, as described below, the provision impacts the 
deduction for expenses of an employer associated with providing 
food or beverages to employees through an eating facility that 
meets requirements for de minimis fringes and for the 
convenience of the employer.\956\
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    \956\ The provision generally does not impact the other exceptions 
to the 50-percent limitation on deductions for food or beverage 
expenses, as described infra under prior law. For example, a restaurant 
or catering business may continue to deduct 100 percent of its costs 
for food or beverage items, purchased in connection with preparing and 
providing meals to its paying customers, which are consumed at the 
worksite by employees who work in the employer's restaurant or catering 
business.
---------------------------------------------------------------------------

Entertainment, amusement, or recreation expenses

    The provision provides that no deduction is allowed with 
respect to (1) an activity generally considered to be 
entertainment, amusement, or recreation, (2) membership dues 
with respect to any club organized for business, pleasure, 
recreation, or other social purposes, or (3) a facility or 
portion thereof used in connection with any of the above items. 
Thus, the provision repeals the prior-law exception to the 
deduction disallowance for entertainment, amusement, or 
recreation (collectively, ``entertainment'') that is directly 
related to (or, in certain cases, associated with) the active 
conduct of the taxpayer's trade or business (and the related 
rule applying a 50-percent limit to such deductions).\957\
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    \957\ As discussed above under prior law, section 274(e)(5) 
provides an exception from the deduction disallowance rules for 
entertainment expenses directly related to business meetings of a 
taxpayer's employees, stockholders, agents, or directors, and section 
274(e)(6) provides such an exception for such expenses directly related 
and necessary to attendance at business meetings or conventions of 
organizations described in section 501(c)(6) and exempt from taxation 
under section 501(a). A technical correction may be necessary to 
clarify that such exceptions do not apply to expenses of entertainment, 
amusement, or recreation (including any facility or portion thereof 
used in connection with entertainment, amusement, or recreation) for 
which no deduction is allowed under the provision. However, such 
exceptions continue to apply to 50 percent of food or beverage expenses 
that otherwise satisfy applicable requirements.
---------------------------------------------------------------------------
    Notwithstanding these limitations, taxpayers may still 
deduct 50 percent of certain business-related food and beverage 
expenses. A taxpayer may still generally deduct 50 percent of 
the food or beverage expenses associated with operating its 
trade or business (e.g., meals consumed by employees on work 
travel). A taxpayer may also continue to deduct 50 percent of 
the properly substantiated food or beverage expenses associated 
with a meal that is considered a business meal with a client, 
provided the business meal is not lavish or extravagant.\958\ 
When a meal is included in an activity or event with a client 
that primarily constitutes entertainment, the provision 
disallows the deduction for the entire activity or event 
including the meal.\959\ For example, food or beverages 
consumed during a theatre or sporting event would be 
nondeductible under this rule because the activity or event is 
primarily entertainment. However, a meal between the taxpayer 
(or an employee of the taxpayer) and a client at a restaurant 
to primarily discuss business is a business meal that may be 
50-percent deductible, provided other applicable requirements 
are satisfied, including substantiation.\960\
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    \958\ See section 274(k), which was not amended by Pub. L. No. 115-
97.
    \959\ An objective test like that under Treas. Reg. sec. 1.274-
2(b)(1)(ii) (which under prior law applies to determine whether an 
activity is of a type generally considered to constitute entertainment) 
should apply to determine whether an event or activity primarily 
constitutes entertainment.
    \960\ See sec. 274(d) and (k).
---------------------------------------------------------------------------

Qualified transportation fringes and employer-provided commuting

    The provision disallows a deduction for items with respect 
to providing any qualified transportation fringe to employees 
of the taxpayer. Such items include amounts elected by an 
employee to be used on a pretax salary basis towards any 
qualified transportation fringe benefit. The term ``qualified 
transportation fringe'' is defined \961\ to include qualified 
parking, and therefore encompasses costs associated with 
providing qualified parking, including any parking facility 
maintained by the employer or parking on any portion of the 
employer's business premises used in connection with qualified 
parking. This includes appropriate allocations of depreciation 
and other costs with respect to facilities used for parking 
(e.g., allocable salaries for security and maintenance 
personnel, property taxes, repairs and maintenance, etc.). The 
amount of the deduction disallowance is equal to the amount of 
direct and other properly allocable costs of the taxpayer to 
provide the qualified transportation fringe. Accordingly, the 
deduction disallowance is not determined by reference to the 
value of the transportation fringe benefit calculated for 
purposes of applying section 132(f) and instead, the employer 
must take into account the direct and other properly allocable 
costs that it incurs to maintain and provide the qualified 
parking to its employees.\962\
---------------------------------------------------------------------------
    \961\ Sec. 132(f).
    \962\ The determination of costs associated with providing 
qualified transportation fringes that are subject to a deduction 
disallowance is consistent with the determination of such costs 
required to be included in unrelated business taxable income under 
section 512(a)(7) (as added by section 13703 of the Act (Unrelated 
Business Taxable Income Increased by Amount of Certain Fringe Benefit 
Expenses for which Deduction is Disallowed)). Therefore, this 
determination includes pretax salary amounts attributable to any 
qualified transportation fringe benefit, costs for parking facilities 
used in connection with qualified parking (as defined in section 
132(f)(5)(C)), and appropriate allocations of depreciation and other 
costs for such facilities. See description of section 13703 of the Act. 
A technical correction may be necessary to reflect this intent.
---------------------------------------------------------------------------
    The provision also disallows a deduction for any expense 
incurred for providing any transportation, or any payment or 
reimbursement, for commuting between the employee's residence 
and place of employment, except as necessary for ensuring the 
safety of an employee.
    The provision is intended to include qualified 
transportation fringe expenses in the exception to the 
deduction disallowance for expenses that are treated as 
compensation.\963\ Any expenses incurred for providing any form 
of transportation which are not qualified transportation 
fringes (or any payment or reimbursement) for commuting between 
the employee's residence and place of employment, even if 
included in compensation, are not eligible for this exception.
---------------------------------------------------------------------------
    \963\ See section 274(e). A technical correction may be necessary 
to reflect this intent. Note that this would apply to qualified bicycle 
commuting reimbursements during the suspension period (taxable years 
beginning after December 31, 2017, and ending before January 1, 2026) 
of the exclusion from gross income for such benefits.
---------------------------------------------------------------------------

Meals that are a de minimis fringe or for the convenience of the 
        employer

    For amounts incurred and paid after December 31, 2017, and 
before January 1, 2026, the provision reduces the deduction to 
50 percent for expenses of the employer associated with 
providing food or beverages to employees through an eating 
facility that meets the requirements for de minimis fringes and 
for the convenience of the employer. Such amounts incurred and 
paid after December 31, 2025, are not deductible.

    The Treasury Department has issued published guidance 
addressing this provision.\964\
---------------------------------------------------------------------------
    \964\ Notice 2018-76, 2018-42 I.R.B. 599; IRS Publication 15-B, 
Employer's Tax Guide to Fringe Benefits (revised Feb. 22, 2018), p. 21.
---------------------------------------------------------------------------

                             Effective Date

    The provision generally applies to amounts paid or incurred 
after December 31, 2017. However, for expenses of the employer 
associated with providing food or beverages to employees 
through an eating facility that meets the requirements for de 
minimis fringes and for the convenience of the employer, 
amounts paid or incurred after December 31, 2025, are not 
deductible.

 E. Repeal of Deduction for Income Attributable to Domestic Production 
   Activities (sec. 13305 of the Act and former sec. 199 of the Code)


                               Prior Law


In general

    Section 199 provides a deduction from taxable income (or, 
in the case of an individual, adjusted gross income \965\ ) 
that is equal to nine percent of the lesser of the taxpayer's 
qualified production activities income or taxable income 
(determined without regard to the section 199 deduction) for 
the taxable year.\966\ For corporations subject to the 35-
percent corporate income tax rate, the nine-percent deduction 
effectively reduces the corporate income tax rate to slightly 
less than 32 percent on qualified production activities 
income.\967\ A similar reduction applies to the graduated rates 
applicable to individuals with qualifying domestic production 
activities income.
---------------------------------------------------------------------------
    \965\ For this purpose, adjusted gross income is determined after 
application of sections 86, 135, 137, 219, 221, 222, and 469, without 
regard to the section 199 deduction. Sec. 199(d)(2).
    \966\ Sec. 199(a). In the case of oil related qualified production 
activities income, the deduction is reduced by three percent of the 
least of the taxpayer's oil related qualified production activities 
income, qualified production activities income, or taxable income 
(determined without regard to the section 199 deduction) for the 
taxable year. Sec. 199(d)(9). For this purpose, oil related qualified 
production activities income for any taxable year is the portion of 
qualified production activities income attributable to the production, 
refining, processing, transportation, or distribution of oil, gas, or 
any primary product thereof (within the meaning of section 927(a)(2)(C) 
as in effect before its repeal) during the taxable year. Sec. 
199(d)(9).
    \967\ This example assumes the deduction does not exceed the wage 
limitation discussed below.
---------------------------------------------------------------------------
    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 those 
receipts; and (2) other expenses, losses, or deductions which 
are properly allocable to those receipts.\968\
---------------------------------------------------------------------------
    \968\ Sec. 199(c)(1). In computing qualified production activities 
income, the domestic production activities deduction itself is not an 
allocable deduction. Sec. 199(c)(1)(B)(ii). See Treas. Reg. secs. 
1.199-1 through 1.199-9 where the Secretary has prescribed rules for 
the proper allocation of items of income, deduction, expense, and loss 
for purposes of determining qualified production activities income.
---------------------------------------------------------------------------
    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 \969\ that was 
manufactured, produced, grown or extracted by the taxpayer in 
whole or in significant part within the United States; \970\ 
(2) any sale, exchange, or other disposition, or any lease, 
rental, or license, of qualified film \971\ produced by the 
taxpayer; (3) any sale, exchange, or other disposition, or any 
lease, rental, or license, of electricity, natural gas, or 
potable water produced by the taxpayer in the United States; 
(4) construction of real property performed in the United 
States by a taxpayer in the ordinary course of a construction 
trade or business; or (5) engineering or architectural services 
performed in the United States for the construction of real 
property located in the United States.\972\
---------------------------------------------------------------------------
    \969\ Qualifying production property generally includes any 
tangible personal property, computer software, and sound recordings. 
Sec. 199(c)(5).
    \970\ When used in the Code in a geographical sense, the term 
``United States'' generally includes only the States and the District 
of Columbia. Sec. 7701(a)(9). A special rule for determining domestic 
production gross receipts, however, provides that for taxable years 
beginning after December 31, 2005, and before January 1, 2017, in the 
case of any taxpayer with gross receipts from sources within the 
Commonwealth of Puerto Rico, the term ``United States'' includes the 
Commonwealth of Puerto Rico, but only if all of the taxpayer's Puerto 
Rico-sourced gross receipts are taxable under the Federal income tax 
for individuals or corporations for such taxable year. See sections 
199(d)(8)(A) and (C). Such special rule was extended to taxable years 
beginning before January 1, 2018, by the Bipartisan Budget Act of 2018, 
Pub. L. No. 115-123, February 9, 2018. In computing the 50-percent wage 
limitation, the taxpayer is permitted to take into account wages paid 
to bona fide residents of Puerto Rico for services performed in Puerto 
Rico. Sec. 199(d)(8)(B).
    \971\ Qualified film includes any motion picture film or videotape 
(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 the film (including 
compensation in the form of residuals and participations) constitutes 
compensation for services performed in the United States by actors, 
production personnel, directors, and producers. Sec. 199(c)(6).
    \972\ Sec. 199(c)(4)(A).
---------------------------------------------------------------------------
    The amount of the deduction for a taxable year is limited 
to 50 percent of the W-2 wages paid by the taxpayer, and 
properly allocable to domestic production gross receipts, 
during the calendar year that ends in such taxable year.\973\
---------------------------------------------------------------------------
    \973\ Sec. 199(b)(1). For purposes of the provision, ``W-2 wages'' 
include the sum of the amounts of wages as defined in section 3401(a) 
and elective deferrals that the taxpayer properly reports to the Social 
Security Administration with respect to the employment of employees of 
the taxpayer during the calendar year ending during the taxpayer's 
taxable year. Elective deferrals include elective deferrals as defined 
in section 402(g)(3), amounts deferred under section 457, and 
designated Roth contributions as defined in section 402A. See sec. 
199(b)(2)(A). The wage limitation for qualified films includes any 
compensation for services performed in the United States by actors, 
production personnel, directors, and producers and is not restricted to 
W-2 wages. Sec. 199(b)(2)(D).
---------------------------------------------------------------------------

Agricultural and horticultural cooperatives

    With regard to member-owned agricultural and horticultural 
cooperatives formed under Subchapter T of the Code, section 199 
provides the same treatment of qualified production activities 
income derived from agricultural or horticultural products that 
are manufactured, produced, grown, or extracted by 
cooperatives,\974\ 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).
---------------------------------------------------------------------------
    \974\ 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.
---------------------------------------------------------------------------
    In addition, section 199(d)(3)(A) 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). In 
addition, section 199(d)(3)(B) provides that the cooperative 
cannot reduce its income under section 1382 (e.g., cannot claim 
a dividends-paid deduction) for such amounts.

                        Explanation of Provision

    The provision repeals the deduction for income attributable 
to domestic production activities.

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.
    As the enactment of section 199A is also effective for 
taxable years beginning after December 31, 2017,\975\ any item 
taken into account in determining the qualified production 
activities income of the taxpayer under former section 199 
cannot be taken into account in determining the combined 
qualified business income amount of the taxpayer under section 
199A. For example, assume that an individual holds an interest 
in a fiscal-year partnership or S corporation, the taxable year 
of which began before January 1, 2018, and ends within or with 
the individual's first taxable year beginning after December 
31, 2017 (e.g., the individual's 2018 calendar taxable year). 
The individual's share of any item from the partnership or S 
corporation that constitutes qualified business income, 
qualified REIT dividends, qualified cooperative dividends,\976\ 
and qualified publicly traded partnership income and that is 
taken into account in determining taxable income for the 
individual's 2018 taxable year is eligible for the section 199A 
deduction. However, the individual's share of any item from the 
partnership or S corporation that would otherwise be taken into 
account in determining qualified production activities income 
for the individual's 2018 taxable year is not eligible for the 
former section 199 deduction, as former section 199 is repealed 
for taxable years beginning after December 31, 2017.
---------------------------------------------------------------------------
    \975\ For a discussion of the effective date of the enactment of 
section 199A, see the description of section 11011 of the Act 
(Deduction for Qualified Business Income).
    \976\ As originally enacted. Modifications enacted March 23, 2018, 
are described in the Appendix.
---------------------------------------------------------------------------

F. Denial of Deduction for Certain Fines, Penalties, and Other Amounts 
            (sec. 13306 of the Act and sec. 162 of the Code)


                               Prior Law


In general

    The Code denies a deduction for fines or penalties paid to 
a government for the violation of any law.\977\
---------------------------------------------------------------------------
    \977\ Sec. 162(f).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision denies deductibility for any otherwise 
deductible amount paid or incurred (whether by suit, agreement, 
or otherwise) to or at the direction of a government or 
specified nongovernmental entity in relation to the violation 
of any law or the investigation or inquiry by such government 
or entity into the potential violation of any law. An exception 
applies to payments that the taxpayer establishes are either 
restitution (including remediation of property) or amounts 
required to come into compliance with any law that was violated 
or involved in the investigation or inquiry, that are 
identified in the court order or settlement agreement as 
restitution, remediation, or required to come into compliance. 
In the case of any amount of restitution for failure to pay any 
tax and assessed as restitution under the Code, such 
restitution is deductible only to the extent it would have been 
allowed as a deduction if it had been timely paid. The IRS 
remains free to challenge the characterization of an amount so 
identified; however, no deduction is allowed unless the 
identification is made. Restitution or included remediation of 
property does not include reimbursement of government 
investigative or litigation costs.
    An exception also applies to any amount paid or incurred as 
taxes due.\978\
---------------------------------------------------------------------------
    \978\ Thus, amounts paid or incurred as taxes due are not affected 
by the provision (e.g., State taxes that are otherwise deductible). The 
reference to taxes due is also intended to include interest with 
respect to such taxes (but not interest, if any, with respect to any 
penalties imposed with respect to such taxes).
---------------------------------------------------------------------------
    The provision applies only where a government (or other 
entity treated in a manner similar to a government under the 
provision) is a complainant or investigator with respect to the 
violation or potential violation of any law.\979\ The provision 
requires government agencies (or entities treated as such 
agencies under the provision) to report to the IRS and to the 
taxpayer the amount of each settlement agreement or order 
entered into where the aggregate amount required to be paid or 
incurred to or at the direction of the government is at least 
$600 (or such other amount as may be specified by the Secretary 
of the Treasury as necessary to ensure the efficient 
administration of the internal revenue laws). The report must 
separately identify any amounts that are for restitution or 
remediation of property, or correction of noncompliance. The 
report must be made at the time the agreement is entered into, 
as determined by the Secretary of the Treasury.
---------------------------------------------------------------------------
    \979\ Thus, for example, the provision does not apply to payments 
made by one private party to another in a lawsuit between private 
parties, merely because a judge or jury acting in the capacity as a 
court directs the payment to be made. The mere fact that a court enters 
a judgment or directs a result in a private dispute does not cause the 
payment to be made ``at the direction of a government'' for purposes of 
the provision.
---------------------------------------------------------------------------

                             Effective Date

    The provision denying the deduction and the reporting 
provision are effective for amounts paid or incurred on or 
after the date of enactment (i.e., December 22, 2017), except 
that they do not apply to amounts paid or incurred under any 
binding order or agreement entered into before such date. Such 
exception does not apply to an order or agreement requiring 
court approval unless the approval was obtained before such 
date.

    G. Denial of Deduction for Settlements Subject to Nondisclosure 
 Agreements Paid in Connection with Sexual Harassment or Sexual Abuse 
            (sec. 13307 of the Act and sec. 162 of the Code)


                               Prior Law


In general

    A taxpayer generally is allowed a deduction for ordinary 
and necessary expenses paid or incurred in carrying on any 
trade or business.\980\ However, certain exceptions apply. No 
deduction is allowed for: (1) any charitable contribution or 
gift that exceeds the amount allowable as a deduction under 
section 170; (2) any illegal bribe, illegal kickback, or other 
illegal payment; (3) certain lobbying and political 
expenditures; (4) any fine or similar penalty paid to a 
government for the violation of any law; (5) two-thirds of 
treble damage payments under the antitrust laws; (6) certain 
foreign advertising expenses; (7) certain amounts paid or 
incurred by a corporation in connection with the reacquisition 
of its stock or of the stock of any related person; or (8) 
certain applicable employee remuneration.
---------------------------------------------------------------------------
    \980\ Sec. 162(a).
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                        Explanation of Provision

    Under the provision, no deduction is allowed for any 
settlement or payment related to sexual harassment or sexual 
abuse if such settlement or payment is subject to a 
nondisclosure agreement. In addition, in the case of the 
taxpayer for whom a deduction is disallowed, no deduction is 
allowed for attorney's fees related to such settlement or 
payment. Any attorney's fees incurred by the beneficiary of the 
settlement or recipient of the payment are not subject to this 
rule.\981\
---------------------------------------------------------------------------
    \981\ A technical correction may be necessary to reflect this 
intent.
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                             Effective Date

    The provision is effective for amounts paid or incurred 
after the date of enactment (i.e., December 22, 2017).

 H. Repeal of Deduction for Local Lobbying Expenses (sec. 13308 of the 
                     Act and sec. 162 of the Code)


                               Prior Law


In general

    A taxpayer generally is allowed a deduction for ordinary 
and necessary expenses paid or incurred in carrying on any 
trade or business.\982\ However, section 162(e) denies a 
deduction for amounts paid or incurred in connection with (1) 
influencing legislation,\983\ (2) participation in, or 
intervention in, any political campaign on behalf of (or in 
opposition to) any candidate for public office, (3) any attempt 
to influence the general public, or segments thereof, with 
respect to elections, legislative matters, or referendums, or 
(4) any direct communication with a covered executive branch 
official \984\ in an attempt to influence the official actions 
or positions of such official. Expenses paid or incurred in 
connection with lobbying and political activities (such as 
research for, or preparation, planning, or coordination of, any 
previously described activity) also are not deductible.\985\
---------------------------------------------------------------------------
    \982\ Sec. 162(a).
    \983\ The term ``influencing legislation'' means any attempt to 
influence any legislation through communication with any member or 
employee of a legislative body, or with any government official or 
employee who may participate in the formulation of legislation. The 
term ``legislation'' includes actions with respect to Acts, bills, 
resolutions, or similar items by the Congress, any State legislature, 
any local council, or similar governing body, or by the public in a 
referendum, initiative, constitutional amendment, or similar procedure. 
Secs. 162(e)(4) and 4911(e)(2).
    \984\ The term ``covered executive branch official'' means (1) the 
President, (2) the Vice President, (3) any officer or employee of the 
White House Office of the Executive Office of the President, and the 
two most senior level officers of each of the other agencies in such 
Executive Office, (4) any individual servicing in a position in level I 
of the Executive Schedule under section 5312 of title 5, United States 
Code, (5) any other individual designated by the President as having 
Cabinet-level status, and (6) any immediate deputy of an individual 
described in (4) or (5). Sec. 162(e)(6).
    \985\ Sec. 162(e)(5)(C).
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Exceptions

            Local legislation
    Notwithstanding the above, a deduction is allowed for 
ordinary and necessary expenses incurred in connection with any 
legislation of any local council or similar governing body 
(``local legislation'').\986\ With respect to local 
legislation, the exception permits a deduction for amounts paid 
or incurred in carrying on any trade or business (1) in direct 
connection with appearances before, submission of statements 
to, or sending communications to the committees or individual 
members of such council or body with respect to legislation or 
proposed legislation of direct interest to the taxpayer, or (2) 
in direct connection with communication of information between 
the taxpayer and an organization of which the taxpayer is a 
member with respect to any such legislation or proposed 
legislation which is of direct interest to the taxpayer and 
such organization, and (3) that portion of the dues paid or 
incurred with respect to any organization of which the taxpayer 
is a member which is attributable to the expenses of the 
activities described in (1) or (2) carried on by such 
organization.\987\
---------------------------------------------------------------------------
    \986\ Sec. 162(e)(2)(A).
    \987\ Sec. 162(e)(2)(B).
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    For purposes of this exception, legislation of an Indian 
tribal government is treated in the same manner as local 
legislation.\988\
---------------------------------------------------------------------------
    \988\ Sec. 162(e)(7).
---------------------------------------------------------------------------
            De minimis
    For taxpayers with $2,000 or less of in-house expenditures 
related to lobbying and political activities, a de minimis 
exception is provided that permits a deduction.\989\
---------------------------------------------------------------------------
    \989\ Sec. 162(e)(5)(B).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision repeals the exception for amounts paid or 
incurred related to lobbying local councils or similar 
governing bodies, including Indian tribal governments. Thus, 
the general disallowance rules applicable to lobbying and 
political expenditures will apply to costs incurred related to 
such local legislation.

                             Effective Date

    The provision applies to amounts paid or incurred on or 
after the date of enactment (i.e., December 22, 2017).

   I. Recharacterization of Certain Gains in the Case of Partnership 
  Profits Interests Held in Connection with Performance of Investment 
       Services (sec. 13309 of the Act and sec. 1061 of the Code)


                               Prior Law


Partnership profits interest for services

    A profits interest in a partnership is the right to receive 
future profits in the partnership but does not generally 
include any right to receive money or other property upon the 
immediate liquidation of the partnership. The treatment of the 
receipt of a profits interest in a partnership (sometimes 
referred to as a carried interest) in exchange for the 
performance of services has been the subject of controversy. 
Though courts have differed, in some instances, a taxpayer 
receiving a profits interest for performing services has not 
been taxed upon the receipt of the partnership interest.\990\
---------------------------------------------------------------------------
    \990\ Only a handful of cases have addressed this issue. Though one 
case required the value to be included currently, where value was 
easily determined by a sale of the profits interest soon after receipt 
(Diamond v. Commissioner, 56 T.C. 530 (1971), aff'd 492 F.2d 286 (7th 
Cir. 1974)), a more recent case concluded that partnership profits 
interests were not includable on receipt, because the profits interests 
were speculative and without fair market value (Campbell v. 
Commissioner, 943 F. 2d 815 (8th Cir. 1991)).
---------------------------------------------------------------------------
    In 1993, the IRS, referring to the litigation of the tax 
treatment of receiving a partnership profits interest and the 
results in the cases, issued administrative guidance that the 
IRS generally would treat the receipt of a partnership profits 
interest for services as not a taxable event for the 
partnership or the partner.\991\ Under this guidance, this 
treatment does not apply, however, if: (1) the profits interest 
relates to a substantially certain and predictable stream of 
income from partnership assets, such as income from high-
quality debt securities or a high-quality net lease; (2) within 
two years of receipt, the partner disposes of the profits 
interest; or (3) the profits interest is a limited partnership 
interest in a publicly traded partnership. More recent 
administrative guidance \992\ clarifies that this treatment 
applies with respect to a substantially unvested profits 
interest provided the service partner takes into income his 
distributive share of partnership income, and the partnership 
does not deduct any amount either on grant or on vesting of the 
profits interest.\993\
---------------------------------------------------------------------------
    \991\ Rev. Proc. 93-27, 1993-2 C.B. 343, citing the Diamond and 
Campbell cases, supra.
    \992\ Rev. Proc. 2001-43, 2001-2 C.B. 191. This result applies 
under the guidance even if the interest is substantially nonvested on 
the date of grant.
    \993\ A similar result would occur under the ``safe harbor'' 
election under proposed regulations regarding the application of 
section 83 to the compensatory transfer of a partnership interest. REG-
105346-03, 70 Fed. Reg. 29675, May 24, 2005.
---------------------------------------------------------------------------
    By contrast, a partnership capital interest received for 
services is includable in the partner's income under generally 
applicable rules relating to the receipt of property for the 
performance of services.\994\ A partnership capital interest 
for this purpose is an interest that would entitle the 
receiving partner to a share of the proceeds if the 
partnership's assets were sold at fair market value and the 
proceeds were distributed in liquidation.\995\
---------------------------------------------------------------------------
    \994\ Secs. 61 and 83; Treas. Reg. sec. 1.721-1(b)(1); see U.S. v. 
Frazell, 335 F.2d 487 (5th Cir. 1964), cert. denied, 380 U.S. 961 
(1965).
    \995\ Rev. Proc. 93-27, 1993-2 C.B. 343.
---------------------------------------------------------------------------

Property received for services under section 83

            In general
    Section 83 governs the amount and timing of income and 
deductions attributable to transfers of property in connection 
with the performance of services. If property is transferred in 
connection with the performance of services, the person 
performing the services (the ``service provider'') generally 
must recognize income for the taxable year in which the 
property is first substantially vested (i.e., transferable or 
not subject to a substantial risk of forfeiture).\996\ The 
amount includible in the service provider's income is the 
excess of the fair market value of the property when it is 
substantially vested over the amount (if any) paid for the 
property. A deduction generally is allowed to the person for 
whom such services are performed (the ``service recipient'') 
equal to the amount included in gross income by the service 
provider. The deduction generally is allowed for the taxable 
year of the service recipient in which or with which ends the 
taxable year in which the amount is included in the service 
provider's income.\997\
---------------------------------------------------------------------------
    \996\ The Department of Treasury has issued proposed regulations 
regarding the application of section 83 to the compensatory transfer of 
a partnership interest. 70 Fed. Reg. 29675, May 24, 2005. The proposed 
regulations provide that a partnership interest is ``property'' for 
purposes of section 83. Thus, a compensatory transfer of a partnership 
interest is includible in the service provider's gross income at the 
time that it first becomes substantially vested (or, in the case of a 
substantially nonvested partnership interest, at the time of grant if a 
section 83(b) election is made). However, because the fair market value 
of a compensatory partnership interest is often difficult to determine, 
the proposed regulations also permit a partnership and a partner to 
elect a safe harbor under which the fair market value of a compensatory 
partnership interest is treated as being equal to the liquidation value 
of that interest. Therefore, in the case of a true profits interest in 
a partnership (one under which the partner would be entitled to nothing 
if the partnership were liquidated immediately following the grant), 
under the proposed regulations, the grant of a substantially vested 
profits interest (or, if a section 83(b) election is made, the grant of 
a substantially nonvested profits interest) results in no income 
inclusion under section 83 because the fair market value of the 
property received by the service provider is zero. The proposed safe 
harbor is subject to a number of conditions. For example, the election 
cannot be made retroactively and must apply to all compensatory 
partnership transfers that occur during the period that the election is 
in effect.
    \997\ Sec. 83(h).
---------------------------------------------------------------------------
    Property that is subject to a substantial risk of 
forfeiture and that is not transferable is generally referred 
to as ``substantially nonvested.'' Property is subject to a 
substantial risk of forfeiture if the individual's right to the 
property is conditioned on the future performance (or 
refraining from performance) of substantial services. In 
addition, a substantial risk of forfeiture exists if the right 
to the property is subject to a condition other than the 
performance of services, provided that the condition relates to 
a purpose of the transfer and there is a substantial 
possibility that the property will be forfeited if the 
condition does not occur.
            Section 83(b) election
    Under section 83(b), even if the property is substantially 
nonvested at the time of transfer, the service provider may 
nevertheless elect within 30 days of the transfer to recognize 
income for the taxable year of the transfer. Such an election 
is referred to as a ``section 83(b) election.'' The service 
provider makes an election by filing with the IRS a written 
statement that includes the fair market value of the property 
at the time of transfer and the amount (if any) paid for the 
property. The service provider must also provide a copy of the 
statement to the service recipient.

Passthrough tax treatment of partnerships

    The character of partnership items passes through to the 
partners, as if the items were realized directly by the 
partners.\998\ Thus, for example, long-term capital gain of the 
partnership is treated as long-term capital gain in the hands 
of the partners.
---------------------------------------------------------------------------
    \998\ Sec. 702.
---------------------------------------------------------------------------
    A partner holding a partnership interest includes in income 
its distributive share (whether or not actually distributed) of 
partnership items of income and gain, including capital gain 
eligible for the lower tax rates. A partner's basis in the 
partnership interest is increased by any amount of gain thus 
included and is decreased by losses. These basis adjustments 
prevent double taxation of partnership income to the partner, 
preserving the partnership's tax status as a passthrough 
entity. Money distributed to the partner by the partnership is 
taxed to the extent the amount exceeds the partner's basis in 
the partnership interest.

Net long-term capital gain

    In general, gain is not recognized and loss is not 
deductible for income tax purposes until a taxpayer disposes of 
an asset. The amount of gain recognized generally is included 
in income and the amount of loss sustained in a business or for 
profit transaction is generally deductible.
    Special rules apply in the case of the sale or exchange of 
capital assets. In the case of an individual, estate, or trust, 
any adjusted net capital gain that otherwise would be taxed at 
the 10- or 15-percent rate is not taxed. Any adjusted net 
capital gain that otherwise would be taxed at rates over 15 
percent and below 39.6 percent is taxed at a 15-percent rate. 
Any adjusted net capital gain that otherwise would be taxed at 
a 39.6-percent rate is taxed at a 20-percent rate.\999\
---------------------------------------------------------------------------
    \999\ Sec. 1. Other rates apply to certain types of gain. The 
unrecaptured section 1250 gain is taxed at a maximum rate of 25 
percent, and 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 the 
otherwise applicable rate. In addition, a tax is imposed on net 
investment income in the case of an individual, estate, or trust. In 
the case of an individual, the tax is 3.8 percent of the lesser of net 
investment income, which includes gains and dividends, or the excess of 
modified adjusted gross income over the threshold amount. The threshold 
amount is $250,000 in the case of a joint return or surviving spouse, 
$125,000 in the case of a married individual filing a separate return, 
and $200,000 in the case of any other individual.
---------------------------------------------------------------------------
    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.\1000\
---------------------------------------------------------------------------
    \1000\ Sec. 163(d).
---------------------------------------------------------------------------
    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.
    Net long term capital gain means the excess (if any) of 
gain from the sale or exchange of capital assets held more than 
one year over the loss from the sale or capital assets held 
more than one year (to the extent taken into account in 
computing income).
    Net short term capital loss means the excess (if any) of 
loss from the sale or exchange of capital assets held for not 
more than one year over the gain from the sale or capital 
assets held for not more than one year (to the extent taken 
into account in computing income).

                        Explanation of Provision


In general

    The provision provides for a three-year holding period in 
the case of certain net long-term capital gain with respect to 
any applicable partnership interest held by the taxpayer.

Interaction with section 83

    The provision provides for a three-year holding period in 
the case of certain net long-term capital gain with respect to 
any applicable partnership interest held by the taxpayer, 
notwithstanding the rules of section 83 or any election in 
effect under section 83(b). The Congress wishes to clarify the 
interaction of section 83 with the provision's three-year 
holding requirement, which applies notwithstanding the rules of 
section 83 or any election in effect under section 83(b). Under 
the provision, the fact that an individual may have included an 
amount in income upon acquisition of the applicable partnership 
interest, or that an individual may have made a section 83(b) 
election with respect to an applicable partnership interest, 
does not change the three-year holding period requirement for 
long-term capital gain treatment with respect to the applicable 
partnership interest. Thus, the provision treats as short-term 
capital gain taxed at ordinary income rates the amount of the 
taxpayer's net long-term capital gain with respect to an 
applicable partnership interest for the taxable year that 
exceeds the amount of such gain calculated as if a three-year 
(rather than one-year) holding period applies. In making this 
calculation, the provision takes account of long-term capital 
losses calculated as if a three-year holding period applies.

Short-term capital gain

    The provision treats as short-term capital gain taxed at 
ordinary income tax rates the amount of the taxpayer's net 
long-term capital gain with respect to an applicable 
partnership interest for the taxable year that exceeds the 
amount of such gain calculated as if a three-year (not one-
year) holding period applies.\1001\ In making this calculation, 
the provision takes account of long-term capital losses 
calculated as if a three-year holding period applies.
---------------------------------------------------------------------------
    \1001\ Sec. 1061(a). A net long-term capital gain is defined in 
section 1222(7) to mean the excess of long-term capital gains for the 
taxable year over the long-term capital losses for such year.
---------------------------------------------------------------------------
    A special rule provides that, as provided in regulations or 
other guidance issued by the Secretary, this rule does not 
apply to income or gain attributable to any asset that is not 
held for portfolio investment on behalf of third party 
investors. A third party investor means a person (1) who holds 
an interest in the partnership that is not property held in 
connection with an applicable trade or business (defined below) 
with respect to that person, and (2) who is not and has not 
been actively engaged in directly or indirectly providing 
substantial services for the partnership or any applicable 
trade or business (and is (or was) not related to a person so 
engaged). A related person for this purpose is a family member 
(within the meaning of attribution rules \1002\) or colleague 
that is a person who performed a service within the current 
calendar year or the preceding three calendar years in any 
applicable trade or business in which or for which the taxpayer 
performed a service.
---------------------------------------------------------------------------
    \1002\ Sec. 318(a)(1).
---------------------------------------------------------------------------

Applicable partnership interest

    An applicable partnership interest is any interest in a 
partnership that, directly or indirectly, is transferred to (or 
held by) the taxpayer in connection with performance of 
services in any applicable trade or business. The services may 
be performed by the taxpayer or by any other related person or 
persons \1003\ in any applicable trade or business. It is 
intended that partnership interests shall not fail to be 
treated as transferred or held in connection with the 
performance of services merely because the taxpayer also made 
contributions to the partnership, and the Treasury Department 
is directed to provide guidance implementing this intent. An 
applicable partnership interest does not include an interest 
held by a person who is employed by another entity that is 
conducting a trade or business (which is not an applicable 
trade or business) and who provides services only to the other 
entity.
---------------------------------------------------------------------------
    \1003\ Although the provision does not supply a definition of a 
related person for purposes of the rule defining an applicable 
partnership interest in section 1061(c)(1), it is intended that for 
this purpose a related person means a related person within the meaning 
of section 267(b) or 707(b). A technical correction may be needed to 
carry out this intent.
---------------------------------------------------------------------------
    An applicable partnership interest does not include an 
interest in a partnership directly or indirectly held by a 
corporation. For example, if two corporations form a 
partnership to conduct a joint venture for developing and 
marketing a pharmaceutical product, the partnership interests 
held by the two corporations are not applicable partnership 
interests. The term ``corporation'' for purposes of section 
1061(c)(4)(A) does not include an S corporation, so a 
partnership interest held by an S corporation is not excluded 
from the term ``applicable partnership interest.''
    An applicable partnership interest does not include any 
capital interest in a partnership giving the taxpayer a right 
to share in partnership capital commensurate with the amount of 
capital contributed (as of the time the partnership interest 
was received), or commensurate with the value of the 
partnership interest that is taxed under section 83 on receipt 
or vesting of the partnership interest. For example, in the 
case of a partner who holds a capital interest in the 
partnership with respect to capital he or she contributed to 
the partnership, if the partnership agreement provides that the 
partner's share of partnership capital is commensurate with the 
amount of capital he or she contributed (as of the time the 
partnership interest was received) compared to total 
partnership capital, the partnership interest is not an 
applicable partnership interest to that extent.
            Applicable trade or business
    An applicable trade or business means any activity 
(regardless of whether the activity is conducted in one or more 
entities) that consists in whole or in part of the following: 
(1) raising or returning capital, and either (2) investing in 
(or disposing of) specified assets (or identifying specified 
assets for investing or disposition), or (3) developing 
specified assets.
    Developing specified assets takes place, for example, if it 
is represented to investors, lenders, regulators, or others 
that the value, price, or yield of a portfolio business may be 
enhanced or increased in connection with choices or actions of 
a service provider or of others acting in concert with or at 
the direction of a service provider. Services performed as an 
employee of an applicable trade or business are treated as 
performed in an applicable trade or business for purposes of 
this rule. Merely voting shares owned or exercising the right 
to vote with respect to shares owned does not amount to 
development; for example, a mutual fund that merely votes 
proxies received with respect to shares of stock it holds is 
not engaged in development.
            Specified assets
    Under the provision, specified assets means securities 
(generally as defined under rules for mark-to-market accounting 
for securities dealers), commodities (as defined under rules 
for mark-to-market accounting for commodities dealers), real 
estate held for rental or investment, cash or cash equivalents, 
options or derivative contracts with respect to such 
securities, commodities, real estate, cash or cash equivalents, 
as well as an interest in a partnership to the extent of the 
partnership's proportionate interest in the foregoing. A 
security for this purpose means any (1) share of corporate 
stock, (2) partnership interest or beneficial ownership 
interest in a widely held or publicly traded partnership or 
trust, (3) note, bond, debenture, or other evidence of 
indebtedness, (4) interest rate, currency, or equity notional 
principal contract, (5) interest in, or derivative financial 
instrument in, any such security or any currency (regardless of 
whether section 1256 applies to the contract), and (6) position 
that is not such a security and is a hedge with respect to such 
a security and is clearly identified. A commodity for this 
purpose means any (1) commodity that is actively traded, (2) 
notional principal contract with respect to such a commodity, 
(3) interest in, or derivative financial instrument in, such a 
commodity or notional principal contract, or (4) position that 
is not such a commodity and is a hedge with respect to such a 
commodity and is clearly identified. For purposes of the 
provision, real estate held for rental or investment does not 
include, for example, real estate on which the holder operates 
an active farm.
    A partnership interest, for purposes of determining the 
proportionate interest of a partnership in any specified asset, 
includes any partnership interest that is not otherwise treated 
as a security for purposes of the provision (for example, an 
interest in a partnership that is not widely held or publicly 
traded). For example, assume that a hedge fund acquires an 
interest in a partnership that is neither publicly traded nor 
widely held and whose assets consist of stocks, bonds, 
positions that are clearly identified hedges with respect to 
securities, and commodities; the partnership interest is a 
specified asset for purposes of the provision.

     Transfer of applicable partnership interest to related person

    If a taxpayer transfers any applicable partnership 
interest, directly or indirectly, to a person related to the 
taxpayer, then the taxpayer includes in gross income as short-
term capital gain so much of the taxpayer's net long-term 
capital gain attributable to the sale or exchange of an asset 
held for not more than three years as is allowable to the 
interest. The amount included as short-term capital gain on the 
transfer is reduced by the amount treated as short-term capital 
gain on the transfer for the taxable year under the general 
rule of the provision (that is, amounts are not double-
counted). A related person for this purpose is a family member 
(within the meaning of attribution rules \1004\) or colleague, 
that is a person who performed a service within the current 
calendar year or the preceding three calendar years in any 
applicable trade or business in which or for which the taxpayer 
performed a service.
---------------------------------------------------------------------------
    \1004\ Sec. 318(a)(1).
---------------------------------------------------------------------------

Reporting requirement

    The Secretary is directed to require reporting (at the time 
in the manner determined by the Secretary) necessary to carry 
out the purposes of the provision. The penalties otherwise 
applicable to a failure to report to partners under section 
6031(b) apply to failure to report under this requirement.

Regulatory authority

    The Treasury Department is directed to issue regulations or 
other guidance necessary to carry out the purposes of the 
provision. Such guidance is to address prevention of the abuse 
of the purposes of the provision, including through the 
allocation of income to tax-indifferent parties. Guidance is 
also to provide for the application of the provision in the 
case of tiered structures of entities.

    The Treasury Department and IRS have issued published 
guidance addressing this provision.\1005\
---------------------------------------------------------------------------
    \1005\ Notice 2018-18, 2018-12 I.R.B. 443, March 19, 2018.
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

  J. Prohibition on Cash, Gift Cards, and Other Nontangible Personal 
  Property as Employee Achievement Awards (sec. 13310 of the Act and 
                  secs. 74(c) and 274(j) of the Code)


                               Prior Law

    An employer's deduction for the cost of an employee 
achievement award is limited to a certain amount.\1006\ 
Employee achievement awards that are deductible by an employer 
(or would be deductible but for the fact that the employer is a 
tax-exempt organization) are excludible from an employee's 
gross income.\1007\ Amounts attributable to employee 
achievement awards that are excludible from gross income under 
section 74(c) for income tax purposes are also excluded from 
wages for employment tax purposes.
---------------------------------------------------------------------------
    \1006\ Secs. 274(j)(1) and (2).
    \1007\ Sec. 74(c).
---------------------------------------------------------------------------
    Generally, an employee achievement award is an item of 
tangible personal property given to an employee in recognition 
of either length of service or safety achievement and presented 
as part of a meaningful presentation.\1008\
---------------------------------------------------------------------------
    \1008\ Sec. 274(j)(3).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision adds a definition of ``tangible personal 
property'' that may be considered a deductible employee 
achievement award. It provides that tangible personal property 
shall not include cash, cash equivalents, gift cards, gift 
coupons or gift certificates (other than arrangements 
conferring only the right to select and receive tangible 
personal property from a limited array of such items 
preselected or preapproved by the employer), or vacations, 
meals, lodging, tickets to theater or sporting events, stocks, 
bonds, other securities, and other similar items. No inference 
is intended that this is a change from prior law and guidance.

                             Effective Date

    The provision applies to amounts paid or incurred after 
December 31, 2017.

K. Elimination of Deduction for Living Expenses Incurred by Members of 
       Congress (sec. 13311 of the Act and sec. 162 of the Code)


                               Prior Law

    Section 162 generally permits a deduction for ordinary and 
necessary expenses paid or incurred during the taxable year in 
carrying on any trade or business. Such expenses include 
certain traveling expenses while temporarily (within a one-year 
period) away from home in the pursuit of a trade or business. 
For this purpose, the place of residence of a Member of 
Congress within the State, congressional district, or 
possession that he or she represents is considered the Member's 
home, but amounts expended for living expenses in excess of 
$3,000 within a taxable year are not deductible.

                        Explanation of Provision

    The provision repeals the deduction for living expenses of 
Members of Congress.

                             Effective Date

    The provision is effective for taxable years beginning 
after the date of enactment of the Act (i.e., December 22, 
2017).

   L. Certain Contributions by Governmental Entities Not Treated as 
  Contributions to Capital (sec. 13312 of the Act and sec. 118 of the 
                                 Code)


                               Prior Law

    The gross income of a corporation does not include any 
contribution to its capital.\1009\ For purposes of this rule, a 
contribution to the capital of a corporation does not include 
any contribution in aid of construction or any other 
contribution from a customer or potential customer.\1010\ A 
special rule allows certain contributions in aid of 
construction received by a regulated public utility that 
provides water or sewerage disposal services to be treated as a 
tax-free contribution to the capital of the utility.\1011\ No 
deduction or credit is allowed for, or by reason of, any 
expenditure that constitutes a contribution that is treated as 
a tax-free contribution to the capital of the utility.\1012\ 
Section 118 applies only to corporations.
---------------------------------------------------------------------------
    \1009\ Sec. 118(a).
    \1010\ Sec. 118(b).
    \1011\ Sec. 118(c)(1).
    \1012\ Sec. 118(c)(4).
---------------------------------------------------------------------------
    If property is acquired by a corporation as a contribution 
to capital and is not contributed by a shareholder as such, the 
adjusted basis of the property is zero.\1013\ If the 
contribution consists of money, the corporation must first 
reduce the basis of any property acquired with the contributed 
money within the following 12-month period, and then reduce the 
basis of other property held by the corporation.\1014\ 
Similarly, the adjusted basis of any property acquired by a 
utility with a contribution in aid of construction is 
zero.\1015\
---------------------------------------------------------------------------
    \1013\ Sec. 362(c)(1).
    \1014\ Sec. 362(c)(2). See also Treas. Reg. sec. 1.362-2.
    \1015\ Sec. 118(c)(4).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision provides that the term ``contribution to the 
capital of the taxpayer'' does not include (1) any contribution 
in aid of construction (without exception) \1016\ or any other 
contribution as a customer or potential customer, and (2) any 
contribution by any governmental entity or civic group (other 
than a contribution made by a shareholder as such). Thus, for 
example, a municipal tax abatement for locating a business in a 
particular municipality is not considered a contribution to 
capital of the corporation. The provision instructs the 
Secretary to issue such regulations or other guidance as may be 
necessary or appropriate to carry out this section, including 
regulations or other guidance for determining whether any 
contribution constitutes a contribution in aid of construction.
---------------------------------------------------------------------------
    \1016\ The special rules for water and sewerage disposal utilities 
are repealed.
---------------------------------------------------------------------------

                             Effective Date

    In general, the provision applies to contributions made 
after the date of enactment (i.e., December 22, 2017). The 
provision does not apply to any contribution made after 
December 22, 2017, by a governmental entity which is made 
pursuant to a master development plan that has been approved 
prior to such date by a governmental entity.

     M. Repeal of Rollover of Publicly Traded Securities Gain into 
Specialized Small Business Investment Companies (sec. 13313 of the Act 
                   and former sec. 1044 of the Code)


                               Prior Law

    A corporation or individual may elect to roll over tax-free 
any capital gain realized on the sale of publicly-traded 
securities to the extent of the taxpayer's cost of purchasing 
common stock or a partnership interest in a specialized small 
business investment company within 60 days of the sale.\1017\ 
The amount of gain that an individual may elect to roll over 
for a taxable year is limited to (1) $50,000 or (2) $500,000 
reduced by the gain previously excluded.\1018\ For 
corporations, these limits are $250,000 and $1 million, 
respectively.\1019\
---------------------------------------------------------------------------
    \1017\ Sec. 1044(a).
    \1018\ Sec. 1044(b)(1).
    \1019\ Sec. 1044(b)(2).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision repeals the election to roll over tax-free 
capital gain realized on the sale of publicly-traded 
securities.

                             Effective Date

    The provision applies to sales after December 31, 2017.

 N. Certain Self-Created Property Not Treated as a Capital Asset (sec. 
           13314 of the Act and sec. 1221(a)(3) of the Code)


                               Prior Law

    In general, property held by a taxpayer (whether or not 
connected with his trade or business) is considered a capital 
asset.\1020\ Certain assets, however, are specifically excluded 
from the definition of capital asset. Such excluded assets are: 
inventory property, property of a character subject to 
depreciation (including real property),\1021\ certain self-
created intangibles, accounts or notes receivable acquired in 
the ordinary course of business (e.g., for providing services 
or selling property), publications of the U.S. Government 
received by a taxpayer other than by purchase at the price 
offered to the public, commodities derivative financial 
instruments held by a commodities derivatives dealer unless 
established to the satisfaction of the Secretary that any such 
instrument has no connection to the activities of such dealer 
as a dealer and clearly identified as such before the close of 
the day on which it was acquired, originated, or entered into, 
hedging transactions clearly identified as such, and supplies 
regularly used or consumed by the taxpayer in the ordinary 
course of a trade or business of the taxpayer.\1022\
---------------------------------------------------------------------------
    \1020\ Sec. 1221(a).
    \1021\ The net gain from the sale, exchange, or involuntary 
conversion of certain property used in the taxpayer's trade or business 
(in excess of depreciation recapture) is treated as long-term capital 
gain. Sec. 1231. However, net gain from such property is treated as 
ordinary income to the extent that losses from such property in the 
previous five years were treated as ordinary losses. Sec. 1231(c).
    \1022\ Sec. 1221(a)(1)-(8).
---------------------------------------------------------------------------
    Self-created intangibles subject to the exception are 
copyrights, literary, musical, or artistic compositions, 
letters or memoranda, or similar property which is held either 
by the taxpayer whose personal efforts created the property, or 
(in the case of a letter, memorandum, or similar property) a 
taxpayer for whom the property was produced.\1023\ For the 
purpose of determining gain, a taxpayer with a transferred 
basis from the taxpayer whose personal efforts created the 
property, or for whom the property was created, also is subject 
to the exception.\1024\ However, a taxpayer may elect to treat 
musical compositions and copyrights in musical works as capital 
assets.\1025\
---------------------------------------------------------------------------
    \1023\ Sec. 1221(a)(3)(A) and (B).
    \1024\ Sec. 1221(a)(3)(C).
    \1025\ Sec. 1221(b)(3). Thus, if a taxpayer who owns musical 
compositions or copyrights in musical works that the taxpayer created 
(or if a taxpayer to which the musical compositions or copyrights have 
been transferred by the works' creator in a substituted basis 
transaction) elects the application of this provision, gain from a sale 
of the compositions or copyrights is treated as capital gain, not 
ordinary income.
---------------------------------------------------------------------------
    Since the intent of Congress is that profits and losses 
arising from everyday business operations be characterized as 
ordinary income and loss, the general definition of capital 
asset is narrowly applied and the categories of exclusions are 
broadly interpreted.\1026\
---------------------------------------------------------------------------
    \1026\ Corn Products Refining Co. v. Commissioner, 350 U.S. 46, 52 
(1955).
---------------------------------------------------------------------------

                        Explanation of Provision

    This provision amends section 1221(a)(3), resulting in the 
exclusion of a patent, invention, model or design (whether or 
not patented), and a secret formula or process which is held 
either by the taxpayer who created the property or a taxpayer 
with a substituted or transferred basis from the taxpayer who 
created the property (or for whom the property was created) 
from the definition of a ``capital asset.'' Thus, gains or 
losses from the sale or exchange of a patent, invention, model 
or design (whether or not patented), or a secret formula or 
process which is held either by the taxpayer who created the 
property or a taxpayer with a substituted or transferred basis 
from the taxpayer who created the property (or for whom the 
property was created) will not receive capital gain treatment 
under section 1221.\1027\
---------------------------------------------------------------------------
    \1027\ However, consistent with prior law, the transfer (other than 
by gift, inheritance, or devise) of a patent by an individual that 
created the patent, or any other individual who acquired an interest in 
the patent in an exchange for consideration in money (i.e., an exchange 
that did not result in a substituted or transferred basis in the 
patent) prior to the actual reduction to practice of the invention 
covered by the patent (where such other individual is not the employer 
of the creator or related to the creator), is treated as a sale or 
exchange of a capital asset held for more than one year. See section 
1235.
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                             Effective Date

    The provision applies to dispositions after December 31, 
2017.

                        PART V--BUSINESS CREDITS

A. Modification of Orphan Drug Credit (sec. 13401 of the Act and secs. 
                       45C and 280C of the Code)

                               Prior Law

    Section 45C provides a 50-percent business tax credit for 
qualified clinical testing expenses incurred in testing of 
certain drugs for rare diseases or conditions, generally 
referred to as ``orphan drugs.'' Qualified clinical testing 
expenses are costs incurred to test an orphan drug after the 
drug has been approved for human testing by the Food and Drug 
Administration (``FDA'') but before the drug has been approved 
for sale by the FDA.\1028\ A rare disease or condition is 
defined as one that (1) affects fewer than 200,000 persons in 
the United States, or (2) affects more than 200,000 persons, 
but for which there is no reasonable expectation that 
businesses could recoup the costs of developing a drug for such 
disease or condition from sales in the United States of the 
drug.\1029\
---------------------------------------------------------------------------
    \1028\ Sec. 45C(b).
    \1029\ Sec. 45C(d).
---------------------------------------------------------------------------
    Amounts included in computing the credit under this section 
are excluded from the computation of the research credit under 
section 41.\1030\
---------------------------------------------------------------------------
    \1030\ Sec. 45C(c).
---------------------------------------------------------------------------
    No deduction is allowed for the portion of otherwise 
allowable qualified clinical testing expenses equal to the 
amount of the orphan drug credit allowed for the taxable 
year.\1031\
---------------------------------------------------------------------------
    \1031\ Sec. 280C(b).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision reduces the credit rate to 25 percent of 
qualified clinical testing expenses. The provision also allows 
taxpayers to elect a reduced orphan drug credit rather than 
having their otherwise allowable deduction for qualified 
clinical testing expenses reduced by that amount. If an 
election is made, the orphan drug credit is reduced by an 
amount equal to that credit multiplied by the highest corporate 
tax rate.

                             Effective Date

    The provision applies to amounts paid or incurred in 
taxable years beginning after December 31, 2017.

B. Rehabilitation Credit Limited to Certified Historic Structures (sec. 
               13402 of the Act and sec. 47 of the Code)

                               Prior Law

    Section 47 provides a two-tier tax credit for 
rehabilitation expenditures.
    A 20-percent credit is provided for qualified 
rehabilitation expenditures with respect to a certified 
historic structure. For this purpose, a certified historic 
structure means any building that is listed in the National 
Register, or that is located in a registered historic district 
and is certified by the Secretary of the Interior to the 
Secretary of the Treasury as being of historic significance to 
the district.
    A 10-percent credit is provided for qualified 
rehabilitation expenditures with respect to a qualified 
rehabilitated building, which generally means a building that 
was first placed in service before 1936. A pre-1936 building 
must meet requirements with respect to retention of existing 
external walls and internal structural framework of the 
building in order for expenditures with respect to it to 
qualify for the 10-percent credit. A building is treated as 
having met the substantial rehabilitation requirement under the 
10-percent credit only if the rehabilitation expenditures 
during the 24-month period selected by the taxpayer and ending 
within the taxable year exceed the greater of (1) the adjusted 
basis of the building (and its structural components), or (2) 
$5,000.
    The provision requires the use of straight-line 
depreciation or the alternative depreciation system in order 
for rehabilitation expenditures to be treated as qualified 
under the provision.

                        Explanation of Provision

    The provision repeals the 10-percent credit for pre-1936 
buildings.
    The provision retains the 20-percent credit for qualified 
rehabilitation expenditures with respect to a certified 
historic structure, with a modification. Under the provision, 
the credit allowable for a taxable year during the five-year 
period beginning in the taxable year in which the qualified 
rehabilitated building is placed in service is an amount equal 
to the ratable share. The ratable share for a taxable year 
during the five-year period is amount equal to 20 percent of 
the qualified rehabilitation expenditures for the building, as 
allocated ratably to each taxable year during the five-year 
period. Congress intended that the sum of the ratable shares 
for the taxable years during the five-year period does not 
exceed 100 percent of the credit for qualified rehabilitation 
expenditures for the qualified rehabilitated building.

                             Effective Date

    The provision applies to amounts paid or incurred after 
December 31, 2017.
    A transition rule provides that in the case of qualified 
rehabilitation expenditures (for either a certified historic 
structure or a pre-1936 building), with respect to any building 
owned or leased (as provided under prior law) by the taxpayer 
at all times on and after January 1, 2018, the 24-month period 
selected by the taxpayer (section 47(c)(1)(C)(i)), or the 60-
month period selected by the taxpayer under the rule for phased 
rehabilitation (section 47(c)(1)(C)(ii)), is to begin not later 
than the end of the 180-day period beginning on the date of the 
enactment of the Act, and the amendments made by the provision 
apply to such expenditures paid or incurred after the end of 
the taxable year in which such 24-month or 60-month period 
ends.

C. Employer Credit for Paid Family and Medical Leave (sec. 13403 of the 
                   Act and new sec. 45S of the Code)


                               Prior Law

    The Family and Medical Leave Act of 1993, as amended (the 
``FMLA''), generally requires employers to provide employees 
with up to 26 weeks of leave under certain circumstances.\1032\ 
The FMLA does not require that the employer continue to pay 
employees during such leave, although employers may choose to 
pay for all or a portion of such leave. State and local 
governments may provide, or State and local laws may require 
employers to provide, employees with up to a certain amount of 
paid leave for types of leave that may or may not fall under 
the FMLA.
---------------------------------------------------------------------------
    \1032\ Pub. L. No. 103-3 (Feb. 5, 1993); 29 U.S.C. sec. 2601, et 
seq.
---------------------------------------------------------------------------
    Compensation paid to employees during FMLA leave is 
generally deductible as an ordinary and necessary business 
expense. Such compensation constitutes wages taxable to the 
employee for income and employment tax purposes. Although the 
wages may be taken into account in the computation of the 
general business credit \1033\ as part of the computation of 
those credits that are computed with respect to qualified wages 
paid,\1034\ prior law does not otherwise provide a credit to 
employers for compensation paid to employees while on leave.
---------------------------------------------------------------------------
    \1033\ Under section 38 and applicable rules.
    \1034\ See, e.g., sec. 45A (Indian employment credit) and sec. 51 
(work opportunity tax credit).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision temporarily allows ``eligible employers'' to 
claim a general business credit equal to 12.5 percent of the 
amount of eligible wages (based on the normal hourly wage rate) 
\1035\ paid to ``qualifying employees'' during any period in 
which such employees are on ``family and medical leave'' if the 
rate of payment under the program is 50 percent of the wages 
normally paid to an employee for actual services performed for 
the employer. The credit is increased by 0.25 percentage points 
(but not above 25 percent) for each percentage point by which 
the rate of payment exceeds 50 percent. The maximum amount of 
family and medical leave that may be taken into account with 
respect to any qualifying employee for any taxable year is 12 
weeks.
---------------------------------------------------------------------------
    \1035\ Wages for this purpose are Federal Unemployment Tax Act 
wages defined in section 3306(b), without regard to the dollar 
limitation, but do not include amounts taken into account for purposes 
of determining any other credit under subpart D of the Code. A 
technical correction may be necessary to reflect that the wages with 
respect to the credit are limited to the employee's normal hourly wage 
rate and do not include additional amounts, such as a bonus, that could 
be paid during the leave period.
---------------------------------------------------------------------------
    An ``eligible employer'' is one which has in place a 
written policy that allows all qualifying full-time employees 
not less than two weeks of annual paid family and medical 
leave, and which allows all less-than-full-time qualifying 
employees a commensurate amount of leave (on a pro rata basis) 
compared to the leave provided to full-time employees. The 
policy must also provide that the rate of payment under the 
program is not less than 50 percent of the wages normally paid 
to any such employee for services performed for the employer.
    In addition, in order to be an eligible employer, the 
employer is prohibited from certain practices or acts which are 
also prohibited under the FMLA, regardless of whether the 
employer is subject to the FMLA. Specifically, the employer 
must provide paid family and medical leave in compliance with a 
written policy that ensures that the employer will not 
interfere with, restrain, or deny the exercise of or the 
attempt to exercise, any right provided under the policy and 
will not discharge or in any other manner discriminate against 
any individual for opposing any practice prohibited by the 
policy.
    The provision treats all members of an aggregated group 
\1036\ as a single employer, other than for purposes of the 
requirement for an employer to have in place a written policy 
with certain terms.\1037\ In other words, the aggregation rule 
does not prevent an employer within an aggregated group from 
qualifying for the credit notwithstanding that other employers 
within the same aggregated group do not have the required 
written policy. However, the terms (the offer, the actual 
benefit, etc.) of the employer's paid leave cannot be 
discriminatory based on taking into account all employees of 
all employers otherwise treated as a single employer under the 
provision. For example, if employees who earn below a certain 
threshold (such as $20,000 annually) are employed by one or 
more employers within the aggregated group that do not have the 
required written policy in place, while employees earning above 
$20,000 are employed by another employer in the group having 
the required written policy (Employer A), Employer A is not an 
eligible employer. Similarly, if employees are separately 
employed by category or position (such as part-time employees, 
or administrative employees) on a discriminatory basis for 
purposes of providing paid family and medical leave, this 
results in failure to be an eligible employer.
---------------------------------------------------------------------------
    \1036\ Under subsections (a) and (b) of section 52.
    \1037\ A technical correction may be necessary to reflect this 
intent.
---------------------------------------------------------------------------
    A ``qualifying employee'' means any individual who is an 
employee under tax rules and principles and is defined in 
section 3(e) of the Fair Labor Standards Act of 1938,\1038\ as 
amended, who has been employed by the employer for one year or 
more, and who for the preceding year, had compensation not in 
excess of 60 percent of the compensation threshold for highly 
compensated employees.\1039\ For 2018, this 60 percent amount 
is $72,000.
---------------------------------------------------------------------------
    \1038\ Pub. L. No. 75-718 (June 25, 1938); 29 U.S.C. sec. 201, et 
seq.
    \1039\ Sec. 414(q)(1)(B) ($120,000 for 2018).
---------------------------------------------------------------------------
    ``Family and medical leave'' for purposes of new section 
45S is generally defined as leave described under sections 
102(a)(1)(A)-(E) or 102(a)(3) of the FMLA.\1040\ If an employer 
provides paid leave as vacation leave, personal leave, or other 
medical or sick leave \1041\ (unless the medical or sick leave 
is specifically for one or more of the ``family and medical 
leave'' purposes defined above), such paid leave would not be 
considered to be family and medical leave. In addition, leave 
paid for by a State or local government or required by State or 
local law (including such leave required to be paid by the 
employer) is not taken into account in determining the amount 
of paid family and medical leave provided by the employer that 
is eligible for the credit.
---------------------------------------------------------------------------
    \1040\ FMLA section 102(a)(1) provides leave for FMLA purposes due 
to (A) the birth of a son or daughter of the employee and in order to 
care for such son or daughter; (B) the placement of a son or daughter 
with the employee for adoption or foster care; (C) caring for the 
spouse, or a son, daughter, or parent, of the employee, if such spouse, 
son, daughter, or parent has a serious health condition; (D) a serious 
health condition that makes the employee unable to perform the 
functions of the employee's position; (E) any qualifying exigency (as 
the Secretary of Labor shall, by regulation, determine) arising out of 
the fact that the spouse, or a son, daughter, or parent of the employee 
is on covered active duty (or has been notified of an impending call or 
order to covered active duty) in the Armed Forces. In addition, FMLA 
section 102(a)(3) provides leave for FMLA purposes due to the need of 
an employee who is a spouse, son, daughter, parent, or next-of-kin of 
an eligible service member to care for such service member.
    \1041\ These terms mean these types of leave within the meaning of 
FMLA section 102(d)(2).
---------------------------------------------------------------------------
    The Secretary will make determinations as to whether an 
employer or an employee satisfies the applicable requirements 
for an eligible employer or qualifying employee, based on 
information provided by the employer that the Secretary 
determines to be necessary or appropriate.
    The following examples illustrate the operation of the 
interaction between State or local government mandated paid 
leave and the credit. Assume that in each of the examples 1 
through 3 below, a State mandates that an employer provide two 
weeks of family and medical leave at a rate of 50 percent of 
its employees' normal hourly wage rate. For purposes of the 
examples, assume that all other applicable requirements of 
section 45S are met (including that employees are qualifying 
employees) unless otherwise indicated:
    Example 1.--Assume that the employer provides its employees 
with four weeks of paid leave, at 50 percent of the employees' 
normal hourly wage rate. Under this fact pattern, the employer 
would be eligible for a credit of 12.5 percent of the eligible 
wages paid with respect to weeks three and four of paid leave, 
as those payments constitute two weeks of non-mandated paid 
leave at 50 percent of the employees' normal hourly wage rate.
    Example 2.--Assume that the employer provides its employees 
with three weeks of paid leave, at 50 percent of the employees' 
normal hourly wage rate. Under this fact pattern, the employer 
would not be eligible for the credit under section 45S. 
Although the employer pays its employees a total of three 
weeks' compensation at 50 percent of the employees' normal 
hourly wage rate, because the compensation for two of those 
weeks are mandated by State law, under 45S(c)(4), that 
compensation is disregarded for purposes of the credit. Thus, 
the employer provides only one week of non-mandated paid leave 
at 50 percent of its employees' normal hourly wage rate, and 
fails to qualify as an eligible employer under 45S(c)(1)(A).
    Example 3.--Assume that the employer provides its employees 
with two weeks of paid leave, at 100 percent of the employees' 
normal hourly wage rate. Under this fact pattern, the employer 
would be eligible for a credit of 12.5 percent of the eligible 
wages paid with respect to the two weeks of paid leave. The 
employer has provided non-mandated paid leave at 50 percent of 
the employees' normal hourly wage rate for two weeks, and thus 
qualifies for the credit under section 45S. The employer may 
not receive a credit at a rate in excess of 12.5 percent, 
notwithstanding that the total compensation paid to its 
employees on family and medical leave was 100 percent of the 
normal hourly wage rate, because 50 percent of the paid leave 
provided by the employer was mandated by State law.\1042\
---------------------------------------------------------------------------
    \1042\ If this example instead assumed that the State required an 
employer to provide paid leave at a rate of only 40 percent of its 
employees' normal hourly wage rate, then the employer would be eligible 
for a credit based on 15 percent of the employees' wages (as the 
employer would have paid non-State mandated compensation of 60 percent 
of the employees' normal hourly wage rate under this fact pattern). 
Alternatively, if the example instead assumed that the State required 
an employer to pay 60 percent of its employees' normal hourly wage 
rate, the employer could not qualify for the section 45S credit if the 
employer paid its employees 100 percent of their normal hourly wage 
rate (because the amount of non-State mandated paid leave from the 
employer does not equal or exceed 50 percent of the employee's normal 
hourly wage rate).
---------------------------------------------------------------------------
    Example 4.--Assume instead that the State requires only 
that an employer offer four weeks of unpaid family and medical 
leave. If the employer were to provide its employees with two 
weeks of paid leave at 50 percent of its employees' normal 
hourly wage rate, the employer would be eligible for a credit 
of 12.5 percent of the wages paid with respect to those two 
weeks of paid leave, as those payments constitute two weeks of 
non-mandated paid leave at 50 percent of the employees' normal 
hourly wage rate.

    The Treasury Department has issued published guidance 
addressing this provision.\1043\
---------------------------------------------------------------------------
    \1043\ Notice 2018-71, 2018-41 I.R.B.548.
---------------------------------------------------------------------------

                             Effective Date

    The provision is generally effective for wages paid in 
taxable years beginning after December 31, 2017, and before 
January 1, 2020.

 D. Repeal of Tax Credit Bonds (sec. 13404 of the Act and former secs. 
           54A, 54B, 54C, 54D, 54E, 54F and 6431 of the Code)


                               Prior Law


In general

    Tax-credit bonds provide tax credits to investors to 
replace a prescribed portion of the interest cost. The 
borrowing subsidy generally is measured by reference to the 
credit rate set by the Treasury Department. Current tax-credit 
bonds include qualified tax credit bonds, which have certain 
common general requirements, and include new clean renewable 
energy bonds, qualified energy conservation bonds, qualified 
zone academy bonds, and qualified school construction 
bonds.\1044\
---------------------------------------------------------------------------
    \1044\ The authority to issue two other types of tax-credit bonds, 
recovery zone economic development bonds and Build America Bonds, 
expired on January 1, 2011.
---------------------------------------------------------------------------

Qualified tax-credit bonds

                General rules applicable to qualified tax-credit bonds 
                    \1045\
---------------------------------------------------------------------------
    \1045\ Certain other rules apply to qualified tax credit bonds, 
such as maturity limitations, reporting requirements, spending rules, 
and rules relating to arbitrage. Separate rules apply in the case of 
tax-credit bonds which are not qualified tax-credit bonds (i.e., 
``recovery zone economic development bonds,'' and ``Build America 
Bonds'').
---------------------------------------------------------------------------
    Unlike tax-exempt bonds, qualified tax-credit bonds 
generally are not interest-bearing obligations. Rather, the 
taxpayer holding a qualified tax-credit bond on a credit 
allowance date is entitled to a tax credit. The amount of the 
credit is determined by multiplying the bond's credit rate by 
the face amount on the holder's bond. The credit rate for an 
issue of qualified tax credit bonds is determined by the 
Secretary and is estimated to be a rate that permits issuance 
of the qualified tax-credit bonds without discount and interest 
cost to the qualified issuer.\1046\ The credit accrues 
quarterly and is includible in gross income (as if it were an 
interest payment on the bond), and can be claimed against 
regular income tax liability and alternative minimum tax 
liability. Unused credits may be carried forward to succeeding 
taxable years. In addition, credits may be separated from the 
ownership of the underlying bond similar to how interest 
coupons can be stripped for interest-bearing bonds.
---------------------------------------------------------------------------
    \1046\ However, for new clean renewable energy bonds and qualified 
energy conservation bonds, the applicable credit rate is 70 percent of 
the otherwise applicable rate.
---------------------------------------------------------------------------
                New clean renewable energy bonds
    New clean renewable energy bonds (``New CREBs''') may be 
issued by qualified issuers to finance qualified renewable 
energy facilities.\1047\ Qualified renewable energy facilities 
are facilities that: (1) qualify for the tax credit under 
section 45 (other than Indian coal and refined coal production 
facilities), without regard to the placed-in-service date 
requirements of that section; and (2) are owned by a public 
power provider, governmental body, or cooperative electric 
company.
---------------------------------------------------------------------------
    \1047\ Sec. 54C.
---------------------------------------------------------------------------
    The term ``qualified issuers'' includes: (1) public power 
providers; (2) a governmental body; (3) cooperative electric 
companies; (4) a not-for-profit electric utility that has 
received a loan or guarantee under the Rural Electrification 
Act; and (5) clean renewable energy bond lenders. There was 
originally a national limitation for New CREBs of $800 million. 
The national limitation was then increased by an additional 
$1.6 billion in 2009. As with other tax credit bonds, a 
taxpayer holding New CREBs on a credit allowance date is 
entitled to a tax credit. However, the credit rate on New CREBs 
is set by the Secretary at a rate that is 70 percent of the 
rate that would permit issuance of such bonds without discount 
and interest cost to the issuer.\1048\
---------------------------------------------------------------------------
    \1048\ Given the differences in credit quality and other 
characteristics of individual issuers, the Secretary cannot set credit 
rates in a manner that will allow each issuer to issue tax credit bonds 
at par.
---------------------------------------------------------------------------
                Qualified energy conservation bonds
    Qualified energy conservation bonds may be used to finance 
qualified conservation purposes.
    The term ``qualified conservation purpose'' means:
           Capital expenditures incurred for purposes 
        of: (a) reducing energy consumption in publicly owned 
        buildings by at least 20 percent; (b) implementing 
        green community programs; \1049\ (c) rural development 
        involving the production of electricity from renewable 
        energy resources; or (d) any facility eligible for the 
        production tax credit under section 45 (other than 
        Indian coal and refined coal production facilities);
---------------------------------------------------------------------------
    \1049\ Capital expenditures to implement green community programs 
include grants, loans, and other repayment mechanisms to implement such 
programs. For example, States may issue these tax credit bonds to 
finance retrofits of existing private buildings through loans and/or 
grants to individual homeowners or businesses, or through other 
repayment mechanisms. Other repayment mechanisms can include periodic 
fees assessed on a government bill or utility bill that approximates 
the energy savings of energy efficiency or conservation retrofits. 
Retrofits can include heating, cooling, lighting, water-saving, storm 
water-reducing, or other efficiency measures.
---------------------------------------------------------------------------
           Expenditures with respect to facilities or 
        grants that support research in: (a) development of 
        cellulosic ethanol or other nonfossil fuels; (b) 
        technologies for the capture and sequestration of 
        carbon dioxide produced through the use of fossil 
        fuels; (c) increasing the efficiency of existing 
        technologies for producing nonfossil fuels; (d) 
        automobile battery technologies and other technologies 
        to reduce fossil fuel consumption in transportation; 
        and (e) technologies to reduce energy use in buildings;
           Mass commuting facilities and related 
        facilities that reduce the consumption of energy, 
        including expenditures to reduce pollution from 
        vehicles used for mass commuting;
           Demonstration projects designed to promote 
        the commercialization of: (a) green building 
        technology; (b) conversion of agricultural waste for 
        use in the production of fuel or otherwise; (c) 
        advanced battery manufacturing technologies; (d) 
        technologies to reduce peak-use of electricity; and (e) 
        technologies for the capture and sequestration of 
        carbon dioxide emitted from combusting fossil fuels in 
        order to produce electricity; and
           Public education campaigns to promote energy 
        efficiency (other than movies, concerts, and other 
        events held primarily for entertainment purposes).
    There was originally a national limitation on qualified 
energy conservation bonds of $800 million. The national 
limitation was then increased by an additional $2.4 billion in 
2009. As with other qualified tax credit bonds, the taxpayer 
holding qualified energy conservation bonds on a credit 
allowance date is entitled to a tax credit. The credit rate on 
the bonds is set by the Secretary at a rate that is 70 percent 
of the rate that would permit issuance of such bonds without 
discount and interest cost to the issuer.\1050\
---------------------------------------------------------------------------
    \1050\ Given the differences in credit quality and other 
characteristics of individual issuers, the Secretary cannot set credit 
rates in a manner that will allow each issuer to issue tax credit bonds 
at par.
---------------------------------------------------------------------------
            Qualified zone academy bonds
    A qualified zone academy bond (``QZABs'') is defined as any 
bond issued by a State or local government, provided that (1) 
at least 95 percent of the proceeds are used for the purpose of 
renovating, providing equipment to, developing course materials 
for use at, or training teachers and other school personnel in 
a ``qualified zone academy,'' and (2) private entities have 
promised to contribute to the qualified zone academy certain 
equipment, technical assistance or training, employee services, 
or other property or services with a value equal to at least 10 
percent of the bond proceeds.
    A total of $400 million of QZABs has been authorized to be 
issued annually in calendar years 1998 through 2008. The 
authorization was increased to $1.4 billion for calendar year 
2009, and also for calendar year 2010. For each of the calendar 
years 2011 through 2016, the authorization was set at $400 
million.
            Qualified school construction bonds
    Qualified school construction bonds must meet three 
requirements: (1) 100 percent of the available project proceeds 
of the bond issue is used for the construction, rehabilitation, 
or repair of a public school facility or for the acquisition of 
land on which such a bond-financed facility is to be 
constructed; (2) the bonds are issued by a State or local 
government within which such school is located; and (3) the 
issuer designates such bonds as qualified school construction 
bonds.
    There is a national limitation on qualified school 
construction bonds of $11 billion for calendar years 2009 and 
2010, and zero after 2010. If an amount allocated is unused for 
a calendar year, it may be carried forward to the following and 
subsequent calendar years. Under a separate special rule, the 
Secretary of the Interior may allocate $200 million of school 
construction bond authority for Indian schools.

Direct-pay bonds and expired tax-credit bond provisions

    The Code provides that an issuer may elect to issue certain 
tax-credit bonds as ``direct-pay bonds.'' Instead of a credit 
to the holder, with a ``direct-pay bond'' the Federal 
government pays the issuer a percentage of the interest on the 
bonds. The following tax-credit bonds may be issued as direct-
pay bonds: new clean renewable energy bonds, qualified energy 
conservation bonds, and qualified school construction bonds. 
Qualified zone academy bonds may not be issued as direct-pay 
using any national zone academy bond allocation for calendar 
years after 2011 or any carryforward of such allocations. The 
ability to issue Build America Bonds and Recovery Zone bonds, 
which have direct-pay features, expired January 1, 2011.

                        Explanation of Provision

    The provision prospectively repeals authority to issue tax-
credit bonds and direct-pay bonds.

                             Effective Date

    The provision applies to bonds issued after December 31, 
2017.

     PART VI--PROVISIONS RELATED TO SPECIFIC ENTITES AND INDUSTRIES

                   SUBPART A--PARTNERSHIPS PROVISIONS

 A. Treatment of Gain or Loss of Foreign Persons from Sale or Exchange 
 of Interests in Partnerships Engaged in Trade or Business Within the 
 United States (sec. 13501 of the Act and secs. 864(c) and 1446 of the 
                                 Code)

                               Prior Law

In general
    A partnership generally is not treated as a taxable entity, 
but rather, income of the partnership is taken into account on 
the tax returns of the partners. The character (as capital or 
ordinary) of partnership items passes through to the partners 
as if the items were realized directly by the partners.\1051\ A 
partner holding a partnership interest includes in income its 
distributive share (whether or not actually distributed) of 
partnership items of income and gain, including capital gain 
eligible for the lower tax rates, and deducts its distributive 
share of partnership items of deduction and loss. A partner's 
basis in the partnership interest is increased by any amount of 
gain and decreased by any amount of losses thus included. These 
basis adjustments prevent double taxation of partnership income 
to the partner. Money distributed to the partner by the 
partnership is taxed to the extent the amount exceeds the 
partner's basis in the partnership interest.
---------------------------------------------------------------------------
    \1051\ Sec. 702.
---------------------------------------------------------------------------
    Gain or loss from the sale or exchange of a partnership 
interest generally is treated as gain or loss from the sale or 
exchange of a capital asset.\1052\ However, the amount of money 
and the fair market value of property received in the exchange 
that represent the partner's share of certain ordinary income-
producing assets of the partnership give rise to ordinary 
income rather than capital gain.\1053\ In general, a 
partnership does not adjust the basis of partnership property 
following the transfer of a partnership interest unless either 
the partnership has made a one-time election to do so,\1054\ or 
the partnership has a substantial built-in loss immediately 
after the transfer.\1055\ If an election is in effect or the 
partnership has a substantial built-in loss immediately after 
the transfer, adjustments are made with respect to the 
transferee partner. These adjustments are to account for the 
difference between the transferee partner's proportionate share 
of the adjusted basis of the partnership property and the 
transferee partner's basis in its partnership interest.\1056\ 
The effect of the adjustments on the basis of partnership 
property is to approximate the result of a direct purchase of 
the property by the transferee partner.
---------------------------------------------------------------------------
    \1052\ Sec. 741; Pollack v. Commissioner, 69 T.C. 142 (1977).
    \1053\ Sec. 751(a). These ordinary income-producing assets are 
unrealized receivables of the partnership or inventory items of the 
partnership (``751 assets'').
    \1054\ Sec. 754.
    \1055\ Sec. 743(a).
    \1056\ Sec. 743(b).
---------------------------------------------------------------------------
Source of gain or loss on transfer of a partnership interest
    A foreign person that is engaged in a trade or business in 
the United States is taxed on income that is effectively 
connected with the conduct of that trade or business 
(``effectively connected gain or loss'').\1057\ Partners in a 
partnership are treated as engaged in the conduct of a trade or 
business within the United States if the partnership is so 
engaged.\1058\ Any gross income derived by the foreign person 
that is not effectively connected with the person's U.S. 
business is not taken into account in determining the rates of 
U.S. tax applicable to the person's income from the 
business.\1059\
---------------------------------------------------------------------------
    \1057\ Secs. 871(b), 864(c), and 882.
    \1058\ Sec. 875.
    \1059\ Secs. 871(b)(2) and 882(a)(2). Non-business income received 
by foreign persons from U.S. sources is generally subject to tax on a 
gross basis at a rate of 30 percent, and is collected by withholding at 
the source of the payment. The income of non-resident aliens or foreign 
corporations that is subject to tax at a rate of 30 percent is fixed or 
determinable annual or periodical income that is not effectively 
connected with the conduct of a U.S. trade or business.
---------------------------------------------------------------------------
    Among the factors taken into account in determining whether 
income, gain, or loss is effectively connected gain or loss are 
the extent to which the income, gain, or loss is derived from 
assets used in or held for use in the conduct of the U.S. trade 
or business and whether the activities of the trade or business 
were a material factor in the realization of the income, gain, 
or loss (the ``asset-use'' and ``business-activities'' 
tests).\1060\ In determining whether the asset-use or business-
activities tests are met, due regard is given to whether such 
assets or such income, gain, or loss were accounted for through 
such trade or business. Thus, notwithstanding the general rule 
that source of gain or loss from the sale or exchange of 
personal property is generally determined by the residence of 
the seller,\1061\ a foreign partner may have effectively 
connected income by reason of the asset use or business 
activities of the partnership in which he is an investor.
---------------------------------------------------------------------------
    \1060\ Sec. 864(c)(2).
    \1061\ Sec. 865(a).
---------------------------------------------------------------------------
    Special rules apply to treat gain or loss from disposition 
of U.S. real property interests as effectively connected with 
the conduct of a U.S. trade or business.\1062\ To the extent 
that consideration received by the nonresident alien or foreign 
corporation for all or part of its interest in a partnership is 
attributable to a U.S. real property interest, that 
consideration is considered to be received from the sale or 
exchange in the United States of such property.\1063\ In 
certain circumstances, gain attributable to sales of U.S. real 
property interests may be subject to withholding tax of ten 
percent of the amount realized on the transfer.\1064\
---------------------------------------------------------------------------
    \1062\ Sec. 897(a) and (g).
    \1063\ Sec. 897(g).
    \1064\ Sec. 1445(e)(5). Temp. Treas. Reg. sec. 1.1445-11T(b) and 
(d).
---------------------------------------------------------------------------
    Under a 1991 revenue ruling, the IRS ruled that the asset-
use test and business-activities test should be applied to 
partnership assets to determine the extent to which income 
derived from the sale or exchange of a partnership interest is 
effectively connected with the partnership's U.S. 
business.\1065\ Under the ruling, unrealized gain or loss in 
partnership assets that would be treated as effectively 
connected with the conduct of a U.S. trade or business if those 
assets were sold by the partnership is treated as effectively 
connected with the conduct of a U.S. trade or business. The 
ruling thus takes an aggregate approach to taxation of the sale 
of a partnership interest, treating such sale as a sale of the 
separate assets of the partnership rather than as a sale of an 
interest in the entity as a whole.
---------------------------------------------------------------------------
    \1065\ Rev. Rul. 91-32, 1991-1 C.B. 107.
---------------------------------------------------------------------------
    However, a 2017 Tax Court case, Grecian Magnesite Mining v. 
Commissioner, rejected the aggregate approach adopted by the 
ruling and instead held that the rules of subchapter K required 
that sale of a partnership interest be treated as sale of an 
interest in the entity as a whole rather than the sale or 
exchange of the underlying partnership property. Having reached 
that conclusion, the court then concluded that the gain from 
the taxpayer's sale of its partnership interest was income from 
sources outside the United States, did not satisfy any 
exception to the general rule that foreign-source income is not 
ECI, and thus was not effectively connected with the conduct of 
the partnership's trade or business in the United States.\1066\
---------------------------------------------------------------------------
    \1066\ See Grecian Magnesite Mining v. Commissioner, 149 T.C. No. 3 
(July 13, 2017). The IRS filed a notice of appeal with the U.S. Circuit 
Court of Appeals for the District of Columbia on December 18, 2017. 
Grecian Magnesite Mining v. Commissioner, No. 17-1269 (D.C. Cir. Filed 
Dec. 18, 2017). The IRS filed its opening brief in that appeal on June 
8, 2018, Grecian Magnesite filed its brief on July 3, 2018, and the IRS 
filed a reply brief on August 6, 2018. Oral argument in the appeal was 
held on October 9, 2018.
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision overturns the result in Grecian Magnesite by 
treating gain or loss from the sale or exchange of a 
partnership interest as effectively connected with a U.S. trade 
or business to the extent that the transferor would have had 
effectively connected gain or loss had the partnership sold all 
of its assets at fair market value as of the date of the sale 
or exchange.\1067\ The provision requires that any gain or loss 
from the hypothetical asset sale by the partnership be 
allocated to interests in the partnership in the same manner as 
non-separately stated income and loss.\1068\
---------------------------------------------------------------------------
    \1067\ Sec. 864(c)(8)(B).
    \1068\ Ibid.
---------------------------------------------------------------------------
    The provision also requires the transferee of a partnership 
interest to withhold 10 percent of the amount realized on the 
sale or exchange of a partnership interest unless the 
transferor certifies that the transferor is not a nonresident 
alien individual or foreign corporation.\1069\ Congress intends 
that, under regulatory authority provided to carry out 
withholding requirements of the provision, the Secretary may 
provide guidance permitting a broker, as agent of the 
transferee, to deduct and withhold the tax equal to 10 percent 
of the amount realized on the disposition of a partnership 
interest to which the provision applies. If the transferee 
fails to withhold the correct amount, the partnership is 
required to deduct and withhold from distributions to the 
transferee partner an amount equal to the amount the transferee 
failed to withhold.\1070\
---------------------------------------------------------------------------
    \1069\ Sec. 1446(f)(1).
    \1070\ Sec. 1446(f)(4).
---------------------------------------------------------------------------
    The provision provides the Secretary of the Treasury with 
specific regulatory authority to issue such regulations as the 
Secretary determines appropriate for the application of the 
provision.\1071\ Such guidance may identify other exchanges to 
which tax-free exchange treatment may otherwise apply, such as 
those described in sections 332, 351, 354, 355, 356, or 361, 
under comparable provisions of subchapter K, or under such 
other provisions that the Secretary determines 
appropriate.\1072\
---------------------------------------------------------------------------
    \1071\ Secs. 864(c)(8)(E) and 1446(f)(6).
    \1072\ Sec. 864(c)(8)(E).

    The Treasury Department and IRS have issued published 
guidance addressing this provision.\1073\
---------------------------------------------------------------------------
    \1073\ Notice 2018-8, 2018-7 I.R.B. 352 (Jan. 2, 2018); Notice 
2018-29, 2018-16 I.R.B. 495 (Apr. 2, 2018).
---------------------------------------------------------------------------

                             Effective Date

    The portion of the provision treating gain or loss on sale 
of a partnership interest as effectively connected income is 
effective for sales and exchanges on or after November 27, 
2017. The portion of the provision requiring withholding on 
sales or exchanges of partnership interests is effective for 
sales and exchanges after December 31, 2017.

   B. Modify Definition of Substantial Built-in Loss in the Case of 
Transfer of Partnership Interest (sec. 13502 of the Act and sec. 743(d) 
                              of the Code)


                               Prior Law

    In general, a partnership does not adjust the basis of 
partnership property following the transfer of a partnership 
interest unless either the partnership has made a one-time 
election under section 754 to make basis adjustments, or the 
partnership has a substantial built-in loss immediately after 
the transfer.\1074\
---------------------------------------------------------------------------
    \1074\ Sec. 743(a).
---------------------------------------------------------------------------
    If an election is in effect, or if the partnership has a 
substantial built-in loss immediately after the transfer, 
adjustments are made with respect to the transferee partner. 
These adjustments are 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.\1075\ The 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.
---------------------------------------------------------------------------
    \1075\ Sec. 743(b).
---------------------------------------------------------------------------
    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.\1076\ 
Certain securitization partnerships and electing investment 
partnerships are not treated as having a substantial built-in 
loss in certain instances, and thus are not required to make 
basis adjustments to partnership property.\1077\ For electing 
investment partnerships, in lieu of the partnership basis 
adjustments, a partner-level loss limitation rule 
applies.\1078\
---------------------------------------------------------------------------
    \1076\ Sec. 743(d).
    \1077\ See sec. 743(e) (alternative rules for electing investment 
partnerships) and sec. 743(f) (exception for securitization 
partnerships).
    \1078\ Unlike in the case of an electing investment partnership, 
the partner-level loss limitation rule does not apply for a 
securitization partnership.
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision modifies the definition of a substantial 
built-in loss for purposes of section 743(d), affecting 
transfers of partnership interests. Under the provision, in 
addition to the prior- and present-law definition, a 
substantial built-in loss also exists if the transferee would 
be allocated a net loss in excess of $250,000 upon a 
hypothetical disposition by the partnership of all 
partnership's assets in a fully taxable transaction for cash 
equal to the assets' fair market value, immediately after the 
transfer of the partnership interest.
    For example, a partnership of three taxable partners 
(partners A, B, and C) has not made an election pursuant to 
section 754. The partnership has two assets, one of which, 
Asset X, has a built-in gain of $1 million, while the other 
asset, Asset Y, has a built-in loss of $900,000. Pursuant to 
the partnership agreement, any gain on sale or exchange of 
Asset X is specially allocated to partner A. The three partners 
share equally in all other partnership items, including in the 
built-in loss in Asset Y. In this case, each of partner B and 
partner C has a net built-in loss of $300,000 (one third of the 
loss attributable to asset Y) allocable to his partnership 
interest. Nevertheless, the partnership does not have an 
overall built-in loss, but a net built-in gain of $100,000 ($1 
million minus $900,000). Partner C sells his partnership 
interest to another person, D, for $33,333. Under the 
provision, the test for a substantial built-in loss applies 
both at the partnership level and at the transferee partner 
level. If the partnership were to sell all its assets for cash 
at their fair market value immediately after the transfer to D, 
D would be allocated a loss of $300,000 (one third of the 
built-in loss of $900,000 in Asset Y). A substantial built-in 
loss exists under the partner-level test added by the 
provision, and the partnership adjusts the basis of its assets 
accordingly with respect to D.

                             Effective Date

    The provision applies to transfers of partnership interests 
after December 31, 2017.

  C. Charitable Contributions and Foreign Taxes Taken into Account in 
 Determining Limitation on Allowance of Partner's Share of Loss (sec. 
               13503 of the Act and sec. 704 of the Code)


                               Prior Law

    A partner's distributive share of partnership loss 
(including capital loss) is allowed only to the extent of the 
adjusted basis (before reduction by current year's losses) of 
the partner's interest in the partnership at the end of the 
partnership taxable year in which the loss occurred. Any 
disallowed loss is allowable as a deduction at the end of the 
first succeeding partnership taxable year, and subsequent 
taxable years, to the extent that the partner's adjusted basis 
for its partnership interest at the end of any such year 
exceeds zero (before reduction by the loss for the year).\1079\
---------------------------------------------------------------------------
    \1079\ Sec. 704(d) and Treas. Reg. sec. 1.704-1(d)(1).
---------------------------------------------------------------------------
    A partner's basis in its partnership interest is increased 
by its distributive share of income (including tax exempt 
income). A partner's basis in its partnership interest is 
decreased (but not below zero) by distributions by the 
partnership and its distributive share of partnership losses 
and expenditures of the partnership not deductible in computing 
partnership taxable income and not properly chargeable to 
capital account.\1080\ In the case of a charitable 
contribution, a partner's basis is reduced by the partner's 
distributive share of the adjusted basis of the contributed 
property.\1081\
---------------------------------------------------------------------------
    \1080\ Sec. 705(a).
    \1081\ Rev. Rul. 96-11, 1996-1 C. B. 140.
---------------------------------------------------------------------------
    A partnership computes its taxable income in the same 
manner as an individual with certain exceptions. The exceptions 
provide, in part, that the deductions for foreign taxes and 
charitable contributions are not allowed to the 
partnership.\1082\ Instead, a partner takes into account its 
distributive share of the foreign taxes paid by the partnership 
and the charitable contributions made by the partnership for 
the taxable year.\1083\
---------------------------------------------------------------------------
    \1082\ Sec. 703(a)(2)(B) and (C). In addition, section 703(a)(2) 
provides that other deductions are not allowed to the partnership, 
notwithstanding that the partnership's taxable income is computed in 
the same manner as an individual's taxable income, specifically: 
personal exemptions, net operating loss deductions, certain itemized 
deductions for individuals, or depletion.
    \1083\ Sec. 702.
---------------------------------------------------------------------------
    However, in applying the basis limitation on partner 
losses, Treasury regulations do not take into account the 
partner's share of partnership charitable contributions and 
foreign taxes paid or accrued.\1084\ The IRS has taken the 
position in a private letter ruling that the basis limitation 
on partner losses does not apply to limit the partner's 
deduction for its share of the partnership's charitable 
contributions.\1085\ While the regulations relating to the loss 
limitation do not mention the foreign tax credit, a taxpayer 
may choose the foreign tax credit in lieu of deducting foreign 
taxes.\1086\
---------------------------------------------------------------------------
    \1084\ The regulation provides that ``[i]f the partner's 
distributive share of the aggregate of items of loss specified in 
section 702(a)(1), (2), (3), (8) [now (7)], and (9) [now (8)] exceeds 
the basis of the partner's interest computed under the preceding 
sentence, the limitation on losses under section 704(d) must be 
allocated to his distributive share of each such loss.'' The regulation 
does not refer to section 702(a)(4) (charitable contributions) and (6) 
(foreign taxes paid or accrued). Treas. Reg. sec. 1.704-1(d)(2).
    \1085\ Priv. Ltr. Rul. 8405084. See also William S. McKee, William 
F. Nelson and Robert L. Whitmire, Federal Taxation of Partnerships and 
Partners, WG&L, 4th Edition (2011), paragraph 11.05[1][b], p. 11-214 
(noting that the ``failure to include charitable contributions in the 
section 704(d) limitation is an apparent technical flaw in the statute. 
Because of it, a zero-basis partner may reap the benefits of a 
partnership charitable contribution without an offsetting decrease in 
the basis of his interest, whereas a fellow partner who happens to have 
a positive basis may do so only at the cost of a basis decrease'').
    \1086\ Sec. 901.
---------------------------------------------------------------------------
    By contrast, under S corporation rules limiting the losses 
and deductions which may be taken into account by a shareholder 
of an S corporation to the shareholder's basis in stock and 
debt of the corporation, the shareholder's pro rata share of 
charitable contributions and foreign taxes are taken into 
account.\1087\ In the case of charitable contributions, a 
special rule is provided prorating the amount of appreciation 
not subject to the limitation in the case of charitable 
contributions of appreciated property by the S 
corporation.\1088\
---------------------------------------------------------------------------
    \1087\ Sec. 1366(d) and (a)(1). Under a related rule, the 
shareholder's basis in his interest is decreased by the basis (rather 
than the fair market value) of appreciated property by reason of a 
charitable contribution of the property by the S corporation (sec. 
1367(a)(2)).
    \1088\ Sec. 1366(d)(4).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision modifies the basis limitation on partner 
losses to provide that the limitation takes into account a 
partner's distributive share of partnership charitable 
contributions (as defined in section 170(c)) and taxes 
(described in section 901) paid or accrued to foreign countries 
and to possessions of the United States. Thus, the amount of 
the basis limitation on partner losses is decreased to reflect 
these items. In the case of a charitable contribution by the 
partnership, the amount of the basis limitation on partner 
losses is decreased by the partner's distributive share of the 
adjusted basis of the contributed property. In the case of a 
charitable contribution by the partnership of property whose 
fair market value exceeds its adjusted basis, a special rule 
provides that the basis limitation on partner losses does not 
apply to the extent of the partner's distributive share of the 
excess.

                             Effective Date

    The provision applies to partnership taxable years 
beginning after December 31, 2017.

 D. Repeal of Technical Termination of Partnerships (sec. 13504 of the 
                    Act and sec. 708(b) of the Code)


                               Prior Law

    A partnership is considered as terminated under specified 
circumstances.\1089\ Special rules apply in the case of the 
merger, consolidation, or division of a partnership.\1090\
---------------------------------------------------------------------------
    \1089\ Sec. 708(b)(1).
    \1090\ Sec. 708(b)(2). Mergers, consolidations, and divisions of 
partnerships take either an assets-over form or an assets-up form 
pursuant to Treas. Reg. sec. 1.708-1(c).
---------------------------------------------------------------------------
    A partnership is treated as terminated if no part of any 
business, financial operation, or venture of the partnership 
continues to be carried on by any of its partners in a 
partnership.\1091\
---------------------------------------------------------------------------
    \1091\ Sec. 708(b)(1)(A).
---------------------------------------------------------------------------
    A partnership is also treated as terminated if within any 
12-month period, there is a sale or exchange of 50 percent or 
more of the total interest in partnership capital and 
profits.\1092\ This is sometimes referred to as a technical 
termination. Under regulations, the technical termination gives 
rise to a deemed contribution of all the partnership's assets 
and liabilities to a new partnership in exchange for an 
interest in the new partnership, followed by a deemed 
distribution of interests in the new partnership to the 
purchasing partners and the other remaining partners.\1093\
---------------------------------------------------------------------------
    \1092\ Sec. 708(b)(1)(B).
    \1093\ Treas. Reg. sec. 1.708-1(b)(4).
---------------------------------------------------------------------------
    The effect of a technical termination is not necessarily 
the end of the partnership's existence, but rather the 
termination of some tax attributes. Upon a technical 
termination, the partnership's taxable year closes, potentially 
resulting in short taxable years.\1094\ Partnership-level 
elections generally cease to apply following a technical 
termination.\1095\ A technical termination generally results in 
the restart of partnership depreciation recovery periods.
---------------------------------------------------------------------------
    \1094\ Sec. 706(c)(1); Treas. Reg. sec. 1.708-1(b)(3).
    \1095\ Partnership level elections include, for example, the 
section 754 election to adjust basis on a transfer or distribution, as 
well as other elections that determine the partnership's tax treatment 
of partnership items. A list of elections can be found at William S. 
McKee, William F. Nelson, and Robert L. Whitmire, Federal Taxation of 
Partnerships and Partners, 4th edition, para. 9.01[7], pp. 9-42-9-44.
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision repeals the section 708(b)(1)(B) rule 
providing for technical terminations of partnerships. The 
provision does not change the prior- and present-law rule of 
section 708(b)(1)(A) that a partnership is considered as 
terminated if no part of any business, financial operation, or 
venture of the partnership continues to be carried on by any of 
its partners in a partnership.

                             Effective Date

    The provision applies to partnership taxable years 
beginning after December 31, 2017.

                      SUBPART B--INSURANCE REFORMS


A. Net Operating Losses of Life Insurance Companies (sec. 13511 of the 
                     Act and sec. 805 of the Code)


                               Prior Law

    A net operating loss (``NOL'') generally means the amount 
by which a taxpayer's business deductions exceed its gross 
income. In general, an NOL may be carried back two years and 
carried over 20 years to offset taxable income in such years. 
NOLs offset taxable income in the order of the taxable years to 
which the NOL may be carried.\1096\
---------------------------------------------------------------------------
    \1096\ Sec. 172(b)(2).
---------------------------------------------------------------------------
    For purposes of computing the alternative minimum tax 
(``AMT''), a taxpayer's NOL deduction cannot reduce the 
taxpayer's alternative minimum taxable income (``AMTI'') by 
more than 90 percent of the AMTI.\1097\
---------------------------------------------------------------------------
    \1097\ Sec. 56(d).
---------------------------------------------------------------------------
    In the case of a life insurance company, a deduction is 
allowed in the taxable year for operations loss carryovers and 
carrybacks, in lieu of the deduction for net operating losses 
allowed to other corporations.\1098\ A life insurance company 
is permitted to treat a loss from operations (as defined under 
section 810(c)) for any taxable year as an operations loss 
carryback to each of the three taxable years preceding the loss 
year and an operations loss carryover to each of the 15 taxable 
years following the loss year.\1099\
---------------------------------------------------------------------------
    \1098\ Secs. 810, 805(a)(5).
    \1099\ Sec. 810(b)(1). Special rules apply with respect to a new 
company as defined in section 810(e).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision repeals the operations loss deduction for 
life insurance companies and allows the NOL deduction under 
section 172, effective for losses arising in taxable years 
beginning after December 31, 2017. Thus, an NOL of a life 
insurance company arising in a taxable year beginning after 
December 31, 2017, is carried over (and not carried back) and 
is subject to a limitation on deductibility based on 80 percent 
of taxable income (determined without regard to certain 
deductions) under the NOL rules.\1100\ Because the provision 
applies to losses arising in taxable years beginning after 
December 31, 2017, operations loss carryovers from taxable 
years beginning on or before December 31, 2017, are allowed as 
deductions in taxable years beginning after December 31, 2017, 
in accordance with section 810 as in effect before its repeal 
by the Act. For example, in the case of an operations loss of a 
life insurance company arising in a taxable year beginning in 
2017, the 15-year carryforward limitation under the law in 
effect for the year in which the loss arose continues to apply 
to the loss. Such losses may expire if not used within the 15-
year carryforward period.
---------------------------------------------------------------------------
    \1100\ See sec. 172. For a discussion of the changes made by the 
Act to section 172, see the description of section 13302 of the Act 
(Modification of Net Operating Loss Deduction).
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to losses arising in taxable years 
beginning after December 31, 2017.

B. Repeal of Small Life Insurance Company Deduction (sec. 13512 of the 
                  Act and former sec. 806 of the Code)


                               Prior Law

    The small life insurance company deduction for any taxable 
year is 60 percent of so much of the tentative life insurance 
company taxable income (``LICTI'') for such taxable year as 
does not exceed $3 million, reduced (but not below zero) by 15 
percent of the excess of tentative LICTI over $3 million. The 
maximum deduction that can be claimed by a small company is 
$1.8 million, and a company with a tentative LICTI of $15 
million or more is not entitled to any small company deduction. 
A small life insurance company for this purpose is one with 
less than $500 million of assets.

                        Explanation of Provision

    The provision repeals the small life insurance company 
deduction.
    The provision makes a conforming amendment, moving to 
section 453B(e)(3) (relating to installment sales) the prior- 
and present-law rule regarding the treatment of a real estate 
activity that constitutes the active conduct of a trade or 
business and of performance of administrative services in 
connection with certain plans.
    The repeal of section 806(b)(3)(C) as part of the repeal of 
section 806 does not alter the applicability of limitations 
under section 1503(c) relating to the use of certain losses 
against income of life insurance companies. Thus, limitations 
under section 1503(c) continue to apply.

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

 C. Adjustment for Change in Computing Reserves (sec. 13513 of the Act 
                      and sec. 807(f) of the Code)


                               Prior Law


Change in method of accounting

    In general, a taxpayer may change its method of accounting 
under section 446 with the consent of the Secretary (or may be 
required to change its method of accounting by the Secretary). 
In such instances, a taxpayer generally is required to make an 
adjustment (a ``section 481(a) adjustment'') to prevent amounts 
from being duplicated in, or omitted from, the calculation of 
the taxpayer's income. Pursuant to IRS procedures, negative 
section 481(a) adjustments generally are deducted from income 
in the year of the change whereas positive section 481(a) 
adjustments generally are required to be included in income 
ratably over four taxable years.\1101\
---------------------------------------------------------------------------
    \1101\ See, e.g., Rev. Proc. 2015-13, 2015-5 I.R.B. 419, and Rev. 
Proc. 2017-30, 2017-18 I.R.B. 1131.
---------------------------------------------------------------------------
    However, section 807(f) explicitly provides that changes in 
the basis for determining life insurance company reserves are 
to be taken into account ratably over 10 years.

10-year spread for change in computing life insurance company reserves

    For Federal income tax purposes, a life insurance company 
includes in gross income any net decrease in reserves, and 
deducts a net increase in reserves.\1102\ Methods for 
determining reserves for tax purposes generally are based on 
reserves prescribed by the National Association of Insurance 
Commissioners for purposes of financial reporting under State 
regulatory rules.
---------------------------------------------------------------------------
    \1102\ Sec. 807.
---------------------------------------------------------------------------
    Income or loss resulting from a change in the method of 
computing reserves is taken into account ratably over a 10-year 
period.\1103\ The rule for a change in basis in computing 
reserves applies only if there is a change in basis in 
computing the Federally prescribed reserve (as distinguished 
from the net surrender value). Although life insurance tax 
reserves require the use of a Federally prescribed method, 
interest rate, and mortality or morbidity table, changes in 
other assumptions for computing statutory reserves (e.g., when 
premiums are collected and claims are paid) may cause increases 
or decreases in a company's life insurance reserves that must 
be spread over a 10-year period. Changes in the net surrender 
value of a contract are not subject to the 10-year spread 
because, apart from its use as a minimum in determining the 
amount of life insurance tax reserves, the net surrender value 
is not a reserve but a current liability.
---------------------------------------------------------------------------
    \1103\ Sec. 807(f).
---------------------------------------------------------------------------
    If for any taxable year the taxpayer is not a life 
insurance company, the balance of any adjustments to reserves 
is taken into account for the preceding taxable year.

                        Explanation of Provision

    A change in the basis for computing life insurance reserves 
or any other item referred to in section 807(c) in a taxable 
year is taken into account under section 481 as an adjustment 
attributable to a change in method of accounting initiated by 
the taxpayer and made with the consent of the Secretary. The 
prior-law 10-year spread rule to account for such a change is 
repealed. Thus, income or loss resulting from a change in 
method of computing life insurance company reserves is taken 
into account consistent with IRS procedures, generally ratably 
over a four-year period, instead of over a 10-year period.
    Consistent with IRS procedures, a company that makes a 
change in method of computing life insurance company reserves 
is required to comply with procedures for automatic method 
changes \1104\ and is required to report and file such 
statements and other information as the Secretary requires 
\1105\ under those procedures.
---------------------------------------------------------------------------
    \1104\ Because the change is treated as initiated by the taxpayer 
and made with the consent of the Secretary, the procedures for 
automatic method changes apply. Procedures for automatic method changes 
are set forth in Rev. Proc. 2018-31, 2018-22 I.R.B. 637.
    \1105\ Thus, the company is required to file Form 3115, for 
example.
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

 D. Repeal of Special Rule for Distributions to Shareholders from Pre-
 1984 Policyholders Surplus Account (sec. 13514 of the Act and former 
                         sec. 815 of the Code)


                               Prior Law

    Under the Federal tax law in effect from 1959 through 1983, 
a life insurance company was subject to a three-phase taxable 
income computation. 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). For 
stock insurance companies, 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.\1106\
---------------------------------------------------------------------------
    \1106\ Former sec. 815. The policyholders surplus account was also 
reduced by the amount of tax paid on distributions from the account. 
The additional reduction in the account was subject to tax. A 
distribution from a policyholders surplus account was subject to tax 
regardless of whether life insurance company taxable income was 
positive or negative, so that the taxable amount was not offset by a 
current operations loss. Former sec. 815(d) and (f).
---------------------------------------------------------------------------
    The Deficit Reduction Act of 1984 \1107\ 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.\1108\
---------------------------------------------------------------------------
    \1107\ Pub. L. No. 98-369.
    \1108\ 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. Prior law for 1984 and 
later years (like pre-1984 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.
    For 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 were 
suspended.\1109\ Distributions in those years were 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.
---------------------------------------------------------------------------
    \1109\ Former sec. 815(g).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision repeals section 815, the rules imposing 
income tax on distributions to shareholders from the 
policyholders surplus account of a stock life insurance 
company.
    In the case of any stock life insurance company with an 
existing policyholders surplus account (as defined in section 
815 before its repeal), tax is imposed on the balance of the 
account as of the close of the company's last taxable year 
beginning before January 1, 2018. A life insurance company is 
required to pay tax on the balance of the account ratably over 
the first eight taxable years beginning after December 31, 
2017. Specifically, the tax imposed on a life insurance company 
is the tax on the sum of life insurance company taxable income 
for the taxable year (but not less than zero) plus 1/8 of the 
balance of the existing policyholders surplus account as of 
December 31, 2017. Thus, life insurance company losses are not 
allowed to offset the amount of the policyholders surplus 
account balance subject to tax.
    For example, assume a company has a policyholders surplus 
account balance of $64 as of December 31, 2017 (the end of its 
taxable year). For its 2018 taxable year, the company has a 
loss of $4. Under the provision, the company has an income 
inclusion for 2018 of $8 (that is, 1/8 of its $64 balance) and 
a $4 net operating loss carryforward to its next taxable year. 
For its 2019 taxable year, the company has a loss of $2 (after 
taking into account the loss carryforward under the rules of 
section 172) and also has a tax credit of $1. Under the 
provision, the company has an income inclusion for 2019 of $8 
(that is, 1/8 of $64), a $2 net operating loss carryforward to 
its next taxable year, and a $1 general business credit 
carryforward.\1110\
---------------------------------------------------------------------------
    \1110\ A technical correction may be needed to clarify that the 
income inclusion under the provision may not be offset by a credit.
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

E. Modification of Proration Rules for Property and Casualty Insurance 
     Companies (sec. 13515 of the Act and sec. 832(b) of the Code)


                               Prior Law

    The taxable income of a property and casualty insurance 
company is determined as the sum of its gross income from 
underwriting income and investment income (as well as gains and 
other income items), reduced by allowable deductions.\1111\ 
Underwriting income means the premiums earned on insurance 
contracts during the taxable year reduced by losses incurred 
and expenses incurred. The amount of losses incurred takes into 
account the change during the taxable year in unpaid losses on 
life insurance contracts (if any) plus discounted unpaid losses 
of the property and casualty insurance company.
---------------------------------------------------------------------------
    \1111\ Sec. 832.
---------------------------------------------------------------------------
    A proration rule applies to property and casualty insurance 
companies. A property and casualty insurance company must 
reduce the amount of its deduction for losses incurred by 15 
percent of (1) the insurer's tax-exempt interest, (2) the 
deductible portion of dividends received (with special rules 
for dividends from affiliates), and (3) the increase for the 
taxable year in the cash value of life insurance, endowment, or 
annuity contracts the company owns.\1112\ This proration rule 
reflects the fact that reserves are generally funded in part 
from tax-exempt interest, from deductible dividends, and from 
other untaxed amounts.\1113\
---------------------------------------------------------------------------
    \1112\ Sec. 832(b)(5).
    \1113\ See H.R. Rep. 99-426, Tax Reform Act of 1985, Report of the 
Committee on Ways and Means, House of Representatives, on H.R. 3838, 
December 7, 1985, page 670 (Reasons for Change). The Conference 
Agreement adopted the House bill provision with modifications. See H.R. 
Rep. 99-841, Tax Reform Act of 1986, Conference Report to Accompany 
H.R. 3838, September 18, 1986, pp. 356-7.
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision replaces the 15-percent reduction under prior 
law \1114\ with a reduction equal to 5.25 percent divided by 
the top corporate tax rate. The top corporate tax rate is 21 
percent for 2018 and thereafter,\1115\ so the percentage 
reduction is 25 percent under the proration rule for property 
and casualty insurance companies. The proration percentage will 
be automatically adjusted in the future if the highest 
corporate tax rate is changed, so that the product of the 
proration percentage and the highest corporate tax rate always 
equals 5.25 percent.
---------------------------------------------------------------------------
    \1114\ The product of the prior-law 15-percent proration percentage 
and the prior-law highest corporate tax rate of 35 percent equals 5.25 
percent.
    \1115\ See the description of section 13001 of the Act (21-Percent 
Corporate Tax Rate).
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

F. Repeal of Special Estimated Tax Payments (sec. 13516 of the Act and 
                      former sec. 847 of the Code)


                               Prior Law


Allowance of additional deduction and establishment of special loss 
        discount account

    Prior law allows an insurance company required to discount 
its unpaid loss reserves an additional deduction that is not to 
exceed the excess of (1) the amount of the undiscounted unpaid 
losses over (2) the amount of the related discounted unpaid 
losses, to the extent the amount was not deducted in a 
preceding taxable year.\1116\ The provision imposes the 
requirement that a special loss discount account be established 
and maintained, and that special estimated tax payments be 
made. Unused amounts of special estimated tax payments are 
treated as a section 6655 estimated tax payment for the 16th 
year after the year for which the special estimated tax payment 
was made.
---------------------------------------------------------------------------
    \1116\ Sec. 847.
---------------------------------------------------------------------------
    The total payments by a taxpayer, including section 6655 
estimated tax payments and other tax payments, together with 
special estimated tax payments made under this provision, are 
generally the same as the total tax payments that the taxpayer 
would make if the taxpayer did not elect to have this provision 
apply, except to the extent amounts can be refunded under the 
provision in the 16th year.

Calculation of special estimated tax payments based on tax benefit 
        attributable to deduction

    More specifically, prior law imposes a requirement that the 
taxpayer make special estimated tax payments in an amount equal 
to the tax benefit attributable to the additional deduction 
allowed under the provision. If amounts are included in gross 
income as a result of a reduction in the taxpayer's special 
loss discount account or the liquidation or termination of the 
taxpayer's insurance business, and an additional tax is due for 
any year as a result of the inclusion, then an amount of the 
special estimated tax payments equal to such additional tax is 
applied against such additional tax. If there is an adjustment 
reducing the amount of additional tax against which the special 
estimated tax payment was applied, then in lieu of any credit 
or refund for the reduction, a special estimated tax payment is 
treated as made in an amount equal to the amount that would 
otherwise be allowable as a credit or refund.
    The amount of the tax benefit attributable to the deduction 
is to be determined (under Treasury regulations (which have not 
been promulgated)) by taking into account tax benefits that 
would arise from the carryback of any net operating loss for 
the year as well as current year benefits. In addition, tax 
benefits for the current and carryback years are to take into 
account the benefit of filing a consolidated return with 
another insurance company without regard to the consolidation 
limitations imposed by section 1503(c).
    The taxpayer's estimated tax payments under section 6655 
are to be determined without regard to the additional deduction 
allowed under this provision and the special estimated tax 
payments. Legislative history \1117\ indicates that it is 
intended that the taxpayer may apply the amount of an 
overpayment of any section 6655 estimated tax payments for the 
taxable year against the amount of the special estimated tax 
payment required under this provision. The special estimated 
tax payments under this provision are not treated as estimated 
tax payments for purposes of section 6655 (e.g., for purposes 
of calculating penalties or interest on underpayments of 
estimated tax) when such special estimated tax payments are 
made.
---------------------------------------------------------------------------
    \1117\ See H.R. Rep. No. 100-1104, Conference Report to accompany 
H.R. 4333, the Technical and Miscellaneous Revenue Act of 1988, October 
21, 1988, p. 174.
---------------------------------------------------------------------------

Refundable amount

    To the extent that a special estimated tax payment is not 
used to offset additional tax due for any of the first 15 
taxable years beginning after the year for which the payment 
was made, such special estimated tax payment is treated as an 
estimated tax payment made under section 6655 for the 
16th year after the year for which the special 
estimated tax payment was made. If the amount of such deemed 
section 6655 payment, together with the taxpayer's other 
payments credited against tax liability for such 
16th year, exceeds the tax liability for such year, 
then the excess (up to the amount of the deemed section 6655 
payment) may be refunded to the taxpayer to the same extent 
provided under prior law with respect to overpayments of tax.

Regulatory authority

    In addition to the regulatory authority to adjust the 
amount of special estimated tax payments in the event of a 
change in the corporate tax rate, authority is provided to 
Treasury to prescribe regulations necessary or appropriate to 
carry out the purposes of the provision.
    Regulations have not been promulgated under section 847.

                        Explanation of Provision

    The provision repeals section 847. Thus, the election to 
apply section 847, the additional deduction, special loss 
discount account, special estimated tax payment, and refundable 
amount rules of prior law are eliminated.
    The entire balance of an existing account is included in 
income of the taxpayer for the first taxable year beginning 
after 2017, and the entire amount of existing special estimated 
tax payments are applied against the amount of additional tax 
attributable to this inclusion. Any special estimated tax 
payments in excess of this amount are treated as estimated tax 
payments under section 6655.

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

 G. Computation of Life Insurance Tax Reserves (sec. 13517 of the Act 
                       and sec. 807 of the Code)


                        Prior Law and Background


In general

    In determining life insurance company taxable income, a 
life insurance company includes in gross income any net 
decrease in reserves, and deducts a net increase in 
reserves.\1118\ Methods for determining reserves for tax 
purposes generally are based on reserves prescribed by the 
National Association of Insurance Commissioners (``NAIC'') for 
purposes of financial reporting under State laws and State 
insurance regulatory rules (known as annual statements).
---------------------------------------------------------------------------
    \1118\ Sec. 807.
---------------------------------------------------------------------------
    For Federal income tax purposes, in computing the net 
increase or net decrease in reserves, six items are taken into 
account. These are: (1) life insurance reserves; (2) unearned 
premiums and unpaid losses included in total reserves; (3) 
amounts that are discounted at interest to satisfy obligations 
under insurance and annuity contracts that do not involve life, 
accident, or health contingencies when the computation is made; 
(4) dividend accumulations and other amounts held at interest 
in connection with insurance and annuity contracts; (5) 
premiums received in advance and liabilities for premium 
deposit funds; and (6) reasonable special contingency reserves 
under contracts of group term life insurance or group accident 
and health insurance that are held for retired lives, premium 
stabilization, or a combination of both. No deduction for asset 
adequacy reserves or deficiency reserves is allowed.
    Life insurance reserves are amounts set aside to mature or 
liquidate future unaccrued claims arising from life insurance, 
annuity, and noncancellable accident and health insurance 
contracts involving, at the time with respect to which the 
reserve is computed, life, accident, or health 
contingencies.\1119\ Additional requirements also apply to life 
insurance reserves.\1120\
---------------------------------------------------------------------------
    \1119\ Sec. 816(b)(1)(B).
    \1120\ See secs. 816(b)(1)(A), 816(b)(2), and 816(h).
---------------------------------------------------------------------------
    The amount of life insurance reserves for any contract is 
the greater of the net surrender value of the contract or the 
reserves determined under Federally prescribed rules, but may 
not exceed the statutory reserve with respect to the contract 
(for regulatory reporting). In computing the Federally 
prescribed reserve for any type of contract, the taxpayer must 
use the tax reserve method applicable to the contract, an 
interest rate for discounting of reserves to take account of 
the time value of money, and the prevailing commissioners' 
standard tables for mortality or morbidity.

Interest rate

    The assumed interest rate to be used in computing the 
Federally prescribed reserve is the greater of the applicable 
Federal interest rate or the prevailing State assumed interest 
rate. The applicable Federal interest rate is the annual rate 
determined by the Secretary under the discounting rules for 
property and casualty reserves for the calendar year in which 
the contract is issued. The prevailing State assumed interest 
rate is generally the highest assumed interest rate permitted 
to be used in at least 26 States in computing life insurance 
reserves for insurance or annuity contracts of that type as of 
the beginning the calendar year in which the contract is 
issued. In determining the highest assumed rates permitted in 
at least 26 States, each State is treated as permitting the use 
of every rate below its highest rate.
    A one-time election is permitted (revocable only with the 
consent of the Secretary) to apply an updated applicable 
Federal interest rate every five years in calculating life 
insurance reserves. The election is provided to take account of 
the fluctuations in market rates of return that companies 
experience with respect to life insurance contracts of long 
duration. The use of the updated applicable Federal interest 
rate under the election does not cause the recalculation of 
life insurance reserves for any prior year. Under the election 
no change is made to the interest rate used in determining life 
insurance reserves if the updated applicable Federal interest 
rate is less than one-half of one percentage point different 
from the rate used by the company in calculating life insurance 
reserves during the preceding five years.

Development of principle-based reserving for insurance regulatory 
        purposes

    In 2012, the NAIC established a task force to develop State 
regulatory insurance reserving methodology that takes into 
account a wide range of future economic conditions (a 
stochastic approach referred to as principle-based reserving or 
``PBR''). The PBR approach would supplement or replace static 
formulas and assumptions for determining reserves as prescribed 
by then-existing State laws (a deterministic or a formulaic 
approach). Starting in 2017, a Valuation Manual that includes 
PBR requirements became operative.\1121\ By October, 2017, 
legislatures of 47 States had enacted legislation relating to 
PBR insurance reserves for State regulatory purposes. The NAIC 
has adopted revised insurance company accreditation standards 
to become effective Jan. 1, 2020; until then, generally, PBR 
methodology for State insurance regulatory purposes is optional 
for many types of insurance contracts issued by life 
insurers.\1122\
---------------------------------------------------------------------------
    \1121\ The Valuation Manual sets forth requirements for insurance 
regulatory reserves. National Association of Insurance Commissioners, 
Valuation Manual, January 1, 2018 Edition, VM-20, Requirements for 
Principle-Based Reserves for Life Products, and VM-21, Requirements for 
Principle-Based Reserves for Variable Annuities, https://www.naic.org/
documents/prod_serv_2018_valuation_manual.pdf.
    \1122\ National Association of Insurance Commissioners Center for 
Insurance Policy and Research, The National System of State Regulation 
and Principle-Based Reserving, July 12, 2018, https://www.naic.org/
cipr_topics/principle_based_reserving_pbr.htm.
---------------------------------------------------------------------------

                        Explanation of Provision

    For purposes of determining the deduction for increases in 
certain reserves of a life insurance company, the amount of the 
life insurance reserves for any contract (other than certain 
variable contracts) is the greater of (1) the net surrender 
value of the contract (if any), or (2) 92.81 percent of the 
amount determined using the tax reserve method applicable to 
the contract as of the date the reserve is determined.\1123\
---------------------------------------------------------------------------
    \1123\ Sec. 807(d)(1)(A).
---------------------------------------------------------------------------
    In the case of a variable contract, the amount of life 
insurance reserves for the contract is the sum of (1) the 
greater of (a) the net surrender value of the contract, or (b) 
the separate-account reserve amount under section 817 for the 
contract, plus (2) 92.81 percent of the excess (if any) of the 
amount determined using the tax reserve method applicable to 
the contract as of the date the reserve is determined over the 
amount determined in (1).\1124\
---------------------------------------------------------------------------
    \1124\ Sec. 807(d)(1)(B).
---------------------------------------------------------------------------
    In no event shall the amount of life insurance reserve 
exceed the amount of the annual statement reserve.\1125\ As 
under prior law, no deduction for asset adequacy reserves or 
deficiency reserves is allowed.\1126\
---------------------------------------------------------------------------
    \1125\ Sec. 807(d)(1)(C).
    \1126\ See sec. 816(h). As under prior law, life insurance reserves 
are amounts set aside to mature or liquidate future unaccrued claims 
arising from life insurance, annuity, and noncancellable accident and 
health insurance contracts involving, at the time with respect to which 
the reserve is computed, life, accident, or health contingencies. Sec. 
816(b)(1)(B).
---------------------------------------------------------------------------
    Consistent with the purpose of the provision to accommodate 
the NAIC-prescribed principle-based reserve methodology and to 
provide for a tax reserve amount that is simpler, more 
transparent, and easier to compute than under prior law, the 
provision provides for a percentage reduction to address the 
inconsistency of insurance regulatory accounting with accurate 
measurement of income for Federal income tax purposes. Under 
NAIC-prescribed principle-based reserve methodology in effect 
at the time of the enactment of the provision, principle-base 
reserves for any contract do not include any asset adequacy 
reserve component.\1127\ Therefore, no asset adequacy reserve-
related reduction to the NAIC-prescribed PBR reserves as then 
in effect is necessary or required before applying the 
percentage reduction in computing tax reserves.
---------------------------------------------------------------------------
    \1127\ National Association of Insurance Commissioners Statutory 
Issue Paper No. 154, Implementation of Principle-Based Reserving, 
finalized December 10, 2016, https://www.naic.org/sap_app_updates/
documents/154_a.pdf (IP No. 154). IP No. 154 states at page IP154-4, 
``Asset adequacy testing is an existing requirement which functions as 
an additional check of reserve adequacy by reviewing to ensure that 
assets will be sufficient and available to meet reserving obligations 
as claims become due. No changes were recommended . . . because asset 
adequacy testing under the Actuarial Opinion and Memorandum Regulation 
(Model #822) have [sic] not changed.'' The Actuarial Opinion and 
Memorandum Regulation (Model #822) indicates or implies that asset 
adequacy reserves are to be separately stated and held as an additional 
reserve for insurance regulatory reporting purposes, stating at page 
822-3 (section 5.E.2), ``If the appointed actuary determines as the 
result of asset adequacy analysis that a reserve should be held in 
addition to the aggregate reserve held by the company and calculated in 
accordance with methods set forth in the Standard Valuation Law, the 
company shall establish the additional reserve.''
---------------------------------------------------------------------------
    For example, an insurance company issues life insurance 
contracts in 2018. The annual statement reserve for the 
contracts can be determined under an NAIC-prescribed PBR method 
in effect in 2018.\1128\ Because the principle-based reserve 
for the contracts includes no asset adequacy reserve component, 
no asset adequacy reserve-related reduction is necessary before 
applying 92.81 percent to determine the tax reserve for the 
contracts. However, as under prior law, asset adequacy reserves 
or deficiency reserves remain nondeductible for Federal income 
tax purposes. If a tax reserve method currently or in the 
future (whether prescribed by the NAIC,\1129\ or consistent 
with the section 807 tax reserve method \1130\) includes an 
amount, such as an asset adequacy reserve, deficiency reserve, 
or other reserve or amount that is not deductible for Federal 
income tax purposes, the reserve amount is reduced by the 
nondeductible amount before applying the percentage reduction 
under section 807.
---------------------------------------------------------------------------
    \1128\ Use of the PBR methodology is optional in some cases until 
2020.
    \1129\ Sec. 807(d)(3)(A)(iv)(I).
    \1130\ Sec. 807(d)(3)(A)(iv)(II).
---------------------------------------------------------------------------
    A no-double-counting rule provides that no amount or item 
is taken into account more than once in determining any reserve 
under subchapter L of the Code.\1131\ For example, an amount 
taken into account in determining a loss reserve under section 
807 may not be taken into account again in determining a loss 
reserve under section 832. Similarly, a loss reserve determined 
under the tax reserve method (whether the Commissioners Reserve 
Valuation Method, the Commissioner's Annuity Reserve Valuation 
Method, a principle-based reserve method, or another method 
developed in the future, that is prescribed for a type of 
contract by the National Association of Insurance 
Commissioners) may not again be taken into account in 
determining the portion of the reserve that is separately 
accounted for under section 817 or be included also in 
determining the net surrender value of a contract. The 
provision provides reserve rules for supplemental benefits and 
retains prior-law rules regarding certain contracts issued by 
foreign branches of domestic life insurance companies.
---------------------------------------------------------------------------
    \1131\ Sec. 807(d)(1)(D).
---------------------------------------------------------------------------
    The provision requires the Secretary to provide for 
reporting (at such time and in such manner as the Secretary 
shall prescribe) with respect to the opening balance and 
closing balance or reserves and with respect to the method of 
computing reserves for purposes of determining income.\1132\ 
For this purpose, the Secretary may require that a life 
insurance company (including an affiliated group filing a 
consolidated return that includes a life insurance company) is 
required to report each of the line item elements of each 
separate account by combining them with each such item from all 
other separate accounts and the general account, and to report 
the combined amounts on a line-by-line basis on the taxpayer's 
return. Similarly, the Secretary may in such guidance provide 
that reporting on a separate account by separate account basis 
is generally not permitted. Under existing regulatory 
authority, if the Secretary determines it is necessary in order 
to carry out and enforce this provision, the Secretary may 
require e-filing or comparable filing of the return on magnetic 
media or other machine readable form, and may require that the 
taxpayer provide its annual statement via a link, electronic 
copy, or other similar means.
---------------------------------------------------------------------------
    \1132\ Sec. 807(e)(6).
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017. For the first taxable year beginning after 
December 31, 2017, the difference in the amount of the reserve 
with respect to any contract at the end of the preceding 
taxable year and the amount of such reserve determined as if 
the proposal had applied for that year is taken into account in 
determining income for each of the eight taxable years 
following that preceding year, one-eighth per year.

 H. Modification of Rules for Life Insurance Proration for Purposes of 
Determining the Dividends Received Deduction (sec. 13518 of the Act and 
                         sec. 812 of the Code)


                               Prior Law


Reduction of reserve deduction and dividends received deduction to 
        reflect untaxed income

    A life insurance company is subject to proration rules in 
calculating life insurance company taxable income.
    The proration rules reduce the company's deductions, 
including reserve deductions and dividends received deductions, 
if the life insurance company has tax-exempt income, deductible 
dividends received, or other similar untaxed income items, 
because deductible reserve increases can be viewed as being 
funded proportionately out of taxable and tax-exempt income.
    Under the proration rules, the net increase and net 
decrease in reserves (for purposes of computing life insurance 
company taxable income) are adjusted by reducing the ending 
balance of the reserve items by the policyholders' share of 
tax-exempt interest and by the policyholders' share of the 
increase for the taxable year in policy cash values of life 
insurance policies and annuity and endowment contracts.\1133\
---------------------------------------------------------------------------
    \1133\ Secs. 807(a)(2)(B) and (b)(1)(B).
---------------------------------------------------------------------------
    Similarly, under the proration rules, a life insurance 
company is allowed a dividends-received deduction for 
intercorporate dividends from nonaffiliates only in proportion 
to the company's share of such dividends,\1134\ but not for the 
policyholders' share. Fully deductible dividends from 
affiliates are excluded from the application of this proration 
formula, if such dividends are not themselves distributions 
from tax-exempt interest or from dividend income that would not 
be fully deductible if received directly by the taxpayer.
---------------------------------------------------------------------------
    \1134\ Secs. 805(a)(4) and 812. Under pre-1984 law, described in 
Joint Committee on Taxation, General Explanation of the Revenue 
Provisions of the Deficit Reduction Act of 1984, JCS-41-84, December 
31, 1984, p. 572-573, ``a life insurance company was taxed on the 
lesser of its table investment income or its gain from operations. If a 
company's gain from operations exceeded its taxable investment income, 
the company was taxed on 50 percent of such excess. . . . The 
computation of gain from operations began with the company's total 
income, including the company's share of investment yield, net capital 
gain, premiums, and other considerations, decreases in insurance 
reserves and all other amounts.'' Thus, under the law prior to 1984, a 
life insurance company preferred to have a low company's share for 
purposes of determining its taxable income, and a high company's share 
for purposes of the proration rules. After 1983, no such tension 
remained.
---------------------------------------------------------------------------

Company's share and policyholder's share

    The life insurance company proration rules provide that the 
company's share, for this purpose, means the percentage 
obtained by dividing the company's share of the net investment 
income for the taxable year by the net investment income for 
the taxable year.\1135\ Net investment income means 95 percent 
of gross investment income, in the case of assets held in 
segregated asset accounts under variable contracts, and 90 
percent of gross investment income in other cases.\1136\
---------------------------------------------------------------------------
    \1135\ Sec. 812(a).
    \1136\ Sec. 812(c).
---------------------------------------------------------------------------
    Gross investment income includes specified items.\1137\ The 
specified items include interest (including tax-exempt 
interest), dividends, rents, royalties and other related 
specified items, the amount by which net short-term capital 
gain exceeds net long-term capital loss, and trade or business 
income. Gross investment income generally does not include gain 
(other than the amount by which net short-term capital gain 
exceeds net long-term capital loss) that is, or is considered 
as, from the sale or exchange of a capital asset. Gross 
investment income also does not include the appreciation in the 
value of assets that is taken into account in computing the 
company's tax reserve deduction under section 817.
---------------------------------------------------------------------------
    \1137\ Sec. 812(d).
---------------------------------------------------------------------------
    The company's share of net investment income, for purposes 
of this calculation, is the net investment income for the 
taxable year, reduced by the sum of (a) the policy interest for 
the taxable year and (b) a portion of policyholder 
dividends.\1138\ Policy interest is defined to include required 
interest at the greater of the prevailing State assumed rate or 
the applicable Federal rate (plus some other interest items). 
In any case where neither the prevailing State assumed interest 
rate nor the applicable Federal rate is used, ``another 
appropriate rate'' is used for this calculation. No statutory 
definition of ``another appropriate rate'' is provided; the law 
is unclear as to what rate or rates are appropriate for this 
purpose.\1139\
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    \1138\ Sec. 812(b)(1). This portion is defined as gross investment 
income's share of policyholder dividends.
    \1139\ Legislative history of section 812 mentions that the general 
concept that items of investment yield should be allocated between 
policyholders and the company was retained from prior law. H. Rep. 98-
861, Conference Report to accompany H.R. 4170, the Deficit Reduction 
Act of 1984, 98th Cong., 2d Sess., 1065 (June 23, 1984). This concept 
is referred to in Joint Committee on Taxation, General Explanation of 
the Revenue Provisions of the Deficit Reduction Act of 1984, JCS-41-84, 
December 31, 1984, p. 622, stating, ``[u]nder the Act, the formula used 
for purposes of determining the policyholders' share is based generally 
on the proration formula used under prior law in computing gain or loss 
from operations (i.e., by reference to `required interest').'' This may 
imply that a reference to pre-1984-law regulations may be appropriate. 
See Rev. Rul. 2003-120, 2003-2 C.B. 1154, and Technical Advice 
Memoranda 20038008 and 200339049.
---------------------------------------------------------------------------
    In 2007, the IRS issued Rev. Rul. 2007-54,\1140\ 
interpreting required interest under section 812(b) to be 
calculated by multiplying the mean of a contract's beginning-
of-year and end-of-year reserves by the greater of the 
applicable Federal interest rate or the prevailing State 
assumed interest rate, for purposes of determining separate 
account reserves for variable contracts. However, Rev. Rul. 
2007-54 was suspended by Rev. Rul. 2007-61, in which the IRS 
and the Treasury Department stated that the issues would more 
appropriately be addressed by regulation.\1141\ No regulations 
have been issued to date.
---------------------------------------------------------------------------
    \1140\ 2007-38 I.R.B. 604.
    \1141\ 2007-42 I.R.B. 799.
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General account and separate accounts

    A variable contract is generally a life insurance (or 
annuity) contract whose death benefit (or annuity payout) 
depends explicitly on the investment return and market value of 
underlying assets.\1142\ The investment risk is generally that 
of the policyholder, not the insurer. The assets underlying 
variable contracts are maintained in separate accounts held by 
life insurers. These separate accounts are distinct from the 
insurer's general account in which it maintains assets 
supporting products other than variable contracts.
---------------------------------------------------------------------------
    \1142\ Section 817(d) provides a more detailed definition of a 
variable contract.
---------------------------------------------------------------------------

Reserves

    For Federal income tax purposes, a life insurance company 
includes in gross income any net decrease in reserves, and 
deducts a net increase in reserves.\1143\ Methods for 
determining reserves for tax purposes generally are based on 
reserves prescribed by the National Association of Insurance 
Commissioners for purposes of financial reporting under State 
regulatory rules.
---------------------------------------------------------------------------
    \1143\ Sec. 807.
---------------------------------------------------------------------------
    In the case of variable contracts, however, a special rule 
eliminates the effect of gains and losses for purposes of 
determining the inclusion or deduction relating to a change in 
the amount of the tax reserves.\1144\ Under this rule, realized 
and unrealized gains are subtracted from, and realized and 
unrealized losses are added to, the amount of tax reserves 
taken into account for variable contracts, whether or not the 
assets have been disposed of. The basis of assets in the 
separate account is increased to reflect appreciation, and 
reduced to reflect depreciation in value, so as to take account 
of the subtracted or added amounts.
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    \1144\ Sec. 817. The rule also applies in the case of certain other 
deductions for benefits paid and assumption reinsurance costs incurred 
with respect to variable contracts (sec. 817(a) flush language).
---------------------------------------------------------------------------

Dividends received deduction

    A corporate taxpayer may partially or fully deduct 
dividends received.\1145\ The percentage of the allowable 
dividends received deduction depends on the percentage of the 
stock of the distributing corporation that the recipient 
corporation owns.
---------------------------------------------------------------------------
    \1145\ Sec. 243 et seq. Conceptually, dividends received by a 
corporation are retained in corporate solution; these amounts are taxed 
when distributed to noncorporate shareholders.
---------------------------------------------------------------------------
            Limitation on dividends received deduction under section 
                    246(c)(4)
    The dividends received deduction is not allowed with 
respect to stock either (1) held for 45 days or less during a 
91-day period beginning 45 days before the ex-dividend date, or 
(2) to the extent the taxpayer is under an obligation to make 
related payments with respect to positions in substantially 
similar or related property.\1146\ The taxpayer's holding 
period is reduced for periods during which its risk of loss is 
reduced.\1147\
---------------------------------------------------------------------------
    \1146\ Sec. 246(c).
    \1147\ Sec. 246(c)(4). For this purpose, the holding period is 
reduced for periods in which (1) the taxpayer has an obligation to sell 
or has shorted substantially similar stock; (2) the taxpayer has 
granted an option to buy substantially similar stock; or (3) under 
Treasury regulations, the taxpayer has diminished its risk of loss by 
holding other positions with respect to substantially similar or 
related property.
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                       Explanation of Provision 

    The provision modifies and simplifies the life insurance 
company proration rules \1148\ for reducing dividends received 
deductions \1149\ and reserve deductions \1150\ with respect to 
untaxed income. For purposes of these life insurance proration 
rules, the company's share is 70 percent. The policyholder's 
share is 30 percent.
---------------------------------------------------------------------------
    \1148\ Sec. 812.
    \1149\ Sec. 804(a)(4).
    \1150\ Secs. 807(a) and (b).
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

I. Capitalization of Certain Policy Acquisition Expenses (sec. 13519 of 
                   the Act and sec. 848 of the Code)


                               Prior Law

    In the case of an insurance company, specified policy 
acquisition expenses for any taxable year are required to be 
capitalized, and generally are amortized over the 120-month 
period beginning with the first month in the second half of the 
taxable year.\1151\
---------------------------------------------------------------------------
    \1151\ Sec. 848.
---------------------------------------------------------------------------
    A special rule provides for 60-month amortization of the 
first $5 million of specified policy acquisition expenses with 
a phase-out. The phase-out reduces the amount amortized over 60 
months by the excess of the insurance company's specified 
policy acquisition expenses for the taxable year over $10 
million.
    Specified policy acquisition expenses are determined as 
that portion of the insurance company's general deductions for 
the taxable year that does not exceed a specific percentage of 
the net premiums for the taxable year on each of three 
categories of insurance contracts. For annuity contracts, the 
percentage is 1.75 percent; for group life insurance contracts, 
the percentage is 2.05 percent; and for all other specified 
insurance contracts, the percentage is 7.7 percent.
    With certain exceptions, a specified insurance contract is 
any life insurance, annuity, or noncancellable accident and 
health insurance contract or combination thereof. A group life 
insurance contract is any life insurance contract that covers a 
group of individuals defined by reference to employment 
relationship, membership in an organization, or similar factor, 
the premiums for which are determined on a group basis, and the 
proceeds of which are payable to (or for the benefit of) 
persons other than the employer of the insured, an organization 
to which the insured belongs, or other similar person.

                        Explanation of Provision

    The provision extends the amortization period for specified 
policy acquisition expenses from a 120-month period to a 180-
month period beginning with the first month in the second half 
of the taxable year. The provision does not change the special 
rule providing for 60-month amortization of the first $5 
million of specified policy acquisition expenses (with 
phaseout). The provision specifies that for annuity contracts, 
the percentage is 2.09 percent; for group life insurance 
contracts, the percentage is 2.45 percent; and for all other 
specified insurance contracts, the percentage is 9.20 
percent.\1152\
---------------------------------------------------------------------------
    \1152\ A technical correction may be needed to correct statutory 
references so that the provision achieves this result.
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017. A transition rule permits specified policy 
acquisition expenses first required to be capitalized in a 
taxable year beginning before January 1, 2018, to continue to 
be allowed as a deduction ratably over the 120-month period 
beginning with the first month in the second half of the 
taxable year. It is intended that the 60-month amortization 
rule continue to apply to such amounts eligible for the 60-
month amortization rule and first required to be capitalized in 
a taxable year beginning before January 1, 2018.

J. Tax Reporting for Life Settlement Transactions and Clarification of 
Tax Basis of Life Insurance Transactions, and Exception to Transfer for 
 Valuable Consideration Rules (secs. 13520-13522 of the Act and secs. 
            101 and 1016(a) and new sec. 6050Y of the Code)


                               Prior Law

    An exclusion from Federal income tax is provided for 
amounts received under a life insurance contract paid by reason 
of the death of the insured.\1153\
---------------------------------------------------------------------------
    \1153\ Sec. 101(a)(1). In the case of certain accelerated death 
benefits and viatical settlements, special rules treat certain amounts 
as amounts paid by reason of the death of an insured (that is, 
generally, excludable from income). Sec. 101(g). The rules relating to 
accelerated death benefits provide that amounts treated as paid by 
reason of the death of the insured include any amount received under a 
life insurance contract on the life of an insured who is a terminally 
ill individual, or who is a chronically ill individual (provided 
certain requirements are met). For this purpose, a terminally ill 
individual is one who has been certified by a physician as having an 
illness or physical condition which can reasonably be expected to 
result in death in 24 months or less after the date of the 
certification. A chronically ill individual is one who has been 
certified by a licensed health care practitioner within the preceding 
12-month period as meeting certain ability-related requirements. In the 
case of a viatical settlement, if any portion of the death benefit 
under a life insurance contract on the life of an insured who is 
terminally ill or chronically ill is sold to a viatical settlement 
provider, the amount paid for the sale or assignment of that portion is 
treated as an amount paid under the life insurance contract by reason 
of the death of the insured (that is, generally, excludable from 
income). For this purpose, a viatical settlement provider is a person 
regularly engaged in the trade or business of purchasing, or taking 
assignments of, life insurance contracts on the lives of terminally ill 
or chronically ill individuals (provided certain requirements are met).
---------------------------------------------------------------------------
    Under rules known as the transfer for value rules, if a 
life insurance contract is sold or otherwise transferred for 
valuable consideration, the amount paid by reason of the death 
of the insured that is excludable generally is limited.\1154\ 
Under the limitation, the excludable amount may not exceed the 
sum of (1) the actual value of the consideration, and (2) the 
premiums or other amounts subsequently paid by the transferee 
of the contract. Thus, for example, if a person buys a life 
insurance contract, and the consideration he pays combined with 
his subsequent premium payments on the contract are less than 
the amount of the death benefit he later receives under the 
contract, then the difference is includable in the buyer's 
income.
---------------------------------------------------------------------------
    \1154\ Sec. 101(a)(2).
---------------------------------------------------------------------------
    Exceptions are provided to the limitation on the excludable 
amount. The limitation on the excludable amount does not apply 
if (1) the transferee's basis in the contract is determined in 
whole or in part by reference to the transferor's basis in the 
contract,\1155\ or (2) the transfer is to the insured, to a 
partner of the insured, to a partnership in which the insured 
is a partner, or to a corporation in which the insured is a 
shareholder or officer.\1156\
---------------------------------------------------------------------------
    \1155\ Sec. 101(a)(2)(A).
    \1156\ Sec. 101(a)(2)(B).
---------------------------------------------------------------------------
    IRS guidance sets forth more details of the tax treatment 
of a life insurance policyholder who sells or surrenders the 
life insurance contract and the tax treatment of other sellers 
and of buyers of life insurance contracts. The guidance relates 
to the character of taxable amounts (ordinary or capital) and 
to the taxpayer's basis in the life insurance contract.
    In Revenue Ruling 2009-13,\1157\ the IRS ruled that income 
recognized under section 72(e) on surrender to the life 
insurance company of a life insurance contract with cash value 
is ordinary income. In the case of a sale of a cash value life 
insurance contract, the IRS ruled that the insured's (seller's) 
basis is reduced by the cost of insurance, and the gain on sale 
of the contract is ordinary income to the extent of the amount 
that would be recognized as ordinary income if the contract 
were surrendered (the ``inside buildup''), and any excess is 
long-term capital gain. Gain on the sale of a term life 
insurance contract (without cash surrender value) is long-term 
capital gain under the ruling.
---------------------------------------------------------------------------
    \1157\ 2009-21 I.R.B. 1029.
---------------------------------------------------------------------------
    In Revenue Ruling 2009-14,\1158\ the IRS ruled that under 
the transfer for value rules, a portion of the death benefit 
received by a buyer of a life insurance contract on the death 
of the insured is includable as ordinary income. The portion is 
the excess of the death benefit over the consideration and 
other amounts (e.g., premiums) paid for the contract. Upon sale 
of the contract by the purchaser of the contract, the gain is 
long-term capital gain, and in determining the gain, the basis 
of the contract is not reduced by the cost of insurance.
---------------------------------------------------------------------------
    \1158\ 2009-21 I.R.B. 1031.
---------------------------------------------------------------------------

                        Explanation of Provision


In general

    The provision imposes reporting requirements in the case of 
the purchase of an existing life insurance contract in a 
reportable policy sale and imposes reporting requirements on 
the payor in the case of the payment of reportable death 
benefits. The provision sets forth rules for determining the 
basis of a life insurance or annuity contract. Lastly, the 
provision modifies the transfer for value rules in a transfer 
of an interest in a life insurance contract in a reportable 
policy sale.

Reporting requirements for acquisitions of life insurance contracts

            Reporting upon acquisition of life insurance contract
    The reporting requirement applies to every person who 
acquires a life insurance contract, or any interest in a life 
insurance contract, in a reportable policy sale during the 
taxable year.\1159\
---------------------------------------------------------------------------
    \1159\ Sec. 6050Y.
---------------------------------------------------------------------------
            Reportable policy sale
    A reportable policy sale means the acquisition of an 
interest in a life insurance contract, directly or indirectly, 
if the acquirer has no substantial family, business, or 
financial relationship with the insured (apart from the 
acquirer's interest in the life insurance contract).\1160\ An 
indirect acquisition includes the acquisition of an interest in 
a partnership, trust, or other entity that holds an interest in 
the life insurance contract.
---------------------------------------------------------------------------
    \1160\ Sec. 101(a)(3)(B). A substantial family, business or 
financial relationship with the insured apart from the interest in the 
life insurance contract is not further defined in the statute. The 
Treasury Department is directed to provide guidance as to the 
definition. Transactions to which new section 101(a)(3)(A) does not 
apply by reason of guidance regarding this definition under new section 
101(a)(3)(B) may be subject to reporting under new section 6050Y as 
provided in such guidance as needed to carry out the purposes of the 
provision.
---------------------------------------------------------------------------
            Buyer reporting
    Under the reporting requirement, the buyer reports 
information about the purchase to the IRS, to the insurance 
company that issued the contract, and to the seller.\1161\ The 
information reported by the buyer about the purchase is (1) the 
buyer's name, address, and taxpayer identification number 
(``TIN''), (2) the name, address, and TIN of each recipient of 
payment in the reportable policy sale, (3) the date of the 
sale, (4) the name of the issuer, and (5) the amount of each 
payment. The statement the buyer provides to any issuer of a 
life insurance contract is not required to include the amount 
of the payment or payments for the purchase of the contract.
---------------------------------------------------------------------------
    \1161\ Sec. 6050Y(a).
---------------------------------------------------------------------------
            Reporting of seller's basis in the life insurance contract
    On receipt of a report described above, or on any notice of 
the transfer of a life insurance contract to a foreign person, 
the issuer is required to report to the IRS and to the seller 
(1) the name, address, and TIN of the seller or the transferor 
to a foreign person, (2) the basis of the contract (i.e., the 
investment in the contract within the meaning of section 
72(e)(6)), and (3) the policy number of the contract.\1162\ 
Notice of the transfer of a life insurance contract to a 
foreign person is intended to include any sort of notice, 
including information provided for nontax purposes such as 
change of address notices for purposes of sending statements or 
for other purposes, or information relating to loans, premiums, 
or death benefits with respect to the contract.
---------------------------------------------------------------------------
    \1162\ Sec. 6050Y(b).
---------------------------------------------------------------------------
            Reporting with respect to reportable death benefits
    When a reportable death benefit is paid under a life 
insurance contract, the payor insurance company is required to 
report information about the payment to the IRS and to the 
payee.\1163\ Under this reporting requirement, the payor 
reports (1) the name, address and TIN of the person making the 
payment, (2) the name, address, and TIN of each recipient of a 
payment, (3) the date of each such payment, (4) the gross 
amount of the payment (5) the payor's estimate of the buyer's 
basis in the contract.
---------------------------------------------------------------------------
    \1163\ Sec. 6050Y(c).
---------------------------------------------------------------------------
    A reportable death benefit means an amount paid by reason 
of the death of the insured under a life insurance contract 
that has been transferred in a reportable policy sale.
    For purposes of these reporting requirements, a payment 
means the amount of cash and the fair market value of any 
consideration transferred in a reportable policy sale.

Determination of basis

    In determining the basis of a life insurance or annuity 
contract, no adjustment is made for mortality, expense, or 
other reasonable charges incurred under the contract (known as 
``cost of insurance'').\1164\ This reverses the position of the 
IRS in Revenue Ruling 2009-13 that on sale of a life insurance 
contract, the insured's (seller's) basis is reduced by the cost 
of insurance.
---------------------------------------------------------------------------
    \1164\ Sec. 1016(a)(1)(B).
---------------------------------------------------------------------------

Scope of transfer for value rules

    The provision provides that the exceptions to the transfer 
for value rules do not apply in the case of a transfer of a 
life insurance contract, or any interest in a life insurance 
contract, in a reportable policy sale.\1165\ Thus, some portion 
of the death benefit ultimately payable under such a contract 
may be includable in income.
---------------------------------------------------------------------------
    \1165\ Sec. 101(a)(3)(A).
---------------------------------------------------------------------------

                             Effective Date

    Under the provision, the reporting requirement is effective 
for reportable policy sales occurring after December 31, 2017, 
and reportable death benefits paid after December 31, 2017. The 
clarification of the basis rules for life insurance and annuity 
contracts is effective for transactions entered into after 
August 25, 2009. The modification of the exceptions to the 
transfer for value rules is effective for transfers occurring 
after December 31, 2017.

    K. Modification of Discounting Rules for Property and Casualty 
Insurance Companies (sec. 13523 of the Act and sec. 846(c) of the Code)


                               Prior Law

    A property and casualty insurance company generally is 
subject to tax on its taxable income.\1166\ 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.\1167\ Among the items that are deductible in 
calculating underwriting income are additions to reserves for 
losses incurred and expenses incurred.
---------------------------------------------------------------------------
    \1166\ Sec. 831(a).
    \1167\ Sec. 832.
---------------------------------------------------------------------------
    To take account of the time value of money, discounting of 
unpaid losses is required. All property and casualty loss 
reserves (unpaid losses and unpaid loss adjustment expenses) 
for each line of business (as shown on the annual statement) 
are required to be discounted for Federal income tax purposes.
    The discounted reserves are calculated using a prescribed 
interest rate which is based on the applicable Federal mid-term 
rate (``mid-term AFR''). The discount rate is the average of 
the mid-term AFRs effective at the beginning of each month over 
the 60-month period preceding the calendar year for which the 
determination is made.
    To determine the period over which the reserves are 
discounted, a prescribed loss payment pattern applies. The 
prescribed length of time is either the accident year and the 
following three calendar years, or the accident year and the 
following 10 calendar years, depending on the line of business. 
In the case of certain ``long-tail'' lines of business, the 10-
year period is extended, but not by more than five additional 
years. Thus, prior law limits the maximum duration of any loss 
payment pattern to the accident year and the following 15 
years. The Treasury Department is directed to determine a loss 
payment pattern for each line of business by reference to the 
historical loss payment pattern for that line of business using 
aggregate experience reported on the annual statements of 
insurance companies, and is required to make this determination 
every five years, starting with 1987.
    Under the discounting rules, an election is provided 
permitting a taxpayer to use its own (rather than an industry-
wide) historical loss payment pattern with respect to all lines 
of business, provided that applicable requirements are met.
    Treasury publishes discount factors for each line of 
business to be applied by taxpayers for discounting 
reserves.\1168\ The discount factors are published annually, 
based on (1) the interest rate applicable to the calendar year, 
and (2) the loss payment pattern for each line of business as 
determined every five years.
---------------------------------------------------------------------------
    \1168\ The most recent property and casualty reserve discount 
factors published by Treasury are in Rev. Proc. 2016-58, 2016-51 I.R.B. 
839, and see Rev. Proc. 2012-44, 2012-49 I.R.B. 645.
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision modifies the reserve discounting rules 
applicable to property and casualty insurance companies. In 
general, the provision modifies the prescribed interest rate, 
extends the periods applicable under the loss payment pattern, 
and repeals the election to use a taxpayer's historical loss 
payment pattern.

Interest rate

    The provision provides that the interest rate is an annual 
rate for any calendar year to be determined by Treasury based 
on the corporate bond yield curve (rather than the mid-term AFR 
as under prior law). For this purpose, the corporate bond yield 
curve means, with respect to any month, a yield curve that 
reflects the average, for the preceding 60-month period (not 
24-month period), of monthly yields on investment grade 
corporate bonds with varying maturities and that are in the top 
three quality levels available.\1169\ It is expected that 
Treasury will determine a 60-month average corporate bond yield 
curve for the 60 months preceding the first month of the 
calendar year for which the determination is made.
---------------------------------------------------------------------------
    \1169\ This rule adopts the definition found in section 
430(h)(2)(D)(i) of the term ``corporate bond yield curve.'' The 
definition provides for a rate based on the average of monthly yields 
on investment grade corporate bonds with varying maturities, so that 
under the property and casualty reserve discounting rules, with respect 
to a payment pattern of any duration, a rate may be determined based on 
corporate bonds of a similar duration. However, section 430, which 
relates to minimum funding standards for single-employer defined 
benefit pension plans, includes other rules not relevant to this 
provision, including rules for determining an ``effective interest 
rate,'' such as segment rate rules. The term ``effective interest 
rate'' along with these other rules, including the segment rate rules, 
do not apply for purposes of property and casualty insurance reserve 
discounting.
---------------------------------------------------------------------------

Loss payment patterns

    The provision extends the periods applicable for 
determining loss payment patterns. Under the provision, the 
maximum duration of the loss payment pattern generally is 
determined by the amount of losses remaining unpaid using 
aggregate industry experience for each line of business.
    Like prior law, the provision provides that Treasury 
determines a loss payment pattern for each line of business by 
reference to the historical loss payment pattern for that line 
of business using aggregate experience reported on the annual 
statements of insurance companies, and is required to make this 
determination every five years.
    The prior-law three-year period for discounting certain 
lines of business other than long-tail lines of business is not 
modified by the provision.
    Under the provision, the prior-law 10-year period following 
the accident year is extended up to a maximum of 14 more years 
for the lines of business to which each period applies. To the 
extent these unpaid losses have not been treated as paid before 
the 24th year after the accident year, they are 
treated as paid in that 24th year. The lines of 
business to which the 10-year period, with any extensions, 
applies are the auto liability, other liability, medical 
malpractice, workers' compensation, nonproportional 
reinsurance, international, and multiple peril lines.\1170\
---------------------------------------------------------------------------
    \1170\ A technical correction may be needed to clarify that the 10-
year period, with any extensions, applies to the reinsurance and 
international lines of business.
---------------------------------------------------------------------------
    The provision repeals the prior-law rule providing that in 
the case of certain long-tail lines of business, the 10-year 
period is extended, but not by more than five additional years.

Election to use own historical loss payment pattern

    The provision repeals the prior-law election permitting a 
taxpayer to use its own (rather than an aggregate industry-
experience-based) historical loss payment pattern with respect 
to all lines of business.

    The Treasury Department and IRS have issued published 
guidance addressing this provision.\1171\
---------------------------------------------------------------------------
    \1171\ Reg-103163-18. 83 Fed. Reg. 55646, November 7, 2018, and 
Rev. Proc. 2018-13, 2018-7 I.R.B. 356, February 12, 2018.
---------------------------------------------------------------------------

                             Effective Date

    The provision generally applies to taxable years beginning 
after December 31, 2017. Under a transitional rule for the 
first taxable year beginning in 2018, the amount of unpaid 
losses and expenses unpaid (under section 832(b)(5)(B) and (6)) 
and the unpaid losses (under sections 807(c)(2) and 805(a)(1)) 
at the end of the preceding taxable year are determined as if 
the provision had applied to these items in such preceding 
taxable year, using the interest rate and loss payment patterns 
for accident years ending with calendar year 2018. Any 
adjustment is spread over eight taxable years, i.e., is 
included in the taxpayer's gross income ratably in the first 
taxable year beginning in 2018 and the seven succeeding taxable 
years. For taxable years subsequent to the first taxable year 
beginning in 2018, the provision applies to such unpaid losses 
and expenses unpaid (i.e., unpaid losses and expenses unpaid at 
the end of the taxable year preceding the first taxable year 
beginning in 2018) by using the interest rate and loss payment 
patterns applicable to accident years ending with calendar year 
2018.

               SUBPART C--BANKS AND FINANCIAL INSTRUMENTS


A. Limitation on Deduction for FDIC Premiums (sec. 13531 of the Act and 
                         sec. 162 of the Code)


                               Prior Law

    Corporations organized under the laws of any of the 50 
States (and the District of Columbia) generally are subject to 
the U.S. corporate income tax on their worldwide taxable 
income. The taxable income of a C corporation \1172\ generally 
comprises gross income less allowable deductions. A taxpayer 
generally is allowed a deduction for ordinary and necessary 
expenses paid or incurred in carrying on any trade or 
business.\1173\
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    \1172\ Corporations subject to tax are commonly referred to as C 
corporations after subchapter C of the Code, which sets forth corporate 
tax rules. Certain specialized entities that invest primarily in real 
estate related assets (real estate investment trusts) or in stock and 
securities (regulated investment companies) and that meet other 
requirements, generally including annual distribution of 90 percent of 
their income, are allowed to deduct their distributions to 
shareholders, thus generally paying little or no corporate-level tax 
despite otherwise being subject to subchapter C.
    \1173\ Sec. 162(a). However, certain exceptions apply. No deduction 
is allowed for: (1) any charitable contribution or gift that would be 
allowable as a deduction under section 170 were it not for the 
percentage limitations, the dollar limitations, or the requirements as 
to the time of payment, set forth in such section; (2) any illegal 
bribe, illegal kickback, or other illegal payment; (3) certain lobbying 
and political expenditures; (4) any fine or similar penalty paid to a 
government for the violation of any law; (5) two-thirds of treble 
damage payments under the antitrust laws; (6) certain foreign 
advertising expenses; (7) certain amounts paid or incurred by a 
corporation in connection with the reacquisition of its stock or of the 
stock of any related person; or (8) certain applicable employee 
remuneration.
---------------------------------------------------------------------------
    Corporations that make a valid election pursuant to section 
1362 of subchapter S of the Code, referred to as S 
corporations, generally are not subject to corporate-level 
income tax on their income. Instead, an S corporation passes 
through to shareholders its items of income and loss. The 
shareholders separately take into account their shares of these 
items on their individual income tax returns.

Banks, thrifts, and credit unions

            In general
    Financial institutions are subject to the same Federal 
income tax rules and rates as are applied to other corporations 
or entities, with specified exceptions.
            C corporation banks and thrifts
    A bank is generally taxed for Federal income tax purposes 
as a C corporation. For this purpose a bank generally means a 
corporation, a substantial portion of whose business is 
receiving deposits and making loans and discounts, or 
exercising certain fiduciary powers.\1174\ A bank for this 
purpose generally includes domestic building and loan 
associations, mutual stock or savings banks, and certain 
cooperative banks that are commonly referred to as 
thrifts.\1175\
---------------------------------------------------------------------------
    \1174\ Sec. 581. See also Treas. Reg. sec. 1.581-1(a).
    \1175\ While the general principles for determining the taxable 
income of a corporation are applicable to a mutual savings bank, a 
building and loan association, and a cooperative bank, there are 
certain exceptions and special rules for such institutions. Treas. Reg. 
sec. 1.581-2(a).
---------------------------------------------------------------------------
            S corporation banks
    A bank is generally eligible to elect S corporation status 
under section 1362, provided it meets the other requirements 
for making this election and it does not use the reserve method 
of accounting for bad debts as described in section 585.\1176\
---------------------------------------------------------------------------
    \1176\ Sec. 1361(b)(2)(A).
---------------------------------------------------------------------------
    Special bad debt loss rules for small banks Section 166 
provides a deduction for any debt that becomes worthless 
(wholly or partially) within a taxable year. The reserve method 
of accounting for bad debts, repealed in 1986 \1177\ for most 
taxpayers, is allowed under section 585 for any bank (as 
defined in section 581) other than a large bank. For this 
purpose, a bank is a large bank if, for the taxable year (or 
for any preceding taxable year after 1986), the average 
adjusted basis of all its assets (or the assets of the 
controlled group of which it is a member) exceeds $500 million. 
Deductions for reserves are taken in lieu of a worthless debt 
deduction under section 166. Accordingly, a small bank is able 
to take deductions for additions to a bad debt reserve. 
Additions to the reserve are determined under an experience 
method that generally looks to the ratio of (1) the total bad 
debts sustained during the taxable year and the five preceding 
taxable years to (2) the sum of the loans outstanding at the 
close of such taxable years.\1178\
---------------------------------------------------------------------------
    \1177\ Tax Reform Act of 1986, Pub. L. No. 99-514.
    \1178\ Sec. 585(b)(2).
---------------------------------------------------------------------------
            Credit unions
    Credit unions are exempt from Federal income 
taxation.\1179\ The exemption is based on their status as not-
for-profit mutual or cooperative organizations (without capital 
stock) operated for the benefit of their members, who generally 
must share a common bond. The definition of common bond has 
been expanded to permit greater use of credit unions.\1180\ 
While significant differences between the rules under which 
credit unions and banks operate have existed in the past, most 
of those differences have disappeared over time.\1181\
---------------------------------------------------------------------------
    \1179\ Sec. 501(c)(14)(A). For a discussion of the history of and 
reasons for Federal tax exemption, see United States Department of the 
Treasury, Comparing Credit Unions with Other Depository Institutions, 
Report 3070, January 15, 2001, available at https://www.treasury.gov/
press-center/press-releases/Documents/report30702.doc.
    \1180\ The Credit Union Membership Access Act, Pub. L. No. 105-219, 
allows multiple common bond credit unions. The legislation in part 
responds to National Credit Union Administration v. First National Bank 
& Trust Co., 522 U.S. 479 (1998), which interpreted the permissible 
membership of tax-exempt credit unions narrowly.
    \1181\ The Treasury Department has concluded that any remaining 
regulatory differences do not raise competitive equity concerns between 
credit unions and banks. United States Department of the Treasury, 
Comparing Credit Unions with Other Depository Institutions, Report 
3070, January 15, 2001, p. 2, available at https://www.treasury.gov/
press-center/press-releases/Documents/report30702.doc.
---------------------------------------------------------------------------

FDIC premiums

    The Federal Deposit Insurance Corporation (``FDIC'') 
provides deposit insurance for banks and savings institutions. 
To maintain its status as an insured depository institution, a 
bank must pay semiannual assessments into the deposit insurance 
fund. Assessments for deposit insurance are treated as ordinary 
and necessary business expenses. These assessments, also known 
as premiums, are deductible once the all events test for the 
premium is satisfied.\1182\
---------------------------------------------------------------------------
    \1182\ Technical Advice Memorandum 199924060, March 5, 1999, and 
Rev. Rul. 80-230, 1980-2 C.B. 169, 1980.
---------------------------------------------------------------------------

                        Explanation of Provision

    No deduction is allowed for the applicable percentage of 
any FDIC premium paid or incurred by the taxpayer. For 
taxpayers with total consolidated assets of $50 billion or 
more, the applicable percentage is 100 percent. Otherwise, the 
applicable percentage is the ratio of the excess of total 
consolidated assets over $10 billion to $40 billion. For 
example, for a taxpayer with total consolidated assets of $20 
billion, no deduction is allowed for 25 percent of FDIC 
premiums. The provision does not apply to taxpayers with total 
consolidated assets (as of the close of the taxable year) that 
do not exceed $10 billion.
    FDIC premium means any assessment imposed under section 
7(b) of the Federal Deposit Insurance Act.\1183\ The term total 
consolidated assets has the meaning given such term under 
section 165 of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act.\1184\
---------------------------------------------------------------------------
    \1183\ 12 U.S.C. sec. 1817(b).
    \1184\ Pub. L. No. 111-203.
---------------------------------------------------------------------------
    For purposes of determining a taxpayer's total consolidated 
assets, members of an expanded affiliated group are treated as 
a single taxpayer. An expanded affiliated group means an 
affiliated group as defined in section 1504(a), determined by 
substituting ``more than 50 percent'' for ``at least 80 
percent'' each place it appears and without regard to the 
exceptions from the definition of includible corporation for 
insurance companies and foreign corporations. A partnership or 
any other entity other than a corporation is treated as a 
member of an expanded affiliated group if such entity is 
controlled by members of such group.

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

 B. Repeal of Advance Refunding Bonds (sec. 13532 of the Act and sec. 
                            149 of the Code)


                               Prior Law

    Section 103 generally provides that gross income does not 
include interest received on State or local bonds. State and 
local bonds are classified generally as either governmental 
bonds or private activity bonds. Governmental bonds are bonds 
the proceeds of which are primarily used to finance 
governmental facilities or the debt is repaid with governmental 
funds. Private activity bonds are bonds in which the State or 
local government serves as a conduit providing financing to 
nongovernmental persons (e.g., private businesses or 
individuals).\1185\ Bonds issued to finance the activities of 
charitable organizations described in section 501(c)(3) 
(``qualified 501(c)(3) bonds'') are one type of private 
activity bond. The exclusion from income for interest on State 
and local bonds only applies if certain Code requirements are 
met.
---------------------------------------------------------------------------
    \1185\ Sec. 141.
---------------------------------------------------------------------------
    The exclusion for income for interest on State and local 
bonds applies to refunding bonds but there are limits on 
advance refunding bonds. A refunding bond is defined as any 
bond used to pay principal, interest, or redemption price on a 
prior bond issue (the refunded bond). Different rules apply to 
current as opposed to advance refunding bonds. A current 
refunding occurs when the refunded bond is redeemed within 90 
days of issuance of the refunding bonds. Conversely, a bond is 
classified as an advance refunding if it is issued more than 90 
days before the redemption of the refunded bond.\1186\ Proceeds 
of advance refunding bonds are generally invested in an escrow 
account and held until a future date when the refunded bond may 
be redeemed.
---------------------------------------------------------------------------
    \1186\ Sec. 149(d)(5).
---------------------------------------------------------------------------
    Although there is no statutory limitation on the number of 
times that tax-exempt bonds may be currently refunded, the Code 
limits advance refundings. The primary Federal tax policy 
concern with advance refundings is that they result in two 
issues of tax-exempt bonds that remain outstanding 
simultaneously for more than 90 days to finance the same 
project or activity and that thereby results in increased 
Federal revenue cost for multiple Federal subsidies.\1187\ 
Generally, governmental bonds and qualified 501(c)(3) bonds may 
be advance refunded one time.\1188\ Private activity bonds, 
other than qualified 501(c)(3) bonds, may not be advance 
refunded at all.\1189\ Furthermore, in the case of an advance 
refunding bond that results in interest savings (e.g., a high 
interest rate to low interest rate refunding), the refunded 
bond must be redeemed on the first call date 90 days after the 
issuance of the refunding bond that results in debt service 
savings.\1190\
---------------------------------------------------------------------------
    \1187\ See S. Rep. No. 99-313 at 828 (1986).
    \1188\ Sec. 149(d)(3). Bonds issued before 1986 and pursuant to 
certain transition rules contained in the Tax Reform Act of 1986 may be 
advance refunded more than one time in certain cases.
    \1189\ Sec. 149(d)(2).
    \1190\ Sec. 149(d)(3)(A)(iii) and (B); Treas. Reg. sec. 1.149(d)-
1(f)(3). A ``call'' provision provides the issuer of a bond with the 
right to redeem the bond prior to the stated maturity.
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision repeals the exclusion from gross income for 
interest on a bond issued to advance refund another tax-exempt 
bond.

                             Effective Date

    The provision applies to advance refunding bonds issued 
after December 31, 2017.

                       SUBPART D--S CORPORATIONS


A. Expansion of Qualifying Beneficiaries of an Electing Small Business 
       Trust (sec. 13541 of the Act and sec. 1361(c) of the Code)


                               Prior Law

    An electing small business trust (``ESBT'') may be a 
shareholder of an S corporation.\1191\ Generally, the eligible 
beneficiaries of an ESBT include individuals, estates, and 
certain charitable organizations eligible to hold S corporation 
stock directly. A nonresident alien individual may not be a 
shareholder of an S corporation and may not be a potential 
current beneficiary of an ESBT.\1192\
---------------------------------------------------------------------------
    \1191\ Sec. 1361(c)(2)(A)(v).
    \1192\ Secs. 1361(b)(1)(C) and (c)(2)(B)(v).
---------------------------------------------------------------------------
    The portion of an ESBT which consists of the stock of an S 
corporation is treated as a separate trust and generally is 
taxed on its share of the S corporation's income at the highest 
rate of tax imposed on individual taxpayers. This income 
(whether or not distributed by the ESBT) is not taxed to the 
beneficiaries of the ESBT.

                        Explanation of Provision

    The provision allows a nonresident alien individual to be a 
potential current beneficiary of an ESBT.

                             Effective Date

    The provision takes effect on January 1, 2018.

B. Charitable Contribution Deduction for Electing Small Business Trusts 
          (sec. 13542 of the Act and sec. 641(c) of the Code)


                               Prior Law

    An electing small business trust (``ESBT'') may be a 
shareholder of an S corporation.\1193\ The portion of an ESBT 
that consists of the stock of an S corporation is treated as a 
separate trust and generally is taxed on its share of the S 
corporation's income at the highest rate of tax imposed on 
individual taxpayers. This income (whether or not distributed 
by the ESBT) is not taxed to the beneficiaries of the ESBT. In 
addition to nonseparately computed income or loss, an S 
corporation reports to its shareholders their pro rata share of 
certain separately stated items of income, loss, deduction, and 
credit.\1194\ For this purpose, charitable contributions (as 
defined in section 170(c)) of an S corporation are separately 
stated and taken by the shareholder.
---------------------------------------------------------------------------
    \1193\ Sec. 1361(c)(2)(A)(v).
    \1194\ Sec. 1366(a)(1).
---------------------------------------------------------------------------
    The treatment of a charitable contribution passed through 
by an S corporation depends on the shareholder. Because an ESBT 
is a trust, the deduction for charitable contributions 
applicable to trusts,\1195\ rather than the deduction 
applicable to individuals,\1196\ applies to the trust. 
Generally, a trust is allowed a charitable contribution 
deduction for amounts of gross income, without limitation, 
which pursuant to the terms of the governing instrument are 
paid for a charitable purpose. No carryover of excess 
contributions is allowed. An individual is allowed a charitable 
contribution deduction limited to certain percentages of 
adjusted gross income generally with a five-year carryforward 
of amounts in excess of this limitation.
---------------------------------------------------------------------------
    \1195\ Sec. 642(c).
    \1196\ Sec. 170.
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision provides that the charitable contribution 
deduction of an ESBT is not determined by the rules generally 
applicable to trusts but rather by the rules applicable to 
individuals. Thus, the percentage limitations and carryforward 
provisions applicable to individuals apply to charitable 
contributions taken into account by the portion of an ESBT 
holding S corporation stock.

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

    C. Modification of Treatment of S Corporation Conversions to C 
Corporations (sec. 13543 of the Act and secs. 481 and 1371 of the Code)


                               Prior Law


Changes in accounting method

            Cash and accrual methods in general
    Taxpayers using the cash method generally recognize items 
of income when actually or constructively received and items of 
expense when paid. The cash method is administratively easy and 
provides the taxpayer flexibility in the timing of income 
recognition. It is the method generally used by most individual 
taxpayers, including farm and nonfarm sole proprietorships.
    Taxpayers using an accrual method generally accrue items of 
income when all the events have occurred that fix the right to 
receive the income and the amount of the income can be 
determined with reasonable accuracy.\1197\ Taxpayers using an 
accrual method of accounting generally may not deduct items of 
expense prior to when all the events have occurred that fix the 
obligation to pay the liability, the amount of the liability 
can be determined with reasonable accuracy, and economic 
performance has occurred.\1198\ Accrual methods of accounting 
generally result in a more accurate measure of economic income 
than does the cash method. The accrual method is often used by 
businesses for financial accounting purposes.
---------------------------------------------------------------------------
    \1197\ See, e.g., sec. 451. For a discussion of changes made to 
section 451 by the Act, see the discussion of section 13221 of the Act 
(Certain Special Rules for Taxable Year of Inclusion).
    \1198\ See, e.g., sec. 461.
---------------------------------------------------------------------------
    A C corporation, a partnership that has a C corporation as 
a partner, or a tax-exempt trust or corporation with unrelated 
business income generally may not use the cash method. 
Exceptions are made for the aforementioned entities to the 
extent their average annual gross receipts do not exceed $5 
million for all prior years (including prior taxable years of 
any predecessor of the entity) (the ``gross receipts 
test''),\1199\ as well as for farming businesses,\1200\ and 
qualified personal service corporations.\1201\ The cash method 
may not be used by any tax shelter.\1202\ In addition, the cash 
method generally may not be used if the purchase, production, 
or sale of merchandise is an income producing factor to the 
taxpayer.\1203\ Such taxpayers generally are required to keep 
inventories and use an accrual method with respect to inventory 
items.\1204\
---------------------------------------------------------------------------
    \1199\ The Act modifies the gross receipts to apply to taxpayers 
with average annual gross receipts that do not exceed $25 million for 
the three prior taxable years. See section 13102 of the Act (Small 
Business Accounting Method Reform and Simplification).
    \1200\ A farming business is defined as a trade or business of 
farming, including operating a nursery or sod farm, or the raising or 
harvesting of trees bearing fruit, nuts, or other crops, timber, or 
ornamental trees (other than evergreen trees that are more than six 
years old at the time they are severed from their roots). Secs. 
448(d)(1) and 263A(e)(4). See also Treas. Reg. sec. 1.263A-4(a)(4).
    \1201\ A qualified personal service corporation is a corporation 
(1) substantially all of whose activities involve the performance of 
services in the fields of health, law, engineering, architecture, 
accounting, actuarial science, performing arts, or consulting, and (2) 
substantially all of the stock of which (by value) is owned by current 
or former employees performing such services, their estates, or heirs. 
Sec. 448(d)(2).
    \1202\ Secs. 448(a)(3) and (d)(3) and 461(i)(3) and (4). For this 
purpose, a tax shelter includes: (1) any enterprise (other than a C 
corporation) if at any time interests in such enterprise have been 
offered for sale in any offering required to be registered with any 
Federal or State agency having the authority to regulate the offering 
of securities for sale; (2) any syndicate (within the meaning of 
section 1256(e)(3)(B)); or (3) any tax shelter as defined in section 
6662(d)(2)(C)(ii). In the case of a farming trade or business, a tax 
shelter includes any tax shelter as defined in section 
6662(d)(2)(C)(ii) or any partnership or any other enterprise other than 
a corporation which is not an S corporation engaged in the trade or 
business of farming, (1) if at any time interests in such partnership 
or enterprise have been offered for sale in any offering required to be 
registered with any Federal or State agency having authority to 
regulate the offering of securities for sale or (2) if more than 35 
percent of the losses during any period are allocable to limited 
partners or limited entrepreneurs. For this purpose, certain holdings 
held directly by individuals that are attributable to active farm 
management activities are not treated as being held by a limited 
partner or a limited entrepreneur. See the second section 461(j) 
(relating to farming syndicate defined), as in effect prior to the 
enactment of the Consolidated Appropriations Act, 2018, Pub. L. No. 
115-141, section 401(a)(117), March 23, 2018, which, as part of 
repealing general deadwood-related provisions, redesignated the second 
``subsection (j)'' (relating to farming syndicate defined) as 
``subsection (k)''.
    \1203\ Treas. Reg. secs. 1.446-1(c)(2) and 1.471-1.
    \1204\ Sec. 471 and Treas. Reg. secs. 1.446-1(c)(2) and 1.471-1. 
However, section 13102 of the Act (Small Business Accounting Method 
Reform and Simplification) provides an exemption from the requirement 
to use inventories for taxpayers that meet the $25 million gross 
receipts test provided in such section. Accordingly, under the Act, 
such taxpayers are also eligible to use the cash method.
---------------------------------------------------------------------------
            Procedures for changing a method of accounting
    A taxpayer filing its first return may adopt any 
permissible method of accounting in computing taxable income 
for the year.\1205\ Except as otherwise provided, section 
446(e) requires taxpayers to secure the consent of the 
Secretary before changing a method of accounting. The 
regulations under section 446 provide rules for determining (1) 
what a method of accounting is, (2) how an adoption of a method 
is adopted,\1206\ and (3) how a change in method of accounting 
is effectuated.\1207\
---------------------------------------------------------------------------
    \1205\ Treas. Reg. sec. 1.446-1(e)(1).
    \1206\ See also, Rev. Rul. 90-38, 1990-1 C.B. 57 (holding that a 
taxpayer adopts a method of accounting (1) when it uses a permissible 
method of accounting on a single tax return, or (2) when it uses the 
same impermissible method of accounting on two or more consecutive tax 
returns).
    \1207\ Treas. Reg. sec. 1.446-1(e).
---------------------------------------------------------------------------
    Section 481 prescribes the rules to be followed in 
computing taxable income in cases where the taxable income of 
the taxpayer is computed under a different method of accounting 
than the prior taxable year (e.g., when changing from the cash 
method to an accrual method). In computing taxable income for 
the year of change, the taxpayer must take into account those 
adjustments which are determined to be necessary solely by 
reason of such change in order to prevent items of income or 
expense from being duplicated or omitted (i.e., ``section 
481(a) adjustments'').\1208\ The year of change is the taxable 
year for which the taxable income of the taxpayer is computed 
under a different method than the prior taxable year.\1209\ 
Congress has provided the Secretary with the authority to 
prescribe the timing and manner in which such adjustments are 
taken into account in computing taxable income.\1210\ Net 
section 481(a) adjustments that decrease taxable income 
generally are taken into account entirely in the taxable year 
of change, and net section 481(a) adjustments that increase 
taxable income generally are taken into account ratably during 
the four-taxable-year period beginning with the taxable year of 
change.\1211\
---------------------------------------------------------------------------
    \1208\ Sec. 481(a)(2) and Treas. Reg. sec. 1.481-1(a)(1).
    \1209\ Treas. Reg. sec. 1.481-1(a)(1).
    \1210\ Sec. 481(c). While Treasury regulations generally provide 
that the entire adjustments required by section 481(a) are taken into 
account entirely in the taxable year of change, the Secretary has 
provided the Commissioner with the authority to provide additional 
guidance regarding the taxable year or years in which section 481(a) 
adjustments are taken into account. See Treas. Reg. secs. 1.446-
1(e)(3), 1.481-1(c)(2), and 1.481-4.
    \1211\ See section 7.03 of Rev. Proc. 2015-13, 2015-5 I.R.B 419.
---------------------------------------------------------------------------

Post-termination distributions

    Termination of a subchapter S election results in the 
conversion of the S corporation to a C corporation, whether the 
termination is by shareholder revocation of the election or 
because the corporation no longer satisfies the definition of a 
small business corporation.\1212\ Distributions of cash by the 
C corporation to its shareholders during the post-termination 
transition period are tax-free to the shareholders (to the 
extent of the amount that was in the S corporation's 
accumulated adjustment account at the time of conversion) and 
reduce the shareholders' adjusted basis in the stock.\1213\ The 
post-termination transition period is generally the one-year 
period after the S corporation election terminates.\1214\ A 
corporation, with the consent of its shareholders, may elect to 
have this provision not apply.\1215\
---------------------------------------------------------------------------
    \1212\ Secs. 1361(b)(1) (definition of small business corporation) 
and 1361(d) (termination).
    \1213\ Sec. 1371(e)(1).
    \1214\ Sec. 1377(b).
    \1215\ Sec. 1371(e)(2).
---------------------------------------------------------------------------

                        Explanation of Provision

    Under the provision, any section 481(a) adjustment of an 
eligible terminated S corporation attributable to the 
revocation of its S corporation election (i.e., a change from 
the cash method to an accrual method) is taken into account 
ratably during the six-taxable-year period beginning with the 
year of change.\1216\ An eligible terminated S corporation is 
any C corporation that (1) is an S corporation on December 21, 
2017 (i.e., the day before enactment of the Act),\1217\ (2) 
revokes its S corporation election under section 1362(a) during 
the two-year period beginning December 22, 2017 (i.e., the date 
of such enactment), and (3) has all of same owners (and in 
identical proportions) on the date the S corporation election 
is revoked as on December 22, 2017.
---------------------------------------------------------------------------
    \1216\ Note that section 13102 of the Act (Small Business 
Accounting Method Reform and Simplification) expands the universe of 
partnerships and C corporations eligible to use the cash method to 
include partnerships or C corporations with average annual gross 
receipts that do not exceed $25 million for the three prior taxable 
years. Accordingly, an eligible terminated S corporation with average 
annual gross receipts that do not exceed $25 million that used the cash 
method prior to revoking its S corporation election may be eligible to 
remain on the cash method as a C corporation.
    \1217\ A clerical correction to the Act may be necessary to clarify 
that the phrase ``date of enactment of the Tax Cuts and Jobs Act'' 
referenced in section 481(d) means the date of enactment of Pub. L. No. 
115-97.
---------------------------------------------------------------------------
    Under the provision, in the case of any distribution of 
money by an eligible terminated S corporation after the post-
termination transition period, the eligible terminated S 
corporation may elect \1218\ to allocate the accumulated 
adjustments account (``AAA'') to such distribution, and treat 
the distribution as chargeable to accumulated earnings and 
profits (``E&P''), in the same ratio as the AAA bears to the 
accumulated E&P. The Secretary may prescribe rules for 
allocation of the AAA and E&P in the case of a distribution of 
money by an eligible terminated S corporation that has both 
accumulated E&P and current E&P.
---------------------------------------------------------------------------
    \1218\ A technical correction may be necessary to reflect this 
intent.

    The Treasury Department has issued published guidance 
addressing this provision.\1219\
---------------------------------------------------------------------------
    \1219\ See Rev. Proc. 2018-44, 2018-37 I.R.B. 426 (Aug. 22, 2018).
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective as of December 22, 2017 (i.e., 
upon enactment).

                          PART VII--EMPLOYMENT

                        SUBPART A--COMPENSATION

A. Modification of Limitation on Excessive Employee Remuneration (sec. 
             13601 of the Act and sec. 162(m) of the Code)

                               Prior Law

In general
    An employer generally may deduct reasonable compensation 
for personal services as an ordinary and necessary business 
expense. Section 162(m) provides an explicit limitation on the 
deductibility of compensation expenses in the case of publicly 
traded corporate employers. The otherwise allowable deduction 
for compensation with respect to a covered employee of a 
publicly held corporation is limited to no more than $1 million 
per year.\1220\ The deduction limitation applies when the 
deduction attributable to the compensation would otherwise be 
taken.
---------------------------------------------------------------------------
    \1220\ Sec. 162(m). This deduction limitation applies for purposes 
of the regular income tax and the alternative minimum tax.
---------------------------------------------------------------------------
Covered employees
    Section 162(m) defines a covered employee as (1) the chief 
executive officer of the corporation (or an individual acting 
in such capacity) as of the close of the taxable year and (2) 
any employee whose total compensation is required to be 
reported to shareholders under the Securities Exchange Act of 
1934 \1221\ (``Exchange Act'') by reason of being among the 
corporation's four most highly compensated officers for the 
taxable year (other than the chief executive officer).\1222\ 
Treasury regulations under section 162(m) provide that whether 
an employee is the chief executive officer or among the four 
most highly compensated officers should be determined pursuant 
to the executive compensation disclosure rules promulgated 
under the Exchange Act.\1223\
---------------------------------------------------------------------------
    \1221\ Pub. L. No. 73-291; 15 U.S.C. sec. 78a, et seq.
    \1222\ Sec. 162(m)(3).
    \1223\ Treas. Reg. sec. 1.162-27(c)(2)(ii).
---------------------------------------------------------------------------
    In 2006, the Securities and Exchange Commission amended 
certain rules relating to executive compensation, including 
which officers' compensation must be disclosed under the 
Exchange Act. Under the new rules, such officers are (1) the 
principal executive officer (or an individual acting in such 
capacity), (2) the principal financial officer (or an 
individual acting in such capacity), and (3) the three most 
highly compensated officers, other than the principal executive 
officer or principal financial officer.
    In response to the Securities and Exchange Commission's new 
disclosure rules, the Internal Revenue Service issued updated 
guidance on identifying which employees are covered by section 
162(m).\1224\ The updated guidance provides that the term 
``covered employee'' means any employee who is (1) as of the 
close of the taxable year, the principal executive officer (or 
an individual acting in such capacity) defined in reference to 
the Exchange Act, or (2) among the three most highly 
compensated officers \1225\ for the taxable year (other than 
the principal executive officer or principal financial 
officer), again defined by reference to the Exchange Act. Thus, 
under current guidance, only four employees are covered under 
section 162(m) for any taxable year. Under Treasury 
regulations, the requirement that the individual meet the 
criteria as of the last day of the taxable year applies to both 
the principal executive officer and the three highest 
compensated officers.\1226\
---------------------------------------------------------------------------
    \1224\ Notice 2007-49, 2007-25 I.R.B. 1429.
    \1225\ By reason of being among the officers whose total 
compensation is required to be reported to shareholders under the 
Securities Exchange Act of 1934.
    \1226\ Treas. Reg. sec. 1.162-27(c)(2)(i).
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Definition of publicly held corporation
    For purposes of the deduction disallowance of section 
162(m), a publicly held corporation means any corporation 
issuing any class of common equity securities required to be 
registered under section 12 of the Exchange Act.\1227\ All U.S. 
publicly traded companies are subject to this registration 
requirement, including their foreign affiliates. A foreign 
company publicly traded through American depository receipts 
(``ADRs''') is also subject to this registration requirement if 
more than 50 percent of the issuer's outstanding voting 
securities are held, directly or indirectly, by residents of 
the United States and either (i) the majority of the executive 
officers or directors are United States citizens or residents, 
(ii) more than 50 percent of the assets of the issuer are 
located in the United States, or (iii) the business of the 
issuer is administered principally in the United States. Other 
foreign companies are not subject to the registration 
requirement even if their stock is publicly traded through 
ADRs.
---------------------------------------------------------------------------
    \1227\ Sec. 162(m)(2).
---------------------------------------------------------------------------
Remuneration subject to the deduction limitation
            In general
    Unless specifically excluded, the deduction limitation 
applies to all remuneration for services, including cash and 
the cash value of all remuneration (including benefits) paid in 
a medium other than cash. If an individual is a covered 
employee for a taxable year, the deduction limitation applies 
to all compensation not explicitly excluded from the deduction 
limitation, regardless of whether the compensation is for 
services as a covered employee and regardless of when the 
compensation was earned. The $1 million cap is reduced by 
excess parachute payments (as defined in section 280G) that are 
not deductible by the corporation.\1228\
---------------------------------------------------------------------------
    \1228\ Sec. 162(m)(4)(F).
---------------------------------------------------------------------------
    Certain types of compensation are not subject to the 
deduction limit and are not taken into account in determining 
whether other compensation exceeds $1 million. The following 
types of compensation are not taken into account: (1) 
remuneration payable on a commission basis; \1229\ (2) 
remuneration payable solely on account of the attainment of one 
or more performance goals if certain outside director and 
shareholder approval requirements are met (``performance-based 
compensation''); \1230\ (3) payments to a tax-favored 
retirement plan (including salary reduction contributions); 
\1231\ (4) amounts that are excludable from the executive's 
gross income (such as employer-provided health benefits and 
miscellaneous fringe benefits \1232\); \1233\ and (5) any 
remuneration payable under a written binding contract which was 
in effect on February 17, 1993.\1234\ In addition, remuneration 
does not include compensation for which a deduction is 
allowable after a covered employee ceases to be a covered 
employee. Thus, the deduction limitation often does not apply 
to deferred compensation that is otherwise subject to the 
deduction limitation (e.g., is not performance-based 
compensation) because the payment of the compensation is 
deferred until after termination of employment.
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    \1229\ Sec. 162(m)(4)(B).
    \1230\ Sec. 162(m)(4)(C).
    \1231\ Treas. Reg. secs. 1.162-27(c)(3)(ii)(A) and (B).
    \1232\ Secs. 105, 106, and 132.
    \1233\ Treas. Reg. sec. 1.162-27(c)(3)(ii)(B).
    \1234\ Treas. Reg. sec. 1.162-27(h).
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            Performance-based compensation
    Compensation qualifies for the exception for performance-
based compensation only if (1) it is paid solely on account of 
the attainment of one or more performance goals, (2) the 
performance goals are established by a compensation committee 
consisting solely of two or more outside directors, (3) the 
material terms under which the compensation is to be paid, 
including the performance goals, are disclosed to and approved 
by the shareholders in a separate majority-approved vote prior 
to payment, and (4) prior to payment, the compensation 
committee certifies that the performance goals and any other 
material terms were in fact satisfied.\1235\
---------------------------------------------------------------------------
    \1235\ Sec. 162(m)(4)(C); Treas. Reg. sec. 162-27(e). A director is 
considered an outside director if he or she is not a current employee 
of the corporation (or related entities), is not a former employee of 
the corporation (or related entities) who is receiving compensation for 
prior services (other than benefits under a qualified retirement plan), 
was not an officer of the corporation (or related entities) at any 
time, and is not currently receiving compensation for personal services 
in any capacity (e.g., for services as a consultant) other than as a 
director. Treas. Reg. sec. 1.162-27(e)(3).
---------------------------------------------------------------------------
    Compensation (other than a stock option or other stock 
appreciation right (``SAR'') that meets certain requirements) 
is not treated as paid solely on account of the attainment of 
one or more performance goals unless the compensation is paid 
to the particular executive pursuant to a pre-established 
objective performance formula or standard that precludes 
discretion. A stock option or SAR with an exercise price not 
less than the fair market value, on the date the option or SAR 
is granted, of the stock subject to the option or SAR, 
generally is treated as meeting the exception for performance-
based compensation, provided that the requirements for outside 
director and shareholder approval are met (without the need for 
certification that the performance standards have been met). 
This is the case because the amount of compensation 
attributable to such an option or SAR received by the executive 
is based solely on an increase in the corporation's stock 
price. Stock-based compensation is not treated as performance-
based if it depends on factors other than corporate 
performance, unless all of the general requirements for 
performance-based compensation are met.\1236\
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    \1236\ Treas. Reg. sec. 1.162-27(e)(2)(vi).
---------------------------------------------------------------------------

                        Explanation of Provision

Definition of covered employee
    The provision revises the definition of covered employee to 
include both the principal executive officer and the principal 
financial officer. Further, an individual is a covered employee 
if the individual holds one of these positions at any time 
during the taxable year. The provision also defines as a 
covered employee the three (rather than four) most highly 
compensated officers for the taxable year (other than the 
principal executive officer or principal financial officer) who 
are required to be reported on the company's proxy statement 
(i.e., the statement required pursuant to executive 
compensation disclosure rules promulgated under the Exchange 
Act) for the taxable year (or who would be required to be 
reported on such a statement for a company not required to make 
such a report to shareholders). This includes such officers of 
a corporation not required to file a proxy statement but which 
otherwise falls within the revised definition of a publicly 
held corporation, as well as such officers of a publicly held 
corporation that would otherwise have been required to file a 
proxy statement for the year (for example, but for the fact 
that the corporation delisted its securities or underwent a 
transaction that resulted in the nonapplication of the proxy 
statement requirement). The determination of the three most 
highly compensated officers who are ``covered employees'' is 
consistent between a publicly held corporation subject to the 
executive compensation disclosure rules under the Exchange Act 
and such a corporation not subject to these disclosure rules. 
The compensation taken into account to make the determination 
is total compensation pursuant to these disclosure rules. 
Therefore, the three highest compensated officers who are 
``covered employees'' under the provision include any employee 
(other than the principal executive officer or principal 
financial officer) whose total compensation for the taxable 
year results in the employee being among the three highest 
compensated officers for the taxable year, whether or not the 
officer's compensation is required to be reported to 
shareholders under the Exchange Act and whether or not such 
individual was employed on the last day of the taxable year.
    In addition, if an individual is a covered employee with 
respect to a corporation for a taxable year beginning after 
December 31, 2016, the individual remains a covered employee 
for all future years. Thus, an individual remains a covered 
employee with respect to compensation otherwise deductible for 
subsequent years, including for years during which the 
individual is no longer employed by the corporation and years 
after the individual has died. The provision clarifies that 
compensation does not fail to be compensation with respect to a 
covered employee and thus subject to the deduction limit for a 
taxable year merely because the compensation is includible in 
the income of, or paid to, another individual, such as 
compensation paid to a beneficiary after the employee's death, 
or to a former spouse pursuant to a domestic relations order.
Definition of publicly held corporation
    The provision expands the definition of publicly held 
corporation to include an issuer that is required to file 
reports under section 15(d) of the Exchange Act. Therefore, in 
addition to applying to all domestic publicly traded 
corporations and certain foreign companies publicly traded 
through ADRs, the provision extends the applicability of 
section 162(m) to include all foreign companies publicly traded 
through ADRs.
    The definition of an issuer that is required to file 
reports under section 15(d) of the Exchange Act may also 
include certain additional corporations that are not publicly 
traded, such as large private C corporations or S corporations. 
For example, entities that are required to report under section 
15(d) of the Exchange Act include (1) any corporation, whether 
publicly or non-publicly traded, that issues securities which 
are held by more than 300 holders of record (1,200 holders of 
record in the case of a bank, savings and loan holding company, 
or a bank holding company), and (2) any S corporation or non-
publicly traded C corporation that has issued asset-backed 
securities, regardless of the number of holders of record, 
unless all of its asset-backed securities are held by 
affiliates of the corporation.\1237\
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    \1237\ See 15 U.S.C. sec. 78o.
---------------------------------------------------------------------------
    It is intended that Treasury apply anti-abuse rules 
regarding the application of section 162(m) to issuers that 
file reports under section 15(d) of the Exchange Act, including 
rules to provide consistency in its application to such 
issuers.
Performance-based compensation and commissions exceptions
    The provision eliminates the exceptions for commissions and 
performance-based compensation from the definition of 
compensation subject to the deduction limit. As a result, such 
compensation is taken into account in determining the amount of 
compensation with respect to a covered employee for a taxable 
year that exceeds $1 million and is thus not deductible under 
section 162.

    The Treasury Department has issued published guidance 
addressing this provision.\1238\
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    \1238\ Notice 2018-68, 2018-36 I.R.B. 418.
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017. A transition rule applies to remuneration 
which is provided pursuant to a written binding contract which 
was in effect on November 2, 2017, and which was not modified 
in any material respect on or after such date.
    For purposes of the transition rule, compensation paid 
pursuant to a plan qualifies for this exception provided that 
the right to participate in the plan is part of a written 
binding contract with the covered employee in effect on 
November 2, 2017. For example, suppose a covered employee was 
hired by XYZ Corporation on October 2, 2017, and one of the 
terms of the written employment contract is that the executive 
is eligible to participate in the `XYZ Corporation Executive 
Deferred Compensation Plan' in accordance with the terms of the 
plan. Assume further that the terms of the plan provide for 
participation after six months of employment, amounts payable 
under the plan are not subject to discretion, and the 
corporation does not have the right to amend materially the 
plan or to terminate the plan (except on a prospective basis 
before any services are performed with respect to the 
applicable period for which such compensation is to be paid). 
Provided that the other conditions of the binding contract 
exception are met (e.g., the plan itself is in writing), 
payments under the plan are grandfathered, even though the 
employee was not actually a participant in the plan on November 
2, 2017.\1239\
---------------------------------------------------------------------------
    \1239\ As discussed in the text below, the grandfather treatment 
ceases to apply if the plan is materially amended.
---------------------------------------------------------------------------
    The fact that a plan was in existence on November 2, 2017 
is not by itself sufficient to qualify the plan for the 
exception for binding written contracts. The exception is 
limited to amounts to which a contractual obligation applies on 
November 2, 2017.
    The exception for remuneration paid pursuant to a binding 
written contract ceases to apply to amounts paid after there 
has been a material modification to the terms of the contract. 
The exception also does not apply to new contracts entered into 
or renewed after November 2, 2017. For purposes of this rule, 
any contract that is entered into on or before November 2, 2017 
and that is renewed after such date is treated as a new 
contract entered into on the day the renewal takes effect. A 
contract that is terminable or cancelable unconditionally at 
will by either party to the contract without the consent of the 
other, or by both parties to the contract, is treated as a new 
contract entered into on the date any such termination or 
cancellation, if made, would be effective. However, a contract 
is not treated as so terminable or cancelable if it can be 
terminated or cancelled only by terminating the employment 
relationship of the covered employee.
    For an individual who would have been a covered employee 
prior to the effective date of the amendments made to section 
162(m), the transition rule is limited to the remuneration of 
such a covered employee that otherwise satisfies the 
performance-based and commission exceptions under prior law as 
well as the requirements applicable to a written binding 
contract in effect on November 2, 2017. As a result, the 
transition rule generally does not extend to any other 
remuneration, including salary, deferred compensation, or non-
performance-based cash or equity compensation, of such a 
covered employee. For an individual who is a covered employee 
as a result of the amendments made by section 13601 of Pub. L. 
No. 115-97, remuneration that does not satisfy the requirements 
applicable to a written binding contract in effect on November 
2, 2017 is subject to section 162(m). Such remuneration may 
include deferred compensation and severance that does not 
satisfy the written binding contract requirements. Remuneration 
subject to section 162(m) does include equity compensation and 
other compensatory awards granted after November 2, 2017, even 
if pursuant to a plan in existence on November 2, 2017.

B. Excise Tax on Excess Tax-Exempt Organization Executive Compensation 
         (sec. 13602 of the Act and new sec. 4960 of the Code)


                               Prior Law

    Taxable employers and other service recipients generally 
may deduct reasonable compensation expenses.\1240\ However, in 
some cases, compensation in excess of specific levels is not 
deductible.
---------------------------------------------------------------------------
    \1240\ Sec. 162(a)(1).
---------------------------------------------------------------------------
    A publicly held corporation generally cannot deduct more 
than $1 million of compensation (that is not compensation 
otherwise excepted from this limit) in a taxable year for each 
``covered employee.'' \1241\ For this purpose, a covered 
employee is the corporation's principal executive officer (or 
an individual acting in such capacity) defined in reference to 
the Securities Exchange Act of 1934 (``Exchange Act'') as of 
the close of the taxable year, or any employee whose total 
compensation is required to be reported to shareholders under 
the Exchange Act by reason of being among the corporation's 
three most highly compensated officers for the taxable year 
(other than the principal executive officer or principal 
financial officer).\1242\
---------------------------------------------------------------------------
    \1241\ Sec. 162(m)(1). Under section 162(m)(6), another limit 
applies to deductions for compensation of individuals performing 
services for certain health insurance providers.
    \1242\ Notice 2007-49, 2007-2 I.R.B. 1429.
---------------------------------------------------------------------------
    Unless an exception applies, generally a corporation cannot 
deduct that portion of the aggregate present value of a 
``parachute payment'' which equals or exceeds three times the 
``base amount'' of certain service providers. The nondeductible 
excess is an ``excess parachute payment.'' \1243\ A parachute 
payment is generally a payment of compensation that is 
contingent on a change in corporate ownership or control made 
to certain officers, shareholders, and highly compensated 
individuals.\1244\ An individual's base amount is the average 
annualized compensation includible in the individual's gross 
income for the five taxable years ending before the date on 
which the change in ownership or control occurs.\1245\ Certain 
amounts are not considered parachute payments, including 
payments under a qualified retirement plan, a simplified 
employee pension plan, or a simple retirement account.\1246\
---------------------------------------------------------------------------
    \1243\ Secs. 280G(a) and (b)(1).
    \1244\ Secs. 280G(b)(2) and (c).
    \1245\ Sec. 280G(b)(3).
    \1246\ Secs. 401(a), 403(a), 408(k), and 408(p).
---------------------------------------------------------------------------
    These deduction limits generally do not affect a tax-exempt 
organization.

                        Explanation of Provision

    Under the provision, an employer is liable for an excise 
tax equal to the corporate tax rate (21 percent) multiplied by 
the sum of (1) any remuneration (other than an excess parachute 
payment) in excess of $1 million paid to a covered employee by 
an applicable tax-exempt organization for a taxable year, and 
(2) any excess parachute payment (under a new definition for 
this purpose that relates solely to separation pay) paid by the 
applicable tax-exempt organization to a covered employee. 
Accordingly, the excise tax applies as a result of an excess 
parachute payment, even if the covered employee's remuneration 
does not exceed $1 million.
    For purposes of the provision, a covered employee is an 
employee (including any former employee) of an applicable tax-
exempt organization if the employee is one of the five highest 
compensated employees of the organization for the taxable year 
or was a covered employee of the organization (or a 
predecessor) for any preceding taxable year beginning after 
December 31, 2016.
    For purposes of determining who is a covered employee, all 
of the compensation of an employee of an applicable tax-exempt 
organization (or a predecessor), including compensation 
directly or indirectly paid to an employee by any related 
person or governmental entity, is taken into account to 
determine the five highest compensated employees of the 
organization for the taxable year. \1247\ Also for purposes of 
determining a covered employee, remuneration paid to a licensed 
medical professional that is directly related to the 
performance of medical or veterinary services by such 
professional is not taken into account, whereas remuneration 
paid to such a professional in any other capacity is taken into 
account. A medical professional for this purpose includes a 
doctor, nurse, or veterinarian. Therefore, if a surgeon 
performs direct medical services as part of his or her medical 
practice, and also performs services that are not direct 
medical services (such as teaching, research, or acting as 
dean, officer, or board member of a hospital), that portion of 
such a medical professional's remuneration attributable to 
those services that are direct medical services is not treated 
as remuneration.
---------------------------------------------------------------------------
    \1247\ The compensation used for purposes of determining who is a 
covered employee is intended to be expansive to most accurately 
determine the five highest compensated employees, and includes 
compensation from disregarded entities.
---------------------------------------------------------------------------
    An ``applicable tax-exempt organization'' is an 
organization exempt from tax under section 501(a), an exempt 
farmers' cooperative,\1248\ a Federal, State or local 
governmental entity with excludable income,\1249\ or a 
political organization.\1250\ Applicable tax-exempt 
organizations are intended to include State colleges and 
universities.\1251\
---------------------------------------------------------------------------
    \1248\ Sec. 521(b).
    \1249\ Sec. 115(1).
    \1250\ Sec. 527(e)(1).
    \1251\ A technical correction may be necessary to reflect this 
intent.
---------------------------------------------------------------------------
    For purposes of the timing of application of the excise 
tax, remuneration is treated as paid when there is no 
substantial risk of forfeiture of the rights to such 
remuneration. For this purpose, the determination of when a 
``substantial risk of forfeiture'' no longer exists is based on 
the definition under section 457(f)(3)(B). Accordingly, the tax 
imposed by this provision can apply to the value of 
remuneration that is vested (and any increases in such value or 
vested remuneration) under this definition, even if it is not 
yet received. Therefore, the excise tax can apply to 
remuneration at a time that is different than the time 
remuneration is required to be included in gross income as 
wages.\1252\
---------------------------------------------------------------------------
    \1252\ For example, even though remuneration may be vested in one 
year but paid within the first two and one-half months of the following 
year such that the income inclusion is required in the year paid, the 
remuneration is treated as paid for this purpose in the year when 
vested. Additionally, earnings on previously vested remuneration, even 
if paid or payable in future years, are treated as paid for this 
purpose as they accrue.
---------------------------------------------------------------------------
    Remuneration for this purpose means wages as defined for 
income tax withholding purposes,\1253\ but does not include any 
designated Roth contribution.\1254\ In addition, the definition 
of remuneration for this purpose includes amounts required to 
be included in gross income under section 457(f).\1255\ This 
definition applies to determine the type of compensation that 
is treated as remuneration but does not control the time when 
the excise tax is assessed on remuneration that exceeds the $1 
million threshold. As described above, the excise tax applies 
when remuneration (once determined under this definition) is 
treated as paid (i.e., when the right to the remuneration is no 
longer subject to a substantial risk of forfeiture, as 
defined), without regard to when such remuneration is actually 
received or otherwise required to be included in gross income 
as wages.
---------------------------------------------------------------------------
    \1253\ Sec. 3401(a).
    \1254\ Under section 402A(c), a designated Roth contribution is an 
elective deferral (that is, a contribution to a tax-favored employer-
sponsored retirement plan made at the election of an employee) that the 
employee designates as not being excludable from income.
    \1255\ Such amounts may not be treated as wages under section 
3401(a), but are treated as remuneration for purposes of the excise tax 
application. See Technical Advice Memorandum 199903032, October 2, 
1998. Sec. 457(f) applies to an ``ineligible'' deferred compensation 
plan of a State or local government or a tax-exempt employer (that is, 
a plan that does not meet the requirements to be an eligible plan under 
section 457(b)). Under an ineligible plan, deferred amounts are treated 
as nonqualified deferred compensation and includible in income for the 
first taxable year in which there is no substantial risk of forfeiture 
of the rights to such compensation. For this purpose, a person's rights 
to compensation are subject to a substantial risk of forfeiture if the 
rights are conditioned on the future performance of substantial 
services by any individual. Earnings post-vesting are generally taxed 
when paid.
---------------------------------------------------------------------------
    Remuneration of a covered employee includes any 
remuneration paid with respect to employment of the covered 
employee by any person or governmental entity related to the 
applicable tax-exempt organization.\1256\ A person or 
governmental entity is treated as related to an applicable tax-
exempt organization if the person or governmental entity (1) 
controls, or is controlled by, the organization, (2) is 
controlled by one or more persons that control the 
organization, (3) is a supported organization \1257\ during the 
taxable year with respect to the organization, (4) is a 
supporting organization \1258\ during the taxable year with 
respect to the organization, or (5) in the case of a voluntary 
employees' beneficiary association (``VEBA''),\1259\ 
establishes, maintains, or makes contributions to the VEBA. 
However, remuneration of a covered employee that is not 
deductible by reason of the $1 million limit on deductible 
compensation \1260\ is not taken into account for purposes of 
the provision.
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    \1256\ Sec. 4960(c)(4). A technical correction may be necessary to 
reflect that the related organization rules also apply to excess 
parachute payments and for purposes of determining covered employees.
    \1257\ Sec. 509(f)(3).
    \1258\ Sec. 509(a)(3).
    \1259\ Sec. 501(c)(9).
    \1260\ Sec. 162(m).
---------------------------------------------------------------------------
    Under the provision, an excess parachute payment is the 
amount by which any parachute payment exceeds the portion of 
the base amount allocated to the payment. A parachute payment 
is a payment in the nature of compensation to (or for the 
benefit of) a covered employee if the payment is contingent on 
the employee's separation from employment and the aggregate 
present value of all such payments equals or exceeds three 
times the base amount. The base amount is the average 
annualized compensation includible in the covered employee's 
gross income for the five taxable years ending before the date 
of the employee's separation from employment. Parachute 
payments do not include payments under a qualified retirement 
plan, a simplified employee pension plan, a simple retirement 
account, a tax-deferred annuity,\1261\ or an eligible deferred 
compensation plan of a State or local government 
employer.\1262\ Parachute payments include amounts contingent 
on separation from employment from severance and deferred 
compensation plans (including supplemental executive retirement 
plans), and do not exclude bona fide severance or separation 
pay plans under section 457(f) or section 409A.
---------------------------------------------------------------------------
    \1261\ Sec. 403(b).
    \1262\ Sec. 457(b).
---------------------------------------------------------------------------
    Payments to employees who are not highly compensated 
employees (within the meaning of section 414(q)), and payments 
attributable to medical services of certain licensed medical 
professionals,\1263\ are exempt from the definition of 
parachute payment.
---------------------------------------------------------------------------
    \1263\ Sec. 4960(c)(5)(C). The principles of allocation described 
above that apply to determine exempt remuneration attributable to 
medical services also apply to determine exempt payments attributable 
to medical services for purposes of parachute payments.
---------------------------------------------------------------------------
    The employer of a covered employee is liable for the excise 
tax. If remuneration of a covered employee from more than one 
employer is taken into account in determining the excise tax, 
each employer is liable for the tax in an amount that bears the 
same ratio to the total tax as the remuneration paid by that 
employer bears to the total remuneration paid by all of the 
employers to the covered employee. For purposes of these rules, 
the liability for the excise tax on an excess parachute payment 
is intended to be treated the same as the liability for the 
excise tax on remuneration.\1264\
---------------------------------------------------------------------------
    \1264\ Sec. 4960(c)(4)(C). A technical correction may be necessary 
to reflect this.
---------------------------------------------------------------------------
    The provision directs the Secretary of the Treasury to 
prescribe regulations as necessary to prevent avoidance of the 
excise tax, including regulations to prevent avoidance of the 
tax through self-employment or through payment or services via 
a pass-through or other entity to avoid the tax. For example, 
the excise tax cannot be avoided if an individual who is an 
employee is classified as an independent contractor and paid as 
such, or if payment is made to an LLC owned all or in part by 
an employee or to or by a person or organization unrelated to 
an applicable tax-exempt organization.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

C. Treatment of Qualified Equity Grants (sec. 13603 of the Act and new 
                        sec. 83(i) of the Code)


                               Prior Law


Income tax treatment of employer stock transferred to an employee

    Specific rules apply to property, including employer stock, 
transferred to an employee in connection with the performance 
of services.\1265\ These rules govern the amount and timing of 
income inclusion by the employee and the amount and timing of 
the employer's compensation deduction.
---------------------------------------------------------------------------
    \1265\ Sec. 83. Section 83 applies generally to transfers of any 
property, not just employer stock, in connection with the performance 
of services by any service provider, not just an employee. However, the 
provision described herein applies only with respect to certain 
employer stock transferred to employees.
---------------------------------------------------------------------------
    Under these rules, an employee generally must recognize 
income in the taxable year in which the employee's right to the 
stock is transferable or is not subject to a substantial risk 
of forfeiture, whichever occurs earlier (referred to herein as 
``substantially vested''). Thus, if the employee's right to the 
stock is substantially vested when the stock is transferred to 
the employee, the employee recognizes income in the taxable 
year of such transfer, in an amount equal to the fair market 
value of the stock as of the date of transfer (less any amount 
paid for the stock). If at the time the stock is transferred to 
the employee, the employee's right to the stock is not 
substantially vested (referred to herein as ``nonvested''), the 
employee does not recognize income attributable to the stock 
transfer until the taxable year in which the employee's right 
becomes substantially vested. In this case, the amount 
includible in the employee's income is the fair market value of 
the stock as of the date that the employee's right to the stock 
is substantially vested (less any amount paid for the stock). 
However, if the employee's right to the stock is nonvested at 
the time the stock is transferred to the employee, under 
section 83(b), the employee may elect within 30 days of 
transfer to recognize income in the taxable year of transfer, 
referred to as a ``section 83(b)'' election.\1266\ If a proper 
and timely election under section 83(b) is made, the amount of 
compensatory income is capped at the amount equal to the fair 
market value of the stock as of the date of transfer (less any 
amount paid for the stock). A section 83(b) election is 
available with respect to grants of ``restricted stock'' 
(nonvested stock), and does not generally apply to the grant of 
options.
---------------------------------------------------------------------------
    \1266\ Under Treas. Reg. sec. 1.83-2, the employee makes an 
election by filing with the Internal Revenue Service a written 
statement that includes the fair market value of the property at the 
time of transfer and the amount (if any) paid for the property. The 
employee must also provide a copy of the statement to the employer.
---------------------------------------------------------------------------
    In general, an employee's right to stock or other property 
is subject to a substantial risk of forfeiture if the 
employee's right to full enjoyment of the property is subject 
to a condition, such as the future performance of substantial 
services.\1267\ An employee's right to stock or other property 
is transferable if the employee can transfer an interest in the 
property to any person other than the transferor of the 
property.\1268\ Thus, generally, employer stock transferred to 
an employee by an employer is not transferable merely because 
the employee can sell it back to the employer.
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    \1267\ See section 83(c)(1) and Treas. Reg. sec. 1.83-3(c) for the 
definition of substantial risk of forfeiture for this purpose.
    \1268\ Treas. Reg. sec. 1.83-3(d). In addition, under section 
83(c)(2), the right to stock is transferable only if any transferee's 
right to the stock would not be subject to a substantial risk of 
forfeiture.
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    In the case of stock transferred to an employee, the 
employer is allowed a deduction (to the extent a deduction for 
a business expense is otherwise allowable) equal to the amount 
included in the employee's income as a result of transfer of 
the stock.\1269\ The employer deduction generally is permitted 
in the employer's taxable year in which or with which ends the 
employee's taxable year when the amount is included and 
properly reported in the employee's income.\1270\
---------------------------------------------------------------------------
    \1269\ Sec. 83(h).
    \1270\ Treas. Reg. sec. 1.83-6.
---------------------------------------------------------------------------
    These rules do not apply to the grant of a nonqualified 
option on employer stock unless the option has a readily 
ascertainable fair market value.\1271\ Instead, these rules 
apply to the transfer of employer stock to the employee on 
exercise of the option. That is, if the right to the stock is 
substantially vested on transfer (the time of exercise), income 
recognition applies for the taxable year of transfer. If the 
right to the stock is nonvested on transfer, the timing of 
income inclusion is determined under the rules applicable to 
the transfer of nonvested stock. In either case, the amount 
includible in income by the employee is the fair market value 
of the stock as of the required time of income inclusion, less 
the exercise price paid by the employee. A section 83(b) 
election generally does not apply to the grant of options. If 
upon the exercise of an option, nonvested stock is transferred 
to the employee, a section 83(b) election may apply. The 
employer's deduction is generally determined under the rules 
that apply to transfers of restricted stock, but a special 
accrual rule may apply under Treasury regulations when the 
transferred stock is substantially vested.\1272\
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    \1271\ See section 83(e)(3) and Treas. Reg. sec. 1.83-7. A 
nonqualified option is an option on employer stock that is not a 
statutory option, discussed below.
    \1272\ Treas. Reg. sec. 1.83-6(a)(3).
---------------------------------------------------------------------------

Employment taxes and reporting

    Employment taxes generally consist of taxes under the 
Federal Insurance Contributions Act (``FICA''), tax under the 
Federal Unemployment Tax Act (``FUTA''), and income taxes 
required to be withheld by employers from wages paid to 
employees (``income tax withholding'').\1273\ Unless an 
exception applies under the applicable rules, compensation 
provided to an employee constitutes wages subject to these 
taxes.
---------------------------------------------------------------------------
    \1273\ Secs. 3101-3128 (FICA), 3301-3311 (FUTA), and 3401-3404 
(income tax withholding). Instead of FICA taxes, railroad employers and 
employees are subject, under the Railroad Retirement Tax Act 
(``RRTA''), sections 3201-3241, to taxes equivalent to FICA taxes with 
respect to compensation as defined for RRTA purposes. Sections 3501-
3510 provide additional rules relating to all these taxes.
---------------------------------------------------------------------------
    FICA imposes tax on employers and employees, generally 
based on the amount of wages paid to an employee during the 
year. Special rules as to the timing and amount of FICA taxes 
apply in the case of nonqualified deferred compensation, as 
defined for FICA purposes.\1274\
---------------------------------------------------------------------------
    \1274\ Sec. 3121(v); Treas. Reg. sec. 31.3121(v)(2)-1.
---------------------------------------------------------------------------
    The tax imposed on the employer and on the employee is each 
composed of two parts: (1) the Social Security or old age, 
survivors, and disability insurance (``OASDI'') tax equal to 
6.2 percent of covered wages up to the OASDI wage base 
($127,200 for 2017); and (2) the Medicare or hospital insurance 
(``HI'') tax equal to 1.45 percent of all covered wages.\1275\ 
The employee portion of FICA tax generally must be withheld 
and, along with the employer portion, remitted to the Federal 
government by the employer. FICA tax withholding applies 
regardless of whether compensation is provided in the form of 
cash or a noncash form, such as a transfer of property 
(including employer stock) or in-kind benefits.\1276\
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    \1275\ The employee portion of the HI tax under FICA (not the 
employer portion) is increased by an additional tax of 0.9 percent on 
wages received in excess of a threshold amount. The threshold amount is 
$250,000 in the case of a joint return, $125,000 in the case of a 
married individual filing a separate return, and $200,000 in any other 
case.
    \1276\ Under section 3501(b), employment taxes with respect to 
noncash fringe benefits are to be collected (or paid) by the employer 
at the time and in the manner prescribed by the Secretary of the 
Treasury. Announcement 85-113, 1985-31 I.R.B. 31, provides guidance on 
the application of employment taxes with respect to noncash fringe 
benefits.
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    FUTA imposes a tax on employers of six percent of wages up 
to the FUTA wage base of $7,000.
    Income tax withholding generally applies when wages are 
paid by an employer to an employee, based on graduated 
withholding rates set out in tables published by the Internal 
Revenue Service (``IRS'').\1277\ Like FICA tax withholding, 
income tax withholding applies regardless of whether 
compensation is provided in the form of cash or a noncash form, 
such as a transfer of property (including employer stock) or 
in-kind benefits.
---------------------------------------------------------------------------
    \1277\ Sec. 3402. Specific withholding rates apply in the case of 
supplemental wages.
---------------------------------------------------------------------------
    An employer is required to furnish each employee with a 
statement of compensation information for a calendar year, 
including taxable compensation, FICA wages, and withheld income 
and FICA taxes.\1278\ In addition, information relating to 
certain nontaxable items must be reported, such as certain 
retirement and health plan contributions. The statement, made 
on Form W-2, Wage and Tax Statement, must be provided to each 
employee by January 31 of the succeeding year.\1279\
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    \1278\ Secs. 6041 and 6051.
    \1279\ Employers send Form W-2 information to the Social Security 
Administration, which records information relating to Social Security 
and Medicare and forwards the Form W-2 information to the IRS. 
Employees include a copy of Form W-2 with their income tax returns.
---------------------------------------------------------------------------

Statutory options

    Two types of statutory options apply with respect to 
employer stock: incentive stock options (``ISOs''') and options 
provided under an employee stock purchase plan 
(``ESPP'').\1280\ Stock received pursuant to a statutory option 
is subject to special rules, rather than the rules for 
nonqualified options, discussed above. No amount is includible 
in an employee's income on the grant, vesting, or exercise of a 
statutory option.\1281\ In addition, generally no deduction is 
allowed to the employer with respect to the option or the stock 
transferred to an employee.
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    \1280\ Sections 421-424 govern statutory options. Section 423(b)(5) 
requires that, under the terms of an ESPP, all employees granted 
options generally must have the same rights and privileges.
    \1281\ Under section 56(b)(3), this income tax treatment with 
respect to stock received on exercise of an ISO does not apply for 
purposes of the alternative minimum tax under section 55.
---------------------------------------------------------------------------
    If a holding requirement is met with respect to the stock 
transferred on exercise of a statutory option and the employee 
later disposes of the stock, the employee's gain generally is 
treated as capital gain rather than ordinary income. Under the 
holding requirement, the employee must not dispose of the stock 
within two years after the date the option is granted and also 
must not dispose of the stock within one year after the date 
the option is exercised. If a disposition occurs before the end 
of the required holding period (a ``disqualifying 
disposition''), the employee recognizes ordinary income in the 
taxable year in which the disqualifying disposition occurs, and 
the employer may be allowed a corresponding deduction in the 
taxable year in which such disposition occurs. The amount of 
ordinary income recognized when a disqualifying disposition 
occurs generally equals the fair market value of the stock on 
the date of exercise (that is, when the stock was transferred 
to the employee) less the exercise price paid.
    Employment taxes do not apply with respect to the grant or 
vesting of a statutory option, transfer of stock pursuant to 
the option, or a disposition (including a disqualifying 
disposition) of the stock.\1282\ However, certain special 
reporting requirements apply.
---------------------------------------------------------------------------
    \1282\ Secs. 3121(a)(22), 3306(b)(19), and the last sentence of 
section 421(b).
---------------------------------------------------------------------------

Nonqualified deferred compensation

    Compensation is generally includible in an employee's 
income when paid to the employee. However, in the case of a 
nonqualified deferred compensation plan,\1283\ unless the 
arrangement either is exempt from or meets the requirements of 
section 409A, the amount of deferred compensation is first 
includible in income for the taxable year when not subject to a 
substantial risk of forfeiture (as defined \1284\), even if 
payment will not occur until a later year.\1285\ In general, to 
meet the requirements of section 409A, the time when 
nonqualified deferred compensation will be paid, as well as the 
amount, must be specified at the time of deferral with limits 
on further deferral after the time for payment. Various other 
requirements apply, including that payment can only occur on 
specific defined events.
---------------------------------------------------------------------------
    \1283\ Compensation earned by an employee is generally paid to the 
employee shortly after being earned. However, in some cases, payment is 
deferred to a later period, referred to as ``deferred compensation.'' 
Deferred compensation may be provided through a plan that receives tax-
favored treatment, such as a qualified retirement plan under section 
401(a). Deferred compensation provided through a plan that is not 
eligible for tax-favored treatment is referred to as ``nonqualified'' 
deferred compensation.
    \1284\ Treas. Reg. sec. 1.409A-1(d).
    \1285\ Section 409A and the regulations thereunder provide rules 
for nonqualified deferred compensation. Compensation that fails to meet 
the requirements of section 409A is also subject to an additional 
income tax of 20 percent on amounts includible in income and a 
potential interest factor tax (``409A taxes''). Section 409A and the 
additional 409A taxes apply to increases in the value of the failed 
compensation each year until it is paid.
---------------------------------------------------------------------------
    Various exemptions from section 409A apply, including 
transfers of property subject to section 83.\1286\ Nonqualified 
options are not automatically exempt from section 409A, but may 
be structured so as not to be considered nonqualified deferred 
compensation.\1287\ A restricted stock unit (``RSU'') is a term 
used for an arrangement under which an employee has the right 
to receive at a specified time in the future an amount 
determined by reference to the value of one or more shares of 
employer stock. An employee's right to receive the future 
amount may be subject to a condition, such as continued 
employment for a certain period or the attainment of certain 
performance goals. The payment to the employee of the amount 
due under the arrangement is referred to as settlement of the 
RSU. The arrangement may provide for the settlement amount to 
be paid in cash or as a transfer of employer stock (or both). 
An arrangement providing RSUs is generally considered a 
nonqualified deferred compensation plan and is subject to the 
rules, including the limits, of section 409A. The employer 
deduction generally is permitted in the employer's taxable year 
in which or with which ends the employee's taxable year when 
the amount is included and properly reported in the employee's 
income.\1288\
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    \1286\ Treas. Reg. sec. 1.409A-1(b)(6).
    \1287\ Treas. Reg. sec. 1.409A-1(b)(5). In addition, statutory 
option arrangements are not nonqualified deferred compensation 
arrangements.
    \1288\ Sec. 404(a)(5).
---------------------------------------------------------------------------

                        Explanation of Provision


In general

    The provision allows a qualified employee to elect to 
defer, for income tax purposes, the inclusion in income 
attributable to qualified stock transferred to the employee by 
the employer. An election to defer income inclusion 
(``inclusion deferral election'') with respect to qualified 
stock must be made no later than 30 days after the first time 
the employee's right to the stock is substantially vested or is 
transferable, whichever occurs earlier.
    Similar to statutory options, employers are not required to 
offer elections to employees under the new provision unless the 
employer has made the determination that the various 
requirements have been or can be met, as applicable. As 
described below in more detail, an employer must satisfy 
various requirements and make certain determinations in order 
for the provision to apply, including information that an 
employee may not necessarily know in order to make an election. 
This includes whether the employer is an ``eligible 
corporation,'' whether the employee is a ``qualified employee'' 
(or is instead an ``excluded employee'' who may not make an 
election), and whether ``qualified stock'' has been 
transferred. This also includes certain requirements that the 
employer must satisfy under a written plan, and must notify and 
certify (subject to transition rules) to employees, before an 
election may be made. In addition, specific employer 
withholding and reporting obligations cannot be properly met by 
an employer unless the employer satisfies the various 
requirements and makes the necessary determinations, and has 
implemented appropriate procedures to ensure that the 
withholding and reporting requirements are met.
    If an employee elects to defer income inclusion under the 
provision, the income must be included in the employee's income 
for the taxable year that includes the earliest of (1) the 
first date the qualified stock becomes transferable, including, 
solely for this purpose, transferable to the employer; \1289\ 
(2) the date the employee first becomes an excluded employee 
(as described below); (3) the first date on which any stock of 
the employer becomes readily tradable on an established 
securities market; \1290\ (4) the date five years after the 
first date the employee's right to the stock becomes 
substantially vested; or (5) the date on which the employee 
revokes her inclusion deferral election.\1291\ It is intended 
that the limited circumstances outlined in section 83(c)(3) and 
applicable regulations apply with respect to the determination 
of when stock first becomes transferrable or is no longer 
subject to a substantial risk of forfeiture. For example, 
income inclusion cannot be delayed due to a lock-up period as a 
result of an initial public offering.
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    \1289\ For purposes of the inclusion deferral election, if shares 
are substantially vested under the rules of section 83 but the employee 
has the right to sell such shares to the employer or any other person, 
the qualified stock is considered transferable and therefore income 
inclusion immediately applies. Therefore, section 83(i)(1)(B)(i) 
operates to effectively invalidate the deferral of income inclusion 
when an employee has been transferred shares that the employee has a 
right to sell.
    \1290\ An established securities market is determined for this 
purpose by the Secretary, but does not include any market unless the 
market is recognized as an established securities market for purposes 
of another Code provision.
    \1291\ An inclusion deferral election is revoked at the time and in 
the manner as the Secretary provides.
---------------------------------------------------------------------------
    An inclusion deferral election is made in a manner similar 
to the manner in which a section 83(b) election is made.\1292\ 
The provision does not apply to income with respect to 
nonvested stock that is includible as a result of a section 
83(b) election. The provision clarifies that other than 
subsection (i), the provisions of section 83 including 
subsection (b) shall not apply to RSUs. Therefore, RSUs are not 
eligible for a section 83(b) election. This is the case 
because, absent this provision, RSUs are nonqualified deferred 
compensation and therefore subject to the rules that apply to 
nonqualified deferred compensation.
---------------------------------------------------------------------------
    \1292\ Thus, as in the case of a section 83(b) election, the 
employee must file with the IRS the inclusion deferral election and 
provide the employer with a copy.
---------------------------------------------------------------------------
    An employee may not make an inclusion deferral election for 
a year with respect to qualified stock if, in the preceding 
calendar year, the corporation purchased any of its outstanding 
stock unless at least 25 percent of the total dollar amount of 
the stock so purchased is stock with respect to which an 
inclusion deferral election is in effect (``deferral stock'') 
and the determination of which individuals from whom deferral 
stock is purchased is made on a reasonable basis.\1293\ For 
purposes of this requirement, stock purchased from an 
individual is not treated as deferral stock (and the purchase 
is not treated as a purchase of deferral stock) if, immediately 
after the purchase, the individual holds any deferral stock 
with respect to which an inclusion deferral election has been 
in effect for a longer period than the election with respect to 
the purchased stock. Thus, in general, in applying the purchase 
requirement, an individual's deferral stock with respect to 
which an inclusion deferral election has been in effect for the 
longest periods must be purchased first. A corporation that has 
deferral stock outstanding as of the beginning of any calendar 
year and that purchases any of its outstanding stock during the 
calendar year must report on its income tax return for the 
taxable year in which, or with which, the calendar year ends 
the total dollar amount of the outstanding stock purchased 
during the calendar year and such other information as the 
Secretary may require for purposes of administering this 
requirement.
---------------------------------------------------------------------------
    \1293\ This requirement is met if the stock purchased by the 
corporation includes all the corporation's outstanding deferral stock.
---------------------------------------------------------------------------
    A qualified employee may make an inclusion deferral 
election with respect to qualified stock attributable to a 
statutory option.\1294\ In that case, the option is not treated 
as a statutory option and the rules relating to statutory 
options and related stock do not apply. In addition, an 
arrangement under which an employee may receive qualified stock 
is not treated as a nonqualified deferred compensation plan 
under section 409A with respect to that employee solely because 
of the employee's election, or ability to make an election, to 
defer income recognition with respect to such stock.
---------------------------------------------------------------------------
    \1294\ For purposes of the requirement that an ESPP provide 
employees with the same rights and privileges, the rules of the 
provision apply in determining which employees have the right to make 
an inclusion deferral election with respect to stock received under the 
ESPP.
---------------------------------------------------------------------------
    Deferred income inclusion applies also for purposes of the 
employer's deduction of the amount of income attributable to 
the qualified stock. That is, if an employee makes an inclusion 
deferral election, the employer's deduction is deferred until 
the employer's taxable year in which or with which ends the 
taxable year of the employee for which the amount is included 
in the employee's income as described in (1)-(5) above.\1295\
---------------------------------------------------------------------------
    \1295\ Note that the deduction rule under Treas. Reg. sec. 1.83-
6(a)(3), which allows an employer a deduction in accordance with its 
method of accounting when property is substantially vested upon 
transfer, is not applicable.
---------------------------------------------------------------------------

Qualified employee and qualified stock

    Under the provision, a qualified employee means an 
individual who is not an excluded employee and who agrees, in 
the inclusion deferral election, to meet the requirements 
necessary (as determined by the Secretary) to ensure the income 
tax withholding requirements of the employer corporation with 
respect to the qualified stock (as described below) are met. 
For this purpose, an excluded employee with respect to a 
corporation is any individual (1) who was a one-percent owner 
of the corporation at any time during the 10 preceding calendar 
years,\1296\ (2) who is, or has been at any prior time, the 
chief executive officer or chief financial officer of the 
corporation or an individual acting in either capacity, (3) who 
is a family member of an individual described in (1) or 
(2),\1297\ or (4) who has been one of the four highest 
compensated officers of the corporation for any of the 10 
preceding taxable years.\1298\ An excluded employee includes an 
individual who first becomes a one-percent owner or one of the 
four highest compensated officers in a taxable year, 
notwithstanding that such individual may not have been among 
such categories for the 10 preceding taxable years.
---------------------------------------------------------------------------
    \1296\ One-percent owner status is determined under the top-heavy 
rules for qualified retirement plans, under section 416(i)(1)(B)(ii).
    \1297\ In the case of one-percent owners, this results from 
application of the attribution rules of section 318 under section 
416(i)(1)(B)(i)(I). Family members are determined under section 
318(a)(1) and generally include an individual's spouse, children, 
grandchildren, and parents.
    \1298\ These officers are determined on the basis of shareholder 
disclosure rules for compensation under the Securities Exchange Act of 
1934, as if such rules applied to the corporation.
---------------------------------------------------------------------------
    Qualified stock is any stock of a corporation if--
           an employee receives the stock in connection 
        with the exercise of an option or in settlement of an 
        RSU, and
           the option or RSU was granted by the 
        corporation to the employee in connection with the 
        performance of services and in a year in which the 
        corporation was an eligible corporation (as described 
        below).
    However, qualified stock does not include any stock if, at 
the time the employee's right to the stock becomes 
substantially vested, the employee may sell the stock to, or 
otherwise receive cash in lieu of stock from, the corporation. 
Stock is qualified stock only if it relates to stock received 
in connection with options or RSUs, and does not include stock 
received in connection with other forms of equity compensation, 
including stock appreciation rights or restricted stock.
    A corporation is an eligible corporation with respect to a 
calendar year if (1) no stock of the employer corporation (or 
any predecessor) is readily tradable on an established 
securities market during any preceding calendar year,\1299\ and 
(2) the corporation has a written plan under which, in the 
calendar year, the corporation grants stock options or grants 
restricted stock units (``RSUs'') with the same rights and 
privileges to receive qualified stock to not less than 80 
percent of all employees who provide services to the 
corporation in the United States or any U.S. possession (``80-
percent requirement'').\1300\ For this purpose, in general, the 
determination of rights and privileges with respect to stock is 
determined in a similar manner as provided under the ESPP 
rules.\1301\ However, employees will not fail to be treated as 
having the same rights and privileges to receive qualified 
stock solely because the number of shares available to all 
employees is not equal in amount, provided that the number of 
shares available to each employee is more than a de minimis 
amount. In addition, rights and privileges with respect to the 
exercise of a stock option are not treated for this purpose as 
the same as rights and privileges with respect to the 
settlement of an RSU.\1302\ The requirement that 80 percent of 
all applicable employees be granted stock options or restricted 
stock units with the same rights and privileges cannot be 
satisfied in a calendar year by granting a combination of stock 
options and RSUs; instead all such employees must either be 
granted stock options or be granted restricted stock units for 
that year. It is intended that the requirement that 80 percent 
of all applicable employees be granted stock options or be 
granted restricted stock units apply consistently to eligible 
employees in each calendar year, whether they are new hires or 
existing employees in the relevant year.
---------------------------------------------------------------------------
    \1299\ This requirement continues to apply up to the time an 
inclusion deferral election is made. That is, under the provision, no 
inclusion deferral election may be made with respect to qualified stock 
if any stock of the corporation is readily tradable on an established 
securities market at any time before the election is made.
    \1300\ In applying the requirement that 80 percent of employees 
receive stock options or RSUs, excluded employees and part-time 
employees are not taken into account. For this purpose, a part-time 
employee is defined under section 4980G(d)(4), as an employee who is 
customarily employed for fewer than 30 hours per week.
    \1301\ Sec. 423(b)(5).
    \1302\ Under a transition rule, in the case of a calendar year 
beginning before January 1, 2018, the 80-percent requirement is applied 
without regard to whether the rights and privileges with respect to the 
qualified stock are the same.
---------------------------------------------------------------------------
    For purposes of the provision, corporations that are 
members of the same controlled group \1303\ are treated as one 
corporation.
---------------------------------------------------------------------------
    \1303\ As defined in section 414(b).
---------------------------------------------------------------------------

Notice, withholding, and reporting requirements

    Under the provision, a corporation that transfers qualified 
stock to a qualified employee must provide a notice to the 
qualified employee at the time (or a reasonable period before) 
the employee's right to the qualified stock is substantially 
vested (and income attributable to the stock would first be 
includible absent an inclusion deferral election). The notice 
must (1) certify to the employee that the stock is qualified 
stock, and (2) notify the employee (a) that the employee may 
(if eligible) elect to defer income inclusion with respect to 
the stock and (b) that, if the employee makes an inclusion 
deferral election, the amount of income required to be included 
at the end of the deferral period will be based on the value of 
the stock at the time the employee's right to the stock first 
becomes substantially vested, notwithstanding whether the value 
of the stock has declined during the deferral period (including 
whether the value of the stock has declined below the 
employee's tax liability with respect to such stock). The 
notice must also notify the employee that if the employee makes 
an inclusion deferral election, the amount of income to be 
included at the end of the deferral period will be subject to 
withholding as provided under the provision,\1304\ and outline 
the employee's responsibilities with respect to the required 
withholding. Failure to provide the notice may result in the 
imposition of a penalty of $100 for each failure, subject to a 
maximum penalty of $50,000 for all failures during any calendar 
year.
---------------------------------------------------------------------------
    \1304\ As described in section 3401(i) and at the rate determined 
in section 3402(t).
---------------------------------------------------------------------------
    An inclusion deferral election applies only for income tax 
purposes. The provision includes specific income tax 
withholding and reporting requirements with respect to income 
subject to an inclusion deferral election. The application of 
FICA and FUTA are not affected. However, when an inclusion 
deferral election is made with respect to stock transferred in 
connection with the exercise of an ISO or ESPP (a statutory 
option), the option is not treated as a statutory option but 
rather as a nonqualified stock option for FICA and FUTA 
purposes (in addition to being subject to section 83(i) for 
income tax purposes).
    For the taxable year for which income subject to an 
inclusion deferral election is required to be included in 
income by the employee (as described above), the amount 
required to be included in income is treated as wages with 
respect to which the employer is required to withhold income 
tax at a rate not less than the highest income tax rate 
applicable to individual taxpayers.\1305\ The employer must 
report on Form W-2 the amount of income covered by an inclusion 
deferral election (1) for the year of deferral and (2) for the 
year the income is required to be included in income by the 
employee. In addition, for any calendar year, the employer must 
report on Form W-2 the aggregate amount of income covered by 
inclusion deferral elections, determined as of the close of the 
calendar year.
---------------------------------------------------------------------------
    \1305\ That is, the maximum rate of tax in effect for the year 
under section 1. The provision specifies that qualified stock is 
treated as a noncash fringe benefit for income tax withholding 
purposes. Sec. 3402(t).

    The Treasury Department has issued published guidance 
addressing this provision.\1306\
---------------------------------------------------------------------------
    \1306\ Notice 2018-97, 2018-52 I.R.B., December 24, 2018.
---------------------------------------------------------------------------

                             Effective Date

    The provision generally applies with respect to stock 
attributable to options exercised or RSUs settled after 
December 31, 2017. Therefore, an election under the provision 
could apply to options or restricted stock units that were 
previously granted. Under a transition rule, until the 
Secretary issues regulations or other guidance implementing the 
80-percent and employer notice requirements \1307\ under the 
provision, a corporation will be treated as complying with 
those requirements (respectively) if it complies with a 
reasonable good faith interpretation of the requirements. It is 
intended for the transition rule provided with respect to 
compliance with the 80-percent and employer notice requirements 
to not be expanded beyond these specific items, and for the 80-
percent requirement for purposes of the transition rule to 
apply on a calendar year basis in the same manner as it does 
for purposes of the provision generally. The penalty for a 
failure to provide the notice required under the provision 
applies to failures after December 31, 2017.
---------------------------------------------------------------------------
    \1307\ Secs. 83(i)(2)(C)(i)(II) and 83(i)(6). The 80-percent 
requirement includes a written plan requirement.
---------------------------------------------------------------------------

 D. Increase in Excise Tax Rate for Stock Compensation of Insiders in 
 Expatriated Corporations (sec. 13604 of the Act and sec. 4985 of the 
                                 Code)


                               Prior Law


Income tax treatment of employee stock compensation

            In general
    Employers may grant various forms of stock compensation to 
employees,\1308\ including nonstatutory and statutory stock 
options, restricted stock, restricted stock units, and stock 
appreciation rights. The tax treatment of these various forms 
of stock compensation depends on the specific terms and 
conditions of the arrangement and applicable rules.
---------------------------------------------------------------------------
    \1308\ The terms ``employer'' and ``employee'' are used, although 
the provision herein also applies to individuals who are not employees 
and the service recipients of such non-employee individuals.
---------------------------------------------------------------------------
            Stock compensation treated as property transferred in 
                    connection with the performance of services
    Section 83 generally governs the taxation of transfers of 
any property in connection with the performance of services by 
any service provider. Typically, this encompasses the transfer 
of stock to an employee which is subject to conditions that 
amount to a substantial risk of forfeiture, called ``restricted 
stock.'' Section 83 also generally governs the taxation of 
nonstatutory (or nonqualified) stock options. In general, an 
employee's right to stock or other property is subject to a 
substantial risk of forfeiture if the employee's right to full 
enjoyment of the property is subject to a condition, such as 
the future performance of substantial services.\1309\
---------------------------------------------------------------------------
    \1309\ See section 83(c)(1) and Treas. Reg. sec. 1.83-3(c) for the 
definition of substantial risk of forfeiture for this purpose.
---------------------------------------------------------------------------
    Generally, an employee must recognize income in the taxable 
year in which the employee's right to the stock is transferable 
or is not subject to a substantial risk of forfeiture, 
whichever occurs earlier (referred to herein as ``substantially 
vested''). Thus, if the employee's right to the stock is 
substantially vested when the stock is transferred to the 
employee, the employee recognizes income in the taxable year of 
such transfer, in an amount equal to the fair market value of 
the stock as of the date of transfer (less any amount paid for 
the stock). If at the time the stock is transferred to the 
employee, the employee's right to the stock is not 
substantially vested (referred to herein as ``nonvested''), the 
employee does not recognize income attributable to the stock 
transfer until the taxable year in which the employee's right 
becomes substantially vested. In this case, the amount 
includible in the employee's income is the fair market value of 
the stock as of the date that the employee's right to the stock 
is substantially vested (less any amount paid for the 
stock).\1310\
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    \1310\ Under section 83(b), the employee may elect within 30 days 
of transfer to recognize income in the taxable year of transfer, 
referred to as a ``section 83(b)'' election. If a proper and timely 
election under section 83(b) is made, the amount of compensatory income 
is capped at the amount equal to the fair market value of the stock as 
of the date of transfer (less any amount paid for the stock).
---------------------------------------------------------------------------
    These rules do not apply to the grant of a nonqualified 
option unless the option has a readily ascertainable fair 
market value.\1311\ Instead, these rules generally apply to the 
transfer of employer stock to the employee on exercise of the 
option. That is, if the right to the stock is substantially 
vested on transfer (the time of exercise), income recognition 
applies for the taxable year of transfer. If the right to the 
stock is nonvested on transfer, the timing of income inclusion 
is determined under the rules applicable to the transfer of 
nonvested stock. In either case, the amount includible in 
income by the employee is the fair market value of the stock as 
of the required time of income inclusion, less the exercise 
price paid by the employee.
---------------------------------------------------------------------------
    \1311\ See section 83(e)(3) and Treas. Reg. sec. 1.83-7. A 
nonqualified option is an option on employer stock that is not a 
statutory option, discussed below.
---------------------------------------------------------------------------
            Statutory stock options
    Two types of statutory options apply with respect to 
employer stock: incentive stock options (``ISOs''') and options 
provided under an employee stock purchase plan 
(``ESPP'').\1312\ Stock received pursuant to a statutory option 
is subject to special rules, rather than the rules for 
nonqualified options, discussed above. Unlike nonqualified 
options, statutory options may only be considered as such if 
granted to employees.\1313\ No amount is includible in an 
employee's income on the grant, vesting, or exercise of a 
statutory option.
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    \1312\ Sections 421-424 govern statutory options. Section 423(b)(5) 
requires that, under the terms of an ESPP, all employees granted 
options generally must have the same rights and privileges.
    \1313\ Secs. 422(a)(2) and 423(a)(2).
---------------------------------------------------------------------------
    If a holding requirement is met with respect to the stock 
transferred on exercise of a statutory option and the employee 
later disposes of the stock, the employee's gain generally is 
treated as capital gain rather than ordinary income. Under the 
holding requirement, the employee must not dispose of the stock 
within two years after the date the option is granted and also 
must not dispose of the stock within one year after the date 
the option is exercised. If a disposition occurs before the end 
of the required holding period (a ``disqualifying 
disposition''), the employee recognizes ordinary income in the 
taxable year in which the disqualifying disposition occurs. The 
amount of ordinary income recognized when a disqualifying 
disposition occurs generally equals the fair market value of 
the stock on the date of exercise (that is, when the stock was 
transferred to the employee) less the exercise price paid.
            Stock compensation treated as deferred compensation
    A restricted stock unit (``RSU'') is a term used for an 
arrangement under which an employee has the right to receive at 
a specified time in the future an amount determined by 
reference to the value of one or more shares of employer stock. 
An employee's right to receive the future amount may be subject 
to a condition, such as continued employment for a certain 
period or the attainment of certain performance goals. The 
payment to the employee of the amount due under the arrangement 
is referred to as settlement of the RSU. The arrangement may 
provide for the settlement amount to be paid in cash or as a 
transfer of employer stock. An arrangement providing RSUs is 
generally considered a nonqualified deferred compensation plan 
and is subject to the rules, including the limits, of section 
409A,\1314\ unless it meets an exemption from section 409A. If 
the RSU either is exempt from or complies with section 409A, 
the employee is subject to income taxation on receipt of cash 
or the transfer of shares attributable to the RSU.
---------------------------------------------------------------------------
    \1314\ Section 409A and the regulations thereunder provide rules 
for nonqualified deferred compensation. Unless an arrangement either is 
exempt from or meets the requirements of section 409A, the amount of 
deferred compensation is first includible in income for the taxable 
year when not subject to a substantial risk of forfeiture (as defined), 
even if payment will not occur until a later year. In general, to meet 
the requirements of section 409A, the time when nonqualified deferred 
compensation will be paid, as well as the amount, must be specified at 
the time of deferral with limits on further deferral after the time for 
payment. Various other requirements apply, including that payment can 
only occur on specific defined events. Compensation that fails to meet 
the requirements of section 409A is also subject to an additional 
income tax of 20 percent on amounts includible in income and a 
potential interest factor tax (``409A taxes''). Section 409A and the 
additional 409A taxes apply to increases in the value of the failed 
compensation each year until it is paid.
---------------------------------------------------------------------------
    A stock appreciation right (``SAR'') is an arrangement 
under which an employee has the right to receive an amount (in 
the form of cash or stock) determined by reference to the 
appreciation in value of one or more shares of employer stock, 
based on the difference in the stock's value when the employee 
chooses to exercise the right and the value of the stock on the 
date of grant of the SAR. An SAR is generally taxable at the 
time of exercise on the amount of cash or value of stock 
transferred at the time of exercise of the SAR.\1315\
---------------------------------------------------------------------------
    \1315\ Rev. Rul. 80-300, 1980-2 C.B. 165.
---------------------------------------------------------------------------
    Various exemptions from section 409A apply, including 
transfers of property subject to section 83, such as restricted 
stock.\1316\ Nonqualified options and SARs are not 
automatically exempt from section 409A, but may be structured 
so as not to be considered nonqualified deferred 
compensation.\1317\ In addition, ISOs and ESPPs are exempt from 
section 409A.\1318\
---------------------------------------------------------------------------
    \1316\ Treas. Reg. sec. 1.409A-1(b)(6).
    \1317\ Treas. Reg. sec. 1.409A-1(b)(5).
    \1318\ Treas. Reg. sec. 1.409A-1(b)(5)(ii).
---------------------------------------------------------------------------

Section 4985 excise tax on stock compensation of insiders of 
        expatriated corporations

    Under section 4985, certain holders of stock options and 
other stock-based compensation are subject to an excise tax 
upon certain transactions that result in an expatriated 
corporation \1319\ (also referred to as corporate 
inversions).\1320\ The provision imposes an excise tax, 
currently at the rate of 15 percent, 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.
---------------------------------------------------------------------------
    \1319\ Sec. 7874(a)(2).
    \1320\ For further discussion of the tax treatment of expatriated 
entities before the effective date of section 7874 and concerns that 
led to the enactment of sections 7874 and 4985, see Joint Committee on 
Taxation, General Explanation of Tax Legislation Enacted in the 108th 
Congress (JCS-5-05), May 2005.
---------------------------------------------------------------------------
    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,\1321\ 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)),\1322\ directors, and 10-percent owners of private and 
publicly-held corporations.
---------------------------------------------------------------------------
    \1321\ 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 by 
substituting ``more than 50 percent'' for ``at least 80 percent.''
    \1322\ 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 excise tax is imposed on a disqualified individual of 
an expatriated corporation (as defined for this purpose) only 
if gain is recognized in whole or part by any shareholder by 
reason of the acquisition resulting in the corporate 
inversion.\1323\
---------------------------------------------------------------------------
    \1323\ As referred to in section 7874(a)(2)(B)(i).
---------------------------------------------------------------------------
    Specified stock compensation subject to the excise tax 
includes any payment (or right to payment) \1324\ 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 non-lapse restrictions, are ignored. 
Thus, the excise tax applies, and the value subject to the tax 
is determined, without regard to whether such specified stock 
compensation is subject to a substantial risk of forfeiture or 
is exercisable at the time of the corporate inversion. 
Specified stock compensation includes compensatory stock and 
restricted stock grants, compensatory stock options, and other 
forms of stock-based compensation, including stock appreciation 
rights, restricted stock units, 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 provision 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.
---------------------------------------------------------------------------
    \1324\ Under the provision, 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 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 applies to any such 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 transaction 
and then reissues comparable options three months after the 
transaction, the tax applies both to the cancelled options and 
the newly granted options.
    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, a tax-sheltered annuity, 
a simplified employee pension, or a simple retirement account. 
In addition, under the provision, 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.
    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 provision, 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 and 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 of the Treasury, that 
takes into account the stock price at the valuation date; the 
exercise price under the option; the remaining term of the 
option; the volatility of the underlying stock and the expected 
dividends on it; and 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 provision. 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).
    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. 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 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 provision. 
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 excise tax is not deductible 
and has no effect on any deduction that might be allowed at the 
time of any future exercise or payment.

                        Explanation of Provision

    The provision increases the 15-percent rate of excise tax, 
imposed on the value of stock compensation held by insiders of 
an expatriated corporation, to 20 percent.

                             Effective Date

    The provision applies to corporations first becoming 
expatriated corporations after the date of enactment (i.e., 
December 22, 2017).

                      SUBPART B--RETIREMENT PLANS


    A. Repeal of Special Rule Permitting Recharacterization of Roth 
    Conversions (sec. 13611 of the Act and sec. 408A(d) of the Code)


                               Prior Law


Individual retirement arrangements

    There are two basic types of individual retirement 
arrangements (``IRAs'''): traditional IRAs,\1325\ to which both 
deductible and nondeductible contributions may be made,\1326\ 
and Roth IRAs, to which only nondeductible contributions may be 
made.\1327\ The principal difference between these two types of 
IRAs is the timing of income tax inclusion.
---------------------------------------------------------------------------
    \1325\ Sec. 408.
    \1326\ Secs. 219(a) and 408(o).
    \1327\ Sec. 408A.
---------------------------------------------------------------------------
    An annual limit applies to contributions to IRAs. The 
contribution limit is coordinated so that the aggregate maximum 
amount that can be contributed to all of an individual's IRAs 
(both traditional and Roth) for a taxable year is the lesser of 
a certain dollar amount ($5,500 for 2017) or the individual's 
compensation. In the case of a married couple, contributions 
can be made up to the dollar limit for each spouse if the 
combined compensation of the spouses is at least equal to the 
contributed amount. The dollar limit is increased annually 
(``indexed'') as needed to reflect increases in the cost-of 
living. An individual who has attained age 50 before the end of 
the taxable year may also make catch-up contributions up to 
$1,000 to an IRA. The IRA catch-up contribution limit is not 
indexed.

Traditional IRAs

    An individual may make deductible contributions to a 
traditional IRA up to the IRA contribution limit (reduced by 
any contributions to Roth IRAs) if neither the individual nor 
the individual's spouse is an active participant in an 
employer-sponsored retirement plan. If an individual (or the 
individual's spouse) is an active participant in an employer-
sponsored retirement plan, the deduction is phased out for 
taxpayers with adjusted gross income (``AGI'') for the taxable 
year over certain indexed levels.\1328\ To the extent an 
individual cannot or does not make deductible contributions to 
a traditional IRA or contributions to a Roth IRA for the 
taxable year, the individual may make nondeductible after-tax 
contributions to a traditional IRA (that is, no AGI limits 
apply), subject to the same contribution limits as the limits 
on deductible contributions, including catch-up contributions. 
An individual who has attained age 70\1/2\ before the close of 
a year is not permitted to make contributions to a traditional 
IRA for that year.
---------------------------------------------------------------------------
    \1328\ Sec. 219(g).
---------------------------------------------------------------------------
    Amounts held in a traditional IRA are includible in income 
when withdrawn, except to the extent the withdrawal is a return 
of the individual's basis.\1329\ All traditional IRAs of an 
individual are treated as a single contract for purposes of 
recovering basis in the IRAs.
---------------------------------------------------------------------------
    \1329\ Basis results from after-tax contributions to traditional 
IRAs or rollovers to traditional IRAs of after-tax amounts from other 
eligible retirement plans.
---------------------------------------------------------------------------

Roth IRAs

    Individuals with AGI below certain levels may make 
nondeductible contributions to a Roth IRA. The maximum annual 
contribution that can be made to a Roth IRA is phased out for 
taxpayers with AGI for the taxable year over certain indexed 
levels.\1330\
---------------------------------------------------------------------------
    \1330\ Although an individual with AGI exceeding certain limits is 
not permitted to make a contribution directly to a Roth IRA, the 
individual can make a contribution to a traditional IRA and convert the 
traditional IRA to a Roth IRA, as discussed below.
---------------------------------------------------------------------------
    Amounts held in a Roth IRA that are withdrawn as a 
qualified distribution are not includible in income. 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 first 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.
    Distributions from a Roth IRA that are not qualified 
distributions are includible in income to the extent 
attributable to earnings; amounts that are attributable to a 
return of contributions to the Roth IRA are not includible in 
income. All Roth IRAs are treated as a single contract for 
purposes of determining the amount that is a return of 
contributions.

Separation of traditional and Roth IRA accounts

    Contributions to traditional IRAs and to Roth IRAs must be 
segregated into separate IRAs, meaning arrangements with 
separate trusts, accounts, or contracts, and separate IRA 
documents. Except in the case of a conversion or 
recharacterization, amounts cannot be transferred or rolled 
over between the two types of IRAs.
    Taxpayers generally may convert an amount in a traditional 
IRA to a Roth IRA. The amount converted is includible in the 
taxpayer's income as if a withdrawal had been made.\1331\ The 
conversion is accomplished by a trustee-to-trustee transfer of 
the amount from the traditional IRA to the Roth IRA, or by a 
distribution from the traditional IRA and contribution to the 
Roth IRA within 60 days.
---------------------------------------------------------------------------
    \1331\ Subject to various exceptions, distributions from an IRA 
before age 59\1/2\ that are includible in income are subject to a 10-
percent early distribution tax under section 72(t). An exception 
applies to an amount includible in income as a result of the conversion 
from a traditional IRA into a Roth IRA. However, the early distribution 
tax applies if the taxpayer withdraws the converted amount within five 
years of the conversion.
---------------------------------------------------------------------------
    Rollovers to IRAs of distributions from tax-favored 
employer-sponsored retirement plans (that is, qualified 
retirement plans, tax-deferred annuity plans, and governmental 
eligible deferred compensation plans \1332\) are also 
permitted. For tax-free rollovers, distributions from pretax 
accounts under an employer-sponsored plan generally must be 
contributed to a traditional IRA, and distributions from a 
designated Roth account under an employer-sponsored plan must 
be contributed only to a Roth IRA. However, a distribution from 
an employer-sponsored plan that is not from a designated Roth 
account is also permitted to be rolled over into a Roth IRA, 
subject to the rules that apply to conversions from a 
traditional IRA into a Roth IRA. Thus, a rollover from a tax-
favored employer-sponsored plan to a Roth IRA is includible in 
gross income (except to the extent it represents a return of 
after-tax contributions).\1333\
---------------------------------------------------------------------------
    \1332\ Secs. 401(a), 403(a), 403(b) and 457(b).
    \1333\ As in the case of a conversion of an amount from a 
traditional IRA to a Roth IRA, the special recapture rule relating to 
the 10-percent additional tax on early distributions applies for 
distributions made from the Roth IRA within a specified five-year 
period after the rollover.
---------------------------------------------------------------------------

Recharacterization of IRA contributions

    If an individual makes a contribution to an IRA 
(traditional or Roth) for a taxable year, the individual is 
permitted to recharacterize the contribution as a contribution 
to the other type of IRA (traditional or Roth) by making a 
trustee-to-trustee transfer to the other type of IRA before the 
due date (including extensions) for the individual's income tax 
return for that year.\1334\ In the case of a 
recharacterization, the contribution will be treated as having 
been made to the transferee IRA (and not the original, 
transferor IRA) as of the date of the original contribution. 
Both regular contributions and conversion contributions to a 
Roth IRA can be recharacterized as having been made to a 
traditional IRA.
---------------------------------------------------------------------------
    \1334\ Sec. 408A(d)(6).
---------------------------------------------------------------------------
    The amount transferred in a recharacterization must be 
accompanied by any net income allocable to the contribution. In 
general, even if a recharacterization is accomplished by 
transferring a specific asset, net income is calculated as a 
pro rata portion of income on the entire account rather than 
income allocable to the specific asset transferred. However, 
when doing a Roth conversion of an amount for a year, an 
individual may establish multiple Roth IRAs, for example, Roth 
IRAs with different investment strategies, and divide the 
amount being converted among the IRAs. The individual can then 
choose whether to recharacterize any of the Roth IRAs as a 
traditional IRA by transferring the entire amount in the 
particular Roth IRA to a traditional IRA.\1335\ For example, if 
the value of the assets in a particular Roth IRA declines after 
the conversion, the conversion can be reversed by 
recharacterizing that IRA as a traditional IRA. The individual 
may then later convert that traditional IRA to a Roth IRA 
(referred to as a reconversion), including only the lower value 
in income. Treasury regulations prevent the reconversion from 
taking place immediately after the recharacterization, by 
requiring a minimum period to elapse before the reconversion. 
Generally the reconversion cannot occur sooner than the later 
of 30 days after the recharacterization or a date during the 
taxable year following the taxable year of the original 
conversion.\1336\
---------------------------------------------------------------------------
    \1335\ Treas. Reg. sec. 1.408A-5, Q&A-2(b).
    \1336\ Treas. Reg. sec. 1.408A-5, Q&A-9.
---------------------------------------------------------------------------

                        Explanation of Provision

    Under the provision, the special rule that allows a 
contribution to one type of IRA to be recharacterized as a 
contribution to the other type of IRA does not apply to a 
conversion contribution to a Roth IRA. Thus, recharacterization 
cannot be used to unwind a Roth conversion. However, 
recharacterization is still permitted with respect to other 
contributions. For example, an individual may make a 
contribution for a year to a Roth IRA and, before the due date 
for the individual's income tax return for that year, 
recharacterize it as a contribution to a traditional IRA. In 
addition, an individual may still make a contribution to a 
traditional IRA and convert the traditional IRA to a Roth IRA, 
but the provision precludes the individual from later unwinding 
the conversion through a recharacterization.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

 B. Modification of Rules Applicable to Length of Service Award Plans 
          (sec. 13612 of the Act and sec. 457(e) of the Code)


                               Prior Law

    Special rules apply to deferred compensation plans of State 
and local government and private, tax-exempt employers.\1337\ 
However, an exception to these rules applies in the case of a 
plan paying solely length of service awards to bona fide 
volunteers (or their beneficiaries) on account of qualified 
services performed by the volunteers. For this purpose, 
qualified services consist of firefighting and fire prevention 
services, emergency medical services, and ambulance services. 
An individual is treated as a bona fide volunteer for this 
purpose if the only compensation received by the individual for 
performing qualified services is in the form of (1) 
reimbursement or a reasonable allowance for reasonable expenses 
incurred in the performance of such services, or (2) reasonable 
benefits (including length of service awards) and nominal fees 
for the services, customarily paid in connection with the 
performance of such services by volunteers. The exception 
applies only if the aggregate amount of length of service 
awards accruing for a bona fide volunteer with respect to any 
year of service does not exceed $3,000.
---------------------------------------------------------------------------
    \1337\ Sec. 457.
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision increases the aggregate amount of length of 
service awards that may accrue for a bona fide volunteer with 
respect to any year of service to $6,000 and adjusts that 
amount in $500 increments to reflect changes in cost-of-living 
for years after the first year the provision is effective. In 
addition, under the provision, if the plan is a defined benefit 
plan, the limit applies to the actuarial present value of the 
aggregate amount of length of service awards accruing with 
respect to any year of service. Actuarial present value is to 
be calculated using reasonable actuarial assumptions and 
methods, assuming payment will be made under the most valuable 
form of payment under the plan with payment commencing at the 
later of the earliest age at which unreduced benefits are 
payable under the plan or the participant's age at the time of 
the calculation.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

C. Extended Rollover Period for Plan Loan Offset Amounts (sec. 13613 of 
                  the Act and sec. 402(c) of the Code)


                               Prior Law


Taxation of retirement plan distributions

    A distribution from a tax-favored employer-sponsored 
retirement plan (that is, a qualified retirement plan, section 
403(b) plan, or a governmental section 457(b) plan) is 
generally includible in gross income, except in the case of a 
qualified distribution from a designated Roth account or to the 
extent the distribution is a recovery of basis under the plan 
or the distribution is contributed to another such plan or an 
IRA (referred to as eligible retirement plans) in a tax-free 
rollover.\1338\ In the case of a distribution from a retirement 
plan to an employee under age 59 \1/2\, the distribution (other 
than a distribution from a governmental section 457(b) plan) is 
also subject to a 10-percent early distribution tax unless an 
exception applies.\1339\
---------------------------------------------------------------------------
    \1338\ Secs. 402(a) and (c), 402A(d), 403(a) and (b), 457(a) and 
(e)(16).
    \1339\ Sec. 72(t).
---------------------------------------------------------------------------
    A distribution from a tax-favored employer-sponsored 
retirement plan that is an eligible rollover distribution may 
be rolled over to an eligible retirement plan.\1340\ The 
rollover generally can be achieved by direct rollover (direct 
payment from the distributing plan to the recipient plan) or by 
contributing the distribution to the eligible retirement plan 
within 60 days of receiving the distribution (``60-day 
rollover'').
---------------------------------------------------------------------------
    \1340\ Certain distributions are not eligible rollover 
distributions, such as annuity payments, required minimum 
distributions, hardship distributions, and loans that are treated as 
deemed distributions under section 72(p).
---------------------------------------------------------------------------
    Employer-sponsored retirement plans are required to offer 
an employee a direct rollover with respect to any eligible 
rollover distribution before paying the amount to the employee. 
If an eligible rollover distribution is not directly rolled 
over to an eligible retirement plan, the taxable portion of the 
distribution generally is subject to mandatory 20-percent 
income tax withholding.\1341\ Employees who do not elect a 
direct rollover but who roll over eligible distributions within 
60 days of receipt also defer tax on the rollover amounts; 
however, the 20 percent that is withheld remains taxable unless 
the employee substitutes funds within the 60-day period.
---------------------------------------------------------------------------
    \1341\ Treas. Reg. sec. 1.402(c)-2, Q&A-1(b)(3).
---------------------------------------------------------------------------

Plan loans

    Employer-sponsored retirement plans may provide loans to 
employees. Unless the loan satisfies certain requirements in 
both form and operation, the amount of a retirement plan loan 
is a deemed distribution from the retirement plan. Among the 
requirements that the loan must satisfy are that the loan's 
terms must provide for a repayment period of not more than five 
years (except for a loan specifically to purchase a home) and 
for level amortization of loan payments to be made not less 
frequently than quarterly.\1342\ Thus, if an employee stops 
making payments on a loan before the loan is repaid, a deemed 
distribution of the outstanding loan balance generally occurs. 
A deemed distribution of an unpaid loan balance is generally 
taxed as though an actual distribution occurred, including 
being subject to a 10-percent early distribution tax, if 
applicable. A deemed distribution is not eligible for rollover 
to another eligible retirement plan.
---------------------------------------------------------------------------
    \1342\ Sec. 72(p).
---------------------------------------------------------------------------
    A plan may also provide that, in certain circumstances (for 
example, if an employee terminates employment), an employee's 
obligation to repay a loan is accelerated and, if the loan is 
not repaid, the loan is cancelled and the amount in an 
employee's account balance is offset by the amount of the 
unpaid loan balance, referred to as a loan offset. A loan 
offset is treated as an actual distribution from the plan equal 
to the unpaid loan balance (rather than a deemed distribution), 
and (unlike a deemed distribution) the amount of the 
distribution is eligible for tax-free rollover to another 
eligible retirement plan within 60 days. However, the plan is 
not required to offer a direct rollover with respect to a plan 
loan offset amount that is an eligible rollover distribution, 
and the plan loan offset amount is generally not subject to 20-
percent income tax withholding.

                        Explanation of Provision

    Under the provision, the period during which a plan loan 
offset amount may be contributed to an eligible retirement plan 
as a rollover contribution is extended from 60 days after the 
date of the offset, if the plan loan is a qualified plan loan 
offset. The extended deadline is the due date (including 
extensions) for filing the Federal income tax return for the 
taxable year in which the plan loan offset occurs, that is, the 
taxable year in which the amount is treated as distributed from 
the plan. Under the provision, a qualified plan loan offset 
amount is a plan loan offset amount that is treated as 
distributed from a qualified retirement plan, a section 403(b) 
plan, or a governmental section 457(b) plan solely by reason of 
the termination of the plan or the failure to meet the 
repayment terms of the loan because of the employee's severance 
from employment. As under prior law, a loan offset amount under 
the provision is the amount by which an employee's account 
balance under the plan is reduced to repay a loan from the 
plan.

                             Effective Date

    The provision is effective for plan loan offset amounts 
treated as distributed in taxable years beginning after 
December 31, 2017.

                    PART VIII--EXEMPT ORGANIZATIONS

   A. Excise Tax Based on Investment Income of Private Colleges and 
   Universities (sec. 13701 of the Act and new sec. 4968 of the Code)

                               Prior Law

Public charities and private foundations
    An organization qualifying for tax-exempt status under 
section 501(c)(3) is further classified as either a public 
charity or a private foundation. An organization may qualify as 
a public charity in several ways.\1343\ Certain organizations 
are classified as public charities per se, regardless of their 
sources of support. These include churches, certain schools, 
hospitals and other medical organizations, certain 
organizations providing assistance to colleges and 
universities, and governmental units.\1344\ Other organizations 
qualify as public charities because they are broadly publicly 
supported. First, a charity may qualify as publicly supported 
if at least one-third of its total support is from gifts, 
grants, or other contributions from governmental units or the 
general public.\1345\ Alternatively, it may qualify as publicly 
supported if it receives more than one-third of its total 
support from a combination of gifts, grants, and contributions 
from governmental units and the public plus revenue arising 
from activities related to its exempt purposes (e.g., fee for 
service income). In addition, this category of public charity 
must not rely excessively on endowment income as a source of 
support.\1346\ A supporting organization, i.e., an organization 
that provides support to another section 501(c)(3) entity that 
is not a private foundation and meets the requirements of the 
Code, also is classified as a public charity.\1347\
---------------------------------------------------------------------------
    \1343\ The Code does not expressly define the term ``public 
charity,'' but rather provides exceptions to those entities that are 
treated as private foundations.
    \1344\ Sec. 509(a)(1) (referring to sections 170(b)(1)(A)(i) 
through (iv) for a description of these organizations).
    \1345\ Treas. Reg. sec. 1.170A-9(f)(2). Failing this mechanical 
test, the organization may qualify as a public charity if it passes a 
``facts and circumstances'' test. Treas. Reg. sec. 1.170A-9(f)(3).
    \1346\ To meet this requirement, the organization must normally 
receive more than one-third of its support from a combination of (1) 
gifts, grants, contributions, or membership fees and (2) certain gross 
receipts from admissions, sales of merchandise, performance of 
services, and furnishing of facilities in connection with activities 
that are related to the organization's exempt purposes. Sec. 
509(a)(2)(A). In addition, the organization must not normally receive 
more than one-third of its public support in each taxable year from the 
sum of (1) gross investment income and (2) the excess of unrelated 
business taxable income as determined under section 512 over the amount 
of unrelated business income tax imposed by section 511. Sec. 
509(a)(2)(B).
    \1347\ Sec. 509(a)(3). Supporting organizations are further 
classified as Type I, II, or III depending on the relationship they 
have with the organizations they support. Supporting organizations must 
support public charities listed in one of the other categories (i.e., 
per se public charities, broadly supported public charities, or revenue 
generating public charities), and they are not permitted to support 
other supporting organizations or testing for public safety 
organizations. Organizations organized and operated exclusively for 
testing for public safety also are classified as public charities. Sec. 
509(a)(4). Such organizations, however, are not eligible to receive 
deductible charitable contributions under section 170.
---------------------------------------------------------------------------
    A section 501(c)(3) organization that does not fit within 
any of the above categories is a private foundation. In 
general, private foundations receive funding from a limited 
number of sources (e.g., an individual, a family, or a 
corporation).
Excise tax on investment income of private foundations
    Under section 4940(a), private foundations that are 
recognized as exempt from Federal income tax under section 
501(a) (other than exempt operating foundations) \1348\ are 
subject to a two-percent excise tax on their net investment 
income. Net investment income generally includes interest, 
dividends, rents, royalties (and income from similar sources), 
and capital gain net income, and is reduced by expenses 
incurred to earn this income. The two-percent rate of tax is 
reduced to one-percent in any year in which a foundation 
exceeds the average historical level of its charitable 
distributions. Specifically, the excise tax rate is reduced if 
the foundation's qualifying distributions (generally, amounts 
paid to accomplish exempt purposes) \1349\ equal or exceed the 
sum of (1) the amount of the foundation's assets for the 
taxable year multiplied by the average percentage of the 
foundation's qualifying distributions over the five taxable 
years immediately preceding the taxable year in question, and 
(2) one percent of the net investment income of the foundation 
for the taxable year.\1350\ In addition, the foundation cannot 
have been subject to tax in any of the five preceding years for 
failure to meet minimum qualifying distribution requirements in 
section 4942.
---------------------------------------------------------------------------
    \1348\ Exempt operating foundations are exempt from the section 
4940 tax. Sec. 4940(d)(1). Exempt operating foundations generally 
include organizations such as museums or libraries that devote their 
assets to operating charitable programs but have difficulty meeting the 
``public support'' tests necessary not to be classified as a private 
foundation. To be an exempt operating foundation, an organization must: 
(1) be an operating foundation (as defined in section 4942(j)(3)); (2) 
be publicly supported for at least 10 taxable years; (3) have a 
governing body no more than 25 percent of whom are disqualified persons 
and that is broadly representative of the general public; and (4) have 
no officers who are disqualified persons. Sec. 4940(d)(2).
    \1349\ Sec. 4942(g).
    \1350\ Sec. 4940(e).
---------------------------------------------------------------------------
    Private foundations that are not exempt from tax under 
section 501(a), such as certain charitable trusts, are subject 
to an excise tax under section 4940(b). The tax is equal to the 
excess of the sum of the excise tax that would have been 
imposed under section 4940(a) if the foundation were tax exempt 
and the amount of the tax on unrelated business income that 
would have been imposed if the foundation were tax exempt, over 
the income tax imposed on the foundation under subtitle A of 
the Code.
    Private foundations are required to make a minimum amount 
of qualifying distributions each year to avoid tax under 
section 4942. The minimum amount of qualifying distributions a 
foundation has to make to avoid tax under section 4942 is 
reduced by the amount of section 4940 excise taxes paid.\1351\
---------------------------------------------------------------------------
    \1351\ Sec. 4942(d)(2).
---------------------------------------------------------------------------
Private colleges and universities
    Private colleges and universities generally are treated as 
public charities rather than private foundations \1352\ and 
thus are not subject to the private foundation excise tax on 
net investment income.
---------------------------------------------------------------------------
    \1352\ Secs. 509(a)(1) and 170(b)(1)(A)(ii).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision imposes an excise tax on an applicable 
educational institution for each taxable year equal to 1.4 
percent of the net investment income of the institution for the 
taxable year. Net investment income is determined using rules 
similar to the rules of section 4940(c) (relating to the net 
investment income of a private foundation).
    For purposes of the provision, an applicable educational 
institution is an eligible education institution (as described 
in section 25A of the Code): \1353\ (1) that has at least 500 
students \1354\ during the preceding taxable year; (2) more 
than 50 percent of the students \1355\ of which are located in 
the United States; (3) that is not described in the first 
section of section 511(a)(2)(B) of the Code (generally 
describing State colleges and universities); and (4) the 
aggregate fair market value of the assets of which at the end 
of the preceding taxable year (other than those assets that are 
used directly in carrying out the institution's exempt purpose) 
\1356\ is at least $500,000 per student. For these purposes, 
the number of students of an institution is based on the 
average daily number of full-time students attending the 
institution, with part-time students being taken into account 
on a full-time student equivalent basis.
---------------------------------------------------------------------------
    \1353\ Section 25A defines an eligible educational institution as 
an institution (1) which is described in section 481 of the Higher 
Education Act of 1965 (20 U.S.C. sec. 1088), as in effect on August 5, 
1977, and (2) which is eligible to participate in a program under title 
IV of such Act.
    \1354\ The December 15, 2017, conference agreement required that an 
applicable educational institution have at least 500 tuition paying 
students and that more than 50 percent of the tuition paying students 
be located in the United States, but the phrase ``tuition paying'' was 
stricken before final passage of the Act. In subsequently enacted 
legislation, the phrase ``tuition paying'' was reinstated in both 
places where it had originally appeared (Code sections 4968(b)(1)(A) 
and (b)(1)(B)). Sec. 41109 of the Bipartisan Budget Act of 2018, Pub. 
L. No. 115-123, February 9, 2018.
    \1355\ See ibid.
    \1356\ Assets used directly in carrying out the institution's 
exempt purpose include, for example, classroom buildings and physical 
facilities used for educational activities and office equipment or 
other administrative assets used by employees of the institution in 
carrying out exempt activities, among other assets.
---------------------------------------------------------------------------
    For purposes of determining whether an educational 
institution meets the asset-per-student threshold \1357\ and 
for purposes of determining net investment income, assets and 
net investment income of a related organization with respect to 
the educational institution are treated as assets and net 
investment income, respectively, of the educational 
institution, except that:
---------------------------------------------------------------------------
    \1357\ In cross-referencing the asset-per-student threshold for 
this purpose, new section 4968(d)(1) includes a reference to subsection 
(b)(1)(C) that should instead read ``(b)(1)(D).'' A clerical correction 
may be necessary to correct this cross-reference.
---------------------------------------------------------------------------
           No such amount is taken into account with 
        respect to more than one educational institution; and
           Unless the related organization is 
        controlled by the educational institution or is a 
        supporting organization (described in section 
        509(a)(3)) with respect to the institution for the 
        taxable year, assets and net investment income that are 
        not intended or available for the use or benefit of the 
        educational institution are not taken into account. For 
        example, assets of a related organization that are 
        earmarked or restricted for (or fairly attributable to) 
        the educational institution would be treated as assets 
        of the educational institution, whereas assets of a 
        related organization that are held for unrelated 
        purposes (and are not fairly attributable to the 
        educational institution) would be disregarded.
           An organization is treated as related to the 
        institution for this purpose if the organization: (1) 
        controls, or is controlled by, the institution; (2) is 
        controlled by one or more persons that control the 
        institution; or (3) is a supported organization \1358\ 
        or a supporting organization \1359\ during the taxable 
        year with respect to the institution.
---------------------------------------------------------------------------
    \1358\ Sec. 509(f)(3).
    \1359\ Sec. 509(a)(3).
---------------------------------------------------------------------------
    It is intended that the Secretary promulgate regulations to 
carry out the intent of the provision, including regulations 
that describe: (1) assets that are used directly in carrying 
out the educational institution's exempt purpose; (2) the 
computation of net investment income; and (3) assets that are 
intended or available for the use or benefit of the educational 
institution.

    The IRS and Treasury Department have issued a notice 
addressing this provision.\1360\
---------------------------------------------------------------------------
    \1360\ Notice 2018-55, 2018-26 I.R.B. 773, June 25, 2018.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

B. Unrelated Business Taxable Income Separately Computed for Each Trade 
  or Business Activity (sec. 13702 of the Act and sec. 512(a) of the 
                                 Code)


                               Prior Law


Tax exemption for certain organizations

    Section 501(a) exempts certain organizations from Federal 
income tax. Such organizations include: (1) tax-exempt 
organizations described in section 501(c) (including among 
others section 501(c)(3) charitable organizations and section 
501(c)(4) social welfare organizations); (2) religious and 
apostolic organizations described in section 501(d); and (3) 
trusts forming part of a pension, profit-sharing, or stock 
bonus plan of an employer described in section 401(a).

Unrelated business income tax, in general

    The unrelated business income tax (``UBIT'') generally 
applies to income derived from a trade or business regularly 
carried on by the organization that is not substantially 
related to the performance of the organization's tax-exempt 
functions.\1361\ An organization that is subject to UBIT and 
that has $1,000 or more of gross unrelated business taxable 
income must report that income on Form 990-T (Exempt 
Organization Business Income Tax Return).
---------------------------------------------------------------------------
    \1361\ Secs. 511-514.
---------------------------------------------------------------------------
    Most exempt organizations may operate an unrelated trade or 
business so long as the organization remains primarily engaged 
in activities that further its exempt purposes. Therefore, an 
organization may generally engage in a substantial amount of 
unrelated business activity without jeopardizing exempt status. 
A section 501(c)(3) (charitable) organization, however, may not 
operate an unrelated trade or business as a substantial part of 
its activities.\1362\ Therefore, the unrelated trade or 
business activity of a section 501(c)(3) organization must be 
insubstantial.
---------------------------------------------------------------------------
    \1362\ Treas. Reg. sec. 1.501(c)(3)-1(e).
---------------------------------------------------------------------------

Organizations subject to tax on unrelated business income

    Most exempt organizations are subject to UBIT. 
Specifically, organizations subject to UBIT generally include: 
(1) organizations exempt from tax under section 501(a), 
including organizations described in section 501(c) (except for 
U.S. instrumentalities and certain charitable trusts); \1363\ 
(2) qualified pension, profit-sharing, and stock bonus plans 
described in section 401(a); \1364\ and (3) certain State 
colleges and universities.\1365\
---------------------------------------------------------------------------
    \1363\ Sec. 511(a)(2)(A).
    \1364\ Sec. 511(a)(2)(A).
    \1365\ Sec. 511(a)(2)(B).
---------------------------------------------------------------------------

Exclusions from unrelated business taxable income

    Certain types of income are specifically excluded from 
unrelated business taxable income, such as dividends, interest, 
royalties, and certain rents,\1366\ unless derived from debt-
financed property or from certain 50-percent controlled 
subsidiaries.\1367\ Certain types of activities are not 
considered unrelated trade or business activities, such as 
activities in which substantially all the work is performed by 
volunteers, which involve the sale of donated goods, or which 
are carried on for the convenience of members, students, 
patients, officers, or employees of a charitable 
organization.\1368\ Additional activities exempt from UBIT 
include certain activities of trade shows and State 
fairs,\1369\ conducting bingo games,\1370\ and the distribution 
of low-cost items incidental to the solicitation of charitable 
contributions.\1371\ Organizations liable for UBIT may also be 
liable for alternative minimum tax determined after taking into 
account adjustments and tax preference items.\1372\
---------------------------------------------------------------------------
    \1366\ Sec. 512(b).
    \1367\ Sec. 512(b)(13).
    \1368\ Sec. 513(a).
    \1369\ Sec. 513(d)
    \1370\ Sec. 513(f).
    \1371\ Sec. 513(h).
    \1372\ See section 55 prior to amendment by the Act. For a 
discussion of the repeal of the corporate alternative minimum tax for 
taxable years beginning after December 31, 2017, see the description of 
sections 12001-12003 of the Act (Alternative Minimum Tax).
---------------------------------------------------------------------------

Specific deduction against unrelated business taxable income

    In computing unrelated business taxable income, an exempt 
organization may take a specific deduction of $1,000. This 
specific deduction may not be used to create a net operating 
loss that will be carried back or forward to another 
year.\1373\
---------------------------------------------------------------------------
    \1373\ Sec. 512(b)(12).
---------------------------------------------------------------------------
    In the case of a diocese, province of a religious order, or 
a convention or association of churches, there is also allowed 
a specific deduction with respect to each parish, individual 
church, district, or other local unit. The specific deduction 
is equal to the lower of $1,000 or the gross income derived 
from any unrelated trade or business regularly carried on by 
the local unit.\1374\
---------------------------------------------------------------------------
    \1374\ Ibid.
---------------------------------------------------------------------------

Operation of multiple unrelated trades or businesses

    An organization determines its unrelated business taxable 
income by subtracting from its gross unrelated business income 
the deductions directly connected with the unrelated trade or 
business.\1375\ In determining unrelated business taxable 
income, an organization that operates multiple unrelated trades 
or businesses aggregates income from all such activities and 
subtracts from the aggregate gross income the aggregate of the 
deductions allowed with respect to such activities.\1376\ As a 
result, an organization may use a deduction from one unrelated 
trade or business to offset income from another, thereby 
reducing total unrelated business taxable income.
---------------------------------------------------------------------------
    \1375\ Sec. 512(a).
    \1376\ Treas. Reg. sec. 1.512(a)-1(a).
---------------------------------------------------------------------------

                        Explanation of Provision

    For an organization with more than one unrelated trade or 
business, the provision requires that unrelated business 
taxable income first be computed separately with respect to 
each trade or business and without regard to the specific 
deduction generally allowed under section 512(b)(12). The 
organization's unrelated business taxable income for a taxable 
year is the sum of the amounts (not less than zero) computed 
for each separate unrelated trade or business, less the 
specific deduction allowed under section 512(b)(12).\1377\ A 
net operating loss deduction is allowed only with respect to a 
trade or business from which the loss arose.
---------------------------------------------------------------------------
    \1377\ An exempt organization that makes charitable contributions 
generally is permitted to deduct its charitable contributions in 
computing its unrelated business taxable income whether or not the 
contributions are directly connected with an unrelated trade or 
business. It is not intended that an exempt organization that has more 
than one unrelated trade or business be required to allocate its 
deductible charitable contributions among its various unrelated trades 
or businesses.
---------------------------------------------------------------------------
    The result of the provision is that a deduction from one 
trade or business for a taxable year may not be used to offset 
income from a different unrelated trade or business for the 
same taxable year. The provision generally does not, however, 
prevent an organization from using a deduction from one taxable 
year to offset income from the same unrelated trade or business 
activity in another taxable year, where appropriate.
    It is intended that the Secretary issue guidance concerning 
when an activity will be treated as a separate unrelated trade 
or business for purposes of the provision. For example, it is 
intended that the Secretary consider whether it would be 
appropriate in certain cases to permit an organization that 
maintains an investment portfolio to treat multiple investment 
activities as one unrelated trade or business.

    The IRS and Treasury Department have issued a notice 
addressing this provision.\1378\
---------------------------------------------------------------------------
    \1378\ Notice 2018-67, 2018-36 I.R.B. 409, September 4, 2018.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017. Under a special transition rule, net 
operating losses arising in a taxable year beginning before 
January 1, 2018, that are carried forward to a taxable year 
beginning on or after such date are not subject to the 
provision.

  C. Unrelated Business Taxable Income Increased by Amount of Certain 
 Fringe Benefit Expenses for which Deduction is Disallowed (sec. 13703 
                  of the Act and sec. 512 of the Code)


                               Prior Law


Tax exemption for certain organizations

    Section 501(a) exempts certain organizations from Federal 
income tax. Such organizations include: (1) tax-exempt 
organizations described in section 501(c) (including among 
others section 501(c)(3) charitable organizations and section 
501(c)(4) social welfare organizations); (2) religious and 
apostolic organizations described in section 501(d); and (3) 
trusts forming part of a pension, profit-sharing, or stock 
bonus plan of an employer described in section 401(a).

Unrelated business income tax, in general

    The unrelated business income tax (``UBIT'') generally 
applies to income derived from a trade or business regularly 
carried on by the organization that is not substantially 
related to the performance of the organization's tax-exempt 
functions.\1379\ An organization that is subject to UBIT and 
that has $1,000 or more of gross unrelated business taxable 
income must report that income on Form 990-T (Exempt 
Organization Business Income Tax Return).
---------------------------------------------------------------------------
    \1379\ Secs. 511-514.
---------------------------------------------------------------------------
    Most exempt organizations may operate an unrelated trade or 
business so long as the organization remains primarily engaged 
in activities that further its exempt purposes. Therefore, an 
organization may generally engage in a substantial amount of 
unrelated business activity without jeopardizing exempt status. 
A section 501(c)(3) (charitable) organization, however, may not 
operate an unrelated trade or business as a substantial part of 
its activities.\1380\ Therefore, the unrelated trade or 
business activity of a section 501(c)(3) organization must be 
insubstantial.
---------------------------------------------------------------------------
    \1380\ Treas. Reg. sec. 1.501(c)(3)-1(e).
---------------------------------------------------------------------------
    An organization determines its unrelated business taxable 
income by subtracting from its gross unrelated business income 
the deductions directly connected with the unrelated trade or 
business.\1381\ In determining unrelated business taxable 
income, an organization that operates multiple unrelated trades 
or businesses aggregates income from all such activities and 
subtracts from the aggregate gross income the aggregate of the 
deductions allowed with respect to such activities.\1382\ As a 
result, an organization may use a deduction from one unrelated 
trade or business to offset income from another, thereby 
reducing total unrelated business taxable income.
---------------------------------------------------------------------------
    \1381\ Sec. 512(a).
    \1382\ Treas. Reg. sec. 1.512(a)-1(a).
---------------------------------------------------------------------------

Organizations subject to tax on unrelated business income

    Most exempt organizations are subject to UBIT. 
Specifically, organizations subject to UBIT generally include: 
(1) organizations exempt from tax under section 501(a), 
including organizations described in section 501(c) (except for 
U.S. instrumentalities and certain charitable trusts); \1383\ 
(2) qualified pension, profit-sharing, and stock bonus plans 
described in section 401(a); \1384\ and (3) certain State 
colleges and universities.\1385\
---------------------------------------------------------------------------
    \1383\ Sec. 511(a)(2)(A).
    \1384\ Sec. 511(a)(2)(A).
    \1385\ Sec. 511(a)(2)(B).
---------------------------------------------------------------------------

Exclusions from unrelated business taxable income

    Certain types of income are specifically excluded from 
unrelated business taxable income, such as dividends, interest, 
royalties, and certain rents,\1386\ unless derived from debt-
financed property or from certain 50-percent controlled 
subsidiaries.\1387\ Certain types of activities are not 
considered unrelated trade or business activities, such as 
activities in which substantially all the work is performed by 
volunteers, which involve the sale of donated goods, or which 
are carried on for the convenience of members, students, 
patients, officers, or employees of a charitable 
organization.\1388\ Additional activities exempt from UBIT 
include certain activities of trade shows and State 
fairs,\1389\ conducting bingo games,\1390\ and the distribution 
of low-cost items incidental to the solicitation of charitable 
contributions.\1391\ Organizations liable for UBIT may also be 
liable for alternative minimum tax determined after taking into 
account adjustments and tax preference items.\1392\
---------------------------------------------------------------------------
    \1386\ Sec. 512(b).
    \1387\ Sec. 512(b)(13).
    \1388\ Sec. 513(a).
    \1389\ Sec. 513(d).
    \1390\ Sec. 513(f).
    \1391\ Sec. 513(h).
    \1392\ See section 55 prior to amendment by the Act. For a 
discussion of the repeal of the corporate alternative minimum tax for 
taxable years beginning after December 31, 2017, see the description of 
sections 12001-12003 of the Act (Alternative Minimum Tax).
---------------------------------------------------------------------------

Specific deduction against unrelated business taxable income

    In computing unrelated business taxable income, an exempt 
organization may take a specific deduction of $1,000. This 
specific deduction may not be used to create a net operating 
loss that will be carried back or forward to another 
year.\1393\
---------------------------------------------------------------------------
    \1393\ Sec. 512(b)(12). For a discussion of changes made to the net 
operating loss rules after 2017, see the description of section 13302 
of the Act (Modification of Net Operating Loss Deduction).
---------------------------------------------------------------------------
    In the case of a diocese, province of a religious order, or 
a convention or association of churches, there is also allowed 
a specific deduction with respect to each parish, individual 
church, district, or other local unit. The specific deduction 
is equal to the lower of $1,000 or the gross income derived 
from any unrelated trade or business regularly carried on by 
the local unit.\1394\
---------------------------------------------------------------------------
    \1394\ Ibid.
---------------------------------------------------------------------------

                        Explanation of Provision

    Under the provision, unrelated business taxable income of a 
tax-exempt organization is increased to the extent that a 
deduction is not allowable by reason of section 274 for any 
item with respect to qualified transportation fringe benefits 
\1395\ or any parking facility used in connection with 
qualified parking.\1396\ The determination of unrelated 
business taxable income associated with providing qualified 
transportation fringes, including parking facilities used in 
connection with qualified parking, is intended to be consistent 
with the determination of the deduction disallowance under 
section 274.\1397\ The amendments to section 274, as enacted, 
do not result in a deduction disallowance for items with 
respect to on-premises athletic facilities,\1398\ and 
therefore, such items are not included in unrelated business 
taxable income.
---------------------------------------------------------------------------
    \1395\ See sec. 132(f).
    \1396\ See sec. 132(f)(5)(C).
    \1397\ A technical correction may be needed to reflect this intent. 
For a discussion on qualified transportation fringe items no longer 
deductible by reason of section 274, including appropriate allocation 
of depreciation and other costs, see description of section 13304 of 
the Act (Limitation on Deduction by Employers of Expenses for Fringe 
Benefits).
    \1398\ Sec. 132(j)(4).
---------------------------------------------------------------------------
    The provision does not apply to any item directly connected 
with an unrelated trade or business that is regularly carried 
on by the organization. The provision grants the Secretary 
specific authority to issue regulations or other guidance 
necessary or appropriate to carry out the provision, including 
regulations or guidance providing for the appropriate 
allocation of depreciation and other costs with respect to 
facilities used for parking. The $1,000 specific deduction 
available to organizations under section 512(b)(12) remains in 
effect and may be used to offset unrelated business taxable 
income resulting from this provision.

                             Effective Date

    The provision is effective for amounts paid or incurred 
after December 31, 2017.

                       PART IX--OTHER PROVISIONS

         SUBPART A--CRAFT BEVERAGE MODERNIZATION AND TAX REFORM

A. Production Period for Beer, Wine, and Distilled Spirits (sec. 13801 
                of the Act and sec. 263A(f) of the Code)

                               Prior Law

In general
    The uniform capitalization (``UNICAP'') rules require 
certain direct and indirect costs allocable to real property or 
tangible personal property produced by the taxpayer to be 
included in either inventory or capitalized into the basis of 
such property, as applicable.\1399\ For real or personal 
property acquired by the taxpayer for resale, section 263A 
generally requires certain direct and indirect costs allocable 
to such property to be included in inventory.
---------------------------------------------------------------------------
    \1399\ Sec. 263A.
---------------------------------------------------------------------------
    In the case of interest expense, the uniform capitalization 
rules apply only to interest paid or incurred during the 
property's production period \1400\ and that is allocable to 
property produced by the taxpayer or acquired for resale which 
(1) is either real property or property with a class life of at 
least 20 years, (2) has an estimated production period 
exceeding two years, or (3) has an estimated production period 
exceeding one year and a cost exceeding $1,000,000.\1401\ The 
production period with respect to any property is the period 
beginning on the date on which production of the property 
begins,\1402\ and ending on the date on which the property is 
ready to be placed in service or held for sale.\1403\ In the 
case of property that is customarily aged (e.g., tobacco, wine, 
and whiskey) before it is sold, the production period includes 
the aging period.\1404\
---------------------------------------------------------------------------
    \1400\ See Treas. Reg. sec. 1.263A-12.
    \1401\ Sec. 263A(f).
    \1402\ In the case of tangible personal property, the production 
period begins on the first date the taxpayer's accumulated production 
expenditures, including planning and design expenditures, are at least 
five percent of the taxpayer's total estimated accumulated production 
expenditures for the property unit. Treas. Reg. sec. 1.263A-12(c)(3). 
Thus, the production period may begin before physical production 
activity has commenced. See Treas. Reg. sec. 1.263A-12(c)(3). For 
example, in the case of the beer, wine, and distilled spirits industry, 
the production period may include time spent planning and designing 
ingredients, production space, or production personnel.
    \1403\ Sec. 263A(f)(4)(B), prior to amendment by the Act. The 
production period for a unit of property produced for sale ends on the 
date that the unit is ready to be held for sale and all production 
activities reasonably expected to be undertaken by, or for, the 
taxpayer or a related person are complete. Treas. Reg. sec. 1.263A-
12(d)(1).
    \1404\ See Treas. Reg. sec. 1.263A-12(d)(1). See also Tech. Adv. 
Mem. 9327007, Mar. 31, 1993 (holding that producers of wine must 
include the time that wine ages in bottles as part of the production 
period, which concludes when the wine vintage is officially released to 
the distribution chain). For beer, the aging period occurs between the 
fermentation period and bottling (or other types of packaging, such as 
kegs), and can vary based on the type of yeast and the strength of the 
beer. In the case of distilled spirits, aging is the period after 
distillation and before bottling.
---------------------------------------------------------------------------
Exceptions from UNICAP
    Section 263A provides a number of exceptions to the general 
capitalization requirements. One such exception exists for 
certain small taxpayers who acquire property for resale and 
have $10 million or less of average annual gross receipts for 
the preceding three-taxable year period; \1405\ such taxpayers 
are not required to include additional section 263A costs in 
inventory.
---------------------------------------------------------------------------
    \1405\ Sec. 263A(b)(2)(B). Under prior law, no statutory exception 
is available for small taxpayers who produce property subject to 
section 263A. However, a de minimis rule under Treasury regulations 
treats producers that use the simplified production method and incur 
total indirect costs of $200,000 or less in a taxable year as having no 
additional indirect costs beyond those normally capitalized for 
financial accounting purposes. Treas. Reg. sec. 1.263A-2(b)(3)(iv). 
However, section 13102 of the Act (Small Business Accounting Method 
Reform and Simplification) expands the exception for small taxpayers 
from the uniform capitalization rules. Under that provision, any 
producer or reseller that meets the $25 million gross receipts test is 
exempted from the application of section 263A.
---------------------------------------------------------------------------
    Another exception exists for taxpayers who raise, harvest, 
or grow trees.\1406\ Under this exception, section 263A does 
not apply to trees raised, harvested, or grown by the taxpayer 
(other than trees bearing fruit, nuts, or other crops, or 
ornamental trees) and any real property underlying such trees. 
Similarly, the UNICAP rules do not apply to any animal or plant 
having a reproductive period of two years or less, which is 
produced by a taxpayer in a farming business (unless the 
taxpayer is required to use an accrual method of accounting 
under section 447 or 448(a)(3)).\1407\
---------------------------------------------------------------------------
    \1406\ Sec. 263A(c)(5).
    \1407\ Sec. 263A(d). See also section 13102 of the Act (Small 
Business Accounting Method Reform and Simplification) which expands the 
universe of farming C corporations that may use the cash method to 
include any farming C corporation that meets the $25 million gross 
receipts test.
---------------------------------------------------------------------------
    Freelance authors, photographers, and artists also are 
exempt from section 263A for any qualified creative 
expenses.\1408\ Qualified creative expenses are defined as 
amounts paid or incurred by an individual in the trade or 
business of being a writer, photographer, or artist. However, 
such term does not include any expense related to printing, 
photographic plates, motion picture files, video tapes, or 
similar items.
---------------------------------------------------------------------------
    \1408\ Sec. 263A(h).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision temporarily excludes the aging periods for 
beer,\1409\ wine,\1410\ and distilled spirits \1411\ from the 
production period as determined for purposes of the UNICAP 
interest capitalization rules. Thus, under the provision, 
producers of beer, wine and distilled spirits (other than 
spirits unfit for beverage purposes) are able to deduct 
interest expenses (subject to any other applicable limitation) 
attributable to a shorter production period that does not 
include the aging period of the beer, wine, or distilled 
spirits.\1412\
---------------------------------------------------------------------------
    \1409\ As defined in section 5052(a).
    \1410\ As defined in section 5041(a).
    \1411\ As defined in section 5002(a)(8), except such spirits that 
are unfit for use for beverage purposes.
    \1412\ The provision defines a period of time during which section 
263A does not apply to interest costs incurred during the aging period. 
Application of the provision is not a change in method of accounting 
subject to section 481 as a taxpayer's method of accounting for 
capitalizable interest costs is unchanged. However, if a taxpayer 
capitalizes aging period interest costs paid or accrued after December 
31, 2017, and before January 1, 2020, and wants to no longer capitalize 
such costs, such a change is a change in method of accounting subject 
to section 481.
---------------------------------------------------------------------------
    The provision does not apply to interest costs paid or 
accrued after December 31, 2019.

                             Effective Date

    The provision is effective for interest costs paid or 
accrued after December 31, 2017, and before January 1, 2020.

 B. Reduced Rate of Excise Tax on Beer (sec. 13802 of the Act and sec. 
                          5051(a) of the Code)


                               Prior Law

    Federal excise taxes are imposed at different rates on 
distilled spirits, wine, and beer and are imposed on these 
products when produced or imported. Generally, these excise 
taxes are administered, collected, and enforced by the Alcohol 
and Tobacco Tax and Trade Bureau (``TTB''), except the taxes on 
imported bottled distilled spirits, wine, and beer are 
collected by the Customs and Border Protection Bureau of the 
Department of Homeland Security (under delegation by the 
Secretary of the Treasury).
    Liability for the excise tax on beer arises when the 
alcohol is produced or imported but is not payable until the 
beer is removed from the brewery or customs custody for 
consumption or sale. Generally, beer may be transferred between 
commonly owned breweries without payment of tax; however, tax 
liability follows these products. Imported bulk beer may be 
released from customs custody without payment of tax and 
transferred in bond to a brewery, which becomes liable for the 
tax on such beer. Beer may be exported without payment of tax 
and may be withdrawn from a brewery without payment of tax or 
free of tax for certain authorized uses, including industrial 
uses and non-beverage uses.\1413\
---------------------------------------------------------------------------
    \1413\ Sec. 5053.
---------------------------------------------------------------------------
    The rate of tax on beer is $18 per barrel (31 
gallons).\1414\ Brewers producing fewer than two million 
barrels of beer during a calendar year (``small brewers'') are 
subject to a reduced tax rate of $7 per barrel on the first 
60,000 barrels of beer domestically produced and removed each 
year.\1415\ The credit reduces the effective per-gallon tax 
rate from approximately 58 cents per gallon to approximately 
22.6 cents per gallon for this beer.
---------------------------------------------------------------------------
    \1414\ Sec. 5051.
    \1415\ Sec. 5051(a)(2).
---------------------------------------------------------------------------
    In the case of a controlled group, the two million barrel 
limitation for small brewers is applied to the controlled 
group, and the 60,000 barrels eligible for the reduced rate of 
tax, are apportioned among the brewers who are component 
members of such group. The term ``controlled group'' has the 
meaning assigned to it by sec. 1563(a), except that the phrase 
``more than 50 percent'' is substituted for the phrase ``at 
least 80 percent'' in each place it appears in sec. 1563(a).
    Individuals may produce limited quantities of beer for 
personal or family use without payment of tax during each 
calendar year. The limit is 200 gallons per calendar year for 
households of two or more adults and 100 gallons per calendar 
year for single-adult households.

                        Explanation of Provision

    The provision temporarily lowers the rate of tax on beer to 
$16 per barrel on the first six million barrels brewed by the 
brewer or imported by the importer. In general, in the case of 
a controlled group of brewers, the six million barrel 
limitation is applied and apportioned at the level of the 
controlled group. Beer brewed or imported in excess of the six 
million barrel limit continues to be taxed at $18 per barrel. 
In the case of small brewers, such brewers are taxed at a rate 
of $3.50 per barrel on the first 60,000 barrels domestically 
produced, and $16 per barrel on any further barrels produced. 
The same rules applicable to controlled groups under prior law 
apply with respect to this limitation.
    For barrels of beer that have been brewed or produced 
outside of the United States and imported into the United 
States, the reduced tax rate may be assigned by the brewer to 
any importer of such barrels pursuant to requirements set forth 
by the Secretary of the Treasury in consultation with the 
Secretary of Health and Human Services and the Secretary of the 
Department of Homeland Security. These requirements are to 
include: (1) a limitation to ensure that the number of barrels 
of beer for which the reduced tax rate has been assigned by a 
brewer to any importer does not exceed the number of barrels of 
beer brewed or produced by such brewer during the calendar year 
which were imported into the United States by such importer; 
(2) procedures that allow a brewer and an importer to elect 
whether to receive the reduced tax rate; (3) requirements that 
the brewer provide any information as the Secretary of the 
Treasury determines necessary and appropriate for purposes of 
assignment of the reduced tax rate; and (4) procedures that 
allow for revocation of eligibility of the brewer and the 
importer for the reduced tax rate in the case of erroneous or 
fraudulent information provided in (3) which the Secretary of 
the Treasury deems to be material for qualifying for the 
reduced tax rate.
    Any importer making an election to receive the reduced tax 
rate shall be deemed to be a member of the controlled group of 
the brewer, within the meaning of section 1563(a), except that 
the phrase ``more than 50 percent'' is substituted for the 
phrase ``at least 80 percent'' in each place it appears in 
section 1563(a).\1416\
---------------------------------------------------------------------------
    \1416\ Members of the controlled group may include foreign 
corporations.
---------------------------------------------------------------------------
    Under rules issued by the Secretary of the Treasury, two or 
more entities (whether or not under common control) that 
produce beer marketed under a similar brand, license, 
franchise, or other arrangement shall be treated as a single 
taxpayer for purposes of the excise tax on beer.
    The provision does not apply to beer removed after December 
31, 2019.

                             Effective Date

    The provision is effective for beer removed after December 
31, 2017.

 C. Transfer of Beer Between Bonded Facilities (sec. 13803 of the Act 
                       and sec. 5414 of the Code)


                               Prior Law

    Federal excise taxes are imposed at different rates on 
distilled spirits, wine, and beer and are imposed on these 
products when produced or imported. Generally, these excise 
taxes are administered, collected, and enforced by the Alcohol 
and Tobacco Tax and Trade Bureau (``TTB''), except the taxes on 
imported bottled distilled spirits, wine, and beer are 
collected by the Customs and Border Protection Bureau of the 
Department of Homeland Security (under delegation by the 
Secretary of the Treasury).
    Liability for the excise tax on beer arises when the 
alcohol is produced or imported but is not payable until the 
beer is removed from the brewery or customs custody for 
consumption or sale. Generally, beer may be transferred between 
commonly owned breweries without payment of tax; however, tax 
liability follows these products. Imported bulk beer may be 
released from customs custody without payment of tax and 
transferred in bond to a brewery, which becomes liable for the 
tax on such beer. Beer may be exported without payment of tax 
and may be withdrawn from a brewery without payment of tax or 
free of tax for certain authorized uses, including industrial 
uses and non-beverage uses.\1417\
---------------------------------------------------------------------------
    \1417\ Sec. 5053.
---------------------------------------------------------------------------
    The rate of tax on beer is $18 per barrel (31 
gallons).\1418\ Brewers producing fewer than two million 
barrels of beer during a calendar year (``small brewers'') are 
subject to a reduced tax rate of $7 per barrel on the first 
60,000 barrels of beer domestically produced and removed each 
year.\1419\ The credit reduces the effective per-gallon tax 
rate from approximately 58 cents per gallon to approximately 
22.6 cents per gallon for this beer.
---------------------------------------------------------------------------
    \1418\ Sec. 5051.
    \1419\ Sec. 5051(a)(2).
---------------------------------------------------------------------------
    Individuals may produce limited quantities of beer for 
personal or family use without payment of tax during each 
calendar year. The limit is 200 gallons per calendar year for 
households of two or more adults and 100 gallons per calendar 
year for single-adult households.

Transfer rules and removals without tax

    Certain removals or transfers of beer are exempt from tax. 
Beer may be transferred without payment of the tax between 
bonded premises under certain conditions specified in the 
regulations.\1420\ The tax liability accompanies the beer that 
is transferred in bond. However, beer may only be transferred 
without payment of tax between breweries if both breweries are 
owned by the same brewer.
---------------------------------------------------------------------------
    \1420\ Sec. 5414.
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision temporarily relaxes the shared ownership 
requirement of section 5414. Thus, under the provision, a 
brewer may transfer beer from one brewery to another without 
payment of tax, provided that: (i) the breweries are owned by 
the same person; (ii) one brewery owns a controlling interest 
in the other; (iii) the same person or persons have a 
controlling interest in both breweries; or (iv) the proprietors 
of the transferring and receiving premises are independent of 
each other, and the transferor has divested itself of all 
interest in the beer so transferred, and the transferee has 
accepted responsibility for payment of the tax.
    For purposes of transferring the tax liability pursuant to 
(iv) above, such relief from liability shall be effective from 
the time of removal from the transferor's bonded premises, or 
from the time of divestment, whichever is later.
    The provision does not apply for calendar quarters 
beginning after December 31, 2019.

                             Effective Date

    The provision applies to any calendar quarters beginning 
after December 31, 2017.

 D. Reduced Rate of Excise Tax on Certain Wine (sec. 13804 of the Act 
                     and sec. 5041(c) of the Code)


                               Prior Law


In general

    Excise taxes are imposed on the wine, according to the 
wine's alcohol content and carbonation levels. The following 
table outlines the rates of tax on wine.

------------------------------------------------------------------------
          Tax (and Code Section)                      Tax Rates
------------------------------------------------------------------------
Wines (sec. 5041):
    ``Still wines'' \1421\ not more than    $1.07 per wine gallon \1422\
     14 percent alcohol.
    ``Still wines'' more than 14 percent,   $1.57 per wine gallon
     but not more than 21 percent, alcohol.
    ``Still wines'' more than 21 percent,   $3.15 per wine gallon
     but not more than 24 percent, alcohol.
    ``Still wines'' more than 24 percent    $13.50 per proof gallon
     alcohol.                                (taxed as distilled
                                             spirits)
    Champagne and other sparkling wines...  $3.40 per wine gallon
    Artificially carbonated wines.........  $3.30 per wine gallon
------------------------------------------------------------------------

    Liability for the excise taxes on wine arises when the wine 
is produced or imported but is not payable until the wine is 
removed from the bonded wine cellar or winery, or from customs 
control, for consumption or sale. Generally, bulk and bottled 
wine may be transferred between bonded premises; however, the 
tax liability on such wine becomes the responsibility of the 
transferee. Bulk natural wine may be released from customs 
custody without payment of tax and transferred in bond to a 
winery. Wine may be exported without payment of tax and may be 
withdrawn from a wine cellar or winery without payment of tax 
or free of tax for certain authorized uses, including 
industrial uses and non-beverage uses.\1423\
---------------------------------------------------------------------------
    \1421\ A ``still wine'' is a non-effervescent or minimally 
effervescent wine containing no more than 0.392 grams of carbon dioxide 
per hundred milliliters of wine. Champagne wine typically contains more 
than twice that amount.
    \1422\ A wine gallon is a U.S. liquid gallon.
    \1423\ Sec. 5042.
---------------------------------------------------------------------------

Reduced rates and exemptions for certain wine producers

    Domestic wine producers having aggregate annual production 
not exceeding 250,000 gallons (``small domestic producers'') 
receive a credit against the wine excise tax equal to 90 cents 
per gallon (the amount of a wine tax increase enacted in 1990) 
on the first 100,000 gallons of wine domestically produced and 
removed during a calendar year.\1424\ The credit is reduced 
(but not below zero) by one percent for each 1,000 gallons 
produced in excess of 150,000 gallons; the credit may not be 
applied to the tax liability on sparkling wines. In the case of 
a controlled group, the 250,000 gallon limitation for wineries 
is applied to the controlled group, and the 100,000 gallons 
eligible for the credit, are apportioned among the wineries who 
are component members of such group. The term ``controlled 
group'' has the meaning assigned to it by section 1563(a), 
except that the phrase ``more than 50 percent'' is substituted 
for the phrase ``at least 80 percent'' in each place it appears 
in section 1563(a).
---------------------------------------------------------------------------
    \1424\ Sec. 5041(c).
---------------------------------------------------------------------------
    Individuals may produce limited quantities of wine for 
personal or family use without payment of tax during each 
calendar year. The limit is 200 gallons per calendar year for 
households of two or more adults and 100 gallons per calendar 
year for single-adult households.

                        Explanation of Provision

    The provision temporarily modifies the credit against the 
wine excise tax for small domestic producers, by removing the 
250,000 wine gallon domestic production limitation (and thus 
making the credit available for all wine producers and 
importers). Additionally, under the provision, the credit may 
be applied to the tax liability on sparkling wine. With respect 
to wine produced in, or imported into, the United States during 
a calendar year, the credit amount is (1) $1.00 per wine gallon 
for the first 30,000 wine gallons of wine, plus; (2) 90 cents 
per wine gallon on the next 100,000 wine gallons of wine, plus; 
(3) 53.5 cents per wine gallon on the next 620,000 wine gallons 
of wine.\1425\ There is no phaseout of the credit.
---------------------------------------------------------------------------
    \1425\ The credit rate for hard cider is tiered at the same level 
of production or importation, but is equal to 6.2 cents, 5.6 cents and 
3.3 cents, respectively.
---------------------------------------------------------------------------
    In the case of any wine gallons of wine that have been 
produced outside of the United States and imported into the 
United States, the tax credit allowable may be assigned by the 
person who produced such wine (the ``foreign producer'') to any 
electing importer of such wine gallons pursuant to requirements 
established by the Secretary of the Treasury, in consultation 
with the Secretary of Health and Human Services and the 
Secretary of the Department of Homeland Security. These 
requirement are to include: (1) a limitation to ensure that the 
number of wine gallons of wine for which the tax credit has 
been assigned by a foreign producer to any importer does not 
exceed the number of wine gallons of wine produced by such 
foreign producer, during the calendar year, which were imported 
into the United States by such importer; (2) procedures that 
allow the election of a foreign producer to assign, and an 
importer to receive, the tax credit; (3) requirements that the 
foreign producer provide any information that the Secretary of 
the Treasury determines to be necessary and appropriate for 
purposes of assigning the tax credit; and (4) procedures that 
allow for revocation of eligibility of the foreign producer and 
the importer for the tax credit in the case of erroneous or 
fraudulent information provided in (3) which the Secretary of 
the Treasury deems to be material for qualifying for the 
reduced tax rate.
    Any importer making an election to receive the reduced tax 
rate shall be deemed to be a member of the controlled group of 
the winemaker, within the meaning of section 1563(a), except 
that the phrase ``more than 50 percent'' is substitute for the 
phrase ``at least 80 percent'' in each place it appears in 
section 1563(a).\1426\
---------------------------------------------------------------------------
    \1426\ Members of the controlled group may include foreign 
corporations.
---------------------------------------------------------------------------
    The provision does not apply to wine removed after December 
31, 2019.

                             Effective Date

    The provision applies to wine removed after December 31, 
2017.

 E. Adjustment of Alcohol Content Level for Application of Excise Tax 
       Rates (sec. 13805 of the Act and sec. 5041(b) of the Code)


                               Prior Law


In general

    Excise taxes are imposed on the wine, according to the 
wine's alcohol content and carbonation levels. The following 
table outlines the rates of tax on wine.

------------------------------------------------------------------------
          Tax (and Code Section)                      Tax Rates
------------------------------------------------------------------------
Wines (sec. 5041).........................
    ``Still wines'' \1427\ not more than    $1.07 per wine gallon \1428\
     14 percent alcohol.
    ``Still wines'' more than 14 percent,   $1.57 per wine gallon
     but not more than 21 percent, alcohol.
    ``Still wines'' more than 21 percent,   $3.15 per wine gallon
     but not more than 24 percent, alcohol.
    ``Still wines'' more than 24 percent    $13.50 per proof gallon
     alcohol.                                (taxed as distilled
                                             spirits)
    Champagne and other sparkling wines...  $3.40 per wine gallon
    Artificially carbonated wines.........  $3.30 per wine gallon
------------------------------------------------------------------------

    Liability for the excise taxes on wine arises when the wine 
is produced or imported but is not payable until the wine is 
removed from the bonded wine cellar or winery, or from customs 
control, for consumption or sale. Generally, bulk and bottled 
wine may be transferred between bonded premises; however, the 
tax liability on such wine becomes the responsibility of the 
transferee. Bulk natural wine may be released from customs 
custody without payment of tax and transferred in bond to a 
winery. Wine may be exported without payment of tax and may be 
withdrawn from a wine cellar or winery without payment of tax 
or free of tax for certain authorized uses, including 
industrial uses and non-beverage uses.\1429\
---------------------------------------------------------------------------
    \1427\ A ``still wine'' is a non-effervescent or minimally 
effervescent wine containing no more than 0.392 grams of carbon dioxide 
per hundred milliliters of wine. Champagne wine typically contains more 
than twice that amount.
    \1428\ A wine gallon is a U.S. liquid gallon.
    \1429\ Sec. 5042.
---------------------------------------------------------------------------

Reduced rates and exemptions for certain wine producers

    Domestic wine producers having aggregate annual production 
not exceeding 250,000 gallons (``small domestic producers'') 
receive a credit against the wine excise tax equal to 90 cents 
per gallon (the amount of a wine tax increase enacted in 1990) 
on the first 100,000 gallons of wine domestically produced and 
removed during a calendar year.\1430\ The credit is reduced 
(but not below zero) by one percent for each 1,000 gallons 
produced in excess of 150,000 gallons; the credit may not be 
applied to the tax liability on sparkling wines. In the case of 
a controlled group, the 250,000 gallon limitation for wineries 
is applied to the controlled group, and the 100,000 gallons 
eligible for the credit, are apportioned among the wineries who 
are component members of such group. The term ``controlled 
group'' has the meaning assigned to it by section 1563(a), 
except that the phrase ``more than 50 percent'' is substituted 
for the phrase ``at least 80 percent'' in each place it appears 
in section 1563(a).
---------------------------------------------------------------------------
    \1430\ Sec. 5041(c).
---------------------------------------------------------------------------
    Individuals may produce limited quantities of wine for 
personal or family use without payment of tax during each 
calendar year. The limit is 200 gallons per calendar year for 
households of two or more adults and 100 gallons per calendar 
year for single-adult households.

                        Explanation of Provision

    The provision temporarily modifies alcohol-by-volume levels 
of the first two tiers of the excise tax on wine, by changing 
14 percent to 16 percent. Thus, under the provision, a wine 
producer or importer may produce or import ``still wine'' that 
has an alcohol-by-volume level of up to 16 percent and remain 
subject to the lowest rate of $1.07 per wine gallon.
    The provision does not apply to wine removed after December 
31, 2019.

                             Effective Date

    The provision applies to wine removed after December 31, 
2017.

F. Definition of Mead and Low Alcohol by Volume Wine (sec. 13806 of the 
                     Act and sec. 5041 of the Code)


                               Prior Law


In general

    Excise taxes are imposed on the wine, according to the 
wine's alcohol content and carbonation levels. The following 
table outlines the rates of tax on wine.
---------------------------------------------------------------------------
    \1431\ A ``still wine'' is a non-effervescent or minimally 
effervescent wine containing no more than 0.392 grams of carbon dioxide 
per hundred milliliters of wine. Champagne wine typically contains more 
than twice that amount.
    \1432\ A wine gallon is a U.S. liquid gallon.

------------------------------------------------------------------------
          Tax (and Code Section)                      Tax Rates
------------------------------------------------------------------------
Wines (sec. 5041).........................
    ``Still wines'' \1431\ not more than    $1.07 per wine gallon \1432\
     14 percent alcohol.
    ``Still wines'' more than 14 percent,   $1.57 per wine gallon
     but not more than 21 percent, alcohol.
    ``Still wines'' more than 21 percent,   $3.15 per wine gallon
     but not more than 24 percent, alcohol.
    ``Still wines'' more than 24 percent    $13.50 per proof gallon
     alcohol.                                (taxed as distilled
                                             spirits)
    Champagne and other sparkling wines...  $3.40 per wine gallon
    Artificially carbonated wines.........  $3.30 per wine gallon
------------------------------------------------------------------------

    Liability for the excise taxes on wine arises when the wine 
is produced or imported but is not payable until the wine is 
removed from the bonded wine cellar or winery, or from customs 
control, for consumption or sale. Generally, bulk and bottled 
wine may be transferred between bonded premises; however, the 
tax liability on such wine becomes the responsibility of the 
transferee. Bulk natural wine may be released from customs 
custody without payment of tax and transferred in bond to a 
winery. Wine may be exported without payment of tax and may be 
withdrawn from a wine cellar or winery without payment of tax 
or free of tax for certain authorized uses, including 
industrial uses and non-beverage uses.\1433\
---------------------------------------------------------------------------
    \1433\ Sec. 5042.
---------------------------------------------------------------------------

Reduced rates and exemptions for certain wine producers

    Domestic wine producers having aggregate annual production 
not exceeding 250,000 gallons (``small domestic producers'') 
receive a credit against the wine excise tax equal to 90 cents 
per gallon (the amount of a wine tax increase enacted in 1990) 
on the first 100,000 gallons of wine domestically produced and 
removed during a calendar year.\1434\ The credit is reduced 
(but not below zero) by one percent for each 1,000 gallons 
produced in excess of 150,000 gallons; the credit may not be 
applied to the tax liability on sparkling wines. In the case of 
a controlled group, the 250,000 gallon limitation for wineries 
is applied to the controlled group, and the 100,000 gallons 
eligible for the credit, are apportioned among the wineries who 
are component members of such group. The term ``controlled 
group'' has the meaning assigned to it by section 1563(a), 
except that the phrase ``more than 50 percent'' is substituted 
for the phrase ``at least 80 percent'' in each place it appears 
in section 1563(a).
---------------------------------------------------------------------------
    \1434\ Sec. 5041(c).
---------------------------------------------------------------------------
    Individuals may produce limited quantities of wine for 
personal or family use without payment of tax during each 
calendar year. The limit is 200 gallons per calendar year for 
households of two or more adults and 100 gallons per calendar 
year for single-adult households.

                        Explanation of Provision

    The provision temporarily designates mead and certain 
sparkling, low alcohol-by-volume wines to be taxed at the 
lowest rate applicable to ``still wine,'' of $1.07 per wine 
gallon of wine. Mead is defined as a wine that contains not 
more than 0.64 grams of carbon dioxide per hundred milliliters 
of wine,\1435\ which is derived solely from honey and water, 
contains no fruit product or fruit flavoring, and contains less 
than 8.5 percent alcohol-by-volume. The sparkling wines 
eligible to be taxed at the lowest rate are those wines that 
contain not more than 0.64 grams of carbon dioxide per hundred 
milliliters of wine,\1436\ which are derived primarily from 
grapes or grape juice concentrate and water, which contain no 
fruit flavoring other than grape, and which contain less than 
8.5 percent alcohol by volume.
---------------------------------------------------------------------------
    \1435\ The Secretary is authorized to prescribe tolerances to this 
limitation as may be reasonably necessary in good commercial practice.
    \1436\ The Secretary is authorized to prescribe tolerances to this 
limitation as may be reasonably necessary in good commercial practice.
---------------------------------------------------------------------------
    The provision does not apply to wine removed after December 
31, 2019.

                             Effective Date

    The provision applies to wine removed after December 31, 
2017.

G. Reduced Rate of Excise Tax on Certain Distilled Spirits (sec. 13807 
                 of the Act and sec. 5001 of the Code)


                               Prior Law

    An excise tax is imposed on all distilled spirits produced 
in, or imported into, the United States.\1437\ The tax 
liability arises the moment the alcohol is produced or imported 
but payment of the tax is not required until a subsequent 
withdrawal or removal from the distillery, or, in the case of 
an imported product, from customs custody or bond.\1438\
---------------------------------------------------------------------------
    \1437\ Secs. 5001.
    \1438\ Secs. 5006, 5043, and 5054.
---------------------------------------------------------------------------
    Distilled spirits are taxed at a rate of $13.50 per proof 
gallon.\1439\ Liability for the excise tax on distilled spirits 
arises when the alcohol is produced but is not determined and 
payable until bottled distilled spirits are removed from the 
bonded premises of the distilled spirits plant where they are 
produced, or customs custody. Generally, bulk distilled spirits 
may be transferred in bond between bonded premises; however, 
tax liability follows these products. Imported bulk distilled 
spirits may be released from customs custody without payment of 
tax and transferred in bond to a distillery. Distilled spirits 
may be exported without payment of tax and may be withdrawn 
from a distillery without payment of tax or free of tax for 
certain authorized uses, including industrial uses and non-
beverage uses.
---------------------------------------------------------------------------
    \1439\ A ``proof gallon'' is a U.S. liquid gallon of proof spirits, 
or the alcoholic equivalent thereof. Generally a proof gallon is a U.S. 
liquid gallon consisting of 50 percent alcohol. On lesser quantities, 
the tax is paid proportionately. Credits are allowed for wine content 
and flavors content of distilled spirits. Sec. 5010.
---------------------------------------------------------------------------
    A portion of the revenues from the distilled spirits excise 
tax imposed on rum imported or brought into \1440\ the United 
States (less certain administrative costs) is transferred 
(``covered over'') to Puerto Rico and the U.S. Virgin 
Islands.\1441\ The amount covered over is $10.50 per proof 
gallon ($13.25 per proof gallon during the period from July 1, 
1999, through December 31, 2016).
---------------------------------------------------------------------------
    \1440\ Because Puerto Rico is inside U.S. customs territory, 
articles entering the United States from that commonwealth are 
``brought into'' rather than ``imported into'' the U.S.
    \1441\ Sec. 7652.
---------------------------------------------------------------------------
    Eligible distilled spirits wholesale distributors and 
distillers receive an income tax credit for the average cost of 
carrying previously imposed excise tax on beverages stored in 
their warehouses.\1442\
---------------------------------------------------------------------------
    \1442\ Sec. 5011. Section 5011 is administered and enforced by the 
IRS.
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision temporarily institutes a tax rate schedule 
for distilled spirits based on annual quantity removed or 
imported. The rate of tax is lowered to $2.70 per proof gallon 
on the first 100,000 proof gallons of distilled spirits 
produced, $13.34 for all proof gallons in excess of that amount 
but below 22,130,000 proof gallons, and $13.50 for amounts 
thereafter. The provision contains rules so as to prevent 
members of the same controlled group from receiving the lower 
rate on more than 100,000 proof gallons of distilled spirits. 
Importers of distilled spirits are eligible for the lower 
rates.
    The provision does not apply to distilled spirits removed 
after December 31, 2019.

                             Effective Date

    The provision applies to distilled spirits removed after 
December 31, 2017.

 H. Bulk Distilled Spirits (sec. 13808 of the Act and sec. 5212 of the 
                                 Code)


                               Prior Law

    An excise tax is imposed on all distilled spirits produced 
in, or imported into, the United States.\1443\ The tax 
liability arises the moment the alcohol is produced or imported 
but payment of the tax is not required until a subsequent 
withdrawal or removal from the distillery, or, in the case of 
an imported product, from customs custody or bond.\1444\
---------------------------------------------------------------------------
    \1443\ Secs. 5001.
    \1444\ Secs. 5006, 5043, and 5054.
---------------------------------------------------------------------------
    Distilled spirits are taxed at a rate of $13.50 per proof 
gallon.\1445\ Liability for the excise tax on distilled spirits 
arises when the alcohol is produced but is not determined and 
payable until bottled distilled spirits are removed from the 
bonded premises of the distilled spirits plant where they are 
produced, or customs custody. Generally, bulk distilled spirits 
may be transferred in bond between bonded premises; however, 
tax liability follows these products. Imported bulk distilled 
spirits may be released from customs custody without payment of 
tax and transferred in bond to a distillery. Distilled spirits 
may be exported without payment of tax and may be withdrawn 
from a distillery without payment of tax or free of tax for 
certain authorized uses, including industrial uses and non-
beverage uses.
---------------------------------------------------------------------------
    \1445\ A ``proof gallon'' is a U.S. liquid gallon of proof spirits, 
or the alcoholic equivalent thereof. Generally a proof gallon is a U.S. 
liquid gallon consisting of 50 percent alcohol. On lesser quantities, 
the tax is paid proportionately. Credits are allowed for wine content 
and flavors content of distilled spirits. Sec. 5010.
---------------------------------------------------------------------------
    A portion of the revenues from the distilled spirits excise 
tax imposed on rum imported or brought into \1446\ the United 
States (less certain administrative costs) is transferred 
(``covered over'') to Puerto Rico and the U.S. Virgin 
Islands.\1447\ The amount covered over is $10.50 per proof 
gallon ($13.25 per proof gallon during the period from July 1, 
1999, through December 31, 2016).
---------------------------------------------------------------------------
    \1446\ Because Puerto Rico is inside U.S. customs territory, 
articles entering the United States from that commonwealth are 
``brought into'' rather than ``imported into'' the U.S.
    \1447\ Sec. 7652.
---------------------------------------------------------------------------
    Eligible distilled spirits wholesale distributors and 
distillers receive an income tax credit for the average cost of 
carrying previously imposed excise tax on beverages stored in 
their warehouses.\1448\
---------------------------------------------------------------------------
    \1448\ Sec. 5011. Section 5011 is administered and enforced by the 
IRS.
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision temporarily allows distillers to transfer 
spirits in bond in containers other than bulk containers 
without payment of tax.
    The provision does not apply to distilled spirits 
transferred in bond after December 31, 2019.

                             Effective Date

    The provision applies to distilled spirits transferred in 
bond after December 31, 2017.

                  SUBPART B--MISCELLANEOUS PROVISIONS


  A. Modification of Tax Treatment of Alaska Native Corporations and 
 Settlement Trusts (sec. 13821 of the Act and secs. 646 and 6039H and 
                  new secs. 139G and 247 of the Code)


                               Prior Law 

    The Alaska Native Claims Settlement Act (``ANCSA'') \1449\ 
established Native Corporations \1450\ to hold property for 
Alaska Natives. Alaska Natives are generally the only permitted 
common shareholders of those corporations under section 7(h) of 
ANCSA, unless a Native Corporation specifically allows other 
shareholders under specified procedures.
---------------------------------------------------------------------------
    \1449\ 43 U.S.C. 1601 et seq.
    \1450\ Defined at 43 U.S.C. 1602(m). Sec. 646(h)(2).
---------------------------------------------------------------------------
    ANCSA permits a Native Corporation to transfer money or 
other property to an Alaska Native Settlement Trust 
(``Settlement Trust'') \1451\ for the benefit of beneficiaries 
who constitute all or a class of the shareholders of the Native 
Corporation, to promote the health, education and welfare of 
beneficiaries, and to preserve the heritage and culture of 
Alaska Natives.\1452\
---------------------------------------------------------------------------
    \1451\ Defined at 43 U.S.C. 1602(t). Sec. 646(h)(4).
    \1452\ With certain exceptions, once an Alaska Native Corporation 
has made a conveyance to a Settlement Trust, the assets conveyed shall 
not be subject to attachment, distraint, or sale or execution of 
judgment, except with respect to the lawful debts and obligations of 
the Settlement Trust.
---------------------------------------------------------------------------
    Native Corporations and Settlement Trusts, as well as their 
shareholders and beneficiaries, are generally subject to tax 
under the same rules and in the same manner as other taxpayers 
that are corporations, trusts, shareholders, or beneficiaries.
    Special rules allow an election to use a more favorable tax 
regime for transfers of property by a Native Corporation to a 
Settlement Trust and for income taxation of the Settlement 
Trust.\1453\ There is also simplified reporting to 
beneficiaries.\1454\
---------------------------------------------------------------------------
    \1453\ Sec. 646.
    \1454\ Sec. 6039H.
---------------------------------------------------------------------------
    Under the special tax rules, a Settlement Trust may make an 
irrevocable election to pay tax on taxable income at the lowest 
rate specified for individuals (rather than the highest rate 
that is generally applicable to trusts) and to pay tax on 
capital gains at a rate consistent with being subject to such 
lowest rate of tax.\1455\ As described further below, 
beneficiaries may generally thereafter exclude from gross 
income distributions from a trust that has made this 
election.\1456\ Also, contributions from a Native Corporation 
to an electing Settlement Trust \1457\ generally will not 
result in the recognition of gross income by beneficiaries on 
account of the contribution.\1458\ An electing Settlement Trust 
remains subject to generally applicable requirements for 
classification and taxation as a trust.
---------------------------------------------------------------------------
    \1455\ Sec. 646(b) and (c).
    \1456\ Sec. 646(e).
    \1457\ Defined at sec. 646(h)(1).
    \1458\ Sec. 646(d)(1).
---------------------------------------------------------------------------
    A Settlement Trust distribution is excludable from the 
gross income of beneficiaries to the extent of the taxable 
income of the Settlement Trust for the taxable year and all 
prior taxable years for which an election was in effect, 
decreased by income tax paid by the Trust, plus tax-exempt 
interest from State and local bonds for the same period.\1459\ 
Amounts distributed in excess of the amount excludable are 
taxed to the beneficiaries as if distributed by the sponsoring 
Native Corporation in the year of distribution by the Trust, 
which means that the beneficiaries must include in gross income 
as dividends the amount of the distribution, up to the current 
and accumulated earnings and profits of the Native 
Corporation.\1460\ Amounts distributed in excess of the current 
and accumulated earnings and profits are not included in gross 
income by the beneficiaries.
---------------------------------------------------------------------------
    \1459\ Sec. 646(e)(1).
    \1460\ Sec. 646(e)(3).
---------------------------------------------------------------------------
    A special loss disallowance rule reduces (but not below 
zero) any loss that would otherwise be recognized upon 
disposition of stock of a sponsoring Native Corporation by a 
proportion, determined on a per share basis, of all 
contributions to all electing Settlement Trusts by the 
sponsoring Native Corporation.\1461\ This rule prevents a 
stockholder from being able to take advantage of a decrease in 
value of a Native Corporation that is caused by a transfer of 
assets from the Native Corporation to a Settlement Trust.
---------------------------------------------------------------------------
    \1461\ Sec. 646(i).
---------------------------------------------------------------------------
    The fiduciary of an electing Settlement Trust is obligated 
to provide certain information relating to distributions from 
the trust in lieu of reporting requirements under section 
6034A.\1462\
---------------------------------------------------------------------------
    \1462\ Sec. 6039H.
---------------------------------------------------------------------------
    The election to pay tax at the lowest rate is not available 
in certain disqualifying cases where transfer restrictions have 
been modified to allow a transfer of either: (a) a beneficial 
interest that would not be permitted by section 7(h) of ANCSA 
if the interest were Settlement common stock,\1463\ or (b) any 
stock in an Alaska Native Corporation that would not be 
permitted by section 7(h) of ANCSA if it were Settlement common 
stock and the Native Corporation thereafter makes a transfer to 
the Trust.\1464\ Where an election is already in effect at the 
time of such disqualifying transfer, the special rules 
applicable to an electing trust cease to apply and rules 
generally applicable to trusts apply. In addition, the 
distributable net income of the trust is increased by 
undistributed current and accumulated earnings and profits of 
the trust, limited by the fair market value of trust assets at 
the date the trust becomes so disposable. The effect is to 
cause the trust to be taxed at regular trust rates on the 
amount of recomputed distributable net income not distributed 
to beneficiaries, and to cause the beneficiaries to be taxed on 
the amount of any distributions received consistent with the 
applicable tax rate bracket.
---------------------------------------------------------------------------
    \1463\ Defined at 43 U.S.C. 1602(p). Sec. 646(h)(3).
    \1464\ Sec. 646(f).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision comprises three separate but related 
sections.\1465\
---------------------------------------------------------------------------
    \1465\ The Act does not amend section 646.
---------------------------------------------------------------------------

Assignments to Alaska Native Settlement Trusts

    The first section allows a Native Corporation to assign 
certain payments described in ANCSA to a Settlement Trust 
without having to recognize gross income from those payments, 
provided the assignment is in writing and the Native 
Corporation has not received the payment prior to 
assignment.\1466\ The Settlement Trust is required to include 
the assigned payment in gross income when received with the 
same character as if such payment was received by the Native 
Corporation. The Native Corporation is not allowed a deduction 
for the assigned payment.
---------------------------------------------------------------------------
    \1466\ The amount and scope of any assignment must be described 
with reasonable particularity and may either be in a percentage of one 
or more such payments or in a fixed dollar amount. Further, such 
assignment must specify a duration either in perpetuity or for a period 
of time, and whether it is revocable.
---------------------------------------------------------------------------

Contributions to Alaska Native Settlement Trusts

    The second section allows a Native Corporation to elect 
annually to deduct contributions made to a Settlement 
Trust.\1467\ If the contribution is in cash, the deduction is 
in the amount of cash contributed. If the contribution is in 
property other than cash, the deduction is the amount of the 
Native Corporation's adjusted basis in the contributed property 
(or the fair market value of such property, if less than the 
Native Corporation's adjusted basis), and no gain or loss may 
be recognized on the contribution. The Native Corporation's 
deduction is limited to the amount of its taxable income \1468\ 
for that year, and any excess may be carried forward 15 
succeeding years. The Native Corporation's earnings and profits 
for the taxable year are reduced by the amount of any deduction 
claimed for that year.
---------------------------------------------------------------------------
    \1467\ A Native Corporation makes the election to deduct 
contributions to a Settlement Trust for a specific taxable year by 
including a statement with its original or amended income tax return. 
See IRS News Release IR-2018-16, January 30, 2018. Any election may be 
revoked on a timely filed amendment or supplement to the Native 
Corporation's income tax return.
    \1468\ As determined without regard to such deduction.
---------------------------------------------------------------------------
    Generally, the Settlement Trust must include income equal 
to the deduction by the Native Corporation. For contributions 
of property other than cash, the Settlement Trust takes a basis 
in the property equal to the adjusted basis of such property in 
the hands of the Native Corporation immediately before the 
contribution (or the fair market value of such property 
immediately before such contribution, if less than the Native 
Corporation's adjusted basis), and may elect to defer 
recognition of the income associated with such property until 
the Settlement Trust sells or exchanges the property, in whole 
or in part.\1469\ In that case, any income that is deferred 
(i.e., the amount of income that would have been included upon 
contribution absent the election to defer) is treated as 
ordinary income, while any gain in excess of the amount of 
income that is deferred takes the same character as if the 
election had not been made. The provision permits the amendment 
of the terms of any Settlement Trust agreement within one year 
of the enactment of the provision (i.e., within one year of 
December 22, 2017) to allow this election, with certain 
restrictions.
---------------------------------------------------------------------------
    \1469\ To make such election, the Settlement Trust must identify 
and describe with reasonable particularity the contributed property on 
a statement attached to its original or amended income tax return for 
the year in which the property was contributed. See IRS News Release 
IR-2018-16, January 30, 2018.
---------------------------------------------------------------------------
    If property subject to this election is disposed of within 
the first taxable year subsequent to the taxable year in which 
the property was contributed to the Settlement Trust, the 
election is voided with respect to such property, and the 
Settlement Trust is required to pay any tax applicable to the 
disposition of the property, including any applicable interest, 
and an additional amount equal to 10 percent of the amount of 
the tax with interest. The provision provides for a four-year 
assessment period in which to assess the tax, interest, and 
penalty amounts.

Information reporting 

    The third section of the provision requires any Native 
Corporation which has made an election to deduct contributions 
to a Settlement Trust as described above to furnish a statement 
to the Settlement Trust not later than January 31 of the 
calendar year subsequent to the calendar year in which the 
contribution was made. The statement must include: (1) the 
total amount of contributions to which the election applies; 
(2) for each contribution, whether the contribution was in 
cash; (3) for each non-cash contribution, the date that the 
contributed property was acquired by the Native Corporation and 
the adjusted basis and fair market value of such property on 
the contribution date; (4) the date on which each contribution 
was made to the Settlement Trust; and (5) such information as 
the Secretary determines is necessary or appropriate for the 
identification of each contribution and the accurate inclusion 
of income relating to such contributions by the Settlement 
Trust.

                             Effective Date

    The provision relating to the exclusion for ANCSA payments 
assigned to Settlement Trusts is effective to taxable years 
beginning after December 31, 2016.
    The provision relating to the deduction of contributions to 
Settlement Trusts is effective for taxable years for which the 
Native Corporation's refund or credit statute of limitations 
period has not expired, and the provision provides a limited 
waiver of the refund or credit statute of limitations period in 
the event that the limitation period expires before the end of 
the one-year period beginning on the date of enactment (i.e., 
the one-year period beginning on December 22, 2017). The waiver 
period ends at the termination of that one-year period.
    The provision relating to the reporting requirement applies 
to taxable years beginning after December 31, 2016.

B. Amounts Paid for Aircraft Management Services (sec. 13822 of the Act 
                     and sec. 4621(e) of the Code)


                               Prior Law


Excise tax on taxable transportation by air

    For domestic passenger transportation, section 4261 imposes 
an excise tax on amounts paid for taxable transportation. In 
general, for domestic flights, the tax consists of two parts: a 
7.5 percent ad valorem tax applied to the amount paid and a 
flat dollar amount for each flight segment (consisting of one 
takeoff and one landing). ``Taxable transportation'' generally 
means transportation by air which begins and ends in the United 
States. The tax is paid by the person making the payment 
subject to tax and the tax is collected by the person receiving 
the payment. For commercial freight aviation, the ad valorem 
tax is 6.25 percent of the amount paid for transportation
    In determining whether a flight constitutes taxable 
transportation and whether the amounts paid for such 
transportation are subject to tax, the Internal Revenue Service 
(``IRS'') has looked at who has ``possession, command, and 
control'' of the aircraft based on the relevant facts and 
circumstances.\1470\
---------------------------------------------------------------------------
    \1470\ See, e.g., Rev. Rul. 60-311, 1960-2 C.B. 341, which held 
that, since the company in question retains the elements of possession, 
command, and control of the aircraft and performs all services in 
connection with the operation of the aircraft, the company is, in fact, 
furnishing taxable transportation to the lessee; and the tax on the 
transportation of persons applies to the portion of the total payment 
which is allocable to the transportation of persons, provided such 
allocation is made on a fair and reasonable basis. If no allocation is 
made, the tax applies to the total payment for the lease of the 
aircraft.
---------------------------------------------------------------------------

Applicability to aircraft management services

    Generally, an aircraft management services company 
(``management company'') has as its business purpose the 
management of aircraft owned by other corporations or 
individuals (``aircraft owners'''). In this function, 
management companies provide aircraft owners, among other 
things, with administrative and support services (such as 
scheduling, flight planning, and weather forecasting), aircraft 
maintenance services, the provision of pilots and crew, and 
compliance with regulatory standards. Although the arrangement 
between management companies and aircraft owners may vary, 
aircraft owners generally pay management companies a monthly 
fee to cover the fixed expenses of maintaining the aircraft 
(such as insurance, maintenance, and recordkeeping) and a 
variable fee to cover the cost of using the aircraft (such as 
the provision of pilots, crew, and fuel).
    In March 2012, the IRS issued a Chief Counsel Advice 
determining that a management company provided all of the 
essential elements necessary for providing transportation by 
air and the owner relinquished possession, command and control 
to the management company.\1471\ Thus, the management company 
was determined to be providing taxable transportation to the 
owner and was required to collect the appropriate federal 
excise tax from the aircraft owner and remit it to the IRS. The 
Chief Counsel Advice resulted in increased audit activity by 
the IRS on aircraft management companies.
---------------------------------------------------------------------------
    \1471\ Chief Coun. Adv. 201210026, March, 2012.
---------------------------------------------------------------------------
    In May 2013, the IRS suspended assessment of the federal 
excise tax with respect to aircraft management services while 
it developed guidance on the tax treatment of aircraft 
management issues. In a 2015 opinion,\1472\ an Ohio district 
court held that the existing revenue rulings (in effect for the 
tax period April 1, 2005, through June 30, 2009, the period 
that was the subject of the litigation) regarding the 
possession, command and control test, failed to provide precise 
and not speculative notice of a collection obligation as it 
related to whole-aircraft management contracts.\1473\ As a 
result, the court ruled as a matter of law that because precise 
and not speculative notice was not received, the aircraft 
management company plaintiff did not have a collection 
obligation with respect to the Federal excise tax on payments 
received for whole-aircraft management services.
---------------------------------------------------------------------------
    \1472\ Netjets Large Aircraft Inc. v. United States, 116 A.F.T.R. 
2d. 2015-6776 (S.D. Ohio, 2015).
    \1473\ The district court held that such notice is required to 
persons having a deputy tax collection obligation under the rationale 
of the Supreme Court's holding in Central Illinois Public Service 
Company v. United States, 435 U.S. 21 (1978).
---------------------------------------------------------------------------
    In 2017, the IRS decided not to pursue examination of the 
issue of whether amounts paid to aircraft companies by the 
owners or lessors of the aircraft are taxable until further 
guidance is made available. According to the IRS, for any exam 
in suspense the aircraft management fee issue was conceded and 
the taxpayers were notified accordingly.\1474\ The IRS has not 
issued further guidance on this issue.
---------------------------------------------------------------------------
    \1474\ See also, Kerry Lynch, IRS To Shelve Pending Audits on 
Aircraft Management Fees, AINonline (July 17, 2017) http://
www.ainonline.com/aviation-news/business-aviation/2017-07-17/irs-
shelve-pending-audits-aircraft-management-fees.
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision exempts certain payments related to the 
management of private aircraft from the excise taxes imposed on 
taxable transportation by air. Exempt payments are those 
amounts paid by an aircraft owner for management services 
related to maintenance and support of the owner's aircraft or 
flights on the owner's aircraft. Applicable services include 
support activities related to the aircraft itself, such as its 
storage, maintenance, and fueling, and those related to its 
operation, such as the hiring and training of pilots and crew, 
as well as administrative services such as scheduling, flight 
planning, weather forecasting, obtaining insurance, and 
establishing and complying with safety standards. Aircraft 
management services also include such other services as are 
necessary to support flights operated by an aircraft owner.
    Payments for flight services are exempt only to the extent 
that they are attributable to flights on an aircraft owner's 
own aircraft.\1475\ Thus, if an aircraft owner makes a payment 
to a management company for the provision of a pilot and the 
pilot provides his services on the aircraft owner's aircraft, 
such payment is not subject to Federal excise tax. However, if 
the pilot provides his services to the aircraft owner on an 
aircraft other than the aircraft owner's (for instance, on an 
aircraft that is part of a fleet of aircraft available for 
third-party charter services), then such payment is subject to 
Federal excise tax.
---------------------------------------------------------------------------
    \1475\ Examples of arrangements that cannot qualify a person as an 
``aircraft owner'' include ownership of stock in a commercial airline 
and participation in a fractional ownership aircraft program. Ownership 
of stock in a commercial airline cannot qualify an individual as an 
``aircraft owner'' of a commercial airline's aircraft, and amounts paid 
for transportation on such flights remain subject to the tax under 
section 4261. Similarly, participation in a fractional ownership 
aircraft program does not constitute ``aircraft ownership'' for 
purposes of this standard. Amounts paid to a fractional ownership 
aircraft program for transportation under such a program are exempt 
from the ticket tax under section 4261(j) if the aircraft is operating 
under subpart K of part 91 of title 14 of the Code of Federal 
Regulations (``subpart K''), and flights under such program are subject 
to both the fuel tax levied on non-commercial aviation an additional 
fuel surtax under section 4043 of the Code. A business arrangement 
seeking to circumvent that surtax by operating outside of subpart K, 
allowing an aircraft owner the right to use any of a fleet of aircraft, 
be it through an aircraft interchange agreement, through holding 
nominal shares in a fleet of aircraft, or any other arrangement that 
does not reflect true tax ownership of the aircraft being flown upon, 
is not considered ownership for purposes of the provision.
---------------------------------------------------------------------------
    The provision provides a pro rata allocation rule in the 
event that a monthly payment made to a management company is 
allocated in part to exempt services and flights on the 
aircraft owner's aircraft, and in part to flights on aircraft 
other than the aircraft owner's. In such a circumstance, 
Federal excise tax must be collected on that portion of the 
payment attributable to flights on aircraft not owned by the 
aircraft owner.
    Under the provision, a lessee of an aircraft is considered 
an aircraft owner provided that the lease is not a 
``disqualified lease.'' A disqualified lease is any lease of an 
aircraft from a management company (or a related party) for a 
term of 31 days or less.

                             Effective Date

    The provision is effective for amounts paid after the date 
of enactment.

 C. Opportunity Zones (sec. 13823 of the Act and new secs. 1400Z-1 and 
                          1400Z-2 of the Code)


                               Prior Law

    Congress has occasionally provided incentives aimed at 
encouraging economic growth and investment in distressed 
communities by providing Federal tax benefits to businesses 
located within designated boundaries.\1476\
---------------------------------------------------------------------------
    \1476\ Such designated areas were referred to as empowerment zones, 
the District of Columbia Enterprise (``DC'') Zone, and the Gulf 
Opportunity (``GO'') Zone, and each of these designations and attendant 
tax incentives have expired. The designations and tax incentives for 
the DC Zone and the GO Zone generally expired after December 31, 2011. 
See secs. 1400(f), 1400N(h), 1400N(c)(5), 1400N(a)(2)(D), 
1400N(a)(7)(C), and 1400N(d). The empowerment zones program and 
attendant tax incentives were extended in the Bipartisan Budget Act of 
2018 through December 31, 2017. Secs. 1391(d)(1). Pub. L. No. 115-123, 
sec. 40311. Additional areas that were designated as renewal 
communities under section 1400E received tax benefits that expired as 
of December 31, 2009, except that a zero-percent capital gains rate 
applies with respect to gain from the sale through December 31, 2014, 
of a qualified community asset acquired after December 31, 2001, and 
before January 1, 2010, and held for more than five years. For more 
information on these programs and attendant tax incentives, see Joint 
Committee on Taxation, Incentives for Distressed Communities: 
Empowerment Zones and Renewal Communities (JCX-38-09), October 5, 2009.
---------------------------------------------------------------------------
    One of these incentives is a Federal income tax credit, the 
new markets tax credit, which totals 39 percent of a taxpayer 
investment in a qualified community development entity 
(``CDE'').\1477\ In general, the credit is allowed to a 
taxpayer who makes a qualified equity investment in a CDE which 
further invests in a qualified active low-income community 
business. CDEs are required to make investments in low-income 
communities (generally communities with poverty rates that 
equal or exceed 20 percent or whose median family income is 
less than 80 percent of the statewide median income). The 
credit is allowed over seven years, five percent in each of the 
first three years and six percent in each of the next four 
years. 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 (1) ceases to be a qualified CDE, 
(2) the proceeds of the investment cease to be used as 
required, or (3) the equity investment is redeemed. The 
Department of Treasury's Community Development Financial 
Institutions Fund (``CDFI'') allocates the new markets tax 
credits.
---------------------------------------------------------------------------
    \1477\ Sec. 45D.
---------------------------------------------------------------------------
    The maximum annual amount of qualified equity investments 
is $3.5 billion for calendar years 2010 through 2019. Any 
amount of unused allocation may be carried forward for five 
calendar years. The new markets tax credit expires on December 
31, 2019. No amount of unused allocation limitation may be 
carried to any calendar year after 2024.

                        Explanation of Provision


In general

    The provision allows taxpayers to make an election when 
investing in a qualified opportunity fund. The election results 
in the following three tax benefits: (1) the temporary deferral 
of inclusion in gross income of capital gains,\1478\ (2) the 
partial exclusion of such capital gains from gross income to 
the extent invested in the qualified opportunity fund for a 
certain length of time, and (3) the permanent exclusion of 
post-acquisition capital gains from the sale or exchange of an 
interest in a qualified opportunity fund held for at least 10 
years.
---------------------------------------------------------------------------
    \1478\ A technical correction may be needed to reflect this intent.
---------------------------------------------------------------------------
    The provision allows for the designation of certain low-
income community population census tracts as qualified 
opportunity zones.\1479\ In addition, a limited number of other 
census tracts that are not low-income communities can be 
designated if they are contiguous to a designated low-income 
community and the median family income of such tracts does not 
exceed 125 percent of the median family income of the 
contiguous low-income community. The designation of a 
population census tract as a qualified opportunity zone remains 
in effect for the period beginning on the date of the 
designation and ending at the close of the tenth calendar year 
beginning on or after the date of designation.
---------------------------------------------------------------------------
    \1479\ See sec. 45D(e) for the definition of low-income community.
---------------------------------------------------------------------------
    The chief executive officer of the State, possession, or 
the District of Colombia (i.e., Governor or mayor in the case 
of the District of Columbia) may submit nominations for a 
limited number of opportunity zones to the Secretary for 
certification and designation. If the number of low-income 
communities in a State is less than 100, the Governor may 
designate up to 25 tracts, otherwise the Governor may designate 
tracts not exceeding 25 percent of the number of low-income 
communities in the State.\1480\
---------------------------------------------------------------------------
    \1480\ In subsequently enacted legislation, Congress passed a 
special rule for Puerto Rico such that each population census tract in 
Puerto Rico that is a low-income community is deemed certified and 
designated as a qualified opportunity zone, effective on the date of 
enactment of Pub. L. No. 115-97 (December 22, 2017). Sec. 41115 of the 
Bipartisan Budget Act of 2018, Pub. L. No. 115-123, February 9, 2018.
---------------------------------------------------------------------------

Qualified opportunity funds

    A qualified opportunity fund is an investment vehicle 
organized as a corporation or a partnership for the purpose of 
investing in qualified opportunity zone property (other than 
another qualified opportunity fund) that holds at least 90 
percent of its assets in qualified opportunity zone property. 
The provision intends that the certification process for a 
qualified opportunity fund will be carried out in a manner 
similar to the process for allocating the new markets tax 
credit. The Secretary is granted the authority to administer 
this process.
    If a qualified opportunity fund fails to meet the 90 
percent requirement, unless the fund establishes reasonable 
cause, the fund is required to pay a monthly penalty of the 
excess of the amount equal to 90 percent of its aggregate 
assets, over the aggregate amount of qualified opportunity zone 
property held by the fund multiplied by the underpayment rate 
in the Code.\1481\ If the fund is a partnership, the penalty is 
taken into account proportionately as part of each partner's 
distributive share.
---------------------------------------------------------------------------
    \1481\ Sec. 6621.
---------------------------------------------------------------------------

Qualified opportunity zone property

    Qualified opportunity zone property means: (1) qualified 
opportunity zone stock, (2) qualified opportunity zone 
partnership interest, and (3) qualified opportunity zone 
business property.
    Qualified opportunity zone stock consists of stock in a 
domestic corporation that is a qualified opportunity zone 
business. There are three requirements that must be met for 
property to be considered qualified opportunity zone 
stock.\1482\ First, the stock must be acquired at original 
issuance (directly or indirectly through an underwriter) solely 
for cash after December 31, 2017. Second, the corporation must 
have been a qualified opportunity zone business when the stock 
was issued (or, for a new corporation, was being organized to 
be a qualified opportunity zone business). Third, the 
corporation must qualify as a qualified opportunity zone 
business during substantially all of the qualified opportunity 
fund's holding period for the stock.
---------------------------------------------------------------------------
    \1482\ Sec. 1400Z-2(d)(2)(B).
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    Qualified opportunity zone partnership interest consists of 
capital or profits interests in a domestic partnership that is 
a qualified opportunity zone business. There are three 
requirements that must be met for property to be considered a 
qualified opportunity zone partnership interest.\1483\ First, 
the interest must be acquired from the partnership solely for 
cash after December 31, 2017. Second, the partnership must have 
been a qualified opportunity zone business when the interest 
was acquired (or, for a new partnership, was being organized to 
be a qualified opportunity zone business). Third, the 
partnership must qualify as a qualified opportunity zone 
business during substantially all of the qualified opportunity 
fund's holding period for the interest.
---------------------------------------------------------------------------
    \1483\ Sec. 1400Z-2(d)(2)(C).
---------------------------------------------------------------------------
    Qualified opportunity zone business property consists of 
tangible property used in the trade or business of a qualified 
opportunity fund or qualified opportunity zone business. There 
are three main requirements that must be met for property to be 
considered qualified opportunity zone business property.\1484\ 
First, the property must be acquired by purchase \1485\ after 
December 31, 2017. Second, the original use of the property in 
the qualified opportunity zone must begin with the qualified 
opportunity fund or qualified opportunity zone business, or the 
qualified opportunity fund or qualified opportunity zone 
business must substantially improve the property. Only new or 
substantially improved property qualifies as opportunity zone 
business property.\1486\ Third, substantially all of the 
property must be in a qualified opportunity zone during 
substantially all of qualified opportunity fund or qualified 
opportunity zone business's holding period for the property. 
Property is treated as substantially improved only if capital 
expenditures on the property in the 30 months after acquisition 
exceeds the property's adjusted basis on the date of 
acquisition.
---------------------------------------------------------------------------
    \1484\ Sec. 1400Z-2(d)(2)(D).
    \1485\ Certain related party purchases are excluded. See secs. 
1400Z-2(d)(2)(D)(i)(I), 1400Z-2(d)(2)(D)(iii), and 1400Z-2(e)(2).
    \1486\ A technical correction may be necessary to reflect this 
intent.
---------------------------------------------------------------------------
    A qualified opportunity zone business is any trade or 
business in which substantially all of the underlying value of 
the tangible property owned or leased by the business is 
qualified opportunity zone business property.
    In addition, (1) at least 50 percent of the total gross 
income of the trade or business must be derived from the active 
conduct of business in the qualified opportunity zone, (2) a 
substantial portion of the business's intangible property must 
be used in the active conduct of business in the qualified 
opportunity zone, and (3) less than 5 percent of the average of 
the aggregate adjusted bases of the property of the business is 
attributable to nonqualified financial property.\1487\ 
Nonqualified financial property means debt, stock, partnership 
interests, annuities, and derivative financial instruments 
(including options, futures, forward contracts, and notional 
principal contracts), other than (1) reasonable amounts of 
working capital held in cash, cash equivalents, or debt 
instruments with a term of no more than 18 months, and (2) 
accounts or notes receivable acquired in the ordinary course of 
a trade or business for services rendered or from the sale of 
inventory property.\1488\ Seventh, the business cannot be a 
golf course, country club, massage parlor, hot tub or suntan 
facility, racetrack or other facility used for gambling, or 
store whose principal business is the sale of alcoholic 
beverages for consumption off premises.\1489\
---------------------------------------------------------------------------
    \1487\ Sec. 1400Z-2(d)(3)(A)(ii).
    \1488\ Secs. 1400Z-2(d)(3)(A)(ii), 1397C(b)(8), and 1397C(e).
    \1489\ Secs. 1400Z-2(d)(3)(A)(iii) and 144(c)(6)(B).
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    Tangible property that ceases to be a qualified opportunity 
zone business property continues to be treated as a qualified 
opportunity zone business property for the lesser of five years 
after the date on which such tangible property ceases to be so 
qualified, or the date on which such tangible property is no 
longer held by the qualified opportunity zone business.\1490\
---------------------------------------------------------------------------
    \1490\ Sec. 1400Z-2(d)(3)(B).
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Tax treatment of a deferred-gain investment

    A taxpayer may elect to temporarily defer and partially 
exclude capital gains from gross income to the extent that the 
taxpayer invests the amount of those gains in a qualified 
opportunity fund. The maximum amount of the deferred gain is 
equal to the amount invested in a qualified opportunity fund by 
the taxpayer during the 180-day period beginning on the date of 
the asset sale that produced the gain to be deferred. Capital 
gains in excess of the deferred amount must be recognized and 
included in gross income.
    In the case of any investment in a qualified opportunity 
fund, only a portion of which consists of the investment of 
gain with respect to which an election is made, such investment 
is treated as two separate investments, consisting of one 
investment that includes only amounts to which the election 
applies (herein ``deferred-gain investment''), and a separate 
investment consisting of other amounts. The temporary deferral 
and permanent exclusion provisions do not apply to the separate 
investment. For example, if a taxpayer sells stock at a gain 
and invests the entire sales proceeds (capital and return of 
basis) in a qualified opportunity zone fund, an election may be 
made only with respect to the capital gain amount. No election 
may be made with respect to amounts attributable to a return of 
basis, and no special tax benefits apply to such amounts.
    The basis of a deferred-gain investment in a qualified 
opportunity zone fund immediately after its acquisition is 
zero. If the deferred-gain investment in the qualified 
opportunity zone fund is held by the taxpayer for at least five 
years, the basis in the deferred-gain investment is increased 
by 10 percent of the original deferred gain. If the opportunity 
zone asset or investment is held by the taxpayer for at least 
seven years, the basis in the deferred gain investment is 
increased by an additional five percent of the original 
deferred gain. Some or all of the deferred gain is recognized 
on the earlier of the date on which the qualified opportunity 
zone investment is disposed of or December 31, 2026. The amount 
of gain recognized is the excess of the lesser of the amount 
deferred and the current fair market value of the investment 
(taking into account any increases at the end of five or seven 
years). The taxpayer's basis in the investment is increased by 
the amount of gain recognized. No election under the provision 
may be made after December 31, 2026.

Exclusion of capital gains from the sale or exchange of an investment 
        in a qualified opportunity fund

    The provision excludes from gross income the post-
acquisition capital gains on deferred-gain investments in 
opportunity zone funds that are held for at least 10 years. 
Specifically, in the case of the sale or exchange of an 
investment in a qualified opportunity zone fund held for more 
than 10 years, a further election is allowed by the taxpayer to 
modify the basis of such deferred-gain investment in the hands 
of the taxpayer to be the fair market value of the deferred-
gain investment at the date of such sale or exchange.
    In the case of a fund organized as a pass-through entity, 
investors recognize gains and losses associated with both 
deferred-gain and non-deferred gain investments in the fund, 
under the rules generally applicable to pass-through entities. 
Thus, for example, investor-partners in a fund organized as a 
partnership would recognize income and increase their basis 
with respect to their distributive share of the fund's taxable 
income.

    The Treasury Department has proposed guidance addressing 
this provision.\1491\
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    \1491\ Notice 2018-48, 2018-28 I.R.B. 9, (July 9, 2018), and Prop. 
Treas. Reg. sec. 1.1400Z-2.
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Example

    Assume a taxpayer sells stock for a gain of $1,000 on 
January 1, 2019, and invests $1,000 in the stock of a qualified 
opportunity fund. Assume also that the taxpayer holds the 
investment for 10 years and then sells the investment for 
$1,500.
    The taxpayer's initial basis in the deferred-gain 
investment is zero. After five years, the basis is increased to 
$100. After seven years, the basis is increased to $150. At the 
end of 2026, assume that the fair market value of the deferred-
gain investment is at least $1,000, and thus the taxpayer has 
to recognize $850 of the deferred capital gain. So at that 
point the basis in the deferred-gain investment is $1,000 ($150 
+ $850). If the taxpayer holds the deferred-gain investment for 
10 years and makes the election to increase the basis, the $500 
post-acquisition capital gain on the sale is excluded.

                             Effective Date

    The provision is effective on the date of enactment (i.e., 
on December 22, 2017).
                SUBTITLE D--INTERNATIONAL TAX PROVISIONS


                               PRIOR LAW

    The following discussion provides an overview of general 
principles of taxation of cross-border activity as well as a 
detailed explanation of provisions in prior law that are 
relevant to the provisions in the Act.

      A. General Overview of International Principles of Taxation

    International law generally recognizes the right of each 
sovereign nation to prescribe rules to regulate conduct and 
persons (whether natural or juridical) with a sufficient nexus 
to the sovereign nation. The nexus may be based on nationality, 
i.e., a nexus based on a connection between the relevant person 
and the sovereign nation, or may be territorial, i.e., a nexus 
based on a connection between the relevant conduct and the 
sovereign nation.\1492\ Nonetheless, most legal systems respect 
limits on the extent to which their laws may be given 
extraterritorial effect. The broad acceptance of such norms 
extends to authority to regulate cross-border trade and 
economic dealings, including taxation.
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    \1492\ See American Law Institute, Restatement (Third) of Foreign 
Relations Law of the United States, secs. 402 and 403 (1987).
---------------------------------------------------------------------------
    The exercise of sovereign jurisdiction to tax is usually 
based on either the nationality of the person taxed or the 
jurisdiction in which the taxed conduct occurs. These concepts 
have been refined and adapted to form the principles for 
determining whether sufficient nexus with a jurisdiction exists 
to conclude that the jurisdiction may enforce its right to tax. 
The elements of nexus and the nomenclature of the principles 
may differ based on whether the tax is a direct tax or an 
indirect tax. A direct tax is imposed directly on a person 
(known as a capitation tax), property, or income from property, 
the burden of which the taxpayer bears and generally cannot 
shift to another. In contrast, indirect taxes are taxes on 
consumption or the production of goods or services, such as 
sales or use taxes, value-added taxes, or customs duties.\1493\ 
Taxpayers may be able to shift the burden of indirect taxes to 
others (e.g., by raising prices).
---------------------------------------------------------------------------
    \1493\ Maria S. Cox, Fritz Neumark, et al., ``Taxation,'' 
Encyclopedia Britannica, https://www.britannica.com/topic/taxation/
Classes-of-taxes. Whether a tax is considered a direct tax or indirect 
tax has varied over time, and no single definition is used. For a 
review of the significance of these terms in Federal tax history, see 
Alan O. Dixler, ``Direct Taxes Under the Constitution: A Review of the 
Precedents,'' Tax History Project, Tax Analysts, available at http://
www.taxhistory.org/thp/readings.nsf/ArtWeb/
2B34C7FBDA41D9DA8525730800067017?OpenDocument.
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    Although governments since ancient times have imposed 
direct taxes on property and indirect taxes and duties on 
specific transactions, the history of direct taxes in the form 
of income taxes is relatively recent.\1494\ When determining 
how to allocate the right to tax a particular item of income, 
most jurisdictions consider principles based on either the 
source of the income or the residence of the person earning the 
income. By contrast, when determining how to allocate the right 
to collect indirect taxes, most jurisdictions consider either 
the origin or the destination of the item being taxed. The 
balance of this Part A describes the source, residence, origin, 
and destination principles in more detail and how jurisdictions 
resolve overlapping claims of jurisdiction.
---------------------------------------------------------------------------
    \1494\ The earliest western income tax system is traceable to the 
British Tax Act of 1798, enacted in 1799 to raise funds needed to 
prosecute the Napoleonic Wars, and rescinded in 1816. See A.M. 
Bardopoulos, eCommerce and the Effects of Technology on Taxation, Law, 
Governance and Technology Series 22, DOI 10.1007/978-3-319-15449-7--2, 
(Springer 2015), at Section 2.2. ``History of Tax,'' pp. 23-24; see 
also http://www.parliament.uk/about/living-heritage/
transformingsociety/private-lives/taxation/overview/incometax/.
---------------------------------------------------------------------------

1. Source and residence principles

    Direct taxes based on a person's citizenship, nationality, 
or residence are residence-based taxes. Such taxes may reach 
the worldwide activities of such person, and, for that reason, 
are the broadest assertion of taxing authority. For 
individuals, the test for residence may depend on citizenship, 
nationality, a physical presence test, or some combination. For 
all other persons, determining residency may be as simple as 
determining the person's place of organization, or may require 
more complex consideration of the person's management and 
control, or even level of activities in a jurisdiction.
    Direct taxes based on where activities occur, or where 
property is located, are source-based taxes. If a person 
conducts activities or owns property in a jurisdiction, taxing 
such activities or property may require allocation and 
apportionment of expenses attributable to the activity or 
property to ensure that only the portion of profits that have 
the required nexus with the jurisdiction are subject to tax. 
Most jurisdictions, including the United States, have rules for 
determining the source of items of income and expense in a 
broad range of categories, such as compensation for services, 
dividends, interest, royalties, and gains.

2. Origin and destination principles

    Indirect taxes based on the place where goods are produced 
or services are performed--irrespective of the residence of the 
owners of the means of production, where the goods go after 
being produced, or the residence of the recipients of the 
services--are origin-based taxes. Indirect taxes based on where 
goods or services are used or consumed are destination-based 
taxes. The most common form of indirect tax is the destination-
based value-added tax (``VAT''). Over 160 countries have 
adopted a VAT,\1495\ which is generally a tax imposed and 
collected on the value added at every stage in the production 
and distribution of a good or service. Although there are 
several ways to compute the taxable base for a VAT, the amount 
of value added can generally be thought of as the difference 
between the value of sales (outputs) and purchases (inputs) of 
a business.\1496\ The United States does not have a VAT, nor is 
there a Federal sales or use tax. However, the majority of the 
States have enacted sales or use taxes, including both origin-
based taxes and destination-based taxes.\1497\
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    \1495\ Alan Schenk, Victor Thuronyi, and Wei Cui, Value Added Tax: 
A Comparative Approach, Cambridge University Press, 2015. Consistent 
with the OECD International VAT/GST Guidelines, the term VAT refers to 
all broad-based final consumption taxes, regardless of the acronym used 
to identify any particular one. Thus, many countries that call their 
national consumption tax a GST (general sales tax) are included in the 
estimate of the number of countries with a VAT.
    \1496\ Nearly all jurisdictions use the credit-invoice method of 
calculating value added to determine VAT liability. Under the credit-
invoice method, a tax is imposed on the seller for all of its sales. 
The tax is calculated by applying the tax rate to the sales price of 
the good or service, and the amount of tax is generally disclosed on 
the sales invoice. A business credit is provided for all VAT levied on 
purchases of taxable goods and services (i.e., ``inputs'') used in the 
seller's business. The ultimate consumer (i.e., a nonbusiness 
purchaser), however, does not receive a credit with respect to his or 
her purchases. The VAT credit for inputs prevents the imposition of 
multiple layers of tax with respect to the total final purchase price 
(i.e., a ``cascading'' of the VAT). As a result, the net tax paid at a 
particular stage of production or distribution is based on the value 
added by that taxpayer at that stage of production or distribution. In 
theory, the total amount of tax paid with respect to a good or service 
from all levels of production and distribution should equal the sales 
price of the good or service to the ultimate consumer multiplied by the 
VAT rate.
    To receive an input credit with respect to any purchase, a business 
purchaser is generally required to possess an invoice from a seller 
that contains the name of the purchaser and indicates the amount of tax 
collected by the seller on the sale of the input to the purchaser. At 
the end of a reporting period, a taxpayer may calculate its tax 
liability by subtracting the cumulative amount of tax stated on its 
purchase invoices from the cumulative amount of tax stated on its sales 
invoices.
    \1497\ EY, Worldwide VAT, GST and Sales Tax Guide 2015, p. 1021, 
available at http://www.ey.com/Publication/vwLUAssets/Worldwide-VAT-
GST-and-sales-tax-guide-2015/$FILE/
Worldwide%20VAT,%20GST%20and%20Sales%20Tax%20Guide%202015.pdf.
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    With respect to cross-border transactions, the OECD has 
recommended that the destination principle be adopted for all 
indirect taxes, in part to conform to the treatment of such 
transactions for purposes of customs duties. The OECD defines 
the destination principle as ``the principle whereby, for 
consumption tax purposes, internationally traded services and 
intangibles should be taxed according to the rules of the 
jurisdiction of consumption.'' \1498\ A jurisdiction may adopt 
the convention that consumption occurs at the place of business 
or residence of the customer. Such proxies are needed to 
determine the location of consumption by persons other than 
individuals, because such persons are more able to move the 
location of use of goods, services, or intangibles in response 
to imposition of tax.
---------------------------------------------------------------------------
    \1498\ See OECD, ``Recommendation of the Council on the application 
of value added tax/goods and services tax to the international trade in 
services and intangibles as approved on September 27, 2016,'' 
[C(2016)120], appendix, page 3, reproduced in the appendix, OECD, 
International VAT/GST Guidelines, OECD Publishing, 2017.
---------------------------------------------------------------------------

3. Resolving overlapping or conflicting jurisdiction to tax

    Widely-accepted norms govern what constitutes a reasonable 
regulatory action by a sovereign state that will be respected 
by other sovereign states. General consensus on the limits of 
state jurisdiction helps to reduce conflicts from 
extraterritorial state action. In addition, jurisdictions have 
developed mechanisms to resolve common conflicts. For example, 
mechanisms to eliminate double taxation address situations in 
which the source and residency determinations of two 
jurisdictions result in duplicative assertion of taxing 
authority over the same item.
    When the same item is subject to tax under the rules of two 
or more jurisdictions, double taxation is usually mitigated by 
bilateral tax treaties or by laws permitting credit for taxes 
paid to another jurisdiction. The United States is a partner in 
numerous bilateral treaties that aim to avoid international 
double taxation and prevent tax avoidance and evasion. Another 
related objective of these treaties is the removal of barriers 
to trade, capital flows, and commercial travel that may be 
caused by overlapping tax jurisdictions and by the burdens of 
complying with the tax laws of a jurisdiction when a person's 
contacts with, and income derived from, that jurisdiction are 
minimal. The current United States Model Income Tax Convention 
(known as the U.S. model treaty), with its accompanying 
preamble, reflects the most recent comprehensive statement of 
the United States' negotiating position with respect to tax 
treaties.\1499\ Bilateral agreements are also used to permit 
limited mutual administrative assistance between 
jurisdictions.\1500\
---------------------------------------------------------------------------
    \1499\ The current U.S. model treaty is available at https://
www.treasury.gov/resource-center/tax-policy/treaties/Documents/Treaty-
US%20Model-2016.pdf; the preamble is available at https://
www.treasury.gov/resource-center/tax-policy/treaties/Documents/
Preamble-US%20Model-2016.pdf. Treasury periodically updates the U.S. 
model treaty to reflect developments in the negotiating position of the 
United States. Such changes include provisions that were successfully 
included in bilateral treaties concluded by the United States, as well 
as new proposed measures not yet included in any bilateral treaty. 
Treasury published the current U.S. model treaty on February 17, 2016.
    \1500\ Although U.S. courts extend comity to foreign judgments in 
some instances, they are not required to recognize or assist in 
enforcement of foreign judgments for collection of taxes, consistent 
with the common law ``revenue rule'' in Holman v. Johnson, 1 Cowp. 341, 
98 Eng. Rep. 1120 (K.B. 1775). American Law Institute, Restatement 
(Third) of Foreign Relations Law of the United States, sec. 483 (1987). 
The rule retains vitality in U.S. case law. See generally Pasquantino 
v. United States, 544 U.S. 349 (2005) (a conviction for criminal wire 
fraud arising from an intent to defraud Canadian tax authorities was 
found not to conflict ``with any well-established revenue rule 
principle[,]'' and thus was not in derogation of the revenue rule). To 
the extent it is abrogated, it is done so in bilateral treaties, to 
ensure reciprocity. At present, the United States has such agreements 
in force with five jurisdictions: Canada, Denmark, France, the 
Netherlands, and Sweden.
---------------------------------------------------------------------------
    In addition to entering into bilateral treaties, 
jurisdictions have worked in multilateral organizations to 
develop common principles to alleviate double taxation. Those 
principles are generally reflected in the provisions of the 
Model Tax Convention on Income and on Capital of the 
Organization for Economic Cooperation and Development (known as 
the OECD model treaty),\1501\ a precursor of which was first 
developed by a predecessor organization in 1958, which in turn 
has antecedents from work by the League of Nations in the 
1920s.\1502\ As a consensus document, the OECD model treaty is 
intended to aid countries in constructing their own bilateral 
treaties. The provisions have developed over time as practice 
with actual bilateral treaties leads to unexpected results and 
new issues are raised by parties to the treaties.\1503\
---------------------------------------------------------------------------
    \1501\ OECD (2014), Model Tax Convention on Income and on Capital: 
Condensed Version 2014, OECD Publishing, 2014, available at http://
dx.doi.org/10.1787//mtc_cond-2014-en. The multinational organization, 
dedicated to global development, was first established in 1961 by the 
United States, Canada, and 18 European countries, and has since 
expanded to 35 members.
    \1502\ See ``Report by the Experts on Double Taxation,'' League of 
Nations Document E.F.S. 73/F19 (1923), which was a report commissioned 
by the League at its second assembly; see also Lara Friedlander and 
Scott Wilkie, ``Policy Forum: The History of Tax Treaty Provisions--And 
Why It Is Important to Know About It,'' 54 Canadian Tax Journal No. 4 
(2006).
    \1503\ For example, the OECD initiated a multi-year study on base-
erosion and profit shifting in response to concerns of multiple 
members. For an overview of that project, see Joint Committee on 
Taxation, Background, Summary, and Implications of the OECD/G20 Base 
Erosion and Profit Shifting Project (JCX-139-15), November 30, 2015. 
This document can also be found on the Joint Committee on Taxation 
website at www.jct.gov.
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4. International principles as applied in the U.S. tax system

    The United States imposes residence-based taxation on U.S. 
persons, taxing them on their worldwide income, whether derived 
in the United States or abroad, with limited deferral of 
taxation of income earned by foreign corporations owned by U.S. 
shareholders, and imposes source-based taxation on U.S.-source 
income of nonresident alien individuals and other foreign 
persons. Under this system (sometimes described as the U.S. 
hybrid system), the application of the Code differs depending 
on whether income arises from outbound investment (i.e., 
investment by U.S. persons outside the United States) or 
inbound investment (i.e., investment by non-U.S. persons in the 
United States).

         B. Principles Common to Inbound and Outbound Taxation

    While the United States taxes inbound and outbound 
investment differently, certain rules are common to the 
taxation of both, including residency rules, entity 
classification rules, source determination rules, and transfer 
pricing rules.

1. Residence

    U.S. persons are subject to U.S. tax on their worldwide 
income, while foreign persons are subject to U.S. tax only on 
income that has sufficient connection with the United States. 
The Code defines U.S. person to include all U.S. citizens and 
residents as well as domestic entities such as partnerships and 
corporations.\1504\ The term ``resident'' is defined only with 
respect to individuals. Noncitizens who are lawfully admitted 
as permanent residents of the United States in accordance with 
immigration laws (colloquially referred to as green card 
holders) are U.S. residents for tax purposes. In addition, 
noncitizens who meet a substantial presence test and are not 
otherwise exempt from U.S. taxation are also taxable as U.S. 
residents.\1505\
---------------------------------------------------------------------------
    \1504\ Sec. 7701(a)(30).
    \1505\ Sec. 7701(b).
---------------------------------------------------------------------------
    Domestic corporations are subject to U.S. tax on their 
worldwide income, whereas partnerships (whether foreign or 
domestic) generally are not subject to U.S. tax at the entity 
level. Rather, partners generally are taxed based on the 
activities of the partnership. Partnerships and corporations 
are domestic if organized or created under the laws of the 
United States, any State, or the District of Columbia, unless, 
in the case of a partnership, the Secretary prescribes 
otherwise by regulation.\1506\ All other partnerships and 
corporations (i.e., those organized under the laws of foreign 
countries) are foreign.\1507\ Other jurisdictions may use 
factors such as situs or management and control to determine 
residence. As a result, legal entities may have more than one 
tax residence, or, in some cases, no residence. In such cases, 
bilateral treaties may resolve conflicting claims of residence.
---------------------------------------------------------------------------
    \1506\ Sec. 7701(a)(4).
    \1507\ Sec. 7701(a)(5) and (9). Entities organized in a possession 
or territory of the United States are not considered to have been 
organized under the laws of the United States.
---------------------------------------------------------------------------
    In certain cases, a foreign corporation that acquires a 
domestic corporation or partnership may be treated as a 
domestic corporation for Federal tax purposes.\1508\ That 
result generally applies following a transaction in which, 
pursuant to a plan or a series of related transactions: (1) a 
domestic corporation becomes a subsidiary of a foreign-
incorporated entity or otherwise transfers substantially all of 
its properties to such an entity; (2) the former shareholders 
of the domestic corporation hold (by reason of the stock they 
had held in the domestic corporation) at least 80 percent (by 
vote or value) of the stock of the foreign-incorporated entity 
after the transaction (often referred to as ``stock held by 
reason of''); and (3) the foreign-incorporated entity, 
considered together with all companies connected to it by a 
chain of greater than 50-percent ownership (the ``expanded 
affiliated group''), does not have substantial business 
activities in the entity's country of organization, compared to 
the total worldwide business activities of the expanded 
affiliated group. If the above requirements are satisfied 
except that the ``stock held by reason of'' the acquisition is 
less than 80 percent but at least 60 percent of the stock of 
the foreign corporation, the foreign corporation is not treated 
as a domestic corporation but certain ``inversion gain'' of the 
acquired entity must be recognized and other consequences may 
apply to post-acquisition restructuring.\1509\
---------------------------------------------------------------------------
    \1508\ Sec. 7874. The Treasury Department and the IRS have 
promulgated detailed guidance, through both regulations and several 
notices, addressing these requirements under section 7874 since the 
section was enacted in 2004, and have sought to expand the reach of the 
section or reduce the tax benefits of inversion transactions.
    \1509\ In addition, an excise tax may be imposed on certain stock 
compensation of executives of companies that undertake inversion 
transactions. Sec. 4985.
---------------------------------------------------------------------------

2. Entity classification

    Certain entities other than ``per se corporations'' are 
eligible to elect their classification for Federal tax purposes 
under the ``check-the-box'' regulations,\1510\ which affects 
the determination of the source of the income, availability of 
tax credits, and other tax attributes. Both foreign and 
domestic entities may make the election. As a result, an entity 
that operates in the United States and at least one other 
jurisdiction may be treated as a hybrid entity (i.e., treated 
as a partnership or disregarded entity for U.S. tax purposes 
but as a corporation for foreign tax purposes) or a reverse 
hybrid entity (i.e., treated as a corporation for U.S. tax 
purposes but as a partnership or disregarded entity for foreign 
tax purposes).
---------------------------------------------------------------------------
    \1510\ Treas. Reg. sec. 301.7701-1, et seq.
---------------------------------------------------------------------------

3. Source of income rules

    Various factors determine the source of income for U.S. tax 
purposes, including the status or nationality of the payor or 
recipient, and the location of the activities or assets that 
generate the income.
            Interest
    Interest is from U.S. sources if paid by the United States 
or any agency or instrumentality thereof, a State or any 
political subdivision thereof, or the District of Columbia. 
Interest is also from U.S. sources if paid by a U.S. resident 
individual, a domestic corporation, or a partnership engaged in 
a trade or business in the United States.\1511\ Interest paid 
by the U.S. branch of a foreign corporation also is from U.S. 
sources.\1512\
---------------------------------------------------------------------------
    \1511\ Sec. 861(a)(1); Treas. Reg. sec. 1.861-2(a)(1). Certain 
exceptions apply. For example, interest paid on deposits with foreign 
branches of domestic corporations or domestic partnerships engaged in 
commercial banking is foreign source, as is interest paid by foreign 
branches of certain domestic financial institutions.
    \1512\ Sec. 884(f)(1).
---------------------------------------------------------------------------
            Dividends
    Dividend income is generally sourced by reference to the 
payor's place of incorporation.\1513\ Thus, dividends paid by a 
domestic corporation generally are U.S.-source income. 
Similarly, dividends paid by a foreign corporation generally 
are foreign-source income. Under a special rule, dividends from 
a foreign corporation engaged in a trade or business in the 
United States may be treated as partly U.S.-source and partly 
foreign-source.\1514\
---------------------------------------------------------------------------
    \1513\ Secs. 861(a)(2) and 862(a)(2).
    \1514\ Sec. 861(a)(2)(B).
---------------------------------------------------------------------------
            Rents and royalties
    Rental and royalty income is sourced by reference to the 
location or place of use of the property.\1515\ Rental income 
from property located in the United States (or from any 
interest in such property) is from U.S. sources. Royalty income 
includes amounts paid for the use of or for the privilege of 
using patents, copyrights, secret processes and formulas, good 
will, trademarks, trade brands, franchises, and other like 
property.
---------------------------------------------------------------------------
    \1515\ Sec. 861(a)(4).
---------------------------------------------------------------------------
            Income from sales of personal property
    Subject to exceptions, income from the sale of personal 
property is sourced according to the residence of the 
seller.\1516\
---------------------------------------------------------------------------
    \1516\ Sec. 865(a).
---------------------------------------------------------------------------
    Several exceptions to that general rule apply. For example, 
income from the sale of inventory property is generally sourced 
to the place of sale, which is determined by where title to the 
property passes.\1517\ If the sale is by a nonresident and is 
attributable to an office or other fixed place of business in 
the United States, however, the gain is income from U.S. 
sources without regard to the place of sale, unless it is sold 
for use, disposition, or consumption outside the United States 
and a foreign office materially participates in the sale.\1518\ 
Income from the sale of inventory property that a taxpayer 
produces (in whole or in part) in the United States and sells 
outside the United States, or that a taxpayer produces (in 
whole or in part) outside the United States and sells in the 
United States, is partly U.S.-source and partly foreign-
source.\1519\
---------------------------------------------------------------------------
    \1517\ Secs. 865(b), 861(a)(6), 862(a)(6); Treas. Reg. sec. 1.861-
7(c).
    \1518\ Sec. 865(e)(2).
    \1519\ Sec. 863(b). While sections 863(b) and 865(e)(2) may appear 
to conflict when a nonresident produces outside the United States and 
then sells through a U.S. office for use, disposition, or consumption 
in the United States, in such cases the income generally is partly 
U.S.-source and partly foreign-source.
---------------------------------------------------------------------------
    Gain on the sale of depreciable property is divided between 
U.S.-source and foreign-source in the same ratio that the 
depreciation was previously deductible for U.S. tax 
purposes.\1520\ Payments received on sales of intangible 
property are sourced in the same manner as royalties to the 
extent the payments are contingent on the productivity, use, or 
disposition of the intangible property.\1521\
---------------------------------------------------------------------------
    \1520\ Sec. 865(c).
    \1521\ Sec. 865(d).
---------------------------------------------------------------------------
            Personal services income
    Compensation for labor or personal services is generally 
sourced to the place of performance. Thus, compensation for 
labor or personal services performed in the United States 
generally is U.S.-source income, subject to an exception for 
amounts that meet certain de minimis criteria.\1522\
---------------------------------------------------------------------------
    \1522\ Sec. 861(a)(3).
---------------------------------------------------------------------------
            Insurance income
    Underwriting income from issuing insurance or annuity 
contracts generally is U.S.-source income if the contract 
involves property in, liability arising out of an activity in, 
or the lives or health of residents of, the United 
States.\1523\
---------------------------------------------------------------------------
    \1523\ Sec. 861(a)(7).
---------------------------------------------------------------------------
            Transportation income
    Transportation income is any income derived from, or in 
connection with, the use (or hiring or leasing for use) of a 
vessel or aircraft (or a container used in connection 
therewith) or the performance of services directly related to 
such use.\1524\ That definition does not encompass land 
transport except to the extent directly related to shipping by 
vessel or aircraft, but regulations provide an analogous rule 
for determining the source of income from transportation 
services other than shipping or aviation. In general, income 
from furnishing transportation that both begins and ends in the 
United States is U.S.-source income, and 50 percent of income 
attributable to transportation that either begins or ends in 
the United States is U.S.-source income.
---------------------------------------------------------------------------
    \1524\ Sec. 863(c)(3).
---------------------------------------------------------------------------
    An exemption from U.S. tax is provided for transportation 
income of foreign persons from countries that extend reciprocal 
relief to U.S. persons. A nonresident alien individual with 
income from the international operation of a ship may qualify, 
provided that the foreign country in which such individual is 
resident grants an equivalent exemption to individual residents 
of the United States.\1525\ A similar exemption from U.S. tax 
is provided for gross income derived by a foreign corporation 
from the international operation of a ship or aircraft, 
provided that the foreign country in which the corporation is 
organized grants an equivalent exemption to corporations 
organized in the United States.\1526\
---------------------------------------------------------------------------
    \1525\ Sec. 872(b)(1).
    \1526\ Sec. 883(a)(1) and (2).
---------------------------------------------------------------------------
            Income from space or ocean activities or international 
                    communications
    For U.S. persons, all income from space or ocean activity 
and 50 percent of income from international communications is 
U.S.-source income. For foreign persons, generally no income 
from a space or ocean activity or from international 
communications is U.S.-source income.\1527\ International 
communications income attributable to an office or other fixed 
place of business in the United States, however, is U.S.-source 
income.\1528\
---------------------------------------------------------------------------
    \1527\ Sec. 863(d).
    \1528\ Sec. 863(e).
---------------------------------------------------------------------------
            Amounts received with respect to guarantees of indebtedness
    Amounts received, directly or indirectly, from a 
noncorporate resident or from a domestic corporation for the 
provision of a guarantee of indebtedness of such person are 
income from U.S. sources.\1529\ In addition, amounts received, 
directly or indirectly, from a foreign person, for the 
provision of a guarantee of indebtedness of that foreign person 
are income from U.S. sources if the amounts received are 
connected with income that is effectively connected with the 
conduct of a trade or business in the United States.
---------------------------------------------------------------------------
    \1529\ Sec. 861(a)(9).
---------------------------------------------------------------------------

4. Intercompany transfers

            Transfer pricing
    A basic U.S. tax principle applicable in dividing profits 
from a transaction between related taxpayers is that the amount 
of profit allocated to each related taxpayer must be measured 
by reference to the amount of profit that a similarly situated 
taxpayer would realize in a similar transaction with unrelated 
parties bargaining at arm's length (the ``arm's-length 
standard''). The transfer pricing rules of section 482 and the 
accompanying Treasury regulations are intended to prevent 
erosion of the U.S. tax base by taxpayers that improperly shift 
income attributable to the United States to a related foreign 
company.\1530\ Similarly, the domestic laws of most U.S. 
trading partners include rules to limit income shifting through 
transfer pricing. The arm's-length standard is difficult to 
administer in situations in which no sufficiently comparable 
transaction can be found to use to evaluate the appropriateness 
of pricing in a transaction between related parties. When a 
foreign person with U.S. activities has transactions with 
related U.S. taxpayers, the amount of income attributable to 
U.S. activities is determined in part by the same transfer 
pricing rules of section 482 that apply when U.S. persons with 
foreign activities transact with related foreign taxpayers.
---------------------------------------------------------------------------
    \1530\ For a detailed description of the U.S. transfer pricing 
rules, see Joint Committee on Taxation, Present Law and Background 
Related to Possible Income Shifting and Transfer Pricing (JCX-37-10), 
July 20, 2010, pp. 18-50.
---------------------------------------------------------------------------
    Section 482 authorizes the Secretary to allocate income, 
deductions, credits, or allowances among related business 
entities \1531\ when necessary to clearly reflect income or 
otherwise prevent tax avoidance. Comprehensive Treasury 
regulations under that section generally adopt the arm's-length 
standard as the method for determining whether a particular 
allocation is appropriate.\1532\ The regulations generally 
attempt to identify the income of each related party to a 
transaction that would have resulted had the parties been 
dealing at arm's length. For income from intangible property, 
section 482 provides, ``in the case of any transfer (or 
license) of intangible property (within the meaning of section 
936(h)(3)(B)), the income with respect to such transfer or 
license shall be commensurate with the income attributable to 
the intangible.'' By requiring inclusion of amounts 
commensurate with the income attributable to the intangible, 
Congress was responding to concerns regarding the effectiveness 
of the arm's-length standard with respect to intangible 
property--including, in particular, high-profit-potential 
intangibles.\1533\
---------------------------------------------------------------------------
    \1531\ The term ``related'' as used herein refers to relationships 
described in section 482, which refers to ``two or more organizations, 
trades or businesses (whether or not incorporated, whether or not 
organized in the United States, and whether or not affiliated) owned or 
controlled directly or indirectly by the same interests.''
    \1532\ Section 1059A buttresses section 482 by limiting the extent 
to which costs used to determine custom valuation can also be used to 
determine basis in property imported from a related party. A taxpayer 
that imports property from a related party may not assign a value to 
the property for cost purposes that exceeds its customs value.
    \1533\ H.R. Rep. No. 99-426, p. 423.
---------------------------------------------------------------------------
            Gain recognition on outbound transfers
    If a transfer of intangible property to a foreign affiliate 
occurs in connection with certain corporate transactions, 
nonrecognition rules that may otherwise apply are suspended. 
The transferor of intangible property must recognize gain from 
the transfer as though the transferor had sold the intangible 
(regardless of the stage of development of the intangible 
property) in exchange for payments contingent on the use, 
productivity, or disposition of the transferred property in 
amounts that would have been received either annually over the 
useful life of the property or upon disposition of the property 
after the transfer.\1534\ The appropriate amounts of those 
imputed payments are determined using transfer-pricing 
principles. Final regulations issued in 2016 eliminated two 
possible interpretations of existing law that taxpayers were 
using to claim that outbound transfers of foreign goodwill and 
going concern value in nonrecognition transactions were not 
subject to taxation at all (i.e., neither immediately under 
section 367(a) nor over the useful life of the property under 
section 367(d)).\1535\ However, the Secretary subsequently 
announced \1536\ that Treasury is considering reinstating an 
exception for the outbound transfer of foreign goodwill and 
going concern value used in the active conduct of a trade or 
business in administratively simple cases with little potential 
for abuse.\1537\
---------------------------------------------------------------------------
    \1534\ Sec. 367(d).
    \1535\ See T.D. 9803, 81 F.R. 91012 (December 17, 2016). Treas. 
Reg. sec. 1.367(d)-1(b) now provides that the rules of section 367(d) 
apply to transfers of intangible property as defined under Treas. Reg. 
sec. 1.367(a)--1(d)(5) after September 14, 2015, and to any transfers 
occurring before that date resulting from entity classification 
elections filed on or after September 15, 2015.
    \1536\ U.S. Treasury Department, Second Report to the President on 
Identifying and Reducing Tax Regulatory Burdens, Executive Order 13789, 
October 2, 2017.
    \1537\ For the relevant legislative history, see H.R. Rep. No. 98-
432, 98th Cong., 2d Sess. 1318-1320 (March 5, 1984) and Conference 
Report, H.R. Rep. No. 98-861, 98th Cong. 2d Sess. 951-957 (June 23, 
1984).
---------------------------------------------------------------------------

    C. U.S. Tax Rules Applicable to Nonresident Aliens and Foreign 
                         Corporations (Inbound)

    Nonresident aliens and foreign corporations generally are 
subject to U.S. tax only on their U.S.-source income. There are 
two broad types of U.S.-source income of foreign taxpayers: 
income that is ``fixed or determinable annual or periodical 
gains, profits, and income'' (``FDAP income'') and income that 
is ``effectively connected with the conduct of a trade or 
business within the United States'' (``ECI''). FDAP income, 
although nominally subject to a statutory 30-percent gross-
basis tax withheld at its source, in many cases is exempt or 
subject to a reduced rate of tax under the Code or a bilateral 
income tax treaty. ECI generally is subject to the same U.S. 
tax rules and rates that apply to business income derived by 
U.S. persons.

1. Gross-basis taxation of U.S.-source income

    Certain income received by foreign persons from U.S. 
sources is subject to a 30-percent gross-basis tax (i.e., a tax 
on gross income without reduction for related expenses), which 
is collected by withholding at the source of the payment. FDAP 
income subject to the 30-percent tax includes interest, 
dividends, rents, salaries, wages, premiums, annuities, 
compensations, remunerations, and emoluments. The categories of 
income subject to the 30-percent tax and the categories for 
which withholding is required are generally coextensive.
    FDAP income of nonresident aliens and foreign corporations 
that is not ECI is subject to the 30-percent tax.\1538\ The 
items enumerated in defining FDAP income are illustrative, and 
the words ``annual or periodical'' are ``merely generally 
descriptive'' of the payments within the purview of the 
statute.\1539\
---------------------------------------------------------------------------
    \1538\ Secs. 871(a) and 881. FDAP income that is ECI is taxed as 
ECI.
    \1539\ Commissioner v. Wodehouse, 337 U.S. 369, 393 (1949).
---------------------------------------------------------------------------
            Exclusions from FDAP income
    FDAP income encompasses a broad range of gross income, but 
has important exceptions. Capital gains of nonresident aliens 
are generally foreign source; however, capital gains of 
nonresident aliens present in the United States for 183 days or 
more \1540\ during the year are income from U.S. sources 
subject to gross-basis taxation.\1541\ In addition, U.S-source 
gains from the sale or exchange of intangibles are subject to 
tax and withholding if they are contingent on the productivity 
of the property sold.\1542\
---------------------------------------------------------------------------
    \1540\ For purposes of this rule, whether a person is considered a 
resident in the United States is determined by application of the rules 
under section 7701(b).
    \1541\ Sec. 871(a)(2). In addition, certain capital gains from 
sales of U.S. real property interests are subject to tax as effectively 
connected income under the Foreign Investment in Real Property Tax Act 
of 1980 (``FIRPTA'').
    \1542\ Secs. 871(a)(1)(D) and 881(a)(4).
---------------------------------------------------------------------------
    Interest on bank deposits may qualify for exemption from 
treatment as FDAP income on two grounds. First, interest on 
deposits with domestic banks and savings and loan associations, 
and certain amounts held by insurance companies, is U.S.-source 
income but is exempt from the 30-percent tax when paid to a 
foreign person.\1543\ Second, interest on deposits with foreign 
branches of domestic banks and domestic savings and loan 
associations is not U.S.-source income and thus is not subject 
to U.S. tax.\1544\ Interest and original issue discount on 
certain short-term obligations also is exempt from U.S. tax 
when paid to a foreign person.\1545\ In addition, there is 
generally no information reporting required with respect to 
payments of such exempt amounts.\1546\
---------------------------------------------------------------------------
    \1543\ Secs. 871(i)(2)(A) and 881(d); Treas. Reg. sec. 1.1441-
1(b)(4)(ii).
    \1544\ Sec. 861(a)(1)(B); Treas. Reg. sec. 1.1441--1(b)(4)(iii).
    \1545\ Secs. 871(g)(1)(B) and 881(a)(3); Treas. Reg. sec. 1.1441-
1(b)(4)(iv).
    \1546\ Treas. Reg. sec. 1.1461-1(c)(2)(ii)(A) and (B). A bank must 
report interest if the recipient is a nonresident alien who resides in 
a country with which the United States has a satisfactory exchange of 
information program under a bilateral agreement and the deposit is 
maintained at an office in the United States. Treas. Reg. secs. 1.6049-
4(b)(5) and -8. The IRS publishes lists of the countries whose 
residents are subject to the reporting requirements, and those 
countries with respect to which the reported information is 
automatically exchanged. See Rev. Proc. 2017-31, supplementing Rev. 
Proc. 2014-64.
---------------------------------------------------------------------------
    Although FDAP income includes U.S.-source portfolio 
interest, such interest is specifically exempt from the 30-
percent gross-basis tax. Portfolio interest is any interest 
(including original issue discount) that is paid on an 
obligation that is in registered form and for which the 
beneficial owner has provided to the U.S. withholding agent a 
statement certifying that the beneficial owner is not a U.S. 
person.\1547\ Portfolio interest, however, does not include 
interest received by a 10-percent shareholder,\1548\ certain 
contingent interest,\1549\ interest received by a controlled 
foreign corporation from a related person,\1550\ or interest 
received by a bank on an extension of credit made pursuant to a 
loan agreement entered into in the ordinary course of its trade 
or business.\1551\
---------------------------------------------------------------------------
    \1547\ Sec. 871(h)(2).
    \1548\ Sec. 871(h)(3).
    \1549\ Sec. 871(h)(4).
    \1550\ Sec. 881(c)(3)(C).
    \1551\ Sec. 881(c)(3)(A).
---------------------------------------------------------------------------
            Withholding of 30-percent gross-basis tax
    The 30-percent tax on FDAP income is generally collected by 
means of withholding.\1552\ Withholding on FDAP payments to 
foreign payees is required unless the withholding agent,\1553\ 
i.e., the person making the payment to the foreign person, can 
establish that the beneficial owner of the amount is eligible 
for an exemption from withholding or a reduced rate of 
withholding under an income tax treaty.\1554\
---------------------------------------------------------------------------
    \1052\ Secs. 1441 and 1442.
    \1053\ A withholding agent includes any U.S. or foreign person that 
has the control, receipt, custody, disposal, or payment of an item of 
income of a foreign person subject to withholding. Treas. Reg. sec. 
1.1441-7(a).
    \1054\ Secs. 871, 881, 1441, and 1442; Treas. Reg. sec. 1.1441-
1(b).
---------------------------------------------------------------------------
    Often the income subject to withholding is the only income 
of the foreign person subject to any U.S. tax. As long as the 
foreign person has no ECI and the withholding is sufficient to 
satisfy the tax liability with respect to FDAP income, the 
foreign person generally is not required to file a U.S. Federal 
income tax return. Accordingly, the withholding of the 30-
percent gross-basis tax generally represents the collection of 
the foreign person's final tax liability.
    To the extent that a withholding agent withholds an amount, 
the withheld tax is credited to the foreign recipient of the 
income.\1555\ If the agent withholds more than is required, and 
that results in an overpayment of tax, the foreign recipient 
may file a claim for refund.
---------------------------------------------------------------------------
    \1555\ Sec. 1462.
---------------------------------------------------------------------------

2. Net-basis taxation of U.S.-source income

    The United States taxes ECI on a net basis.\1556\
---------------------------------------------------------------------------
    \1556\ Secs. 871(b) and 882.
---------------------------------------------------------------------------
            U.S. trade or business
    A foreign person is subject to U.S. tax on a net basis if 
the person is engaged in a U.S. trade or business. Partners in 
a partnership and beneficiaries of an estate or trust are 
treated as engaged in a U.S. trade or business if the 
partnership, estate, or trust is so engaged.\1557\
---------------------------------------------------------------------------
    \1557\ Sec. 875.
---------------------------------------------------------------------------
    Whether a foreign person is engaged in a U.S. trade or 
business is a factual question that has generated much case 
law. Basic issues include whether the activity rises to the 
level of a trade or business, whether a trade or business has 
sufficient connections to the United States, and whether the 
relationship between the foreign person and persons performing 
activities in the United States for the foreign person is 
sufficient to attribute those activities to the foreign person.
    The trade or business rules differ from one activity to 
another. The term ``trade or business within the United 
States'' expressly includes the performance of personal 
services within the United States.\1558\ If, however, a 
nonresident alien individual performs personal services for a 
foreign employer, and the individual's total compensation for 
the services and period in the United States are minimal 
($3,000 or less in total compensation and 90 days or fewer of 
physical presence in a year), the individual is not considered 
to be engaged in a U.S. trade or business.\1559\ Detailed rules 
govern whether trading in stock or securities or commodities 
constitutes the conduct of a U.S. trade or business.\1560\ A 
foreign person who trades in stock or securities or commodities 
in the United States through an independent agent generally is 
not treated as engaged in a U.S. trade or business if the 
foreign person does not have an office or other fixed place of 
business in the United States through which trades are carried 
out. A foreign person who trades stock or securities or 
commodities for the person's own account also generally is not 
considered to be engaged in a U.S. trade or business so long as 
the foreign person is not a dealer in stock or securities or 
commodities.
---------------------------------------------------------------------------
    \1558\ Sec. 864(b).
    \1559\ Sec. 864(b)(1).
    \1560\ Sec. 864(b)(2) and Prop. Treas. Reg. sec. 1.864(b)-1.
---------------------------------------------------------------------------
    For eligible foreign persons, U.S. bilateral income tax 
treaties restrict the application of net-basis U.S. taxation. 
Under each treaty, the United States is permitted to tax 
business profits only to the extent those profits are 
attributable to a U.S. permanent establishment of the foreign 
person. The threshold level of activities that constitute a 
permanent establishment is generally higher than the threshold 
level of activities that constitute a U.S. trade or business. 
For example, a permanent establishment typically requires the 
maintenance of a fixed place of business over a significant 
period of time.
            Effectively connected income
    A foreign person that is engaged in the conduct of a trade 
or business within the United States is subject to U.S. net-
basis taxation on the income that is ``effectively connected'' 
with the business. Specific statutory rules govern whether 
income is ECI.\1561\
---------------------------------------------------------------------------
    \1561\ Sec. 864(c).
---------------------------------------------------------------------------
    In the case of U.S.-source capital gain and U.S.-source 
income of a type that would be subject to gross-basis U.S. 
taxation, the factors taken into account in determining whether 
the income is ECI include whether the income is derived from 
assets used in or held for use in the conduct of the U.S. trade 
or business and whether the activities of the U.S. trade or 
business were a material factor in the realization of the 
amount (the ``asset use'' and ``business activities'' 
tests).\1562\ Under the asset use and business activities 
tests, due regard is given to whether such asset or such 
income, gain, or loss was accounted for through the trade or 
business. All other U.S.-source non-FDAP income is treated as 
ECI.\1563\
---------------------------------------------------------------------------
    \1562\ Sec. 864(c)(2).
    \1563\ Sec. 864(c)(3).
---------------------------------------------------------------------------
    A foreign person who is engaged in a U.S. trade or business 
may have limited categories of foreign-source income that are 
considered to be ECI.\1564\ Foreign-source income not included 
in one of those categories generally is exempt from U.S. tax.
---------------------------------------------------------------------------
    \1564\ This income is subject to net-basis U.S. taxation after 
allowance of a credit for any foreign income tax imposed on the income. 
See sec. 906.
---------------------------------------------------------------------------
    A foreign person's income from foreign sources generally is 
considered to be ECI only if the person has an office or other 
fixed place of business within the United States to which the 
income is attributable and the income is in one of the 
following categories: (1) rents or royalties for the use of 
patents, copyrights, secret processes or formulas, good will, 
trademarks, trade brands, franchises, or other like intangible 
properties derived in the active conduct of the trade or 
business; (2) interest or dividends derived in the active 
conduct of a banking, financing, or similar business within the 
United States or received by a corporation the principal 
business of which is trading in stocks or securities for its 
own account; or (3) income derived from the sale or exchange 
(outside the United States), through the U.S. office or fixed 
place of business, of inventory or property held by the foreign 
person primarily for sale to customers in the ordinary course 
of the trade or business, unless the sale or exchange is for 
use, consumption, or disposition outside the United States and 
an office or other fixed place of business of the foreign 
person in a foreign country participated materially in the sale 
or exchange.\1565\ Foreign-source dividends, interest, and 
royalties are not treated as ECI if the items are paid by a 
foreign corporation more than 50 percent (by vote) of which is 
owned directly, indirectly, or constructively by the recipient 
of the income.\1566\
---------------------------------------------------------------------------
    \1565\ Sec. 864(c)(4)(B).
    \1566\ Sec. 864(c)(4)(D)(i).
---------------------------------------------------------------------------
    In determining whether a foreign person has a U.S. office 
or other fixed place of business, the office or other fixed 
place of business of an agent generally is disregarded. The 
place of business of an agent other than an independent agent 
acting in the ordinary course of business is not disregarded, 
however, if the agent either has the authority (regularly 
exercised) to negotiate and conclude contracts in the name of 
the foreign person or has a stock of merchandise from which he 
regularly fills orders on behalf of the foreign person.\1567\ 
If a foreign person has a U.S. office or fixed place of 
business, income, gain, deduction, or loss is not considered 
attributable to the office unless the office was a material 
factor in the production of the income, gain, deduction, or 
loss and the office regularly carries on activities of the type 
from which the income, gain, deduction, or loss was 
derived.\1568\
---------------------------------------------------------------------------
    \1567\ Sec. 864(c)(5)(A).
    \1568\ Sec. 864(c)(5)(B).
---------------------------------------------------------------------------
    Special rules apply in determining the ECI of an insurance 
company. The foreign-source income of a foreign corporation 
that is subject to tax under the insurance company provisions 
of the Code is treated as ECI if the income is attributable to 
its United States business.\1569\
---------------------------------------------------------------------------
    \1569\ Sec. 864(c)(4)(C).
---------------------------------------------------------------------------
    Income, gain, deduction, or loss for a particular year 
generally is not treated as ECI if the foreign person is not 
engaged in a U.S. trade or business in that year.\1570\ If, 
however, income or gain taken into account for a taxable year 
is attributable to the sale or exchange of property, the 
performance of services, or any other transaction that occurred 
in a prior taxable year, the income or gain is ECI if the 
income or gain would have been ECI in the prior year.\1571\ If 
any property ceases to be used or held for use in connection 
with the conduct of a U.S. trade or business and the property 
is disposed of within 10 years after the cessation, the income 
or gain attributable to the disposition of the property is ECI 
if the income or gain would have been ECI had the disposition 
occurred immediately before the property ceased to be used or 
held for use in connection with the conduct of a U.S. trade or 
business.\1572\
---------------------------------------------------------------------------
    \1570\ Sec. 864(c)(1)(B).
    \1571\ Sec. 864(c)(6).
    \1572\ Sec. 864(c)(7).
---------------------------------------------------------------------------
    Transportation income from U.S. sources is treated as 
effectively connected with a foreign person's conduct of a U.S. 
trade or business only if the foreign person has a fixed place 
of business in the United States that is involved in the 
earning of such income and substantially all of such income of 
the foreign person is attributable to regularly scheduled 
transportation.\1573\ If the transportation income is 
effectively connected with conduct of a U.S. trade or business, 
the transportation income, along with transportation income 
that is from U.S. sources because the transportation both 
begins and ends in the United States, may be subject to net-
basis taxation. Income of certain foreign persons from the 
international operation of a ship or aircraft may be eligible 
for an exemption, provided that the jurisdiction in which the 
foreign person is organized provides an equivalent exemption 
for U.S. persons.\1574\
---------------------------------------------------------------------------
    \1573\ Sec. 887(b)(4).
    \1574\ See sec. 883(a)(1), (2), and (c). The most recent 
compilation of countries that the United States recognizes as providing 
exemptions lists countries in three groups: 27 countries are eligible 
for exemption on the basis of a review of the law of the foreign 
jurisdiction; 39 countries exchanged diplomatic notes with the United 
States that grant exemption to some extent; and more than 50 countries 
are parties with the United States to bilateral income tax treaties 
that include a shipping article. Rev. Rul. 2008-17, 2008-1 C.B. 626, 
modified by Ann. 2008-57, 2008-C.B. 1192, 2008.
---------------------------------------------------------------------------
            Allowance of deductions
    Taxable ECI is computed by taking into account deductions 
associated with gross ECI. Regulations address the allocation 
and apportionment of deductions between ECI and other income. 
Certain deductions may be allocated and apportioned on the 
basis of units sold, gross sales or receipts, costs of goods 
sold, profits contributed, expenses incurred, assets used, 
salaries paid, space used, time spent, or gross income 
received. Specific rules provide for the allocation and 
apportionment of research and experimental expenditures, legal 
and accounting fees, income taxes, losses on dispositions of 
property, and net operating losses. In general, interest is 
allocated and apportioned based on assets rather than income.

3. Special rules

            FIRPTA
    A foreign person's gain or loss from the disposition of a 
U.S. real property interest (``USRPI'') is treated as 
ECI.\1575\ Thus, a foreign person subject to tax on such a 
disposition is required to file a U.S. tax return. In the case 
of a foreign corporation, the gain from the disposition of a 
USRPI may also be subject to the branch profits tax at a 30-
percent rate (or lower treaty rate).
---------------------------------------------------------------------------
    \1575\ Sec. 897(a).
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    The payor of income that FIRPTA treats as ECI is generally 
required to withhold U.S. tax from the payment.\1576\ The 
foreign person can request a refund with its U.S. tax return, 
if appropriate, based on that person's overall tax liability 
for the taxable year.
---------------------------------------------------------------------------
    \1576\ Sec. 1445 and regulations thereunder.
---------------------------------------------------------------------------
            Branch profits taxes
    A domestic corporation is subject to U.S. income tax on its 
net income. The earnings of the domestic corporation may be 
subject to a second tax, this time at the shareholder level, 
when dividends are paid. When the shareholders are foreign, the 
second-level tax may be collected by withholding. Unless the 
portfolio interest exemption or another exemption applies, 
interest payments made by a domestic corporation to foreign 
creditors are likewise subject to withholding tax. To 
approximate those second-level withholding taxes imposed on 
payments made by domestic subsidiaries to their foreign 
shareholders, the United States taxes a foreign corporation 
that is engaged in a U.S. trade or business through a U.S. 
branch on amounts of U.S. earnings and profits that are shifted 
(to the head office) out of, or amounts of interest that are 
deducted by, the U.S. branch of the foreign corporation. Those 
branch taxes may be reduced or eliminated under an applicable 
income tax treaty.\1577\
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    \1577\ See Treas. Reg. secs. 1.884-1(g) and -5.
---------------------------------------------------------------------------
    Under the branch profits tax, the United States imposes a 
tax of 30 percent on a foreign corporation's ``dividend 
equivalent amount.'' \1578\ The dividend equivalent amount 
generally is the earnings and profits of a U.S. branch of a 
foreign corporation attributable to its ECI.\1579\ Limited 
categories of earnings and profits attributable to a foreign 
corporation's ECI are excluded in calculating the dividend 
equivalent amount.\1580\
---------------------------------------------------------------------------
    \1578\ Sec. 884(a).
    \1579\ Sec. 884(b).
    \1580\ See sec. 884(d)(2) (excluding, e.g., earnings and profits 
attributable to gain from the sale of domestic corporation stock that 
constitutes a USRPI subject to FIRPTA).
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    In arriving at the dividend equivalent amount, a branch's 
effectively connected earnings and profits are adjusted to 
reflect changes in a branch's U.S. net equity (i.e., the excess 
of the branch's assets over its liabilities, taking into 
account only amounts treated as connected with its U.S. trade 
or business).\1581\ The first adjustment reduces the dividend 
equivalent amount to the extent the branch's earnings are 
reinvested in trade or business assets in the United States (or 
reduce U.S. trade or business liabilities). The second 
adjustment increases the dividend equivalent amount to the 
extent prior reinvested earnings are considered remitted to the 
home office of the foreign corporation.
---------------------------------------------------------------------------
    \1581\ Sec. 884(b).
---------------------------------------------------------------------------
    Interest paid by a U.S. trade or business of a foreign 
corporation generally is treated as if paid by a domestic 
corporation and therefore generally is subject to 30-percent 
withholding tax if paid to a foreign person.\1582\ Certain 
``excess interest'' of a U.S. trade or business of a foreign 
corporation is treated as if paid by a U.S. corporation to a 
foreign parent and, therefore, also may be subject to 30-
percent withholding tax.\1583\ For this purpose, excess 
interest is the excess of the interest expense of the foreign 
corporation apportioned to the U.S. trade or business over the 
amount of interest paid by the trade or business.
---------------------------------------------------------------------------
    \1582\ Sec. 884(f)(1)(A).
    \1583\ Sec. 884(f)(1)(B).
---------------------------------------------------------------------------
            Earnings stripping
    Earnings stripping generally refers to the process whereby 
a taxpayer reduces its U.S. taxable income by making deductible 
payments to a related foreign person. Taxpayers are limited in 
their ability to engage in certain earnings stripping 
transactions that involve interest payments. If the payor's 
debt-to-equity ratio exceeds 1.5 to 1 (a debt-to-equity ratio 
of 1.5 to 1 or less is considered a ``safe harbor''), a 
deduction for disqualified interest paid or accrued by the 
payor in a taxable year is generally disallowed to the extent 
of the payor's excess interest expense.\1584\ Disqualified 
interest includes interest paid or accrued to related parties 
when no Federal income tax is imposed with respect to such 
interest,\1585\ to unrelated parties in certain cases in which 
a related party guarantees the debt, or to a REIT by a taxable 
REIT subsidiary of that REIT. Excess interest expense is the 
amount by which the payor's net interest expense (i.e., the 
excess of interest paid or accrued over interest income) 
exceeds 50 percent of its adjusted taxable income (generally 
taxable income computed without regard to deductions for net 
interest expense, net operating losses, domestic production 
activities under section 199, depreciation, amortization, and 
depletion). Interest disallowed under these rules can be 
carried forward indefinitely and is allowed as a deduction to 
the extent of excess limitation in a subsequent tax year. Any 
excess limitation (i.e., the excess, if any, of 50 percent of 
the adjusted taxable income of the payor over the payor's net 
interest expense) can be carried forward three years.
---------------------------------------------------------------------------
    \1584\ Sec. 163(j).
    \1585\ If a treaty reduces the tax rate on interest paid or accrued 
by the taxpayer, the interest is treated as interest on which no 
Federal income tax is imposed to the extent of the same proportion of 
such interest as the tax rate imposed without regard to the treaty, 
reduced by the tax rate imposed under the treaty, bears to the tax rate 
imposed without regard to the treaty. Sec. 163(j)(5)(B).
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  D. U.S. Tax Rules Applicable to Foreign Activities of U.S. Persons 
                               (Outbound)


1. In general

    In general, income earned directly by a U.S. person from 
the conduct of a foreign business is taxed currently,\1586\ but 
income earned indirectly by a separate foreign legal entity 
operating the foreign business is not, provided that the entity 
is treated as a corporation for U.S. tax purposes. Instead, 
active foreign business income earned by a U.S. person 
indirectly through an interest in a foreign corporation 
generally is not subject to U.S. tax until the income is 
distributed as a dividend to the U.S. person. Certain anti-
deferral regimes may cause the U.S. owner to be taxed currently 
in the United States on certain categories of passive or highly 
mobile income earned by the foreign corporation regardless of 
whether the income has been distributed as a dividend to the 
U.S. owner. The main anti-deferral regimes that provide such 
exceptions are the controlled foreign corporation (``CFC'') 
rules of subpart F \1587\ and the passive foreign investment 
company (``PFIC'') rules.\1588\ A foreign tax credit generally 
is available to offset, in whole or in part, the U.S. tax owed 
on foreign-source income, whether the income is earned directly 
by the domestic corporation, repatriated as an actual dividend, 
or included in the domestic parent corporation's income under 
one of the anti-deferral regimes.\1589\
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    \1586\ A U.S. citizen or resident living abroad may be eligible to 
exclude from U.S. taxable income certain foreign earned income and 
foreign housing costs under section 911. For a description of this 
exclusion, see Present Law and Issues in U.S. Taxation of Cross-Border 
Income (JCX-42-11), September 6, 2011, p. 52.
    \1587\ Secs. 951-964.
    \1588\ Secs. 1291-1298.
    \1589\ Secs. 901, 902, 960, and 1293(f).
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2. Anti-deferral regimes

Subpart F

    Subpart F,\1590\ applicable to CFCs and their shareholders, 
is the main anti-deferral regime of relevance to a U.S.-based 
multinational corporate group. A CFC generally is defined as 
any foreign corporation if U.S. persons own (directly, 
indirectly, or constructively) more than 50 percent of the 
corporation's stock (measured by vote or value), taking into 
account only those U.S. persons that are within the meaning of 
the term ``United States shareholder,'' which refers only to 
those U.S. persons who own at least 10 percent of the stock 
(measured by vote only).\1591\
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    \1590\ Secs. 951-964.
    \1591\ Secs. 951(b), 957, and 958. The term ``United States 
shareholder'' is used interchangeably herein with ``U.S. shareholder.''
---------------------------------------------------------------------------
            Subpart F income
    Under the subpart F rules, the United States generally 
taxes the 10-percent U.S. shareholders of a CFC on their pro 
rata shares of certain income of the CFC (``subpart F 
income''), without regard to whether the income is distributed 
to the shareholders.\1592\ In effect, the United States treats 
the 10-percent U.S. shareholders of a CFC as having received a 
current distribution of the CFC's subpart F income. With 
exceptions described below, subpart F income generally includes 
passive income and other income that is readily movable from 
one jurisdiction to another. Subpart F income consists of 
foreign base company income,\1593\ insurance income,\1594\ and 
certain income relating to international boycotts and other 
violations of public policy.\1595\
---------------------------------------------------------------------------
    \1592\ Sec. 951(a).
    \1593\ Sec. 954.
    \1594\ Sec. 953.
    \1595\ Sec. 952(a)(3)-(5).
---------------------------------------------------------------------------
    Foreign base company income consists of foreign personal 
holding company income, which includes passive income such as 
dividends, interest, rents, and royalties, and a number of 
categories of income from business operations, including 
foreign base company sales income, foreign base company 
services income, and foreign base company oil-related income. 
\1596\
---------------------------------------------------------------------------
    \1596\ Sec. 954.
---------------------------------------------------------------------------
    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. Finally, 
special rules under subpart F with respect to related person 
insurance income \1597\ address captive insurance 
companies.\1598\ Under these rules, the threshold for 
determining control is reduced to 25 percent, and any level of 
stock ownership by a U.S. person in such corporation is 
sufficient for the person to be treated as a U.S. shareholder.
---------------------------------------------------------------------------
    \1597\ Sec. 953(c). Related person insurance income is defined to 
mean any insurance income attributable to a policy of insurance or 
reinsurance with respect to which the primary insured is either a U.S. 
shareholder (within the meaning of the provision) in the foreign 
corporation receiving the income or a person related to such a 
shareholder.
    \1598\ See Joint Committee on Taxation, General Explanation of the 
Tax Reform Act of 1986 (JCS-10-87), May 4, 1987, p. 968.
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            Investments in U.S. property
    The 10-percent U.S. shareholders of a CFC also are required 
to include in income currently their pro rata shares of the 
corporation's untaxed earnings invested in certain items of 
U.S. property.\1599\ This U.S. property generally includes 
tangible property located in the United States, stock of a U.S. 
corporation, an obligation of a U.S. person, and certain 
intangible assets, such as patents and copyrights, acquired or 
developed by the CFC for use in the United States.\1600\ There 
are specific exceptions to the general definition of U.S. 
property, including for bank deposits, certain export property, 
and certain trade or business obligations.\1601\ The inclusion 
rule for investment of earnings in U.S. property is intended to 
prevent taxpayers from avoiding U.S. tax on dividend 
repatriations by repatriating CFC earnings through non-dividend 
payments, such as loans to U.S. persons.
---------------------------------------------------------------------------
    \1599\ Secs. 951(a)(1)(B) and 956.
    \1600\ Sec. 956(c)(1).
    \1601\ Sec. 956(c)(2).
---------------------------------------------------------------------------
            Subpart F exceptions
    Several exceptions to the broad definition of subpart F 
income permit continued deferral for income from certain 
transactions, dividends, interest, and certain rents and 
royalties received by a CFC from a related corporation 
organized and operating in the same foreign country in which 
the CFC is organized.\1602\ The same-country exception is not 
available to the extent that the payments reduce the subpart F 
income of the payor. A second exception from foreign base 
company income and insurance income is available for any item 
of income received by a CFC if the taxpayer establishes that 
the income was subject to an effective foreign income tax rate 
greater than 90 percent of the maximum U.S. corporate income 
tax rate (i.e., more than 90 percent of 35 percent, or 31.5 
percent).\1603\
---------------------------------------------------------------------------
    \1602\ Sec. 954(c)(3).
    \1603\ Sec. 954(b)(4).
---------------------------------------------------------------------------
    A provision colloquially referred to as the ``CFC look-
through'' rule excludes from foreign personal holding company 
income dividends, interest, rents, and royalties received or 
accrued by one CFC from a related CFC to the extent 
attributable or properly allocable to non-subpart-F income of 
the payor.\1604\ The look-through rule applies to taxable years 
of foreign corporations beginning before January 1, 2020, and 
to taxable years of U.S. shareholders with or within which such 
taxable years of foreign corporations end.
---------------------------------------------------------------------------
    \1604\ Sec. 954(c)(6).
---------------------------------------------------------------------------
    There is also an exclusion from subpart F income for 
certain income of a CFC that is derived in the active conduct 
of banking or financing business (``active financing 
income'').\1605\ 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 to 
qualify for the exclusion. 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 exclusion 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 exclusion applies to 
certain income derived from certain cross border transactions.
---------------------------------------------------------------------------
    \1605\ Sec. 954(h).
---------------------------------------------------------------------------
    For a securities dealer, foreign personal holding company 
income excludes any interest or dividend (or certain equivalent 
amounts) from any transaction, including a hedging transaction 
or a transaction consisting of a deposit of collateral or 
margin, entered into in the ordinary course of the dealer's 
trade or business as a dealer in securities within the meaning 
of section 475.\1606\ In the case of a QBU of the dealer, the 
income is required to be attributable to activities of the QBU 
in the country of incorporation, or to a QBU in the country in 
which the QBU both maintains its principal office and conducts 
substantial business activity. A coordination rule provides 
that, for securities dealers, this exception generally takes 
precedence over the exception for active financing income.
---------------------------------------------------------------------------
    \1606\ Sec. 954(c)(2)(C).
---------------------------------------------------------------------------
    Certain income of a qualifying insurance company (or a 
qualifying branch of a qualifying insurance company) with 
respect to risks located within the home country of the branch 
or within the CFC's country of organization are also excluded 
from foreign personal holding company income. Further, 
additional exclusions apply for certain income of certain CFCs 
or branches with respect to risks located in a country other 
than the United States, provided that certain requirements, 
including reserve requirements, are met.\1607\
---------------------------------------------------------------------------
    \1607\ Subject to approval by the IRS, a taxpayer may establish 
that the reserve of a life insurance company for life insurance and 
annuity contracts is the amount taken into account in determining the 
foreign statement reserve for the contract (reduced by catastrophe, 
equalization, or deficiency reserve or any similar reserve). IRS 
approval is to be based on whether the method, the interest rate, the 
mortality and morbidity assumptions, and any other factors taken into 
account in determining foreign statement reserves (taken together or 
separately) provide an appropriate means of measuring income for 
Federal income tax purposes.
---------------------------------------------------------------------------
            Exclusion of previously taxed earnings and profits
    A 10-percent U.S. shareholder of a CFC may exclude from its 
income actual distributions of earnings and profits from the 
CFC that were previously included in the 10-percent U.S. 
shareholder's income under subpart F.\1608\ Any income 
inclusion (under section 956) resulting from investments in 
U.S. property may also be excluded from the 10-percent U.S. 
shareholder's income when such earnings are ultimately 
distributed.\1609\ Ordering rules provide that distributions 
from a CFC are treated as coming first out earnings and profits 
of the CFC that have been previously taxed under 956, then 
subpart F income, then other earnings and profits.\1610\
---------------------------------------------------------------------------
    \1608\ Sec. 959(a)(1).
    \1609\ Sec. 959(a)(2).
    \1610\ Sec. 959(c).
---------------------------------------------------------------------------
            Basis adjustments
    In general, a 10-percent U.S. shareholder of a CFC 
increases the basis in its CFC stock by the amount of any 
subpart F inclusions.\1611\ Similarly, a 10-percent U.S. 
shareholder of a CFC generally reduces its basis in its CFC 
stock by the amount of any distributions that the 10-percent 
U.S. shareholder receives from the CFC that are excluded from 
its income as previously taxed under subpart F.\1612\
---------------------------------------------------------------------------
    \1611\ Sec. 961(a).
    \1612\ Sec. 961(b).
---------------------------------------------------------------------------

Passive foreign investment companies

    The Tax Reform Act of 1986 \1613\ established the PFIC 
anti-deferral regime. A PFIC is generally defined as any 
foreign corporation if 75 percent or more of its gross income 
for the taxable year consists of passive income, or 50 percent 
or more of its assets consists of assets that produce, or are 
held for the production of, passive income.\1614\ Alternative 
sets of income inclusion rules apply to U.S. persons that are 
shareholders in a PFIC, regardless of their percentage 
ownership in the company. Under one set of rules, U.S. 
shareholders pay tax on certain income or gain realized through 
the company, plus an interest charge that is attributable to 
the value of deferral.\1615\ Under another set of rules for 
PFICs that are qualified electing funds, electing U.S. 
shareholders currently include in gross income their respective 
shares of the company's earnings, with a separate election to 
defer payment of tax, subject to an interest charge, on income 
not currently received.\1616\ A third set of rules applies to 
PFIC stock that is marketable, under which electing U.S. 
shareholders currently take into account as income (or loss) 
the difference between the fair market value of the stock as of 
the close of the taxable year and their adjusted basis in such 
stock (subject to certain limitations), often referred to as 
``marking to market.'' \1617\
---------------------------------------------------------------------------
    \1613\ Pub. L. No. 99-514.
    \1614\ Sec. 1297.
    \1615\ Sec. 1291.
    \1616\ Secs. 1293-1295.
    \1617\ Sec. 1296.
---------------------------------------------------------------------------
    Under the PFIC regime, passive income is any income of a 
kind that would be foreign personal holding company income, 
including dividends, interest, royalties, rents, and certain 
gains on the sale or exchange of property, commodities, or 
foreign currency. However, among other exceptions, passive 
income does not include any income derived in the active 
conduct of an insurance business by a corporation that is 
predominantly engaged in an insurance business and that would 
be subject to tax under subchapter L if it were a domestic 
corporation.\1618\ In applying the insurance exception, the IRS 
analyzes whether risks assumed under contracts issued by a 
foreign company organized as an insurer are truly insurance 
risks, whether the risks are limited under the terms of the 
contracts, and the status of the company as an insurance 
company.\1619\
---------------------------------------------------------------------------
    \1618\ Sec. 1297(b)(2)(B).
    \1619\ Notice 2003-34, 2003-C.B. 1 990, June 9, 2003. See also 
Prop. Treas. Reg. sec. 1.1297-4.
---------------------------------------------------------------------------

Other anti-deferral regimes and coordination rules

    The subpart F and PFIC rules are not the only anti-deferral 
regimes. Other rules that impose current U.S. taxation on 
income earned through corporations include the accumulated 
earnings tax rules \1620\ and the personal holding company 
rules.
---------------------------------------------------------------------------
    \1620\ Secs. 531-537.
---------------------------------------------------------------------------
    Rules for coordination among the anti-deferral regimes are 
provided to prevent U.S. persons from being subject to U.S. tax 
on the same item of income under multiple regimes. For example, 
a corporation generally is not treated as a PFIC with respect 
to a particular shareholder if the corporation is also a CFC 
and the shareholder is a 10-percent U.S. shareholder. That is, 
subpart F trumps the PFIC rules.

3. Foreign tax credit

    Subject to certain limitations, U.S. citizens, resident 
individuals, and domestic corporations are allowed to claim 
credit for foreign income taxes they pay. A domestic 
corporation that owns at least 10 percent of the voting stock 
of a foreign corporation is allowed a ``deemed-paid'' credit 
for foreign income taxes paid by the foreign corporation that 
the domestic corporation is deemed to have paid when the 
related income is distributed as a dividend or is included in 
the domestic corporation's income under the anti-deferral 
rules.\1621\
---------------------------------------------------------------------------
    \1621\ Secs. 901, 902, 960, and 1291(g).
---------------------------------------------------------------------------
    The foreign tax credit generally is limited to a taxpayer's 
U.S. tax liability on its foreign-source taxable income (as 
determined under U.S. tax accounting principles). This limit is 
intended to ensure that the credit serves its purpose of 
mitigating double taxation of foreign-source income without 
offsetting U.S. tax on U.S.-source income. \1622\ The limit is 
computed by multiplying a taxpayer's total pre-credit U.S. tax 
liability for the year by the ratio of the taxpayer's foreign-
source taxable income for the year to the taxpayer's total 
taxable income for the year. If the total amount of foreign 
income taxes paid and deemed paid for the year exceeds the 
taxpayer's foreign tax credit limitation for the year, the 
taxpayer may carry back the excess foreign taxes to the 
previous year or carry forward the excess taxes to one of the 
succeeding 10 years.\1623\
---------------------------------------------------------------------------
    \1622\ Secs. 901 and 904.
    \1623\ Sec. 904(c).
---------------------------------------------------------------------------
    The computation of the foreign tax credit limitation 
requires a taxpayer to determine the amount of its taxable 
income from foreign sources in each limitation category by 
allocating and apportioning deductions between U.S.-source 
gross income, on the one hand, and foreign-source gross income 
in each limitation category, on the other. In general, 
deductions are allocated and apportioned to the gross income to 
which the deductions factually relate.\1624\ However, subject 
to certain exceptions, deductions for interest expense and 
research and experimental expenses are apportioned based on 
certain ratios.\1625\ Interest expense is apportioned based on 
the ratio of the corporation's foreign or domestic (as 
applicable) assets to its worldwide assets. In the case of 
research and experimental expenses, the ratio is based on 
either sales or gross income. All members of an affiliated 
group of corporations generally are treated as a single 
corporation for purposes of determining the apportionment 
ratios.\1626\
---------------------------------------------------------------------------
    \1624\ Treas. Reg. sec. 1.861-8(b) and Temp. Treas. Reg. sec. 
1.861-8T(c).
    \1625\ Temp. Treas. Reg. sec. 1.861-9T and Treas. Reg. sec. 1.861-
17.
    \1626\ Sec. 864(e)(1) and (6); Temp. Treas. Reg. sec. 1.861-
14T(e)(2).
---------------------------------------------------------------------------
    The term ``affiliated group'' is determined by reference to 
the rules for determining whether corporations are eligible to 
file consolidated returns, with certain modifications.\1627\ 
These rules generally exclude foreign corporations from an 
affiliated group.\1628\ Interest expense allocation rules 
permitting a U.S. affiliated group to elect to apportion the 
interest expense of the members of the U.S. affiliated group on 
a worldwide basis were modified in 2004, and initially 
effective for taxable years beginning after December 31, 
2008.\1629\ The effective date of the modified rules has been 
delayed to January 1, 2021.\1630\ A result of this rule is that 
interest expense of foreign members of a U.S. affiliated group 
is taken into account in determining whether a portion of the 
interest expense of the domestic members of the group must be 
allocated to foreign-source income. An allocation to foreign-
source income generally is required only if, in broad terms, 
the domestic members of the group are more highly leveraged 
than is the entire worldwide group.
---------------------------------------------------------------------------
    \1627\ Secs. 864(e)(5) and 1504.
    \1628\ Sec. 1504(b)(3).
    \1629\ Sec. 864(f).
    \1630\ See Hiring Incentives to Restore Employment Act, Pub. L. No. 
111-147, sec. 551(a).
---------------------------------------------------------------------------
    The foreign tax credit limitation is applied separately to 
passive category income and to general category income.\1631\ 
Passive category income includes passive income, such as 
portfolio interest and dividend income, and certain specified 
types of income. All other income is in the general category. 
Passive income is treated as general category income if earned 
by a qualifying financial services entity or if highly taxed 
(i.e., if the foreign tax rate is determined to exceed the 
highest tax rate specified in section 1 or 11, as applicable). 
Dividends (and subpart F inclusions), interest, rents, and 
royalties received by a 10-percent U.S. shareholder from a CFC 
are assigned to the passive category to the extent the payments 
or inclusions are allocable to passive category income of the 
CFC.\1632\ Dividends received by a 10-percent corporate 
shareholder of a foreign corporation that is not a CFC are also 
categorized on a look-through basis.\1633\
---------------------------------------------------------------------------
    \1631\ Sec. 904(d). The foreign tax credit limitation is also 
applied separately to certain additional separate categories. See 
Treas. Reg. sec. 1.904-4(m).
    \1632\ Sec. 904(d)(3).
    \1633\ Sec. 904(d)(4).
---------------------------------------------------------------------------
    Special rules apply to the allocation of income and losses 
from foreign and U.S. sources within each category of 
income.\1634\ Foreign losses from one category first offset 
foreign-source income from other categories. Any remaining 
overall foreign loss offsets U.S.-source income. The same 
principle applies to losses from U.S. sources. In subsequent 
years, any losses deducted against another category or source 
of income are recaptured. That is, an equal amount of income 
from the same category or source that generated a loss in a 
prior year is recharacterized as income from the other category 
or source against which the loss was deducted. Foreign-source 
income in a particular category may be fully recharacterized as 
income in another category, whereas only up to 50 percent of 
income from one source in any subsequent year may be 
recharacterized as income from the other source.
---------------------------------------------------------------------------
    \1634\ Sec. 904(f) and (g).
---------------------------------------------------------------------------
    A taxpayer's ability to claim a foreign tax credit may be 
further limited by a matching rule that prevents the separation 
of creditable foreign taxes from the associated foreign income. 
Under this rule, a foreign tax generally is not taken into 
account for U.S. tax purposes, and thus no foreign tax credit 
is available with respect to that foreign tax, until the 
taxable year in which the related income is taken into account 
for U.S. tax purposes.\1635\
---------------------------------------------------------------------------
    \1635\ Sec. 909.
---------------------------------------------------------------------------

4. Special rules

Dual consolidated loss rules

    A dual consolidated loss (``DCL'') is any net operating 
loss of a domestic corporation if the corporation is subject to 
an income tax of a foreign country without regard to whether 
such income is from sources in or outside such foreign country, 
or if the corporation is subject to such a tax on a residence 
basis (a ``dual resident corporation'').\1636\ A DCL generally 
cannot be used to reduce the taxable income of any member of 
the corporation's affiliated group. Losses of a separate unit 
of a domestic corporation (a foreign branch or an interest in a 
hybrid entity owned by the corporation) are subject to this 
limitation in the same manner as if the unit were a wholly-
owned subsidiary of such corporation. An exemption applies to a 
DCL with respect to which the corporation makes a domestic use 
election (i.e., an election to use the loss only for domestic, 
and not foreign, tax purposes).\1637\ Recapture is required, 
however, upon the occurrence of certain triggering events, 
including the conversion of a separate unit to a foreign 
corporation and the transfer of 50 percent or more of the 
assets of a separate unit within a 12-month period.\1638\
---------------------------------------------------------------------------
    \1636\ Sec. 1503(d). The DCL rules presuppose the loss was used for 
foreign tax purposes.
    \1637\ Treas. Reg. sec. 1.1503(d)-6(d).
    \1638\ See Treas. Reg. sec. 1.1503(d)-6(e)(1).
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Temporary dividends-received deduction for repatriated foreign earnings

    In 2004, Congress enacted section 965, a temporary 
provision intended to encourage U.S. multinational companies to 
repatriate foreign earnings.\1639\ Under that provision, for 
one taxable year certain dividends received by a U.S. 
corporation from its CFCs were eligible for an 85-percent 
dividends-received deduction. At the taxpayer's election, this 
deduction was available for dividends received either during 
the taxpayer's first taxable year beginning on or after October 
22, 2004, or during the taxpayer's last taxable year beginning 
before such date.
---------------------------------------------------------------------------
    \1639\ American Jobs Creation Act of 2004, Pub. L. 108-357, sec. 
421.
---------------------------------------------------------------------------
    The temporary deduction was subject to a number of general 
limitations. First, the deduction applied only to cash 
repatriations generally in excess of the taxpayer's average 
repatriation level calculated for a three-year base period 
preceding the year of the deduction. Second, the amount 
eligible for the deduction was generally limited to the amount 
of earnings shown as permanently invested outside the United 
States on the taxpayer's recent audited financial statements. 
Third, to qualify for the deduction, dividends were required to 
be invested in the United States according to a domestic 
reinvestment plan approved by the taxpayer's senior management 
and board of directors.\1640\
---------------------------------------------------------------------------
    \1640\ Section 965(b)(4). The plan was required to 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.
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    No foreign tax credit (or deduction) was allowed for 
foreign taxes attributable to the deductible portion of any 
dividend.\1641\ For this purpose, the taxpayer was permitted to 
specifically identify which dividends were treated as carrying 
the deduction and which dividends were not. In other words, the 
taxpayer was allowed to choose which of its dividends were 
treated as meeting the base-period repatriation level (and thus 
carry foreign tax credits, to the extent otherwise allowable), 
and which of its dividends were treated as part of the excess 
eligible for the deduction (and thus subject to proportional 
disallowance of any associated foreign tax credits).\1642\ 
Deductions were disallowed for expenses that were directly 
allocable to the deductible portion of any dividend.\1643\
---------------------------------------------------------------------------
    \1641\ Sec. 965(d)(1).
    \1642\ Accordingly, taxpayers generally were expected to pay 
regular dividends out of high-taxed CFC earnings (thereby generating 
deemed-paid credits available to offset foreign-source income) and 
section 965 dividends out of low-taxed CFC earnings (thereby availing 
themselves of the 85-percent deduction).
    \1643\ Sec. 965(d)(2).
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Domestic international sales corporations

    A domestic international sales corporation (``DISC'') is a 
domestic corporation that satisfies the following conditions: 
95 percent of its gross receipts must be qualified export 
receipts; 95 percent of the sum of the adjusted bases of all 
its assets must be attributable to the sum of the adjusted 
bases of qualified export assets; the corporation must have no 
more than one class of stock; the par or stated value of the 
outstanding stock must be at least $2,500 on each day of the 
taxable year; and an election must be in effect to be taxed as 
a DISC.\1644\ In general, a DISC is not subject to corporate-
level tax and offers limited deferral of tax liability to its 
shareholders.\1645\ DISC income attributable to a maximum of 
$10 million annually of qualified export receipts is generally 
exempt from income tax at both the corporate and shareholder 
level. Shareholders must pay interest to account for the 
benefit of deferring the tax liability on undistributed DISC 
income related to this $10 million maximum annual amount.\1646\ 
Such entities are also referred to as interest charge DISCs, or 
IC-DISCs. Shareholders of a DISC are deemed to receive a 
dividend out of current earnings and profits from qualified 
export receipts in excess of $10 million.\1647\ Gain on the 
sale of DISC stock is treated as a dividend to the extent of 
accumulated DISC income.\1648\ The shareholders of a 
corporation which is not a DISC, but was a DISC in a previous 
taxable year, and which has previously taxed income or 
accumulated DISC income, are also required to pay interest on 
the deferral benefit, and gain on the sale or exchange of stock 
in such corporation is treated as a dividend.
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    \1644\ Sec. 992(a) and (b). A corporation that fails to satisfy 
either or both of the 95-percent tests is deemed to satisfy such tests 
if it makes a pro rata distribution of its gross receipts that are not 
qualified export receipts and the fair market value of its assets that 
are not qualified export assets. Sec. 992(c).
    \1645\ Sec. 991. Prior to the 1984 Revenue Act (Pub. L. 98-369), 
DISCs were eligible for more generous tax benefits that were eliminated 
in favor of the since-repealed foreign sales corporation regime 
(``FSC''). An overview of the history of the DISCs and FSCs regimes is 
provided in Joseph Isenbergh, Vol. 3 U.S. Taxation of Foreign Persons 
and Foreign Income, Para. 81. (Fourth Ed. 2016).
    \1646\ The rate is the average of one-year constant maturity 
Treasury yields. The deferral benefit is the excess of the amount of 
tax for which the shareholder would be liable if deferred DISC income 
were included as ordinary income over the actual tax liability of such 
shareholder. Sec. 995(f).
    \1647\ The amount of the deemed distribution is the sum of several 
items, including qualified export receipts in excess of $10 million. 
See sec. 955(b).
    \1648\ Sec. 995(c).

                     PART I--OUTBOUND TRANSACTIONS

SUBPART A--ESTABLISHMENT OF PARTICIPATION EXEMPTION SYSTEM FOR TAXATION 
                           OF FOREIGN INCOME

   A. Deduction for Foreign-Source Portion of Dividends Received by 
     Domestic Corporations from Specified 10-Percent Owned Foreign 
 Corporations (sec. 14101 of the Act and sec. 904(b) and new sec. 245A 
                              of the Code)

                        Explanation of Provision

Background on prior law
    To limit multiple levels of corporate tax in the case of 
tiered corporate structures, corporations are allowed a 
dividends received deduction (``DRD''). U.S. corporations are 
permitted a deduction for qualifying dividends received from 
other U.S. corporations. The amount of the DRD is calculated as 
a percentage of the dividend received. The DRD percentage is 
based on the amount of stock that the recipient U.S. 
corporation owns in the paying U.S. corporation, as follows: 
(1) 50 percent if the ownership is less than 20 percent; (2) 65 
percent if the ownership is at least 20 percent and less than 
80 percent; and (3) 100 percent if the ownership is at least 80 
percent.\1649\ A U.S. corporation may also be eligible for a 
DRD for dividends received from a qualified 10-percent owned 
foreign corporation with respect to the U.S.-source portion of 
the dividends.\1650\
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    \1649\ Sec. 243. The Act changed the DRD percentages. The changes 
to section 243 are discussed in greater detail in the explanation of 
section 13002 of the Act.
    \1650\ Sec. 245. The DRD on the eligible portion of the dividend is 
based on the percentage of stock ownership of the foreign corporation, 
as described in section 243.
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In general
    The provision exempts certain foreign income of certain 
domestic corporations by means of a 100-percent DRD for the 
foreign-source portion of dividends received from a specified 
10-percent owned foreign corporation. A specified 10-percent 
owned foreign corporation is any foreign corporation (other 
than a PFIC that is not also a CFC) with respect to which any 
domestic corporation is a U.S. shareholder.\1651\ A corporate 
U.S. shareholder of a CFC receiving a dividend from a 10-
percent owned foreign corporation shall be allowed a DRD with 
respect to the subpart F inclusion attributable to such 
dividend in the same manner as a dividend would be allowable 
under section 245A.\1652\ However, certain dividends that 
qualify for the DRD may result in an inclusion under section 
951(a) (subpart F) or section 951A (``GILTI'') in cases in 
which any such inclusion is reduced under section 951(a)(2)(B) 
by reason of a dividend or in certain cases in which the CFC 
ceases to have a U.S. shareholder with section 958(a) 
ownership.\1653\
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    \1651\ Sec. 245A(b). Under section 951(b) as revised by section 
14214 of the Act, a domestic corporation is a U.S. shareholder of a 
foreign corporation if it owns, within the meaning of section 958(a), 
or is considered as owning by applying the rules of section 958(b), 10 
percent or more of the vote or value of the foreign corporation.
    \1652\ A technical correction may be necessary to reflect this 
intent.
    \1653\ Technical corrections may be necessary to reflect this 
intent.
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    The term ``dividend received'' is intended to be 
interpreted broadly, consistently with the meaning of the 
phrases ``amount received as dividends''' and ``dividends 
received'' under sections 243 and 245, respectively. For 
example, if a domestic corporation indirectly owns stock of a 
foreign corporation through a partnership and the domestic 
corporation would qualify for the DRD with respect to dividends 
from the foreign corporation if the domestic corporation owned 
such stock directly, the domestic corporation would be allowed 
the DRD with respect to its distributive share of the 
partnership's dividend from the foreign corporation. However, 
the provisions of section 245A are intended to apply only to 
amounts that are treated as dividends for Federal income tax 
purposes. Furthermore, the dividend cannot be a CFC-PFIC's 
section 1291(d)(2)(B) ``purging'' dividend.\1654\ Under section 
245A(g), the Secretary shall prescribe such regulations or 
other guidance as may be necessary or appropriate to carry out 
the provisions of this section, including regulations for the 
treatment of U.S. shareholders owning stock of a specified 10-
percent owned foreign corporation through a partnership.
---------------------------------------------------------------------------
    \1654\ Sec. 245A(f).
---------------------------------------------------------------------------
    The DRD is available only to C corporations that are 
neither RICs nor REITs.\1655\
---------------------------------------------------------------------------
    \1655\ An S corporation's taxable income is computed in the same 
manner as an individual (sec. 1363(b)) so that deductions allowable 
only to corporations, including the section 245A deduction, do not 
apply. See Report by the House Committee on Ways and Means to accompany 
H.R. 6055, Subchapter S Revision Act of 1982, H. Rep. No. 97-826, p. 
14; and Report by the Senate Committee on Finance to accompany H.R. 
6055, Subchapter S Revision Act of 1982, S. Rep. 97-640, p. 15. The 
Code provides that deductions for corporations provided in part VIII of 
subchapter B, which include the DRD under section 245A, do not apply in 
computing RIC taxable income (sec. 852(b)(2)(C)) or REIT taxable income 
(sec. 857(b)(2)(A)). Therefore, the DRD under section 245A is not 
available for RICs or REITs.
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Foreign-source portion of a dividend
    The foreign-source portion of any dividend equals the 
amount of the dividend multiplied by the percentage of 
undistributed earnings that are attributable neither to ECI nor 
to certain dividends received from domestic corporations.\1656\ 
Undistributed earnings are the amount of the earnings and 
profits of a specified 10-percent owned foreign corporation 
\1657\ as of the close of the taxable year of the specified 10-
percent owned foreign corporation in which the dividend is 
distributed and not reduced by dividends \1658\ distributed 
during that taxable year.
---------------------------------------------------------------------------
    \1656\ Sec. 245A(c). Such dividends include any dividend received 
(directly or through a wholly owned foreign corporation) from a 
domestic corporation at least 80 percent of the stock of which is owned 
(directly or through such wholly owned foreign corporation) by the 
specified 10-percent owned foreign corporation.
    \1657\ Computed in accordance with sections 964(a) and 986.
    \1658\ Note that pursuant to section 959(d), a distribution of 
previously taxed income (``PTI'') does not constitute a dividend.
---------------------------------------------------------------------------
    For example, assume a domestic corporation (``U.S. 
Parent'') wholly owns a specified 10-percent owned foreign 
corporation (``SFC''). At the beginning of year 1, SFC has no 
accumulated earnings and profits. SFC has $1,000 of current-
year earnings and profits for year 1, of which $250 is 
attributable to ECI. SFC makes a single distribution of $1,500 
to U.S. Parent in year 1. The amount of the $1,500 distribution 
that is a dividend is $1,000 because SFC has only $1,000 of E&P 
in year 1.\1659\ Of that amount, $750 is the foreign-source 
portion and eligible for the 100-percent DRD under section 245A 
(the $1,000 dividend * ($750 of E&P that is not ECI / $1,000 of 
total E&P)).
---------------------------------------------------------------------------
    \1659\ Secs. 301(c)(1) and 316.
---------------------------------------------------------------------------
Holding period requirement
    A domestic corporation is not permitted a DRD in respect of 
any dividend on any share of stock that is held by the domestic 
corporation for 365 days or less during the 731-day period 
beginning on the date that is 365 days before the date on which 
the share becomes ex-dividend with respect to the dividend. For 
this purpose, the holding period requirement is satisfied only 
if the specified 10-percent owned foreign corporation is a 
specified 10-percent owned foreign corporation at all times 
during the period and the taxpayer is a U.S. shareholder with 
respect to such specified 10-percent owned foreign corporation 
at all times during the period.\1660\
---------------------------------------------------------------------------
    \1660\ Sec. 246(c)(5).
---------------------------------------------------------------------------
Foreign tax credit disallowance
    No foreign tax credit or deduction is allowed for any taxes 
paid or accrued with respect to any dividend that qualifies for 
the DRD. For example, assume $100 of foreign income taxes are 
withheld from a $1,000 dividend from a specified 10-percent 
owned foreign corporation to a domestic corporation. The 
foreign-source portion of the dividend is $800, and an $800 DRD 
is allowed. No foreign tax credit or deduction will be allowed 
for $80 of the foreign income taxes pursuant to section 
245A(d), and no foreign tax credit or deduction will be allowed 
for the remaining $20 of foreign income taxes pursuant to 
section 245(a)(8).
    For purposes of computing the foreign tax credit 
limitation, a domestic corporation that is a U.S. shareholder 
of a specified 10-percent owned foreign corporation must 
determine its foreign-source taxable income (and entire taxable 
income) by disregarding any dividend for which the DRD is 
taken, and any deductions properly allocable or apportioned to 
income (other than amounts includible under section 951(a)(1) 
or 951A(a)) with respect to stock of such foreign corporation, 
or the stock to the extent income with respect to the stock is 
other than amounts includible under section 951(a)(1) or 
951A(a).\1661\
---------------------------------------------------------------------------
    \1661\ Sec. 904(b)(4).
---------------------------------------------------------------------------
Hybrid dividends
    The DRD is not available for any hybrid dividend. A hybrid 
dividend is an amount received from a CFC for which section 
245A(a) would allow a DRD and for which the CFC received a 
deduction (or other tax benefit) with respect to any income, 
war profits, or excess profits taxes imposed by any foreign 
country or possession of the United States. Furthermore, no 
foreign tax credit or deduction is allowed for any taxes paid 
or accrued with respect to any hybrid dividend.
    If a CFC for which a domestic corporation is a U.S. 
shareholder receives a hybrid dividend from any other CFC for 
which that domestic corporation is a U.S. shareholder, the 
hybrid dividend will be treated as subpart F income, and, 
notwithstanding any other provision of the Code, the U.S. 
shareholder will include in income its pro rata share of the 
income under section 951(a).\1662\ This tiered hybrid dividend 
rule applies to an amount treated as a dividend in the hands of 
the recipient CFC (as opposed to amounts allowed the DRD) and 
for which the distributing CFC received a deduction or other 
tax benefit.\1663\
---------------------------------------------------------------------------
    \1662\ This is the result even if, for example, the dividend would 
normally be entitled to look-through treatment under section 954(c)(6), 
the subpart F income would normally be reduced by deductions pursuant 
to section 954(b)(5), or the subpart F income would normally be limited 
by current earnings and profits under section 952(c).
    \1663\ A technical correction may be necessary to reflect this 
intent.
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to distributions made after (and for 
purposes of determining a taxpayer's foreign tax credit 
limitation under section 904, deductions with respect to 
taxable years ending after) December 31, 2017.\1664\
---------------------------------------------------------------------------
    \1664\ A technical correction may be necessary to reflect the 
intent that the DRD be excluded from adjusted current earnings 
(``ACE'') adjustments for purposes of the corporate alternative minimum 
tax (``AMT'') as applicable to certain fiscal-year taxpayers for their 
2017 taxable year.
---------------------------------------------------------------------------

B. Special Rules Relating to Sales or Transfers Involving Specified 10-
  Percent Owned Foreign Corporations (sec. 14102 of the Act and secs. 
     367(a)(3), 961, 964(e), and 1248 and new sec. 91 of the Code)


                        Explanation of Provision


Background on prior law

    Gain recognized by a U.S. person on the sale or exchange of 
the stock of a foreign corporation may be recharacterized as a 
dividend to the extent of the E&P attributable to that stock if 
the U.S. person owned, directly, indirectly or constructively, 
10 percent or more (by vote) of the stock of the foreign 
corporation while the foreign corporation was a CFC at any time 
during the preceding five-year period.\1665\ Similarly, section 
964(e) requires a CFC to include in income as a dividend gain 
recognized on the sale or exchange of the stock of another 
foreign corporation to the same extent that it would have been 
so included under section 1248(a) if the CFC were a U.S. 
person.
---------------------------------------------------------------------------
    \1665\ Sec. 1248(a).
---------------------------------------------------------------------------
    Certain branch loss recapture rules prevent a taxpayer from 
deducting losses incurred by a foreign branch against U.S. 
taxable income and then incorporate the branch when it is 
profitable. Prior law required a U.S. corporation to recapture 
the loss deduction to the extent of built-in gain in the branch 
assets that are transferred outside the U.S. tax jurisdiction 
to a foreign corporation in an otherwise tax-free 
transaction.\1666\ Under prior law, the recapture amount was 
limited to unrealized asset appreciation and treated as 
foreign-source income.
---------------------------------------------------------------------------
    \1666\ Sec. 367(a)(3)(C) as in effect before the enactment of the 
Act. Section 367(a)(3)(C) was enacted to prevent a U.S. corporation 
from using losses of a foreign branch to offset its taxable income 
without having to pay U.S. tax on the associated future income after 
the branch's incorporation.
---------------------------------------------------------------------------
    Section 367 generally requires gain recognition on many 
types of otherwise tax-free transfers by U.S. persons to 
foreign corporations, unless a specific exception applies. One 
such exception under prior law provided that property 
transferred to a foreign corporation for use by the transferee 
in the active conduct of a trade or business outside of the 
United States is not subject to tax.\1667\
---------------------------------------------------------------------------
    \1667\ Sec. 367(a)(3)(A) as in effect before the enactment of the 
Act.
---------------------------------------------------------------------------

In general

    The provision establishes limitations on the ability to 
obtain duplicative tax benefits from losses in specified 10-
percent foreign corporations and transfers of certain foreign 
branch losses to such foreign corporations, as described below. 
It provides a new coordination rule under section 1248 to 
ensure that gain upon the sale or exchange of stock in the 
specified 10-percent foreign corporation that is 
recharacterized as a dividend under section 1248 is treated as 
a ``dividend received'' for purposes of applying section 245A, 
and further prescribes basis adjustments with respect to loss 
from such sales or exchanges. The ability to transfer foreign 
branch losses is limited by new section 91. Finally, the 
aforementioned active trade or business exception is repealed.

Sales by United States persons of CFC stock

    If a domestic corporation sells or exchanges stock in a 
foreign corporation that it has held for one year or more, any 
amount received by the domestic corporation which is treated as 
a dividend for purposes of section 1248, is treated as a 
dividend for purposes of applying the rules of new section 245A 
with respect to the new 100-percent DRD. Thus, to the extent 
section 1248 treats an amount received as a dividend, such 
dividend may qualify for a DRD under section 245A if the 
requirements of section 245A are satisfied.\1668\
---------------------------------------------------------------------------
    \1668\ Sec. 1248(j).
---------------------------------------------------------------------------

Sale of stock in a lower-tier CFC

    If for any taxable year of a CFC beginning after December 
31, 2017, an amount is treated as a dividend because of a sale 
or exchange by the CFC of stock in another foreign corporation 
held for a year or more,\1669\ then: (i) the foreign-source 
portion of the dividend is treated as subpart F income of the 
selling CFC,\1670\ (ii) a U.S. shareholder with respect to the 
selling CFC includes in gross income for the taxable year of 
the shareholder with or within which the taxable year of the 
CFC ends, an amount equal to the shareholder's pro rata share 
of the amount treated as subpart F income under (i), and (iii) 
the amount includible in the gross income of the United States 
shareholder under clause (ii) shall be treated as a divided 
from a specified 10-percent owned foreign corporation for 
purposes of applying section 245A.\1671\
---------------------------------------------------------------------------
    \1669\ See sec. 964(e)(1).
    \1670\ See generally sec. 954(c)(1)(B).
    \1671\ A technical correction may be necessary to reflect this 
intent.
---------------------------------------------------------------------------
    To the extent a dividend arising under section 964(e)(1) is 
a hybrid dividend, the tiered hybrid rules of section 
245A(e)(2), rather than the rules of section 964(e)(4)(A), 
apply to the dividend.\1672\
---------------------------------------------------------------------------
    \1672\ A technical correction may be necessary to reflect this 
intent.
---------------------------------------------------------------------------

Reduction in basis of certain foreign stock

    A distribution from a foreign corporation eligible for a 
DRD could reduce the value of the foreign corporation, reducing 
built-in gain or increasing built-in loss in the stock of the 
foreign corporation. Therefore, solely for the purpose of 
determining a loss, a domestic corporate shareholder's adjusted 
basis in the stock of a specified 10-percent owned foreign 
corporation (as defined in section 245A) is reduced by an 
amount equal to the portion of any dividend received with 
respect to such stock from such foreign corporation that was 
not taxed by reason of the DRD allowable under section 245A in 
any taxable year of such domestic corporation.\1673\ This rule 
applies in coordination with section 1059, such that any 
reduction in basis required pursuant to this provision will be 
disregarded to the extent the basis in the specified 10-percent 
owned foreign corporation's stock has already been reduced 
under section 1059.
---------------------------------------------------------------------------
    \1673\ Sec. 961(d).
---------------------------------------------------------------------------
    In the case of a sale or exchange by a CFC of stock in 
another corporation in a taxable year of the selling CFC 
beginning after December 31, 2017, to which this provision 
applies if gain were recognized, rules similar to the rules of 
section 961(d) apply.\1674\
---------------------------------------------------------------------------
    \1674\ Sec. 964(e)(4)(B).
---------------------------------------------------------------------------

Inclusion of transferred loss amount in certain asset transfers

    If a domestic corporation transfers substantially all of 
the assets of a foreign branch (within the meaning of section 
367(a)(3)(C)) as in effect before the Act) to a specified 10-
percent owned foreign corporation with respect to which it is a 
U.S. shareholder after the transfer, the domestic corporation 
includes in gross income an amount equal to the transferred 
loss amount, subject to certain limitations.\1675\
---------------------------------------------------------------------------
    \1675\ Sec. 91(a).
---------------------------------------------------------------------------
    The transferred loss amount is, with respect to any 
transfer of substantially all of the assets of a foreign 
branch, the excess (if any) of: (1) the sum of the losses 
incurred by the foreign branch after December 31, 2017, and 
before the transfer, for which a deduction was allowed to the 
domestic corporation, over (2) the sum of any taxable income 
earned by the foreign branch after the loss incurred and any 
amount recognized under section 904(f)(3) on account of the 
transfer.\1676\ The transferred loss amount is reduced (but not 
below zero) by the amount of gain recognized by the taxpayer 
(other than gain recognized by reason of an overall foreign 
loss recapture) on account of the transfer.\1677\
---------------------------------------------------------------------------
    \1676\ Sec. 91(b).
    \1677\ Sec. 91(c). Sec. 14102(d)(4) of the Act, relating to 
transition rules, provides:``(4) Transition rule. The amount of gain 
taken into account under section 91(c) of the Internal Revenue Code of 
1986, as added by this subsection, shall be reduced by the amount of 
gain which would be recognized under section 367(a)(3)(C) (determined 
without regard to the amendments made by subsection (e)) with respect 
to losses incurred before January 1, 2018.''
---------------------------------------------------------------------------
    Amounts included in gross income by reason of the provision 
are treated as derived from sources within the United 
States.\1678\ Consistent with regulations or guidance that the 
Secretary of the Treasury shall prescribe, proper adjustments 
are made in the adjusted basis of the taxpayer's stock in the 
specified 10-percent owned foreign corporation to which the 
transfer is made, and in the transferee's adjusted basis in the 
property transferred, to reflect the amounts included in gross 
income under the provision.\1679\
---------------------------------------------------------------------------
    \1678\ Sec. 91(d).
    \1679\ Sec. 91(e).
---------------------------------------------------------------------------
    The amount of gain taken into account under this provision 
is reduced by the amount of gain which would be recognized 
under section 367(a)(3)(C) as in effect before the date of the 
Act \1680\ with respect to losses incurred before January 1, 
2018.
---------------------------------------------------------------------------
    \1680\ Determined without regard to the rule providing for proper 
adjustment of basis in the stock in the specified 10-percent owned 
foreign corporation to which the transfer is made.
---------------------------------------------------------------------------
    To illustrate this provision assume that a U.S. 
multinational corporation (``U.S. Parent''), a calendar year 
taxpayer, incorporates its branch located in country X 
(``Incorporated Country X Branch'') on December 31, 2018. 
Incorporated Country X Branch recognized $150 of losses during 
calendar year 2018 for which U.S. Parent took a deduction.
    On December 31, 2018, Incorporated Country X Branch has 
tangible assets with built-in gain of $100, and U.S. Parent 
recognizes that $100 of gain under section 367(a)(1). Under 
section 91(a), U.S. Parent includes $50 in gross income ($150 
of losses, reduced by $100 section 91(c) reduction amount, 
which in this case is the amount of gain recognized under 
section 367(a)(1)). However, if, for example, Incorporated 
Country X Branch also had $75 of pre-2018 branch losses, the 
$100 section 91(c) reduction amount would be reduced by $75 to 
$25. In this case, U.S. Parent would include $125 in gross 
income ($150 of losses, reduced by the $25 section 91(c) 
reduction amount).

Repeal of active trade or business exception under section 367

    Section 367(a) is amended to provide that in connection 
with any exchange described in sections 332, 351, 354, 356, or 
361, if a U.S. person transfers property used in the active 
conduct of a trade or business outside of the United States to 
a foreign corporation, such foreign corporation shall not, for 
purposes of determining the extent to which gain shall be 
recognized on such transfer, be considered to be a corporation. 
That is, a transfer of property used in the active conduct of a 
trade or business outside of the United States by a U.S. 
corporation to a foreign corporation does not qualify for non-
recognition of gain, notwithstanding that the transfer may 
quality for non-recognition of gain, in whole or part, under 
other provisions of the Code.

                             Effective Date

    The provisions relating to sales or exchanges of CFC stock 
apply to sales or exchanges after December 31, 2017.
    The provision relating to reduction of basis in certain 
foreign stock for the purposes of determining a loss is 
effective for distributions made after December 31, 2017.
    The provisions relating to transfer of loss amounts from 
foreign branches to certain foreign corporations and to the 
repeal of the active trade or business exception under section 
367 apply to transfers after December 31, 2017.

      C. Treatment of Deferred Foreign Income Upon Transition to 
 Participation Exemption System of Taxation and Deemed Repatriation at 
Two-Tier Rate (sec. 14103 of the Act and secs. 78, 904, 907, and 965 of 
                               the Code)


                        Explanation of Provision


In general

    As part of the transition from a deferral system with 
limitations to a system under which companies are eligible for 
a 100-percent dividends received deduction with respect to 
distributions of foreign earnings, the provision requires 
certain foreign corporations to include as subpart F income the 
untaxed and undistributed foreign earnings that were 
accumulated by those corporations in taxable years since 1986. 
The U.S. shareholders of those corporations are subject to tax 
(``transition tax'') with respect to the shareholders' pro rata 
shares of such subpart F income. The transition tax ensures 
that undistributed foreign earnings that accrued before the 
effective date of the participation exemption system are 
subject to tax by the United States, allowing uniform 
applicability of the participation exemption with respect to 
post-enactment foreign earnings and profits of foreign 
subsidiaries.
    The provision generally requires that, for the last taxable 
year beginning before January 1, 2018, any U.S. shareholder of 
a specified foreign corporation \1681\ must include in income 
its pro rata share of the accumulated post-1986 deferred 
foreign income of the corporation. However, a portion of that 
pro rata share of foreign earnings is deductible. The 
deductible amount depends on the proportion of the deferred 
earnings that are held in cash or other assets, resulting in a 
reduced rate of tax applicable to the income includible under 
this provision. A corresponding portion of the credit for 
foreign taxes paid with respect to such income is disallowed, 
thus limiting the credit to the taxable portion of the included 
income. The separate foreign tax credit limitation rules of 
section 904 continue to apply, with coordinating rules. The 
transition tax generally may be paid over an eight-year period. 
Special rules are provided for S corporations and REITs.
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    \1681\ For purposes of this provision, a specified foreign 
corporation is any CFC and any foreign corporation that has at least 
one domestic corporation that is a U.S. shareholder. The term excludes 
PFICs that are not also CFCs.
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Subpart F inclusion of deferred foreign income

    The provision requires that certain pre-effective date 
foreign earnings be treated as subpart F income of a deferred 
foreign income corporation (``DFIC'') in the last taxable year 
that begins before January 1, 2018. The increase in subpart F 
income of the DFIC required by this provision (``the section 
965 inclusion'') is the greater of two measurements of the 
accumulated post-1986 deferred foreign income of the 
corporation, i.e., the amount determined either as of November 
2, 2017,\1682\ or as of December 31, 2017 (the ``measurement 
date(s)'').
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    \1682\ H.R. 1, Tax Cuts and Jobs Act, 115th Cong., was introduced 
in the House of Representatives on November 2, 2017.
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    The transition tax applies to all U.S. shareholders of a 
DFIC, which is any specified foreign corporation with 
accumulated post-1986 deferred income that is greater than 
zero. Consistent with the operation of subpart F in general and 
of section 951 in particular, each U.S. shareholder of a DFIC 
must include in income the shareholder's pro rata share of the 
section 965 inclusion of the DFIC.
    In determining whether a foreign corporation is a specified 
foreign corporation with respect to a U.S. shareholder, the 
shareholder must take into account the contemporaneous change 
in the operation of the constructive ownership rules,\1683\ 
which are effective for the year of the transition tax. 
Taxpayers must determine whether they have constructive 
ownership in entities with respect to which they may not have 
previously had a reporting or tax obligation under the Code.
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    \1683\ Prior to enactment of the Act, Section 958(b)(4) provided 
that the attribution rules of section 318 that would otherwise apply 
are inapplicable if the result would attribute stock held by a foreign 
person to a U.S. person. See, section 14213 of the Act and the 
description thereof, at subpart I.B.
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            Scope of accumulated post-1986 deferred foreign income
    To determine whether a specified foreign corporation is a 
DFIC, the U.S. shareholder must determine whether the 
corporation has accumulated post-1986 deferred foreign income 
greater than zero, based on the accumulated post-1986 deferred 
foreign income as of the measurement date. The earnings and 
profits taken into account for that measurement date include 
all post-1986 earnings and profits that are (1) not 
attributable to income that is effectively connected with the 
conduct of a trade or business in the United States and thus 
subject to current U.S. income tax, or (2) when distributed, 
not excludible from the gross income of a U.S. shareholder when 
distributed as previously taxed income under section 959.
    Post-1986 earnings and profits are those earnings that 
accumulated in taxable years beginning after 1986 (including 
previously taxed earnings and profits), computed in accordance 
with sections 964(a) and 986, for all periods during which the 
corporation was a specified foreign corporation. Post-1986 
earnings and profits are not reduced by distributions during 
the taxable year to which the transition tax applies. The post-
1986 earnings and profits include earnings and profits 
described in sections 959(c)(1) and (2), but do not include 
earnings and profits that were accumulated by a foreign company 
prior to attaining its status as a specified foreign 
corporation.
    The Secretary shall prescribe appropriate rules regarding 
the treatment of accumulated post-1986 foreign deferred income 
of specified foreign corporations that have shareholders who 
are not U.S. shareholders. Such rules may also include rules 
that are appropriate to implement the intent of the transition 
tax and the use of November 2, 2017, the date of introduction, 
as one of the measurement dates in order to establish a floor 
for determining the post-1986 deferred foreign earnings and 
profits. For example, guidance may address the extent to which 
retroactive effective dates selected in entity classification 
elections filed after introduction of the Act will be 
permitted.\1684\
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    \1684\ See, Treas. Reg. sec. 301.7701-3(c), under which an election 
may specify an effective date up to 75 days prior to the date on which 
the election is filed.
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            Deficits netted against accumulated post-1986 earnings and 
                    profits
    A U.S. shareholder may reduce (but not below zero) its 
share of accumulated post-1986 earnings and profits from 
specified foreign corporations by the shareholder's share of 
deficits from other specified foreign corporations, including 
netting against deficits of another U.S. shareholder in a 
different U.S. ownership chain within the same U.S. affiliated 
group. The income inclusion required of a U.S. shareholder from 
DFICs under this transition rule is reduced by the portion of 
the aggregate foreign earnings and profits deficit allocated to 
that person by reason of that person's interest in an earnings 
and profits deficit foreign corporation (``E&P deficit foreign 
corporation''). An E&P deficit foreign corporation is any 
foreign corporation that is a specified foreign corporation 
with respect to the U.S. shareholder as of the date on which 
accumulated earnings and profits are measured for that 
corporation (November 2, 2017, or December 31, 2017, as the 
case may be) and which has a deficit in post-1986 earnings and 
profits as of that date.\1685\ Accordingly, deficits that a 
foreign corporation accumulated prior to the U.S. shareholder 
acquisition of its interest in that corporation may be taken 
into account in determining the aggregate foreign earnings and 
profits deficit of a U.S. shareholder. The netting permitted by 
this rule is applied to the total earnings and profits of the 
specified foreign corporation, without regard to whether the 
earnings and profits and deficits were accumulated in the same 
income category for foreign tax credit limitation purposes.
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    \1685\ It is possible that a specified foreign corporation is 
neither a DFIC nor an earnings and profits deficit foreign corporation, 
despite having post-1986 earnings and profits greater than zero or a 
deficit in accumulated post-1986 deferred foreign income.
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    For example, assume that a foreign corporation organized 
after December 31, 1986 has $100 of accumulated earnings and 
profits as of November 2, 2017, and December 31, 2017 
(determined without diminution by reason of dividends 
distributed during the taxable year, other than dividends 
distributed to other specified foreign corporations), which 
consist of $120 general limitation earnings and profits and a 
$20 passive limitation deficit. Under generally applicable 
rules, if the $20 passive limitation deficit was a hovering 
deficit described in regulations, the foreign corporation's 
post-1986 earnings and profits would be $100, but foreign tax 
credits related to the hovering deficit would not be deemed 
paid by the U.S. shareholder, because the deemed paid credits 
are limited to the amount that is in proportion to the 
absorption of the deficit by current earnings in the same 
income category that gave rise to the deficit.\1686\ Solely for 
purposes of calculating the amount of foreign income taxes 
deemed paid by the U.S. shareholder with respect to an 
inclusion under section 965, Congress intends that a hovering 
deficit may be absorbed by current year earnings and profits 
and the foreign income taxes related to the hovering deficit 
may be added to the specified foreign corporation's post-1986 
foreign income taxes in that separate category on a pro rata 
basis in the year of inclusion.
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    \1686\ See, Treas. Reg. sec. 1.367(b)-7(d)(2)(ii) (hovering deficit 
offset rule) and (iii) (foreign income taxes related to a hovering 
deficit).
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    The U.S. shareholder aggregates its pro rata share of the 
foreign earnings and profits deficits of each E&P deficit 
foreign corporation and allocates such aggregate amount among 
the remaining specified foreign corporations. The aggregate 
foreign earnings and profits deficit is allocable to a 
specified foreign corporation in the same ratio as the U.S. 
shareholder's pro rata share of post-1986 deferred income of 
that corporation bears to the U.S. shareholder's pro rata share 
of accumulated post-1986 deferred foreign income from all 
deferred foreign income companies of such shareholder. The 
earnings and profits of the E&P deficit foreign corporation 
that are taken into account by a U.S. shareholder are increased 
at the foreign corporation level by the amount of the specified 
E&P deficit of such corporation that was used. Such increase 
does not apply for purposes of determining post-1986 
undistributed earnings under section 902.\1687\
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    \1687\ See section 965(b)(4)(B). A technical correction may be 
required to reflect this intent.
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            Example 1
    To illustrate the ratio, assume that Z, a domestic 
corporation, is a U.S. shareholder with respect to each of four 
specified foreign corporations, two of which are earnings and 
profits deficit foreign corporations. Assume further the 
foreign companies have the following accumulated post-1986 
deferred foreign income or foreign earnings and profits 
deficits as of November 2, 2017, and December 31, 2017:

----------------------------------------------------------------------------------------------------------------
                                                                                     Post-1986
                                                                    Percentage     Earnings and
                     Specified Foreign Corp.                           Owned          Profits     Pro rata Share
                                                                                   (Deficit) USD
----------------------------------------------------------------------------------------------------------------
A...............................................................             60%        ($1,000)          ($600)
B...............................................................             10%          ($200)           ($20)
C...............................................................             70%          $2,000          $1,400
D...............................................................            100%          $1,000          $1,000
----------------------------------------------------------------------------------------------------------------

    The aggregate foreign earnings and profits deficit of the 
U.S. shareholder is ($620), and the aggregate share of 
accumulated post-1986 deferred foreign income is $2,400. Thus, 
the portion of the aggregate foreign earnings and profits 
deficit allocable to foreign corporation C is ($362), that is, 
($620)  1400/2400. The remainder of the aggregate 
foreign earnings and profits deficit is allocable to foreign 
Corporation D. The U.S. shareholder has a net surplus of 
earnings and profits in the amount of $1,780.
            Example 2
    The intragroup netting among U.S. shareholders in an 
affiliated group in which there is at least one U.S. 
shareholder with a net earnings and profits surplus and another 
with a net earnings and profits deficit permits the net 
earnings and profits surplus shareholder to reduce its net 
surplus by the shareholder's applicable share of aggregate 
unused earnings and profits deficit, based on the group's 
ownership percentage of the members. For example, a U.S. 
corporation may have two domestic subsidiaries, X and Y, in 
which it owns 100 percent and 80 percent, respectively. If X 
has a $1,000 net earnings and profits surplus, and Y has $1,000 
net earnings and profits deficit, X is an earnings and profits 
net surplus shareholder, and Y is an earnings and profits net 
deficit shareholder. The net earnings and profits surplus of X 
may be reduced by the net earnings and profits deficit of Y to 
the extent of the group's ownership percentage in Y, which is 
80 percent. The remaining net earnings and profits deficit of Y 
is unused. If the U.S. shareholder Z from Example 1 is also a 
wholly owned subsidiary of the same U.S. parent as X and Y, the 
group ownership percentage of Y is unchanged, and the surpluses 
of X and Z are reduced ratably by $800 of the net earnings and 
profits deficit of Y.
    In taxable years beginning after 2017, amounts by which a 
U.S. shareholder's section 951 inclusion is reduced by 
aggregate earnings and profits deficits are considered as 
amounts included in the gross income of the U.S. shareholder. 
The shareholder's pro rata share of the earnings and profits of 
an E&P deficit foreign corporation that used qualified deficits 
to reduce its section 965 inclusion is increased by the amount 
of such deficit and attributed to the same activity to which 
the income was attributed.

Partial participation exemption deduction

    A U.S. shareholder is allowed a deduction under section 
965(c) of a portion of its pro rata share of the section 965 
inclusion from all DFICs. The deductible portion is a sum of an 
amount equal to the 15.5-percent rate equivalent percentage of 
the portion of the shareholder's pro rata share of the 
inclusion amount that is the shareholder's aggregate cash 
position plus the eight-percent rate equivalent percentage of 
the portion of the inclusion that exceeds the aggregate cash 
position. By stating the permitted deduction in the form of a 
tax rate equivalent percentage rather than a flat rate of 
deduction, the provision ensures that all pre-effective date 
accumulated post-1986 deferred foreign income is subject to 
corporate tax at either an 8-percent rate or a 15.5-percent 
rate, without regard to the corporate tax rate that may be in 
effect at the time the shareholder is required to report the 
inclusion. For example, corporate U.S shareholders that use a 
fiscal year as their taxable year may not be required to 
include their pro rata share of the section 965 inclusions 
until a taxable year for which a corporate tax rate lower than 
that in effect for calendar year taxpayers for 2017 would 
apply. The structure of the allowable deduction ensures that 
amounts required to be included under sections 965 and 951 are 
generally subject to U.S. tax at either an 8-percent or 15.5 
percent rate.
            Aggregate cash position
    The aggregate cash position of a U.S. shareholder is the 
shareholder's pro rata share of the earnings and profits 
attributable to cash assets of specified foreign corporations. 
It is the greater of the pro rata share of the cash position of 
all specified foreign corporations of the U.S. shareholder as 
of the last day of the last taxable year beginning before 
January 1, 2018, or the pro rata share of the average of the 
cash position of such corporations determined on the last day 
of each of the two taxable years ending immediately before 
November 9, 2017. If a specified foreign corporation does not 
exist on any particular cash measurement date, its cash 
position would be zero with respect to that date. For purposes 
of this computation, the cash position of certain noncorporate 
entities that would be treated as specified foreign 
corporations if they were foreign corporations is also 
included.
    The cash position of a specified foreign corporation (or of 
an entity treated as such) consists of all cash, net accounts 
receivables, and the fair market value of the following 
enumerated categories of assets: personal property of a type 
that is actively traded on an established financial market 
(other than stock in the specified foreign corporation), 
government securities, certificates of deposit, commercial 
paper, foreign currency, and short-term obligations with a term 
of less than one year. In addition, the Secretary may identify 
other assets to be treated as cash assets if the Secretary 
determines that they are economically equivalent to the types 
of property enumerated in the statute.
    Certain exclusions from aggregate cash position of a U.S. 
shareholder are specified in the provision. First, in limited 
circumstances, the aggregate cash position does not include net 
accounts receivable, short-term obligations, or property of a 
type actively traded on an established financial market (e.g., 
publicly traded stock held by a specified foreign corporation.) 
This exception from inclusion in the aggregate cash position is 
limited to instances in which a U.S. shareholder can 
demonstrate that the value of such asset was taken into account 
as cash or cash equivalent by another specified foreign 
corporation with respect to which such shareholder is a U.S. 
shareholder.
    Second, the aggregate cash position of a U.S. shareholder 
does not generally include the cash attributable to a direct 
ownership interest in a partnership. However, cash positions of 
certain noncorporate foreign entities are taken into account if 
such entities would be specified foreign corporations with 
respect to the U.S. shareholder if the entity were a foreign 
corporation. For example, if a U.S. shareholder owns a five-
percent interest in a partnership, the balance of which is held 
by specified foreign corporations with respect to which such 
shareholder is a U.S. shareholder, the partnership is treated 
as a specified foreign corporation with respect to the U.S. 
shareholder, and the portion of its earnings held in cash or 
cash equivalent is includible in the aggregate cash position of 
the U.S. shareholder on a look-through basis. The Secretary may 
provide guidance for taking into account only the specified 
foreign corporations' share of the partnership's cash position, 
and not the five-percent interest directly owned by the U.S. 
shareholder.
    The provision grants the Secretary authority to disregard 
transactions that the Secretary determines had the principal 
purpose of reducing the aggregate foreign cash position.
            Special rules
    The rate equivalent percentages are intended to ensure that 
deferred foreign income of U.S. shareholders is generally 
subject to comparable rates of tax, without regard to the type 
of U.S. person who is the shareholder or the different rates of 
income tax to which a taxpayer may be subject. Individuals who 
are U.S. shareholders, as well as the individual investors in 
U.S. shareholders that are pass-through entities, may achieve 
rate parity with corporate shareholders by electing application 
of corporate rates for the year under inclusion, under section 
962. That section allows such individual U.S. shareholders to 
make the election for a specific taxable year, subject to 
regulations provided by the Secretary. Consistent with the goal 
of rate parity where possible, and to avoid duplicative tax on 
the amounts included in income under this provision, the entire 
amount of such inclusion, without reduction for the partial 
participation exemption deduction, is considered previously 
taxed income of the DFIC for purposes of subpart F.
    Special rules complement the rules that generally govern 
basis adjustments for U.S. shareholders that are not entities 
organized under subchapter C.\1688\ First, for partners in a 
partnership that is a U.S. shareholder of the DFIC, the 
increase in partnership income that is not taxed by reason of 
the partial dividends-received deduction available to the 
partner is treated as income not exempt from tax for purposes 
of determining the basis in an interest in a partnership.\1689\ 
As a result, the partner's section 951 inclusion requires an 
adjustment to basis for the partner's distributive share of the 
inclusion. Upon actual distribution, basis is decreased by the 
amount of the distribution.
---------------------------------------------------------------------------
    \1688\ Sec. 965(f)(2)(A).
    \1689\ Sec. 705(a)(1)(B).
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    Similar rules apply to the determination of basis in stock 
of an S corporation.\1690\ The general rules governing 
adjustments to basis and the accumulated adjustment account 
(``AAA'') of such corporations require an increase in basis, 
with adjustments to the AAA in a manner similar to basis, with 
several exceptions.\1691\ Among the exceptions is a rule that 
the AAA is not adjusted for tax-exempt income. The general 
rules require that both basis and the AAA increase by the 
taxable portion of the section 951 inclusion, i.e., the 
inclusion less the partial participation exemption deduction. 
The special rule in section 965(f)(2) treats an amount equal to 
the partial participation exemption deduction as income that is 
tax-exempt and requires an increase in shareholder basis for 
this amount, but as income that is not tax-exempt for purposes 
of the AAA adjustment.\1692\ Thus, the entire section 951 
inclusion increases both basis and the AAA. When subsequently 
distributed to the shareholder in the S corporation, a decrease 
in basis in the same amount is required.
---------------------------------------------------------------------------
    \1690\ Section 1361 defines an S corporation as a domestic small 
business corporation that has an election in effect for status as an S 
corporation, with fewer than 100 shareholders, none of whom are 
nonresident aliens, and all of whom are individuals, estates, trusts or 
certain exempt organizations.
    \1691\ Secs. 1367 and 1368. Under section 1367(a)(1), a 
shareholder's basis in an S corporation is increased by the amount 
included in income by the shareholder, including by reason of section 
965. This amount will also increase the S corporation's AAA pursuant to 
section 1368(e)(1)(A). Under section 1367(a)(2), a shareholder's basis 
in an S corporation is reduced by deductions, including the partial 
participation exemption deduction. This amount also reduces the S 
corporation's AAA pursuant to section 1368(e)(1)(A). Thus, both 
shareholder basis and the S corporation's AAA are increased by the net 
amount of the inclusion under section 965 (i.e., the amount included in 
income under Section 965(a)(1) less the amount allowed as a deduction 
under Section 965(c)).
    \1692\ Secs. 1367(a)(1)(A) and 1368(e)(1)(A).
---------------------------------------------------------------------------
    Individual U.S. shareholders of a DFIC who do not make an 
election under section 962 may claim the partial participation 
exemption deduction in computing adjusted gross income, without 
regard to limitations that may apply to itemized deductions. 
The section 965(c) deduction is not treated as an itemized 
deduction for any purpose.\1693\
---------------------------------------------------------------------------
    \1693\ A technical correction may be needed to reflect this intent. 
Filing instructions published for the 2018 filing season reflect this 
intent. See, Internal Revenue Service, ``Questions and Answers about 
Reporting Related to Section 965 on 2017 Tax Returns,'' Appendix: Q&A2, 
available at https://www.irs.gov/newsroom/questions-and-answers-about-
reporting-related-to-section-965-on-2017-tax-returns. See also, sec. 6, 
Notice 2018-26.
---------------------------------------------------------------------------

Foreign tax credits and the section 965(c) deduction

    A portion of foreign income taxes deemed paid under section 
960(a)(1) with respect to a U.S. shareholder's pro rata share 
of section 965 inclusions is creditable against the Federal 
income tax attributable to the inclusion. The portion that is 
attributable to the nontaxed portion of the deferred foreign 
income is neither creditable nor deductible. The disallowed 
portion of foreign taxes deemed paid is 55.7 percent of the 
foreign taxes deemed paid with respect to the inclusion 
attributable to the aggregate cash position plus 77.1 percent 
of the foreign taxes deemed paid with respect to the remaining 
portion of the section 965 inclusion.\1694\ A similar portion 
of foreign taxes paid, accrued or deemed paid with respect to 
distributions of previously taxed earnings and profits that 
result from an inclusion under section 965(a) (including taxes 
imposed on distributions of previously taxed earnings and 
profits that are the result of section 965(a)) is neither 
creditable nor deductible. In addition, it is intended that no 
deduction or credit is allowed for taxes associated with 
earnings and profits that, by reason of section 965(b), are not 
included in income.\1695\
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    \1694\ Other foreign tax credits used by a taxpayer against tax 
liability resulting from the deemed inclusion apply in full.
    \1695\ A technical correction may be needed to reflect this intent.
---------------------------------------------------------------------------
    The provision coordinates the disallowance of foreign tax 
credits described above with the requirement \1696\ that a 
domestic corporate shareholder is deemed to receive a dividend 
in an amount equal to foreign taxes it is deemed to have paid 
and for which it claimed a credit. Under the coordination rule, 
the foreign taxes deemed paid by a domestic corporation as a 
result of the inclusion are limited to the portion of those 
taxes in proportion to the taxable portion of the section 965 
inclusion. The gross-up amount equals the total foreign income 
taxes multiplied by a fraction, the numerator of which is the 
taxable portion of the increased subpart F income under this 
provision and the denominator of which is the total increase in 
subpart F income under this provision.
---------------------------------------------------------------------------
    \1696\ Sec. 78.
---------------------------------------------------------------------------
    A U.S. shareholder may elect,\1697\ no later than with a 
timely filed return for the taxable year, not to apply net 
operating loss carryovers to reduce taxable income in that year 
below the amount of the deemed repatriation. Depending on a 
taxpayer's circumstances, a possible effect of this election 
may be that the taxpayer offsets its U.S. tax in the transition 
tax year with a foreign tax credit that, had net operating 
losses reduced taxable income below the amount of the 
inclusion, would have been carried forward to future tax years 
to which the participation exemption regime applies. If the 
election is made, neither the pro rata share of the section 965 
inclusion (as reduced by the section 965(c) deduction), nor the 
section 78 gross-up in the amount of any related deemed paid 
foreign tax credits is taken into account in computing the 
amount of the net operating loss incurred in, or the amount of 
the net operating loss deduction allowed in that year. 
Deductions, whether for current year expenses or for a net 
operating loss carryover, taken into account in the election 
year may not exceed gross income determined without regard to 
the transition inclusion and related section 78 gross-up.\1698\
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    \1697\ Sec. 965(n).
    \1698\ A technical correction may be needed to reflect the intent. 
The reference in section 965(n)(1)(A) to ``a net operating loss 
deduction under section 172'' may be read to limit the election to a 
taxpayer's net operating loss carryforwards and carrybacks, but not 
allow losses in the year for which the election is made. However, any 
deductions that are deferred to preserve a net operating loss for the 
year may not also be deducted in the election year, so that the 
taxpayer's taxable income for the year cannot be less than the amount 
described in section 965(n)(2).
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Installment payments and special elections

            Election to pay transition tax over eight years
    A U.S. shareholder may elect to pay the net tax liability 
that results from the inclusion of a pro rata share of the 
section 965 inclusions in eight annual installments.\1699\ The 
net tax liability eligible to be paid in installments is the 
excess of the U.S. shareholder's net income tax for the taxable 
year in which the section 965 inclusions are included in income 
over the taxpayer's net income tax for that year determined 
without regard to the inclusion of such earnings or any 
dividend received by a U.S. shareholder from a DFIC. Net income 
tax is defined as the regular tax liability less certain 
nonrefundable credits.\1700\ Regular tax liability means 
regular tax as defined in section 26, which includes neither 
the minimum tax under section 59 nor the base erosion and anti-
abuse tax of section 59A. As a result, neither the alternative 
minimum tax (if applicable in computing the tax liability 
without regard to the section 965 inclusions) nor the base 
erosion and anti-abuse tax is considered in determining the 
portion of the tax liability that is eligible to be paid over 
eight installments.\1701\
---------------------------------------------------------------------------
    \1699\ The amount due with each installment is a prescribed 
percentage of the net tax liability, as follows: Each of installments 
one through five equals eight percent of the net tax liability. The 
sixth and seventh installments increase to 15 percent and 20 percent, 
respectively. The eighth installment equals 25 percent.
    \1700\ The credits taken into account for purposes of determining 
the net tax liability are those described in sections 21 through 26 
(nonrefundable personal credits), section 27 (taxes of foreign 
countries or territories of the United States), section 30A (Puerto 
Rican economic activity credit) sections 30B through 30D (related to 
fuel or motor vehicle), and sections 38 through 45S (certain business 
credits).
    \1701\ A technical correction may be needed to reflect the 
legislative intent.
---------------------------------------------------------------------------
    An election to pay tax in installments must be made by the 
due date for the tax return for the taxable year in which the 
pre-effective date undistributed CFC earnings are included in 
income. The Secretary has authority to prescribe the manner of 
making the election. The first installment must be paid on the 
due date (determined without regard to extensions) for the tax 
return for the taxable year of the income inclusion. Succeeding 
annual installments are due no later than the due dates 
(without extensions) for the income tax return of each 
succeeding year. If a deficiency is later determined with 
respect to the net tax liability, the additional tax due may be 
prorated among all installment payments in most circumstances. 
The portions of the deficiency prorated to an installment that 
was due before the deficiency was assessed must be paid upon 
notice and demand. The portion prorated to any remaining 
installment is payable with the timely payment of that 
installment payment, unless the deficiency is attributable to 
negligence, intentional disregard of rules or regulations, or 
fraud with intent to evade tax, in which case the entire 
deficiency is payable upon notice and demand.
    The timely payment of an installment does not incur 
interest. If a deficiency is determined that is attributable to 
an understatement of the net tax liability due under this 
provision, the deficiency is payable with underpayment interest 
for the period beginning on the date on which the net tax 
liability would have been due, without regard to an election to 
pay in installments, and ending with the payment of the 
deficiency. Furthermore, any amount of deficiency prorated to a 
remaining installment also bears interest on the deficiency, 
but not on the original installment amount.
    The provision also includes an acceleration rule. If (1) 
there is a failure to pay timely any required installment, (2) 
there is a liquidation or sale of substantially all of the U.S. 
shareholder's assets (including in a bankruptcy case), (3) the 
U.S. shareholder ceases business, or (4) another similar 
circumstance arises, the unpaid portion of all remaining 
installments is due on the date of the event (or, in a title 11 
bankruptcy case or similar proceeding, the day before the 
petition is filed).
            Special rule for S corporations
    A special rule permits deferral of the transition net tax 
liability for shareholders of a U.S. shareholder that is itself 
an S corporation and not subject to tax at the entity level. 
The S corporation is required to report on its income tax 
return for its last taxable year that begins before January 1, 
2018, the amount that is includible in gross income by reason 
of this provision, as well as the amount of deduction that 
would be allowable, and provide a copy of such information to 
each shareholder. Any shareholder of the S corporation may 
elect to defer his or her portion of the net tax liability 
until the shareholder's taxable year in which a triggering 
event occurs. The election to defer the net tax liability is 
due not later than the due date for the shareholder's tax 
return for the taxable year that includes the close of the 
taxable year in which the S corporation reports the inclusion 
required by this provision.
    Three types of events may trigger an end to deferral of the 
net tax liability. The first type of triggering event is a 
change in the status of the corporation as an S corporation. 
The second category includes liquidation or sale of 
substantially all corporate assets (including by reason of 
reorganization in bankruptcy or similar proceeding), 
termination of the company or end of business, or similar 
event. The third type of triggering event is a transfer of 
shares of stock in the S corporation by the electing taxpayer, 
whether by sale, death, or otherwise, unless the transferee of 
the stock agrees with the Secretary to be liable for net tax 
liability in the same manner as the transferor. Partial 
transfers trigger the end of deferral only with respect to the 
portion of tax properly allocable to the portion of stock sold.
    If a shareholder of an S corporation has elected deferral 
under the special rule for S corporation shareholders and a 
triggering event occurs, the S corporation and the electing 
shareholder are jointly and severally liable for any net tax 
liability and related interest or penalties. The period within 
which the IRS may collect such liability does not begin before 
the date of an event that triggers the end of the deferral. If 
an election to defer payment of the net tax liability is in 
effect for a shareholder, that shareholder must report the 
amount of the deferred net tax liability on each income tax 
return due during the period that the election is in effect. 
Failure to include that information with each income tax return 
will result in a penalty equal to five percent of the amount 
that should have been reported.
    After a triggering event occurs, a shareholder of the S 
corporation may elect to pay the net tax liability in eight 
installments, subject to rules similar to those generally 
applicable to all U.S. shareholders, with certain exceptions. 
If the triggering event is a liquidation, sale of substantially 
all corporate assets, termination of the company or end of 
business, or similar event, the installment payment election is 
not available. Instead, the entire net tax liability is due 
upon notice and demand. The installment election is due with 
the timely return for the year in which the triggering event 
occurs. The first installment payment is required by the due 
date of the same return, determined without regard to 
extensions of time to file.
            Special rules for REITs
    Special rules are also provided to address instances in 
which the U.S. shareholder is a EIT. First, although the REIT 
must determine its pro rata share of the increase in subpart F 
income in accordance with the rules described above, the REIT 
is not required to take into account the section 951 inclusion 
for purposes of determining the REIT's amount of qualified REIT 
gross income.\1702\ The section 951 inclusion is, however, 
taken into account for purposes of determining the income 
potentially required to be included in taxable income under 
section 857(b).
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    \1702\ To qualify as a REIT, an entity must meet certain income 
requirements. A REIT is restricted to earning certain types of 
generally passive income. Among other requirements, at least 75 percent 
of the gross income of a REIT in each taxable year must consist of real 
estate-related income. Sec. 856. In addition, a REIT is required to 
distribute at least 90 percent of REIT income (other than net capital 
gain) annually. Sec. 857. Even if a REIT meets the 90-percent income 
distribution requirement for REIT qualification, more stringent 
distribution requirements must be met to avoid an excise tax under 
section 4981.
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    A REIT is generally permitted to deduct the portion of its 
income that is distributed to its shareholders as a dividend or 
qualifying liquidating distribution each year.\1703\ The 
distributed income of the REIT is not taxed at the entity 
level; instead, it is taxed once, at the investor level. 
Requiring inclusion under this section could trigger a 
requirement that the REIT distribute an amount equal to 90 
percent of that inclusion despite the fact that the REIT 
received no distribution from the DFIC.
---------------------------------------------------------------------------
    \1703\ Liquidating distributions are covered to the extent of 
earnings and profits, and are defined to include redemptions of stock 
that are treated by shareholders as a sale of stock under section 302. 
Secs. 857(b)(2)(B), 561, and 562(b).
---------------------------------------------------------------------------
    To avoid requiring that any distribution requirement be 
satisfied in one year, a REIT may elect to defer a portion of 
the section 951 inclusion. Under a timely election, a REIT may 
instead take the amounts into income over a period of eight 
years. It must include eight percent in each of the five years 
beginning with the initial year in which the section 951 
inclusion is determined, 15 percent in the sixth year, 20 
percent in the seventh year and 25 percent in the eighth year. 
In each of those years, it may claim a partial dividends-
received deduction in the applicable percentages in proportion 
to the amount included in each of the eight years. If a timely 
election is made by the REIT to defer inclusion, neither the 
REIT nor its investors may invoke the installment payment 
election.\1704\
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    \1704\ Under section 965(m)(2)(B)(i)(III), a rule barring an 
electing trust from making an election to pay in installments refers to 
subsection (g), which deals with foreign tax credits, rather than 
subsection (h). A technical correction may be needed to reflect the 
correct cross-reference.
---------------------------------------------------------------------------
    In the event that a REIT liquidates, ceases to operate its 
business, or distributes substantially all its assets (or any 
other similar event occurs), any portion of the required 
inclusion not yet taken into income is accelerated and required 
to be included as gross income as of the day before the event.

Limitations on assessment extended

    The provision establishes a minimum period of six years for 
assessment of the transition tax, or underpayments with respect 
to the transition tax, measured from the date on which the 
return initially reflecting the section 951 inclusion was 
filed. To the extent that such return was filed by a U.S. 
shareholder that is a domestic partnership, a commensurate 
extension of the period for making adjustments to a partnership 
return is intended.\1705\ The provision does not operate to 
shorten any otherwise applicable limitations period that would 
provide a greater period for such adjustments or assessments.
---------------------------------------------------------------------------
    \1705\ A technical correction may be needed to reflect the intent.
---------------------------------------------------------------------------

Recapture from expatriated entities

    The partial participation exemption deduction is subject to 
recapture if the U.S. shareholder that claimed the deduction 
becomes an expatriated entity at any point during the 10 years 
beginning on the date of enactment of the Act (December 22, 
2017). An entity is subject to the recapture rule if it becomes 
an expatriated entity with respect to which a foreign 
corporation becomes a surrogate foreign corporation for the 
first time during the same 10-year period. For purposes of this 
rule, the terms expatriated entity and surrogate foreign 
corporation are given the same meaning as those terms are 
defined in section 7874(a)(2), except that a surrogate foreign 
corporation that is treated as a domestic corporation under 
section 7874(b) is not within the scope of this recapture 
provision.
    The recapture rule operates by increasing the tax in the 
year of expatriation. The income tax otherwise due in the year 
of expatriation is increased by an amount equal to 35 percent 
of the claimed partial participation exemption deduction. 
Although the amount due is computed by reference to the year in 
which the deemed subpart F income was originally reported and 
the deduction claimed, the additional tax arises and is 
assessed for the taxable year in which the U.S. shareholder 
becomes an expatriated entity. No credits are permitted to 
offset the additional tax due as a result of the recapture 
rule.

Regulatory authority

    The provision specifies several areas for which regulatory 
action is expected to carry out the intent of the provision and 
to deter tax avoidance. With respect to the determination of 
cash position, the provision specifically authorizes the 
Secretary to identify other assets that are economically 
equivalent to the enumerated assets that are treated as cash. 
The provision also authorizes the Secretary to disregard 
transactions that are determined to have the principal purpose 
of reducing the aggregate foreign cash position. The specific 
grants of regulatory authority complement the Secretary's 
authority under the consolidated return provisions and allow 
him to determine proper application of this section on a 
consolidated basis for affiliated groups filing a consolidated 
return.
    To avoid double-counting of earnings (or double 
noncounting) that may occur due to different measurement dates 
applicable to specified foreign corporations within an 
affiliated group or the timing of intragroup distributions, the 
Secretary is required to provide guidance to adjust the amount 
of post-1986 earnings and profits of a specified foreign 
corporation to ensure that a single item of a specified foreign 
corporation is taken into account only once in determining the 
income of a U.S. shareholder subject to this provision. For 
example, the Secretary may identify instances in which it is 
appropriate to adjust the amount of post-1986 earnings and 
profits of a specified foreign corporation to ensure that the 
earnings and profits of the specified foreign corporation are 
taken into account once. Such an adjustment may be necessary, 
for example, when there is a deductible payment (e.g., interest 
or royalties) from one specified foreign corporation to another 
specified foreign corporation between measurement dates.
    The grant of regulatory authority in the provision includes 
a nonexhaustive list of examples of areas in which the 
Secretary shall prescribe rules or guidance that are consistent 
with the intent of the statute and deter tax avoidance through 
use of entity classification elections and accounting method 
changes, among other possible strategies (e.g., intragroup 
transactions such as distributions or liquidations).
    The Secretary has proposed regulations pursuant to this 
provision.\1706\
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    \1706\ See, Prop. Treas. Reg. sec. 1.965-1 et seq. Notice of 
Proposed Rulemaking, 83 FR 39514, August 9, 2018.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for the last taxable year of a 
foreign corporation that begins before January 1, 2018, and 
with respect to U.S. shareholders, for the taxable years in 
which or with which such taxable year of the foreign 
corporation ends.

         SUBPART B--RULES RELATED TO PASSIVE AND MOBILE INCOME


A. Current Year Inclusion of Global Intangible Low-Taxed Income by U.S. 
Shareholders (sec. 14201 of the Act and sec. 78 and new secs. 951A and 
                          960(d) of the Code)


                        Explanation of Provision


In general

    Under the provision, a U.S. shareholder \1707\ of any CFC 
must include in gross income for a taxable year its global 
intangible low-taxed income (``GILTI'') in a manner generally 
similar to inclusions of subpart F income. GILTI means, with 
respect to any U.S. shareholder for the shareholder's taxable 
year, the excess (if any) of the shareholder's net CFC tested 
income over the shareholder's net deemed tangible income 
return. The shareholder's net deemed tangible income return 
equals the excess (if any) of 10 percent of the aggregate of 
its pro rata share of the qualified business asset investment 
(``QBAI'') of each CFC with respect to which it is a U.S. 
shareholder over certain interest expense. The interest expense 
that reduces a U.S. shareholder's net deemed tangible income 
return is the amount of interest expense taken into account in 
determining its net CFC tested income for the taxable year to 
the extent that the interest income attributable to such 
interest expense is not taken into account in determining the 
shareholder's net CFC tested income.
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    \1707\ As determined under section 951A(e)(2), described below.
---------------------------------------------------------------------------
    The formula for GILTI, which is calculated at the U.S. 
shareholder level, is:

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    where Interest Expense is defined and limited in the manner 
described above.\1708\
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    \1708\ As the net deemed tangible income return cannot be less than 
zero, the formula assumes that interest expense does not exceed 10 
percent of QBAI. Otherwise, GILTI equals net CFC tested income.
---------------------------------------------------------------------------
    Although a GILTI inclusion is generally treated as a 
subpart F inclusion, GILTI is not subpart F income. Unlike 
subpart F income, GILTI is computed at the U.S.-shareholder 
level rather than the CFC level, with a U.S. shareholder 
allowed to offset tested income of its CFCs with tested loss of 
other CFCs in computing net CFC tested income. U.S. 
shareholders are not allowed certain other tax attributes of 
CFCs with tested loss--such as foreign tax credits and QBAI--
when computing tax liability associated with GILTI. In 
addition, the foreign tax credit limitation is applied 
separately with respect to GILTI, and, in contrast with the 
general rules allowing carryovers and carrybacks of excess 
foreign tax credits, no carryovers and carrybacks of excess 
foreign tax credits are allowed in the GILTI foreign tax credit 
limitation category.

Net CFC tested income

    Net CFC tested income means, with respect to any U.S. 
shareholder, the excess of the aggregate of the shareholder's 
pro rata share of the tested income of each CFC with respect to 
which it is a U.S. shareholder over the aggregate of its pro 
rata share of the tested loss of each CFC with respect to which 
it is a U.S. shareholder.\1709\ Pro rata shares are determined 
under subpart F principles (i.e., the rules of section 
951(a)(2) and the regulations thereunder).
---------------------------------------------------------------------------
    \1709\ Sec. 951A(c)(1).
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    The formula for net CFC tested income of the U.S. 
shareholder is:

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    The tested income of a CFC is the excess (if any) of the 
gross income of the CFC determined without regard to certain 
amounts that are exceptions to tested income (referred to in 
this document as ``gross tested income'') over deductions 
(including taxes) properly allocable to such gross income. The 
exceptions to a CFC's tested income are: (1) any effectively 
connected income described in section 952(b); (2) any gross 
income taken into account in determining the CFC's subpart F 
income; (3) any gross income excluded from foreign base company 
income or insurance income by reason of the high-tax exception 
under section 954(b)(4); (4) any dividend received from a 
related person (as defined in section 954(d)(3)); and (5) any 
foreign oil and gas extraction income (as defined in section 
907(c)(1)).
    The tested loss of a CFC means the excess (if any) of 
deductions (including taxes) properly allocable to the CFC's 
gross tested income over the amount of such gross income.
    For purposes of computing deductions (including taxes) 
properly allocable to gross tested income, the deductions are 
allocated to such gross income following rules similar to the 
rules of section 954(b)(5) (or to which such deductions would 
be allocable if there were such gross income).

Qualified business asset investment

    QBAI means, with respect to any CFC for a taxable year, the 
average of the aggregate of its adjusted bases, determined as 
of the close of each quarter of the taxable year, in specified 
tangible property used in its trade or business and of a type 
with respect to which a deduction is generally allowable under 
section 167.\1710\ The adjusted basis in any property is 
determined by allocating the depreciation deduction with 
respect to the property ratably to each day during the period 
in the taxable year to which the depreciation relates, with 
depreciation deductions calculated using the alternative 
depreciation system under section 168(g) as in effect on the 
date of enactment of the Act, unless a later enacted law 
specifically and directly amends the definition of QBAI under 
section 951A.
---------------------------------------------------------------------------
    \1710\ Sec. 951A(d)(1).
---------------------------------------------------------------------------
    Specified tangible property means any property used in the 
production of tested income.\1711\ If such property was used in 
the production of both gross tested income and gross income 
that is not gross tested income (i.e., dual-use property), the 
property is treated as specified tangible property in the same 
proportion that the amount of gross tested income produced with 
respect to the property bears to the total amount of gross 
income produced with respect to the property.\1712\
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    \1711\ Sec. 951A(d)(2). Specified tangible property does not 
include property used in the production of tested loss, so that a CFC 
that has a tested loss in a taxable year does not have QBAI for such 
taxable year.
    \1712\ A technical correction may be needed to reflect this intent. 
For example, if a building produces $1,000 of gross tested income and 
$250 of gross subpart F income for a taxable year, then 80 percent 
($1,000/$1,250) of a CFC's average adjusted basis in the building is 
included in QBAI for that taxable year.
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    If a CFC holds an interest in a partnership at the close of 
the CFC's taxable year, the CFC takes into account its 
distributive share of the aggregate of the partnership's 
adjusted basis (determined as of such date in the hands of the 
partnership) in tangible property held by the partnership to 
the extent that the property is used in the trade or business 
of the partnership, is of a type with respect to which a 
deduction is allowable under section 167, and is used in the 
production of tested income (determined with respect to the 
CFC's distributive share of income with respect to the 
property). The CFC's distributive share of the adjusted basis 
of any property is the CFC's distributive share of income with 
respect to the property.

Coordination with subpart F

    In contrast with subpart F income, which is a CFC amount, 
GILTI is a U.S.-shareholder amount. Nonetheless, GILTI 
inclusions are generally treated as subpart F inclusions.\1713\ 
In particular, GILTI inclusions are treated in the same manner 
as amounts included as subpart F income for purposes of 
applying sections 168(h)(2)(B), 535(b)(10), 904(h)(1), 959, 
961, 962, 993(a)(1)(E), 996(f)(1), 1248(b)(1), 1248(d)(1), 
6501(e)(1)(C), 6654(d)(2)(D), and 6655(e)(4).\1714\ The 
Secretary may provide rules for treating GILTI inclusions as 
amounts included as subpart F income for other provisions of 
the Code in which the determination of subpart F income is 
required to be made at the CFC level.
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    \1713\ Under Rev. Proc. 2018-48, amounts included in gross income 
by a REIT under sections 951(a)(1) (except by reason of section 965) 
and 951A(a), among other provisions in the Code, are treated as 
qualifying income for purposes of the gross income test under section 
856(c)(2).
    \1714\ Sec. 951A(f)(1).
---------------------------------------------------------------------------
    The provision requires that the total amount of GILTI 
included by a U.S. shareholder be allocated across all CFCs 
with respect to which it is a U.S. shareholder. The portion of 
GILTI treated as being allocable to a CFC is zero for a CFC 
with no tested income and is, for a CFC with tested income, the 
portion of GILTI which bears the same ratio to the total amount 
of GILTI as the U.S. shareholder's pro rata amount of the 
tested income of the CFC bears to the aggregate amount of the 
U.S. shareholder's pro rata amount of the tested income of each 
CFC with respect to which it is a U.S. shareholder. For a CFC 
with tested income, the following formula expresses how to 
determine the portion of GILTI treated as being allocable to 
the CFC: 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

where Share of CFC's Tested Income is the U.S. shareholder's 
pro rata amount of the tested income of a CFC, Share of Agg. 
CFC Tested Income is the aggregate amount of the U.S. 
shareholder's pro rata amount of the tested income of each CFC 
with respect to which it is a U.S. shareholder, and GILTI is 
the total amount of GILTI included by the U.S. shareholder.
    For purposes of the provision, a person is treated as a 
U.S. shareholder of a CFC for any taxable year of such person 
only if the person owns (within the meaning of section 958(a)) 
stock in the foreign corporation on the last day in the taxable 
year of the foreign corporation on which the foreign 
corporation is a CFC.\1715\ A corporation is generally treated 
as a CFC for any taxable year if the corporation is a CFC at 
any time during the taxable year.
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    \1715\ Sec. 951A(e)(2).
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Deemed-paid credit for taxes properly attributable to tested income

    For any amount of GILTI included in the gross income of a 
domestic corporation, the corporation is allowed a deemed-paid 
credit equal to 80 percent of the corporation's inclusion 
percentage multiplied by the aggregate (i.e., sum of) tested 
foreign income taxes paid or accrued, with respect to tested 
income (but not tested loss), by each CFC with respect to which 
the domestic corporation is a U.S. shareholder.\1716\ The 
inclusion percentage means, with respect to any domestic 
corporation, the ratio (expressed as a percentage) of such 
corporation's GILTI amount divided by the aggregate amount of 
its pro rata share of the tested income (but not tested loss) 
of each CFC with respect to which it is a U.S. shareholder 
(referred to as ``aggregate tested income'' in the formulas 
below). Tested foreign income taxes means, with respect to any 
domestic corporation that is a U.S. shareholder of a CFC, the 
foreign income taxes paid or accrued by the CFC that are 
properly attributable to the CFC's tested income (but not 
tested loss).\1717\
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    \1716\ Sec. 960(d)(1). In addition, only 80 percent of foreign 
income taxes paid or accrued (or treated as paid or accrued) with 
respect to distributions out of income that was previously taxed as 
GILTI are creditable under section 901, and the amount not creditable 
is not deductible under section 901. A technical correction may be 
needed to reflect this intent.
    \1717\ Tested foreign income taxes do not include any foreign 
income tax paid or accrued by a CFC that is properly attributable to 
the CFC's tested loss (if any).
---------------------------------------------------------------------------
    The deemed-paid credit with respect to a U.S. shareholder's 
GILTI inclusion can be expressed in the following formula:

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    The provision creates a separate foreign tax credit 
limitation for GILTI, with no carryforward or carryback 
available for excess credits.\1718\ For purposes of determining 
the foreign tax credit limitation, GILTI is not general 
category income, and income that is both GILTI and passive 
category income is considered passive category income. As 
provided in section 14301 of the Act and amended section 78, 
the taxes deemed to have been paid are treated as a dividend 
under section 78, determined by taking into account 100 percent 
of the product of the inclusion percentage and aggregate tested 
foreign income taxes (instead of 80 percent in the 
determination of the deemed-paid credit). For foreign tax 
credit limitation purposes, the section 78 gross-up amount 
attributable to a GILTI inclusion is assigned to the basket to 
which the related foreign taxes deemed paid were 
allocated.\1719\
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    \1718\ Financial services income (sec. 904(d)(2)(C)(i)) is not 
treated as passive category income for foreign tax credit limitation 
purposes. A technical correction may be needed to reflect this intent. 
In addition, the carryback and carryover rules for foreign oil and gas 
taxes under section 907(f)(1) do not apply to taxes paid or accrued 
with respect to GILTI. A technical correction may be needed to reflect 
this intent.
    \1719\ A technical correction may be needed to reflect this intent.
---------------------------------------------------------------------------
    The section 78 gross-up amount can be expressed in the 
following formula:

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

Regulatory authority to address abuse

    Congress intends that non-economic transactions intended to 
affect tax attributes of CFCs and their U.S. shareholders 
(including amounts of tested income and tested loss, tested 
foreign income taxes, net deemed tangible income return, and 
QBAI) to minimize tax under this provision be disregarded. One 
area of concern for Congress is certain planning related to 
QBAI and the transition to the participation exemption system 
created by the Act. The Secretary is expected to prescribe 
regulations to address transactions undertaken to increase a 
CFC's QBAI that occur after the measurement date of post-1986 
earnings and profits under amended section 965, but before the 
first taxable year for which new section 951A applies.
    The Secretary has proposed regulations pursuant to this 
provision.\1720\
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    \1720\ See Prop. Treas. Reg. sec. 1.951-1 et seq. Notice of 
Proposed Rulemaking, 83 FR 51072, October 10, 2018.
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Examples

    The following examples illustrate how GILTI is calculated 
for domestic corporations and allocated across CFCs. The 
examples are highly stylized and are not meant to represent 
actual taxpayer scenarios. These examples account for the 50-
percent deduction for GILTI available to domestic corporations 
under new section 250 (described in section 14202 of the Act) 
for taxable years beginning after December 31, 2017, and before 
January 1, 2026.\1721\
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    \1721\ For taxable years after December 31, 2025, the deduction for 
GILTI and the GILTI-attributable section 78 gross-up amount is reduced 
to 37.5 percent. The examples assume that the deduction is 50 percent 
and therefore assume that the calculations are being performed with 
respect to a taxable year of a domestic corporation beginning after 
December 31, 2017, and before January 1, 2026.
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            Example 1: Two Wholly Owned CFCs, Each with Tested Income
    Assume a domestic corporation, USCo, wholly owns two CFCs, 
CFC1 and CFC2, and has no expenses or other sources of income. 
These are the only CFCs with respect to which USCo is a U.S. 
shareholder. The following table includes more information 
about CFC1 and CFC2. Assume that their foreign sales income are 
items of gross income included in the computation of tested 
income, and that CFC1 and CFC2 each allocate all of their 
expenses to their foreign sales income. Also assume that CFC1 
and CFC2 each face a uniform tax rate across all their sources 
of income.

                           FACTS FOR EXAMPLE 1
------------------------------------------------------------------------
                                         CFC1                CFC2
------------------------------------------------------------------------
Gross Income:
    Foreign Sales Income........  $300..............  $2,000
    Subpart F Income............  $100..............  $0
    Oil Extraction Income.......  $600..............  $0
Expenses:
    Operating Expenses..........  $200..............  $300
Net Income......................  $800..............  $1,700
Foreign Tax Rate................  20 percent........  5 percent
QBAI............................  $500..............  $0
------------------------------------------------------------------------

            CFC-level calculations of tested income
    CFC1 earns foreign sales income of $300 and has deductions 
of $220 ($20 of taxes plus $200 of operating expenses) 
allocable to its foreign sales income. The subpart F income and 
oil extraction income are not included in tested income. 
Therefore, it has tested income of $80 ($300-$220) and tested 
foreign income tax of $20 (20 percent * [$300-$200]). CFC1 has 
QBAI of $500.
    CFC2 earns foreign sales income of $2,000 and has 
deductions of $385 ($85 of taxes plus $300 of operating 
expenses) allocable to its foreign sales income. Therefore, it 
has tested income of $1,615 ($2,000-$385) and tested foreign 
income tax of $85 (5 percent * [$2,000-$300]). CFC2 has QBAI of 
$0.
            U.S.-shareholder-level calculation of GILTI and U.S. tax 
                    liability
    USCo has net CFC tested income of $1,695, which is the sum 
of CFC1's tested income of $80 and CFC2's tested income of 
$1,615. Its pro rata share of QBAI is $500 ([100 percent * 
$500] + [100 percent * $0]). Therefore, USCo's GILTI = 
$1,695-(10 percent * $500) = $1,645.
    USCo is allowed a deemed-paid credit equal to 80 percent of 
its inclusion percentage multiplied by the aggregate tested 
foreign income taxes paid or accrued by CFC1 and CFC2. Its 
inclusion percentage is 97.05 percent (GILTI/Aggregate Tested 
Income = $1,645/$1,695). With respect to USCo, the aggregate 
tested foreign income taxes paid or accrued by CFC1 and CFC2 is 
$105 ($20 + $85). Therefore, USCo's deemed-paid credit is 80 
percent * 97.05 percent * $105 = $81.52.
    USCo includes 100 percent of its GILTI and section 78 
gross-up amount in gross income, or $1,746.90 ($1,645 + 
$101.90).\1722\ It is allowed a deduction for 50 percent of 
this amount, or $873.45, resulting in U.S. taxable income of 
$873.45. The tentative U.S. tax owed on this income is the U.S. 
corporate tax rate of 21 percent applied to USCo's taxable 
income amount of $873.45, or $183.42.
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    \1722\ The section 78 gross-up amount = 100 percent * 97.05 percent 
* $105 = $101.90.
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    The residual U.S. tax paid by USCo on its GILTI is its 
tentative U.S. tax of $183.42 less its deemed-paid credit of 
$81.52, or $101.90.
            Allocation of GILTI across CFCs
    USCo's GILTI amount is allocated across each CFC with 
respect to which it is a U.S. shareholder based on the 
percentage of its pro rata share of the tested income of all 
CFCs that is accounted for by each CFC. The portion of USCo's 
GILTI amount of $1,645 treated as being with respect to CFC1 
equals $77.64 ($1,645 * [$80/$1,695]). The portion of USCo's 
GILTI amount that is treated as being with respect to CFC2 is 
the remainder, or $1,567.36 ($1,645 * [$1,615/$1,695]).
            Example 2: Variant of Example 1, With Tested Loss
    Example 2 generally has the same facts as Example 1, except 
that CFC2 has foreign sales income of $360. Assume that CFC2 
still pays foreign taxes of $85 with respect to its foreign 
sales income. Thus, CFC2 has foreign sales income of $360 and 
deductions of $385 ($85 of taxes plus $300 of operating 
expenses) allocable to its foreign sales income. Therefore, it 
has tested loss of $25 ($360-$385). Because CFC2 has a tested 
loss, the foreign income taxes paid by CFC2 are not tested 
foreign income taxes.
    As in Example 1, CFC1 has tested income of $80 and tested 
foreign income tax of $20.
            U.S.-shareholder-level calculation of GILTI and U.S. 
                    liability
    USCo has net CFC tested income of $55, which is CFC1's 
tested income of $80 less CFC2's tested loss of $25. Its pro 
rata share of QBAI is $500 ([100 percent * $500] + [100 percent 
* $0]).\1723\ Therefore, USCo's GILTI = $55-(10 percent * $500) 
= $5.
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    \1723\ Note that a CFC that has a tested loss in a taxable year 
(such as CFC2 in Example 2) does not have QBAI for such taxable year.
---------------------------------------------------------------------------
    USCo is allowed a deemed-paid credit equal to 80 percent of 
its inclusion percentage multiplied by the aggregate tested 
foreign income taxes paid or accrued by CFC1 and CFC2. Its 
inclusion percentage is 6.25 percent (GILTI/Aggregate Tested 
Income = $5/$80). With respect to USCo, the aggregate tested 
foreign income taxes paid or accrued by CFC1 and CFC2 is $20. 
Therefore, USCo's deemed-paid credit is 80 percent * 6.25 
percent * $20 = $1.
    USCo includes 100 percent of its GILTI and section 78 
gross-up amount in gross income, or $6.25 ($5 + $1.25).\1724\ 
It is allowed a deduction for 50 percent of this amount, or 
$3.13, resulting in U.S. taxable income of $3.12 ($6.25-$3.13). 
The tentative U.S. tax owed on this income is the U.S. 
corporate tax rate of 21 percent applied to USCo's taxable 
income amount, or $0.66.
---------------------------------------------------------------------------
    \1724\ The section 78 gross-up amount = 100 percent * 6.25 percent 
* $20 = $1.25.
---------------------------------------------------------------------------
    The residual U.S. tax paid by USCo on its GILTI is its 
tentative U.S. tax of $0.66 less its deemed-paid credit of $1, 
or $0. The amount of USCo's deemed-paid credit that is unused, 
$0.34, may not be carried back or carried forward.
            Allocation of GILTI across CFCs
    Because only CFC1 has tested income among each CFC with 
respect to which USCo is a U.S. shareholder, all of USCo's 
GILTI of $5 is allocated to CFC1.
            Example 3: Multiple U.S. Shareholders and CFCs
    Example 3 illustrates how GILTI is calculated when there 
are multiple U.S. shareholders of one CFC, and each U.S. 
shareholder wholly owns another CFC.
    Consider two domestic corporations, US1 and US2. US1 wholly 
owns CFC1 and owns 75 percent of the shares in CFC2. US2 wholly 
owns CFC3 and owns 25 percent of the shares in CFC2. Neither 
US1 nor US2 have expenses or other sources of income or own 
shares in other CFCs besides the ones described.
    Additional facts for Example 3 are described below. Assume 
that gross income from foreign sales is included in the 
computation of tested income for each CFC.

                                               FACTS FOR EXAMPLE 3
----------------------------------------------------------------------------------------------------------------
                                                 CFC1                     CFC2                     CFC3
----------------------------------------------------------------------------------------------------------------
Gross Income:
    Foreign Sales Income.............  $1,500.................  $2,000.................  $700
Expenses:
    Operating Expenses...............  $200...................  $300...................  $800
Net Income...........................  $1,300.................  $1,700.................  -$100
Foreign Tax Rate.....................  10 percent.............  5 percent..............  15 percent
QBAI.................................  $500...................  $1,000.................  $0
----------------------------------------------------------------------------------------------------------------

            CFC-level calculations of tested income
    CFC1 earns foreign sales income of $1,500, pays foreign 
income tax of $130 (10 percent * $1,300), and has deductions of 
$330 ($130 of taxes plus $200 of expenses) allocable to its 
foreign sales income. Therefore, it has tested income of $1,170 
($1,500-$330) and tested foreign income tax of $130. CFC1 has 
QBAI of $500.
    CFC2 earns foreign sales income of $2,000, pays foreign 
income tax of $85 (5 percent * $1,700), and has deductions of 
$385 ($85 of taxes plus $300 of expenses) allocable to its 
foreign sales income. Therefore, it has tested income of $1,615 
($2,000-$385) and tested foreign income tax of $85. CFC2 has 
QBAI of $1,000.
    CFC3 earns foreign sales income of $700, pays no foreign 
income tax, and has deductions of $800 allocable to its foreign 
sales income. Therefore, it has tested loss of $100. Because 
CFC3 has tested loss, it has no QBAI.
                U.S.-shareholder-level calculation of GILTI and U.S. 
                    tax liability
            US1's GILTI and U.S. tax liability
    US1 has net CFC tested income of $2,381.25, which is the 
sum of CFC1's tested income of $1,170 and US1's pro rata share 
(75 percent) of CFC2's tested income of $1,615 (or $1,211.25). 
US1 has aggregate tested foreign income tax of $193.75, which 
is the sum of CFC1's tested foreign income tax of $130 and 
US1's pro rata share of CFC2's tested foreign income tax of $85 
(or $63.75). Its pro rata share of QBAI is $1,250 ([100 percent 
* $500] + [75 percent * $1,000]). Therefore, US1's GILTI = 
$2,381.25-(10 percent * $1,250) = $2,256.25.
    US1 is allowed a deemed-paid credit equal to 80 percent of 
its inclusion percentage multiplied by the aggregate tested 
foreign income taxes paid or accrued by CFC1 and CFC2. Its 
inclusion percentage is 94.8 percent (GILTI/Aggregate Tested 
Income = $2,256.25/$2,381.25). The aggregate tested foreign 
income taxes paid or accrued by CFC1 and CFC2 with respect to 
US1 is $193.75. Therefore, US1's deemed-paid credit is 80 
percent * 94.8 percent * $193.75 = $146.94.
    US1 includes 100 percent of its GILTI and section 78 gross-
up amount in gross income, or $2,439.93 ($2,256.25 + 
$183.68).\1725\ 
It is allowed a deduction of 50 percent of this amount, or 
$1,219.97, resulting in U.S. taxable income of $1,219.96 
($2,439.93-$1,219.97). The tentative U.S. tax owed on this 
income is the U.S. corporate tax rate of 21 percent applied to 
US1's taxable income of $1,219.96, or $256.19.
---------------------------------------------------------------------------
    \1725\ The section 78 gross-up amount = 100 percent * 94.8 percent 
* $193.75 = $183.68.
---------------------------------------------------------------------------
    The residual U.S. tax paid by US1 on its GILTI is its 
tentative U.S. tax of $256.19 less its deemed-paid credit of 
$146.94, or $109.25.
            US2's GILTI and U.S. tax liability
    US2 has net CFC tested income of $303.75, which is its pro 
rata share of CFC2's tested income ($403.75 = 25 percent * 
$1,615) less the $100 in tested loss of CFC3. US2 has aggregate 
tested foreign income tax of $21.25, which is 25 percent of 
CFC2's tested foreign income tax of $85. Because CFC3 has a 
tested loss, it has no tested foreign income tax and no QBAI. 
US2's pro rata share of QBAI is $250 ([25 percent * $1,000] + 
[100 percent * $0]). Therefore, US2's GILTI = $303.75-(10 
percent * $250) = $278.75.
    US2 is allowed a deemed-paid credit equal to 80 percent of 
its inclusion percentage multiplied by its aggregate tested 
foreign income taxes. Its inclusion percentage is 69 percent 
(GILTI/Aggregate Tested Income = $278.75/$403.75). US2's pro 
rata share of CFC2's tested foreign income tax is $21.25 (25 
percent * $85). Therefore, US2's deemed-paid credit is 80 
percent * 69 percent * $21.25 = $11.73.
    US2 includes 100 percent of its GILTI and section 78 gross-
up amount in gross income, or $293.41 ($278.75 + $14.66).\1726\ 
It is allowed a deduction for 50 percent of this amount, or 
$146.71, resulting in U.S. taxable income of $146.70 
($293.41-$146.71). The tentative U.S. tax owed on this income 
is the U.S. corporate tax rate of 21 percent applied to US2's 
taxable income of $146.70, or $30.81.
---------------------------------------------------------------------------
    \1726\ The section 78 gross-up amount = 100 percent * 69 percent * 
$21.25 = $14.66.
---------------------------------------------------------------------------
    The residual U.S. tax paid by US2 on its GILTI is its 
tentative U.S. tax of $30.81 less its deemed-paid credit of 
$11.73, or $19.08.
            Allocation of GILTI across CFCs
    US1 has $2,256.25 of GILTI to be allocated across each of 
its CFCs with tested income. Its pro rata share of the 
aggregate tested income of each CFC with respect to which it is 
a U.S. shareholder is $2,381.25, with its pro rata share of 
CFC1's tested income accounting for 49.1 percent ($1,170/
$2,381.25) and its pro rata share of CFC2's tested income 
accounting for the remaining 50.9 percent. Therefore, the 
amount of US1's GILTI allocated to CFC1 is $1,107.82 (49.1 
percent * $2,256.25), while the remainder of $1,148.43 is 
allocated to CFC2.
    US2 has $278.75 of GILTI to allocate across each CFC with 
tested income with respect to which it is a U.S. shareholder. 
Since CFC3 has a tested loss, all of US2's GILTI of $278.25 is 
allocated to CFC2.
    As a result, the amount of GILTI allocated to each CFC by 
both US1 and US2 is as follows: $1,107.82 for CFC1, $1,426.68 
for CFC2, and $0 for CFC3.

                             Effective Date

    The provision is effective for taxable years of foreign 
corporations beginning after December 31, 2017, and for taxable 
years of U.S. shareholders in which or with which such taxable 
years of foreign corporations end.

     B. Deduction for Foreign-Derived Intangible Income and Global 
Intangible Low-Taxed Income (sec. 14202 of the Act and new sec. 250 of 
                               the Code)


                        Explanation of Provision


In general

    New section 250 allows a domestic corporation a 37.5-
percent deduction for its foreign-derived intangible income 
(``FDII'') and a 50-percent deduction on the sum of its GILTI 
and the amount treated as a dividend received by the 
corporation under section 78 that is attributable to its GILTI 
(referred to in this document as the ``GILTI-attributable 
section 78 gross-up amount'').\1727\ FDII is a corporation's 
deemed intangible income multiplied by the percentage of its 
deduction eligible income that is derived from serving foreign 
markets. A corporation's deemed intangible income equals the 
excess (if any) of its deduction eligible income over a 10-
percent return on its qualified business asset investment 
(``QBAI''). The formula for FDII can be expressed as the 
following:
---------------------------------------------------------------------------
    \1727\ The section 250 deduction is only available to C 
corporations that are neither RICs nor REITs.
    An S corporation's taxable income is computed in the same manner as 
an individual (sec. 1363(b)) so that deductions allowable only to 
corporations, including the section 250 deduction, do not apply. See 
Report by the House Committee on Ways and Means to accompany H.R. 6055, 
Subchapter S Revision Act of 1982, H. Rep. No. 97-826, p. 14; and 
Report by the Senate Committee on Finance to accompany H.R. 6055, 
Subchapter S Revision Act of 1982, S. Rep. 97-640, p. 15.
    The Code provides that deductions for corporations provided in part 
VIII of subchapter B, which include the section 250 deduction, do not 
apply in computing RIC taxable income (sec. 852(b)(2)(C)) or REIT 
taxable income (sec. 857(b)(2)(A)). Therefore, the section 250 
deduction is not available for RICs or REITs.
    In general, it is intended that the Secretary may provide that the 
section 250 deduction be treated as exempting the deducted income from 
tax. However, the section 250 deduction would not give rise to an 
increase in a domestic corporate partner's basis in a domestic 
partnership under section 705(a)(1)(B) because the deduction is allowed 
at the domestic corporate partner level.
    In addition, the section 250 deduction is computed after applying 
the limitation on the deduction for business interest (sec. 163(j)) and 
the limitation on the deduction for NOLs (sec. 172).

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    Note that, for purposes of determining FDII, deemed 
intangible income is calculated on a formulaic basis and not on 
an item-of-income basis. Although a factual inquiry is made to 
determine which components of a corporation's overall income 
are derived from serving foreign markets, no factual inquiry is 
made to determine whether deemed intangible income is derived 
from serving foreign markets.

Deduction for FDII and GILTI

    In the case of domestic corporations for taxable years 
beginning after December 31, 2017, and before January 1, 2026, 
the provision generally allows as a deduction an amount equal 
to the sum of 37.5 percent of the corporation's FDII plus 50 
percent of the sum of its GILTI (if any) and GILTI-attributable 
section 78 gross-up amount. For taxable years beginning after 
December 31, 2025, the deduction for FDII is reduced to 21.875 
percent and the deduction for GILTI is reduced to 37.5 
percent.\1728\ As a result, for taxable years beginning after 
December 31, 2017, and before January 1, 2026, the effective 
U.S. tax rate (i.e., taking into account the effect of the 
deduction) on FDII is 13.125 percent and the effective U.S. tax 
rate on GILTI is 10.5 percent.\1729\ For taxable years 
beginning after December 31, 2025, the effective U.S. tax rate 
on FDII rises to 16.406 percent and the effective U.S. tax rate 
on GILTI rises to 13.125 percent.
---------------------------------------------------------------------------
    \1728\ Sec. 250(a)(2)(B)(3).
    \1729\ Due to the reduction in the effective U.S. tax rate 
resulting from the deduction for FDII and GILTI, the Secretary is 
expected to provide, as appropriate, regulations or other guidance 
similar to that under amended section 965 with respect to the 
determination of gain or loss under section 986(c).
---------------------------------------------------------------------------
    The Secretary is authorized to prescribe regulations or 
other guidance as may be necessary or appropriate to carry out 
this provision.\1730\
---------------------------------------------------------------------------
    \1730\ Sec. 250(c).
---------------------------------------------------------------------------

Deduction eligible income

    A domestic corporation's FDII is its deemed intangible 
income multiplied by the percentage of its deduction eligible 
income that is foreign-derived.\1731\ While deemed intangible 
income and foreign-derived deduction eligible income are 
calculated separately, the starting point for each calculation 
is a corporation's deduction eligible income.
---------------------------------------------------------------------------
    \1731\ Sec. 250(b)(1).
---------------------------------------------------------------------------
    Deduction eligible income means, with respect to any 
domestic corporation, the excess (if any) of the gross income 
of the corporation determined without regard to certain amounts 
that exceptions to deduction eligible income (referred to in 
this document as ``gross deduction eligible income'') over 
deductions (including taxes) properly allocable to such gross 
income.\1732\ The exceptions to deduction eligible income are: 
(1) any subpart F income included in the gross income of the 
corporation under 951(a)(1); (2) any GILTI of the corporation; 
(3) any financial services income (as defined in section 
904(d)(2)(D)) of the corporation; (4) any dividend received 
from a CFC with respect to which the corporation is a U.S. 
shareholder; (5) any domestic oil and gas extraction income of 
the corporation; (6) any foreign branch income (as defined in 
new section 904(d)(2)(J)) of the corporation; (7) any income 
received or accrued that is of a kind that would be foreign 
personal holding company income (as defined in section 
954(c));\1733\ and any amount included in gross income of the 
corporation under section 1293.\1734\
---------------------------------------------------------------------------
    \1732\ Sec. 250(b)(3)(A).
    \1733\ A technical correction may be needed to reflect this intent.
    \1734\ A technical correction may be needed to reflect this intent.
---------------------------------------------------------------------------

Deemed intangible income

    The domestic corporation's deemed intangible income means 
the excess (if any) of its deduction eligible income over its 
deemed tangible income return.\1735\ The deemed tangible income 
return means, with respect to any corporation, an amount equal 
to 10 percent of the corporation's QBAI. Deemed intangible 
income can be calculated as follows:\1736\
---------------------------------------------------------------------------
    \1735\ Sec. 250(b)(2).
    \1736\ If the quantity in this formula is negative, deemed 
intangible income is zero.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

Qualified business asset investment

    For purposes of computing its FDII, a domestic 
corporation's QBAI is the average of the aggregate of its 
adjusted bases, determined as of the close of each quarter of 
the taxable year, in specified tangible property used in its 
trade or business and of a type with respect to which a 
deduction is allowable under section 167.\1737\ The adjusted 
basis in any property must be determined using the alternative 
depreciation system under section 168(g) as in effect on the 
date of enactment of the Act, unless a later enacted law 
specifically and directly amends the definition of QBAI for 
purposes of computing FDII.
---------------------------------------------------------------------------
    \1737\ The definition of QBAI for purposes of computing FDII relies 
on the definition of QBAI for purposes of computing GILTI under section 
951A(d), determined by substituting ``deduction eligible income'' for 
``tested income'' in section 951A(d)(2) and without regard to whether 
the corporation is a controlled foreign corporation. Sec. 250(b)(2)(B).
---------------------------------------------------------------------------
    Specified tangible property means any tangible property 
used in the production of deduction eligible income.\1738\ If 
such property was used in the production of gross deduction 
eligible income and income that is not gross deduction eligible 
income (i.e., dual-use property), the property is treated as 
specified tangible property in the same proportion that the 
amount of gross deduction eligible income produced with respect 
to the property bears to the total amount of gross income 
produced with respect to the property.\1739\ In other words, 
the percentage of a domestic corporation's adjusted basis in 
dual-use property that is included in QBAI equals the gross 
deduction eligible income produced with respect to the property 
divided by the total gross income produced with respect to the 
property.
---------------------------------------------------------------------------
    \1738\ The adjusted basis in any tangible depreciable property held 
by a foreign branch is generally not included in QBAI for purposes of 
computing FDII because foreign branch income is excluded from gross 
deduction eligible income.
    \1739\ A technical correction may be needed to reflect this intent. 
For example, if a building is used in the production of $1,000 of total 
gross income for a taxable year, $250 of which was gross domestic oil 
and gas extraction income and the remaining $750 of which was gross 
deduction eligible income, then 75 percent of a domestic corporation's 
average adjusted basis in the building is included in QBAI for that 
taxable year.
---------------------------------------------------------------------------

Foreign-derived deduction eligible income

    Foreign-derived deduction eligible income means, with 
respect to a taxpayer for its taxable year, any deduction 
eligible income of the taxpayer that is derived in connection 
with (1) property that is sold by the taxpayer to any person 
who is not a U.S. person \1740\ and that the taxpayer 
establishes to the satisfaction of the Secretary is for a 
foreign use \1741\ or (2) services provided by the taxpayer 
that the taxpayer establishes to the satisfaction of the 
Secretary are provided to any person, or with respect to 
property, not located within the United States.\1742\
---------------------------------------------------------------------------
    \1740\ If property is sold by the taxpayer to a person who is not a 
U.S. person, but the Federal government facilitates the transaction 
purely as an intermediary (e.g., for certain foreign military sales), 
income derived from the sale of such property may be treated as 
foreign-derived deduction eligible income if the other requirements are 
met. A technical correction may be needed to reflect this intent.
    \1741\ If property is sold by a taxpayer to a person who is not a 
U.S. person, and after such sale the property is subject to 
manufacture, assembly, or other processing (including the incorporation 
of such property, as a component, into a second product by means of 
production, manufacture, or assembly) outside the United States by such 
person, then the property is for a foreign use.
    \1742\ Sec. 250(b)(4).
---------------------------------------------------------------------------
    Foreign use means any use, consumption, or disposition that 
is not within the United States.\1743\ Special rules for 
determining foreign use apply to transactions that involve 
property or services provided to domestic intermediaries or to 
certain related parties.\1744\
---------------------------------------------------------------------------
    \1743\ Sec. 250(b)(5)(A).
    \1744\ Secs. 250(b)(5)(B) and (C).
---------------------------------------------------------------------------
    For purposes of determining foreign-derived intangible 
income, the terms ``sold,'' ``sells''', and ``sale'' include 
any lease, license, exchange, or other disposition.\1745\
---------------------------------------------------------------------------
    \1745\ Sec. 250(b)(5)(E).
---------------------------------------------------------------------------
            Property or services provided to domestic intermediaries 
                    \1746\
---------------------------------------------------------------------------
    \1746\ Sec. 250(b)(5)(B).
---------------------------------------------------------------------------
    If a taxpayer sells property to another person (other than 
a related party) for further manufacture or modification within 
the United States, the property is generally not treated as 
sold for a foreign use even if such other person subsequently 
utilizes such property for foreign use.\1747\ Deduction 
eligible income derived in connection with services provided to 
another person (other than a related party) located within the 
United States is not treated as foreign-derived deduction 
eligible income, even if the other person uses the services in 
providing services the income from which is considered foreign-
derived deduction eligible income.
---------------------------------------------------------------------------
    \1747\ In other words, the fact that a component is included in 
property that is eventually sold for a foreign use is insufficient for 
the sale of the component to be considered for a foreign use.
---------------------------------------------------------------------------
            Special rules with respect to certain related party 
                    transactions \1748\
---------------------------------------------------------------------------
    \1748\ Sec. 250(b)(5)(C).
---------------------------------------------------------------------------
    If property is sold to a related foreign party, the sale is 
not treated as for a foreign use unless (1) the property is 
ultimately sold by a related party to (or used by a related 
party in connection with property that is sold to or in 
connection with the provision of services to) another person 
who is an unrelated party who is not a U.S. person and (2) the 
taxpayer establishes to the satisfaction of the Secretary that 
such property is for a foreign use. Income derived in 
connection with services provided to a related party who is not 
located in the United States is not treated as foreign-derived 
deduction eligible income unless the taxpayer establishes to 
the satisfaction of the Secretary that such service is not 
substantially similar to services provided by the related party 
to persons located within the United States.\1749\
---------------------------------------------------------------------------
    \1749\ A clerical correction may be needed to reflect this intent.
---------------------------------------------------------------------------
            Related party
    For purposes of determining foreign use, a related party 
means any member of an affiliated group as defined in section 
1504(a) determined by substituting ``more than 50 percent'' for 
``at least 80 percent'' each place it appears and without 
regard to sections 1504(b)(2) and 1504(b)(3).\1750\ Any person 
(other than a corporation) is treated as a member of the 
affiliated group if the person is controlled by members of the 
group (including any entity treated as a member of the group by 
reason of this sentence) or controls any member, with control 
being determined under the rules of section 954(d)(3).
---------------------------------------------------------------------------
    \1750\ Sec. 250(b)(5)(D).
---------------------------------------------------------------------------

Taxable income limitation

    If the sum of a domestic corporation's FDII, GILTI, and 
GILTI-attributable section 78 gross-up amounts exceeds its 
taxable income determined without regard to this provision, 
then the amount of FDII, GILTI, and GILTI-attributable section 
78 gross-up for which a deduction is allowed is reduced (but 
not below zero) by an amount determined by such excess.\1751\ 
The reduction in the amount of FDII for which a deduction is 
allowed equals such excess multiplied by a percentage equal to 
the corporation's FDII divided by the sum of its FDII, GILTI, 
and GILTI-attributable section 78 gross-up amounts. The 
reduction in the sum of the corporation's GILTI and GILTI-
attributable section 78 gross-up amounts for which a deduction 
is allowed equals the remainder of such excess.\1752\
---------------------------------------------------------------------------
    \1751\ Technical corrections may be needed to reflect this intent.
    \1752\ For example, consider a domestic corporation with $1,250 of 
FDII, $650 of GILTI, and $100 of GILTI-attributable section 78 gross-
up, and taxable income (determined without regard to this provision) of 
$1,500. The sum of the corporation's FDII, GILTI, and GILTI-
attributable section 78 gross-up amounts is $2,000, which exceeds 
$1,500 by $500. For purposes of this provision, the amount of FDII for 
which a deduction is allowed is reduced by $500 multiplied by $1,250/
$2,000, or $312.50. The sum of the amount of GILTI and GILTI-
attributable section 78 gross-up amounts for which a deduction is 
allowed is reduced by the remainder of the excess, or $187.50 ($500 * 
$750/$2,000).
---------------------------------------------------------------------------

Illustration of effective tax rates on FDII and GILTI

    This section provides an algebraic illustration of 
effective tax rates on FDII and GILTI and shows how the 
effective tax rates on FDII and GILTI may align. For 
simplicity, the illustration assumes, among other things, that 
the taxable income limitation is not binding, that the CFCs 
relevant to the calculations each have tested income, and that 
the domestic corporation has no expenses.\1753\ If these 
assumptions do not hold, the effective tax rates on FDII and 
GILTI may not align and the results below may change.
---------------------------------------------------------------------------
    \1753\ As under the law prior to enactment of the Act, U.S. 
shareholders are required to allocate expenses to foreign-source income 
for foreign tax credit limitation purposes based on principles 
applicable prior to the enactment of the Act.
---------------------------------------------------------------------------
    As a result of the deduction, and with respect to domestic 
corporations, the effective tax rate on FDII is 13.125 percent 
and the effective U.S. tax rate on GILTI is 10.5 percent for 
taxable years beginning after December 31, 2017, and before 
January 1, 2026. Since only a portion (80 percent) of foreign 
tax credits are allowed to offset U.S. tax on GILTI, the 
minimum foreign tax rate, with respect to GILTI, at which no 
U.S. residual tax is owed by a domestic corporation is 13.125 
percent.\1754\ If the foreign tax rate on GILTI is zero 
percent, then the U.S. residual tax rate on GILTI is 10.5 
percent. Therefore, as foreign tax rates on GILTI range between 
zero percent and 13.125 percent, the total combined foreign and 
U.S. tax rate on GILTI ranges between 10.5 percent and 13.125 
percent. At foreign tax rates greater than or equal to 13.125 
percent, there is no residual U.S. tax owed on GILTI, so that 
the combined foreign and U.S. tax rate on GILTI equals the 
foreign tax rate.
---------------------------------------------------------------------------
    \1754\ The effective GILTI rate of 10.5 percent divided by 80 
percent equals 13.125 percent. If the foreign tax rate on a particular 
amount of GILTI is 13.125 percent, and domestic corporations are 
allowed a credit equal to 80 percent of foreign taxes paid, then the 
foreign tax rate, after accounting for the 80-percent haircut, on this 
amount of GILTI equals 10.5 percent (13.125 percent * 80 percent), 
which equals the effective GILTI rate of 10.5 percent. Therefore, no 
U.S. residual tax is owed.
---------------------------------------------------------------------------
    For domestic corporations in taxable years beginning after 
December 31, 2025, the effective tax rate on FDII rises to 
16.406 percent and the effective U.S. tax rate on GILTI rises 
to 13.125 percent. The minimum foreign tax rate, with respect 
to GILTI, at which no U.S. residual tax is owed by a domestic 
corporation rises to 16.406 percent.\1755\
---------------------------------------------------------------------------
    \1755\ Under the assumptions in this illustration of effective tax 
rates, if the foreign tax rate on GILTI is zero percent, then the U.S. 
residual tax rate on GILTI is 13.125 percent. Therefore, as foreign tax 
rates on GILTI range between zero percent and 16.406 percent, the total 
combined foreign and U.S. tax rate on GILTI ranges between 13.125 
percent and 16.406 percent. At foreign tax rates greater than or equal 
to 16.406 percent, there is no residual U.S. tax on GILTI, and the 
combined foreign and U.S. tax rate on GILTI equals the foreign tax 
rate.
---------------------------------------------------------------------------

Example of FDII calculation

    This example illustrates how the deduction for FDII is 
calculated. Calculations related to GILTI can be found in the 
explanation of section 14201 of the Act.
    Consider USCo, a domestic corporation which has $5,000 of 
gross deduction eligible income and $2,000 of deductions 
allocable to that gross income. These are USCo's only items of 
income and deductions, so that all its gross income is gross 
deduction eligible income and all of its deductions are 
allocable to its gross deduction eligible income.
    USCo's deduction eligible income is its gross deduction 
eligible income less deductions allocable to that income, or 
$5,000 - $2,000 = $3,000. In this particular example, USCo's 
deduction eligible income equals its taxable income. Assume 
that USCo has established to the satisfaction of the Secretary 
that $1,200 of its deduction eligible income is foreign-
derived, and that USCo has $10,000 of QBAI.
    USCo's deemed intangible income equals its deduction 
eligible income minus a 10 percent return on its QBAI, or 
$3,000 - (10 percent * $10,000) = $2,000.
    USCo's FDII is its deemed intangible income multiplied by 
the percentage of its deduction eligible income that is 
foreign-derived, or $2,000 * ($1,200/$3,000) = $800. USCo is 
allowed a deduction of 37.5 percent on its FDII of $800, or 
$300.
    USCo's taxable income, less the deduction for FDII, is 
$3,000 -- $300 = $2,700. Under a 21-percent corporate tax rate, 
USCo's tax liability is $567 (21 percent * $2,700). Therefore, 
the deduction for FDII has reduced the effective tax rate on 
USCo's pre-deduction taxable income of $3,000 from 21 percent 
to 18.9 percent ($567/$3,000).\1756\
---------------------------------------------------------------------------
    \1756\ USCo's effective tax rate is not reduced by the full amount 
of the deduction (i.e., from 21 percent to 13.125 percent, or 7.875 
percentage points). This is because only a portion (66.7 percent) of 
USCo's deduction eligible income is deemed intangible income, and only 
a portion (40 percent) of USCo's deduction eligible income is foreign-
derived. In this particular example, the rate reduction of 2.1 
percentage points equals 7.875 percentage points * 66.7 percent * 40 
percent.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

 C. Repeal of Treatment of Foreign Base Company Oil Related Income as 
  Subpart F Income (sec. 14211 of the Act and sec. 954(a) of the Code)


                        Explanation of Provision

    The provision eliminates foreign base company oil related 
income as a category of foreign base company income.

                             Effective Date

    The provision is effective for taxable years of foreign 
corporations beginning after December 31, 2017, and for taxable 
years of U.S. shareholders in which or with which such taxable 
years of foreign corporations end.

   D. Repeal of Inclusion Based on Withdrawal of Previously Excluded 
 Subpart F Income from Qualified Investment (sec. 14212 of the Act and 
                         sec. 955 of the Code)


                        Explanation of Provision


Background on prior law

    In 1975, foreign base company shipping income was added as 
a category of subpart F income for taxable years beginning 
after 1975. Foreign base company shipping income was 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). A reinvestment exception permitted a CFC to defer 
inclusion of foreign base company shipping income to the extent 
that it was reinvested during the taxable year in certain 
qualified shipping investments.\1757\ Subsequent net decreases 
in qualified shipping investments were considered subpart F 
income, to the extent of previously excluded subpart F income. 
In the Tax Reform Act of 1986,\1758\ the reinvestment exception 
was repealed, but foreign base company shipping income that was 
previously deferred by reason of the reinvestment exception 
remained deferred until a net decrease in such qualified 
investments triggered an inclusion required by section 955. For 
taxable years beginning after 2004, foreign base company 
shipping income is no longer subpart F income. However, to the 
extent that foreign base company shipping income deferred 
before 1987 was withdrawn from qualified investments, it 
remained subject to inclusion under section 955.
---------------------------------------------------------------------------
    \1757\ The qualified shipping investments were described in former 
section 954(b)(2).
    \1758\ Pub. L. No. 99-514 (October 22, 1986).
---------------------------------------------------------------------------

Repeal of section 955

    The provision repeals section 955. As a result, a U.S. 
shareholder in a CFC that invested its previously excluded 
subpart F income in qualified foreign base company shipping 
operations is no longer required to include in income a pro 
rata share of the previously excluded subpart F income when the 
CFC decreases such investments.

                             Effective Date

    The provision is effective for taxable years of foreign 
corporations beginning after December 31, 2017, and to taxable 
years of U.S. shareholders within which or with which such 
taxable years of foreign corporations end.

E. Modification of Stock Attribution Rules for Determining Status as a 
Controlled Foreign Corporation (sec. 14213 of the Act and secs. 318 and 
                            958 of the Code)


                        Explanation of Provision


Background on prior law

    The ownership attribution rules for determining 
constructive ownership of corporate stock are modified for 
purposes of determining U.S. shareholder status. Prior to the 
Act, stock owned by a foreign person, regardless of the 
ownership threshold, was not attributed to U.S. persons, 
including domestic corporations, through so-called downward 
attribution from a parent to its subsidiary.\1759\ As a result, 
a wholly-owned domestic subsidiary of a foreign corporation was 
not treated as owning stock in other foreign corporations owned 
by the foreign parent.\1760\ In a common example, a new foreign 
parent, or another non-CFC foreign affiliate, could transfer 
property to a CFC in exchange for stock representing at least 
50 percent of the voting power and value of the CFC. Such 
transactions ``de-control'' the CFC, thus converting former 
CFCs to non-CFCs, despite continuous ownership by the U.S. 
shareholders, and avoiding the application of subpart F 
provisions.
---------------------------------------------------------------------------
    \1759\ Secs. 318 and former 958(b)(4). Specifically, section 
958(b)(4) provided that section 318(a)(3) did not apply to treat a U.S. 
person as owning stock owned by a foreign person.
    \1760\ Sec. 958(b)(4); Treas. Reg. sec. 1.958-2(d)(1)(iii).
---------------------------------------------------------------------------

Change to the modification of stock attribution rules

    The provision amends the ownership attribution rules by 
repealing the paragraph that precluded downward attribution of 
stock owned by a foreign person to a U.S. person. As a result, 
certain stock of a foreign corporation owned by a foreign 
person is attributed to a related U.S. person owned by the 
foreign person for purposes of determining whether the related 
U.S. person is a U.S. shareholder of the foreign corporation 
and, therefore, whether the foreign corporation is a CFC. In 
other words, the provision requires ``downward attribution'' 
from a foreign person to a related U.S. person in circumstances 
in which prior law did not. Congress intended to render 
ineffective certain transactions among related persons that are 
used as a means of avoiding the subpart F provisions, including 
the ``de-control'' transactions described above.\1761\ The pro 
rata share of a CFC's subpart F income that a U.S. shareholder 
is required to include in gross income, however, continues to 
be determined based on direct or indirect ownership of the CFC, 
without application of the new downward attribution rule.
---------------------------------------------------------------------------
    \1761\ A technical correction may be necessary to reflect the 
intent expressed by Congress. See, Committee Report, Reconciliation 
Recommendations Pursuant to H. Con. Res. 71, S. Prt. 115-20, December 
2017, p. 378, as reprinted on the website of the Senate Budget 
Committee, available at https://www.budget.senate.gov/taxreform, (the 
Committee did not intend ``to cause a foreign corporation to be treated 
as a controlled foreign corporation with respect to a U.S. shareholder 
as a result of attribution of ownership under section 318(a)(3) to a 
U.S. person that is a related person (within the meaning of section 
954(d)(3)) to such U.S. shareholder as a result of the repeal of 
section 958(b)(4)'') and Conference Report to accompany H.R. 1, H.R. 
Report 115-466, December 15, 2017, pp. 633-634.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for the last taxable year of 
foreign corporations beginning before January 1, 2018, and each 
subsequent year of such foreign corporations and for the 
taxable years of U.S. shareholders in which or with which such 
taxable years of foreign corporations end.

F. Modification of Definition of United States Shareholder (sec. 14214 
                  of the Act and sec. 951 of the Code)


                        Explanation of Provision

    U.S. shareholders of a CFC must include in their gross 
income certain types of income and investments of the CFC that 
otherwise would not be currently taxable to them under general 
tax rules. The Act expands the definition of a U.S. shareholder 
under section 951(b) to include not only (as under prior law) a 
U.S. person who owns 10 percent of the voting stock of a 
foreign corporation, but also any U.S. person who owns 10 
percent or more of the total value of shares of all classes of 
stock of a foreign corporation. This expanded definition of a 
U.S. shareholder applies for all purposes of the Code.\1762\
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    \1762\ For purposes of determining U.S. shareholder status, stock 
owned directly, indirectly and constructively is taken into account. 
See sec. 958. However, U.S. shareholders are subject to taxation under 
subpart F only to the extent of their direct and indirect ownership. 
Sec. 951(a).
---------------------------------------------------------------------------
    Section 1248 provides special rules for taxing U.S. 
shareholders (and certain former U.S. shareholders) of a CFC 
upon the disposition of stock in the CFC. These rules are 
designed to insure that any gain recognized on the disposition 
of CFC stock is taxed as ordinary income (rather than as 
capital gain) to the U.S. shareholders to the extent of 
earnings and profits of the CFC that had not previously been 
subject to U.S. taxation under subpart F.\1763\ Accordingly, 
section 1248(a)(2) should require ownership of at least 10 
percent of the value or voting stock of the CFC during periods 
in which the expanded definition of U.S. shareholder under 
section 951(b) applies.\1764\
---------------------------------------------------------------------------
    \1763\ See S. Rep. No. 1881, 87th Cong., 2d Sess. 107 (1962).
    \1764\ A technical correction may be necessary to reflect this 
intent.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for taxable years of foreign 
corporations beginning after December 31, 2017, and for taxable 
years of U.S. shareholders in which or with which such taxable 
years of foreign corporations end.

 G. Elimination of Requirement that Corporation Must Be Controlled for 
 30 Days Before Subpart F Inclusions Apply (sec. 14215 of the Act and 
                      sec. 951(a)(1) of the Code)


                        Explanation of Provision

    The provision eliminates the requirement that a corporation 
must be a CFC for an uninterrupted period of 30 days in a 
taxable year before a U.S. shareholder is required to include 
its pro rata share of the subpart F income of the foreign 
corporation. Instead, a U.S. shareholder is required to include 
its pro rata share of the subpart F income of a foreign 
corporation that is a CFC at any time during any taxable year 
(assuming the stock ownership requirements of section 951(a)(1) 
are satisfied with respect to the shareholder).

                             Effective Date

    The provision is effective for taxable years of foreign 
corporations beginning after December 31, 2017, and for taxable 
years of U.S. shareholders with or within which such taxable 
years of foreign corporations end.

H. Limitations on Income Shifting Through Intangible Property Transfers 
       (sec. 14221 of the Act and secs. 367 and 482 of the Code)


                        Explanation of Provision


Background on prior law

    Profits from transfers of intangible property between 
related taxpayers generally are allocated to each related 
taxpayer by reference to the amount of profit that a similarly 
situated taxpayer would realize in similar transactions with 
unrelated parties.\1765\ A U.S. person may transfer intangible 
property to a related person (typically, a foreign affiliate) 
in one of four ways.\1766\ Whether for purposes of determining 
gain recognition under section 367(d) or determining whether 
profits should be reallocated under section 482, the definition 
of intangible property was found in the former section 
936(h)(3)(B).\1767\ That provision defined intangible property 
to include the several enumerated categories, including ``any 
similar item.'' \1768\ Recurring definitional and 
methodological issues have arisen in controversies with respect 
to the identification and appropriate valuation of intangible 
property transferred in related party transactions.\1769\
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    \1765\ See discussion of intercompany transfers in the summary of 
Prior Law above.
    \1766\ The four methods are an outright transfer of the intangible 
property; a license of the intangible property, in which the U.S. 
person transfers less than all substantial rights in the intangible 
property to the foreign affiliate; the provision of a service by the 
U.S. person to the foreign affiliate using the intangible property, 
rather than a direct transfer of the property; and finally, a transfer 
by the U.S. person of intangible property through a qualified cost-
sharing arrangement with one or more foreign affiliates, under which 
the participants make resources available and contribute funds (through 
a combination of cash and existing intangible property rights) toward 
the joint development of a new marketable product or service. The 
method of transfer may determine whether the applicable section is 
section 482 or section 367(d). Special rules may apply in the case of a 
U.S. taxpayer's transfer or property to a partnership with related 
foreign partners under sections 704(c) and 721(c) and related 
regulations.
    \1767\ Sec. 936(h)(3)(B). The operative definition of intangible 
property, as amended by the Act, was moved to section 367(d) as a 
conforming amendment to the repeal of section 936 as deadwood, in the 
Consolidated Appropriations Act 2018. See, Pub. L. No. 115-141, 
Division U, Title IV, at sec. 401(d)(1)(C) (the repeal of section 936) 
and sec. 401(d)(1)(D)(viii)(I) (definition of intangible property added 
to section 367(d)) (March 23, 2018).
    \1768\ Prior to amendment, subparagraph (B) of section 936(h)(3) 
and its concluding flush language read as follows: The term 
``intangible property means any--(i) patent, invention, formula, 
process, design, pattern or know-how; (ii) copyright and literary, 
musical or artistic composition; (iii) trademark, trade name or brand 
name; (iv) franchise, license or contract; (v) method, program, system, 
procedure, campaign, survey, study, forecast, estimate, customer list 
or technical data; or (vi) any similar item, which has substantial 
value independent of any individual.
    \1769\ Veritas v. Commissioner, 133 T.C. No. 14 (December 10, 
2009), (including goodwill and going concern value within the 
definition would ``expand'' the regulatory definition in effect for the 
tax year before the Court), non-acq., IRB 2010-49 (December 6, 2010). 
Amazon v. Commissioner, 148 T.C. No. 8 (2017) (holding that ``workforce 
in place, going concern value, goodwill, and what trial witnesses 
described as `growth options' and corporate `resources' or 
`opportunities' '' all fell outside the definition under prior law).
---------------------------------------------------------------------------
    Extensive guidance promulgated under section 482 with 
respect to intangibles provide guidance on how to determine 
whether the intangibles transferred should be valued 
collectively or separately. The interrelation of intangible 
assets that are transferred in one or more contemporaneous 
transactions may produce synergies that increase the value of 
the assets if viewed in the aggregate, compared to the sum of 
values assigned if assets are valued asset-by-asset. If a 
valuation method fails to take into account such synergies, it 
may not reach an arm's length result.\1770\
---------------------------------------------------------------------------
    \1770\ See Treas. Reg. secs. 1.482-1(f)(2), 1.482-4(c)(1) and 
1.482-1T (sunset September 14, 2018).
---------------------------------------------------------------------------
    The regulations also establish a realistic alternative 
principle that underlies the evaluation of all transfer pricing 
methodologies for a transfer of intangibles. In determining the 
income attributable to a taxpayer that participated in a 
specific transfer of intangibles, the method of valuation 
chosen must yield results consistent with the economic results 
from alternative arrangements that were realistically available 
to that taxpayer. The degree of consistency between anticipated 
benefits from the transactions under the chosen pricing method 
and the anticipated benefits of a realistic alternative to the 
transaction indicates the reliability and appropriateness of 
the valuation.\1771\ This principle is predicated on the notion 
that a taxpayer enters into a particular transaction only if 
none of its realistic alternatives is economically preferable 
to the transaction under consideration.
---------------------------------------------------------------------------
    \1771\ See Treas. Reg. sec. 1.482-7(g)(2)(iii) and Exs. (1), (2) 
and (3), thereunder.
---------------------------------------------------------------------------

Revisions to definition of intangible property

    The provision revises the definition of intangible 
property. First, it adds any goodwill (both foreign and 
domestic), going concern value and workforce in place to the 
list of specific property within the scope of the definition. 
The residual category of ``any similar item'' is replaced by 
``any item the value of which is not attributable to tangible 
property or the services of any individual'' and flush language 
at the end of the former subparagraph is removed, thus 
clarifying that neither source nor amount of value is relevant 
to determining whether property in one of the other enumerated 
categories of intangible property is within the scope of the 
definition.

Codification of valuation guidance

    The provision also clarifies the authority of the Secretary 
to specify the method to be used to determine the value of 
intangible property that is transferred. It does not modify the 
basic approach of the existing transfer pricing rules with 
regard to income from intangible property. In particular, the 
provision amends section 482 and expands the grant of 
regulatory authority under section 367 to make clear that the 
IRS may require the use of aggregate basis valuation and may 
apply the realistic alternative principle in valuation of 
intangibles transferred in either outbound restructuring of 
U.S. operations or intercompany pricing allocations.\1772\
---------------------------------------------------------------------------
    \1772\ Secs. 367(d) and 482.
---------------------------------------------------------------------------
    The provision requires the use of the aggregate basis 
valuation method in cases in which multiple intangible 
properties are transferred in one or more related transactions 
if the Secretary determines that the result of the aggregation 
method is a more reliable measure of the income properly 
allocable to a taxpayer. This approach is consistent with Tax 
Court decisions in cases outside of the section 482 context, 
where collections of multiple, related intangible assets were 
viewed by the Tax Court in the aggregate.\1773\ Finally, it is 
also consistent with the cost-sharing regulations.\1774\
---------------------------------------------------------------------------
    \1773\ See, e.g., Kraft Foods Co. v. Commissioner, 21 T.C. 513 
(1954) (thirty-one related patents must be valued as a group and the 
useful life for depreciation should be based on the average of the 
patents' useful lives); Standard Conveyor Co. v. Commissioner, 25 
B.T.A. 281, p. 283 (1932) (``[I]t is evident that it is impossible to 
value these seven patents separately. Their value, as in the case of 
many groups of patents representing improvements on the prior art, 
appears largely to consist of their combination.''); Massey-Ferguson, 
Inc. v. Commissioner, 59 T.C. 220 (1972) (taxpayer who abandoned a 
distribution network of contracts with separate distributorships was 
entitled to an abandonment loss for the entire network in the taxable 
year during which the last of the contracts was terminated because that 
was the year in which the entire intangible value was lost).
    \1774\ See Treas. Reg. sec. 1.482-7(g)(2)(iv) (if multiple 
transactions in connection with a cost-sharing arrangement involve 
platform, operating and other contributions of resources, capabilities 
or rights that are reasonably anticipated to be interrelated, then 
determination of the arm's-length charge for platform contribution 
transactions and other transactions on an aggregate basis may provide 
the most reliable measure of an arm's-length result).
---------------------------------------------------------------------------
    The provision codifies application of the realistic 
alternative principle to determine valuation of transferred 
intangible property. As a result, the IRS may require that an 
arm's-length price be determined by reference to a transaction 
(for example, the U.S. owner of intangible property such as a 
patent uses it to manufacture a product) that is different from 
the transaction that was actually completed (the U.S. owner of 
that same intangible property licenses the manufacturing rights 
to a foreign affiliate and then buys the resulting product from 
the licensee).

Effective Date

    The provision applies to transfers in taxable years 
beginning after December 31, 2017. No inference is intended 
with respect to application of section 936(h)(3)(B) or the 
authority of the Secretary to provide by regulation for such 
application with respect to taxable years beginning before 
January 1, 2018.

I. Certain Related Party Amounts Paid or Accrued in Hybrid Transactions 
  or With Hybrid Entities (sec. 14222 of the Act and sec. 267A of the 
                                 Code)


                        Explanation of Provision


In general

    The provision denies a deduction for any disqualified 
related party amount that is paid or accrued pursuant to a 
hybrid transaction or that is paid by or to a hybrid entity. A 
disqualified related party amount is any interest or royalty 
paid or accrued to a related party to the extent that: (1) 
there is no corresponding inclusion to the related party under 
the tax law of the country of which such related party is a 
resident for tax purposes or in which such related party is 
subject to tax, or (2) such related party is allowed a 
deduction with respect to such amount under the tax law of such 
country. A disqualified related party amount does not include 
any payment to the extent such payment is included in the gross 
income of a U.S. shareholder under subpart F. In general, a 
related party is any person that controls, or is controlled by, 
the taxpayer, with control being direct or indirect ownership 
of more than 50 percent of the vote, value, or beneficial 
interests of the relevant person.

Hybrid transactions

    A hybrid transaction is any transaction, series of 
transactions, agreement, or instrument one or more payments 
with respect to which are treated as interest or royalties for 
Federal income tax purposes and which are not so treated for 
purposes of the tax law of the foreign country of which the 
recipient of such payment is resident for tax purposes or in 
which the recipient is subject to tax.

Hybrid entities

    A hybrid entity is any entity which is either: (1) treated 
as fiscally transparent for Federal income tax purposes but not 
so treated for purposes of the tax law of the foreign country 
of which the entity is resident for tax purposes or in which 
the entity is subject to tax, or (2) treated as fiscally 
transparent for purposes of the tax law of the foreign country 
of which the entity is resident for tax purposes or in which 
the entity is subject to tax but not so treated for Federal 
income tax purposes.

Regulatory authority

    The Secretary has broad authority to issue regulations or 
other guidance as may be necessary or appropriate to carry out 
the purposes of the provision, including by issuing regulations 
or other guidance providing: (1) rules for treating certain 
conduit arrangements which involve a hybrid transaction or 
hybrid entity as subject to the provision; (2) rules for 
applying this provision to branches (domestic or foreign) or 
domestic entities, even if such branches or entities do not 
meet the statutory definition of a hybrid entity; \1775\ (3) 
rules for applying this provision to certain structured 
transactions; (4) rules for denying all or a portion of a 
deduction claimed for an interest or a royalty payment that, as 
a result of the hybrid transaction or entity, is included in 
the recipient's income under a preferential tax regime of the 
country of residence of the recipient and has the effect of 
reducing the country's generally applicable statutory tax rate 
by at least 25 percent; (5) rules for denying all of a 
deduction claimed for an interest or a royalty payment if such 
amount is subject to a participation exemption system or other 
system which provides for the exclusion or deduction of a 
substantial portion of such amount; (6) rules for determining 
the tax residence of a foreign entity if the foreign entity is 
otherwise considered a resident of more than one country or of 
no country; (7) exceptions to the general rule set forth in the 
provision with respect to (A) cases in which the disqualified 
related party amount is taxed under the laws of a foreign 
country other than the country of which the related party is a 
resident for tax purposes, and (B) other cases which the 
Secretary determines do not present a risk of eroding the 
Federal tax base; and (8) requirements for record keeping and 
information in addition to any requirements imposed by section 
6038A.
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    \1775\ For example, Treasury may issue guidance that addresses 
certain disregarded branch structures or diverted branch payments. 
Unlike hybrid mismatches, branch mismatches could arise when the 
ordinary rules for allocating income and expenditure between a branch 
and head office result in a portion of the taxpayer's net income 
escaping tax in both the branch and residence jurisdictions.
    A simple example illustrates a disregarded branch structure. Assume 
a foreign multinational corporation (``Foreign Parent'') resident in 
country X has a U.S. subsidiary (``U.S. Sub'') and forms a separate 
financing branch in the United States (``U.S. Branch'') which lacks 
sufficient presence in the United States to be subject to Federal 
income tax. Foreign Parent lends money to U.S. Sub through U.S. Branch. 
Country X exempts or excludes the interest paid by U.S. Sub to U.S. 
Branch from taxation on the grounds that it is attributable to a 
foreign branch. U.S. Branch's interest income is not, however, taxed in 
the United States because U.S. Branch does not have sufficient presence 
in the United States for its interest to be subject to tax there. Thus, 
the result of this disregarded branch structure is a deduction for the 
interest paid by U.S. Sub to U.S. Branch, with no corresponding income 
inclusion for Foreign Parent in either country X or the United States.
    A diverted branch payment has the same structure and outcome as a 
payment to a disregarded branch. The mismatch arises, however, not 
because of conflict in the characterization of the branch, but rather 
as a result of a difference between the laws of the residence and 
branch jurisdictions in the attribution of the payments to the branch. 
For example, consider the same facts as above, except that now the 
United States treats U.S. Branch as subject to Federal income tax. A 
mismatch may still arise if U.S. Branch treats the interest payment as 
made directly to the Foreign Parent head office in country X, while the 
Foreign Parent head office treats the payment as made to U.S. Branch.
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    The Secretary's authority includes addressing overly broad 
or under-inclusive application of this provision. An example of 
an under-inclusive application of provision may involve an 
imported mismatch arrangement (i.e., an arrangement where 
deductible payments made through an intermediary payee are not 
taxable on ultimate receipt). To illustrate this type of 
arrangement, assume that a foreign multinational corporation 
(``Foreign Parent'') resident in country X has a foreign 
subsidiary in country Y (``Foreign Sub''), which in turn wholly 
owns a U.S. corporation (``U.S. Sub''). Foreign Parent 
capitalizes Foreign Sub with cash in exchange for a hybrid 
instrument that is treated as debt for country Y purposes, but 
as equity for country X purposes. Foreign Sub then lends the 
cash to U.S. Sub in exchange for a note on which interest paid 
is deductible. The result is a deduction for interest in the 
United States, and an inclusion (of interest income) offset by 
a deductible payment on the hybrid instrument by Foreign Sub in 
country Y. Furthermore, the payment on the hybrid instrument 
made by Foreign Sub to Foreign Parent may not be includible to 
Foreign Parent in country X if such payment is treated as a 
distribution on equity that is exempt from taxation in country 
X.
    A similar example might involve a hybrid entity. Using the 
same facts as above, assume Foreign Parent and a country X 
subsidiary (``Foreign X Sub'') form a financing company in 
country Y that is treated as a partnership for country Y 
purposes and as a corporation for country X purposes (``Reverse 
Hybrid''). Reverse Hybrid lends cash to U.S. Sub in exchange 
for a note on which interest paid is deductible. Interest 
income of Reverse Hybrid is not includible to Foreign Parent 
and Foreign Sub in country X. Furthermore, country Y does not 
impose tax on interest income of Reverse Hybrid. The result is 
a deduction for interest in the United States with no 
corresponding income inclusion in either country X or Y.
    An example of an overly broad application of this provision 
may involve a debt issuance that is primarily targeted and sold 
to a tax-exempt domestic investor base, but a minor portion of 
which is acquired by unrelated persons who benefit from hybrid 
treatment in their countries of residence. Such a debt issuance 
should not be considered a structured transaction because the 
hybrid treatment is unrelated to the tax-exempt status of the 
domestic investor base. Treasury may also issue guidance 
identifying circumstances under which the hybrid nature of a 
transaction or entity is deemed to be unrelated to the 
application of a preferential tax regime. For example, assume 
Foreign Parent from country X wholly owns U.S. Sub, which 
wholly owns an entity that is disregarded for U.S. tax purposes 
(``DRE''). DRE pays a royalty directly to Foreign Parent. 
Several years after the formation of DRE, country X implements 
a preferential tax regime under which royalties paid by DRE to 
Foreign Parent are subject to a reduced rate of tax. Under 
these facts, Treasury could determine that the hybrid nature of 
DRE is unrelated to the application of country X's preferential 
regime.

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

  J. Shareholders of Surrogate Foreign Corporations Not Eligible for 
       Reduced Rate on Dividends (sec. 14223 of the Act and sec. 
                     1(h)(11)(C)(iii) of the Code)


                        Explanation of Provision

    The provision states that dividends from certain surrogate 
foreign corporations are excluded from qualified dividend 
income within the meaning of section 1(h)(11)(B) and are 
ineligible to be taxed as net capital gains. As a result, 
individual shareholders in such corporations cannot claim the 
reduced rate on dividends. The term surrogate foreign 
corporation is given the same meaning as in section 7874 and 
generally refers to a foreign corporation that is a surrogate 
for a domestic entity that migrated its tax home from the 
United States to a foreign jurisdiction pursuant to a plan or 
series of related transactions completed after March 4, 
2003.\1776\ However, this provision applies only to those 
companies that first become surrogate foreign corporations 
after date of enactment.
---------------------------------------------------------------------------
    \1776\ Under section 7874(a)(2)(B), a foreign-incorporated entity 
is a surrogate foreign corporation if, pursuant to a plan, (1) the 
foreign entity acquired substantially all properties held by a domestic 
corporation (or properties constituting a trade or business of a 
domestic partnership); (2) at least 60 percent but less than 80 percent 
(by vote or value) of the stock of the foreign entity after the 
transaction is held by the former shareholders of the domestic 
corporation (by reason of the stock they had held in the domestic 
corporation), and (3) the foreign corporation, considered together with 
all companies connected to it by a chain of greater than 50 percent 
ownership (that is, 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.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for dividends received after the 
date of enactment (December 22, 2017).

     SUBPART C--MODIFICATIONS RELATED TO FOREIGN TAX CREDIT SYSTEM


A. Repeal of Section 902 Indirect Foreign Tax Credits; Determination of 
  Section 960 Credit on Current Year Basis (sec. 14301 of the Act and 
                  secs. 902, 960, and 78 of the Code)


                        Explanation of Provision


Background on prior law

    The United States allows a foreign tax credit for foreign 
taxes paid on income derived from direct operations (conducted, 
e.g., through a branch office) or passive investments in a 
foreign country. Under prior law, the United States also 
allowed a credit with respect to dividends received from 
foreign subsidiary corporations out of earnings that had been 
subject to foreign taxes.\1777\ The latter credit is called a 
deemed-paid credit or an indirect credit.
---------------------------------------------------------------------------
    \1777\ Sec. 902.
---------------------------------------------------------------------------
    The United States also provides a deemed-paid credit with 
respect to any income inclusion under subpart F.\1778\ Under 
prior law, the deemed-paid credit is limited to the amount of 
foreign income taxes \1779\ that would have been deemed paid if 
the inclusion were treated as a dividend.
---------------------------------------------------------------------------
    \1778\ Sec. 960.
    \1779\ Foreign income taxes under the provision include income, war 
profits, or excess profits taxes paid or accrued by the CFC to any 
foreign country or possession of the United States.
---------------------------------------------------------------------------
    Section 78 requires that a domestic corporation claiming a 
deemed-paid credit include, as additional dividend income, an 
amount equal to the foreign taxes deemed paid. This section 78 
``gross-up'' ensures that the full amount of the earnings on 
which the foreign taxes were paid are included in taxable 
income and reflected in the calculation of the foreign tax 
credit limitation under section 904.\1780\
---------------------------------------------------------------------------
    \1780\ The separate foreign tax credit limitations are discussed in 
greater detail in the explanation of section 14302 of the Act.
---------------------------------------------------------------------------

Repeal of section 902

    The provision repeals the deemed-paid credit under section 
902 with respect to dividends received by a domestic 
corporation that owns 10 percent or more of the voting stock of 
a foreign corporation.

Modification and expansion of section 960

    The provision retains but modifies the deemed-paid credit 
rules under section 960. The deemed-paid credit under section 
960(a) is limited to the amount of foreign income taxes 
properly attributable to a subpart F inclusion. The provision 
eliminates the need for computing and tracking cumulative tax 
pools. In addition to modifying the rules with respect to 
deemed-paid foreign tax credits attributable to subpart F 
inclusions, the provision further expands the deemed-paid 
credit rules to a portion of the foreign income taxes properly 
attributable to GILTI inclusions.\1781\
---------------------------------------------------------------------------
    \1781\ New section 960(d) is discussed in greater detail in the 
explanation of section 14201 of the Act.
---------------------------------------------------------------------------
    The provision also provides rules applicable to foreign 
taxes attributable to distributions from previously taxed 
earnings and profits, including distributions made through 
tiered CFCs. These rules allow foreign tax credits under 
section 960 in the year the previously taxed income is 
distributed to a corporation that is a U.S. shareholder of the 
CFC. For example, if a U.S. shareholder excludes any part of a 
distribution received from a lower-tier CFC through a chain of 
CFCs as previously taxed income, the U.S. shareholder will be 
deemed to have paid any withholding or other taxes paid by an 
upper-tier CFC that are properly attributable to distributions 
of the previously taxed income by the lower-tier CFC. A credit 
is allowed under section 901 only for 80 percent of the foreign 
income taxes imposed with respect to previously taxed earnings 
and profits attributable to GILTI and no credit is allowed for 
any taxes paid or accrued (or treated as paid or accrued) with 
respect to distributions of previously taxed amounts described 
in section 965(b)(4)(A).\1782\
---------------------------------------------------------------------------
    \1782\ A technical correction may be necessary to reflect this 
intent.
---------------------------------------------------------------------------
    Furthermore, the provision does not allow a credit for 
taxes that are not attributable to actual distributions of 
previously taxed earnings and profits. For example, no credit 
is allowed for taxes related to earnings and profits that were 
not included in income by reason of section 965(b) (reduction 
in amounts included in gross income of U.S. shareholders of 
specified foreign corporations with deficits of earnings and 
profits), or for the portion of taxes not allowed as a deemed 
paid credit for taxes properly attributable to tested income by 
reason of the inclusion percentage or 80 percent multiplicand 
in section 960(d)(1).\1783\
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    \1783\ A technical correction may be necessary to reflect this 
intent.
---------------------------------------------------------------------------
    The Secretary is granted authority under the provision to 
provide regulations and other guidance as may be necessary and 
appropriate to carry out the purposes of this provision. Under 
such rules, taxes are not attributable to an item of subpart F 
income if the base upon which the tax was imposed does not 
include the item of subpart F income. For example, if foreign 
law exempts a certain type of income from its tax base, no 
deemed-paid credit results from the inclusion of such income as 
subpart F. Tax imposed on income that is not included in 
subpart F income is not considered attributable to subpart F 
income.

Extension of section 78

    The provision extends the existing language of section 78, 
which treats the gross up as a dividend to the domestic 
corporation, to new section 245A (i.e., the deemed dividend 
does not receive the benefit of the participation 
exemption).\1784\ The provision further revises new section 
250(a)(1)(B) to apply the section 250 deduction to the section 
78 gross-up with respect to a section 951A inclusion.\1785\ The 
section 78 gross-up amount attributable to a GILTI inclusion is 
considered GILTI for foreign tax credit limitation 
purposes.\1786\
---------------------------------------------------------------------------
    \1784\ A technical correction to the effective date of the changes 
to section 78 may be necessary to reflect the intent that fiscal-year 
taxpayers are not eligible to claim the benefit of the participation 
exemption for section 78 gross-ups made in taxable years beginning 
before December 31, 2017. A technical correction to section 78 may also 
be necessary to reflect the intent to allow previously taxed income 
from lower-tier CFCs that give rise to deemed paid credits under 
section 960(b) to be distributed without additional U.S. taxation. 
Furthermore, a technical correction may be necessary to reflect the 
intent that the section 78 gross-up amount attributable to a GILTI 
inclusion should be assigned to the basket to which the taxes relate 
for foreign tax credit limitation purposes.
    \1785\ New section 250 is discussed in greater detail in the 
explanation of section 14202 of the Act.
    \1786\ A technical correction may be necessary to reflect this 
intent.
---------------------------------------------------------------------------

Other rules

    The provision also allows deemed-paid credits to reduce the 
U.S. tax on an inclusion of income of a qualified electing fund 
(as defined in section 1295) consistent with prior law. 
Further, the provision preserves the prior-law suspension of 
taxes and credits until related income is taken into account 
under section 909 for all taxpayers that claim foreign tax 
credits, including shareholders of qualified electing funds.

    The Treasury Department has issued proposed regulations 
addressing these provisions.\1787\
---------------------------------------------------------------------------
    \1787\ REG-105600-18, November 28, 2018, available at https://
www.irs.gov/pub/irs-drop/res-105600-18.pdf.
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

  B. Separate Foreign Tax Credit Limitation Basket for Foreign Branch 
        Income (sec. 14302 of the Act and sec. 904 of the Code)


                        Explanation of Provision


Background on prior law

    Under prior law, the amount of allowable foreign tax 
credits is limited to the amount of U.S. tax attributable to 
foreign-source net income, with separate limitations for 
passive category income, general category income, and income 
that is resourced under applicable treaties.\1788\ For each 
category (or ``basket'') of foreign-source income, the maximum 
amount of foreign tax credits equals the same proportion of the 
overall U.S. tax liability (as determined without regard to 
foreign tax credits) that the amount of foreign-source income 
in the relevant basket bears to the U.S. taxpayer's worldwide 
income.
---------------------------------------------------------------------------
    \1788\ See sec. 904(d).
---------------------------------------------------------------------------
    A domestic corporation may operate in a foreign country 
through an actual foreign branch, or may own a foreign entity 
that is classified as a disregarded entity and treated as a 
foreign branch for U.S. tax purposes. All income of a foreign 
branch is included in the taxable income of the domestic 
corporation, regardless of whether any amounts are remitted to 
the United States in the year earned. Foreign taxes imposed on 
the foreign branch income may be claimed as credits against any 
U.S. tax liability. Furthermore, the losses of a foreign branch 
reduce the taxable income of such domestic corporation. Dual 
consolidated loss rules under section 1503(d), however, provide 
that such losses cannot be used currently if the losses can 
also be used by a foreign subsidiary to reduce its income under 
foreign law.

Separate foreign tax credit limitation basket for foreign branch income

    In addition to the separate limitation categories for 
passive income, general income, and, for taxable years 
beginning after December 31, 2017, amounts includible in gross 
income under section 951A (i.e., GILTI), the provision provides 
that the foreign tax credit limitation is applied separately to 
foreign branch income.\1789\ As a result, the U.S. tax on 
foreign branch income can be reduced only by credits for taxes 
paid by foreign branches of a U.S. person, and any excess 
credits for foreign income taxes paid by a U.S. person's 
foreign branches cannot be used to reduce U.S. tax on other 
foreign-source income.\1790\
---------------------------------------------------------------------------
    \1789\ Sec. 904(d)(1)(B). Clerical corrections may be necessary to 
reflect the intent to add two new foreign tax credit limitation 
categories (i.e., GILTI and foreign branch income) to section 
904(d)(1). For example, the cross-reference in section 904(d)(2)(H)(i) 
to section 904(d)(1)(B) (foreign branch income) should be changed to 
section 904(d)(1)(D) (general category income).
    \1790\ Pursuant to section 904(c), excess credits can be carried 
back one year and forward 10 years.
---------------------------------------------------------------------------
    Foreign branch income means the business profits of a U.S. 
person \1791\ which are attributable to one or more qualified 
business units \1792\ (``QBUs''') in one or more foreign 
countries. Under the provision, business profits of a QBU are 
determined under rules established by the Secretary. Business 
profits of a QBU, however, do not include any income that is 
passive category income. Financial services income attributable 
to a QBU shall not be treated as passive category income.\1793\
---------------------------------------------------------------------------
    \1791\ Sec. 904(d)(2)(J)(i).
    \1792\ As defined in section 989(a).
    \1793\ A technical correction may be necessary to reflect this 
intent.
---------------------------------------------------------------------------
    Like the passive and general foreign tax credit separate 
limitation categories, the separate limitation category for 
foreign branch income is intended to prevent so-called ``cross-
crediting'' of foreign tax paid with respect to foreign-source 
income in one limitation category (here, foreign branch income) 
against U.S. tax imposed on income in another limitation 
category (e.g., general limitation category income). Like the 
other separate limitation categories, the foreign branch income 
limitation allows blending of foreign tax credits for foreign 
taxes imposed on different income streams within the same 
category (e.g., income from two or more foreign branches). For 
an example of a restriction created by the provision, assume 
that a U.S. taxpayer receives foreign-source royalty income 
that has been subject to little or no foreign tax and that is 
in the general limitation category. Assume the U.S. taxpayer 
also has manufacturing sales income in one or more foreign 
branches that has been subject to foreign tax at a rate higher 
than the applicable U.S. tax rate. If the U.S. taxpayer has 
foreign tax credits related to foreign tax paid on its foreign 
branch manufacturing sales income in excess of the separate 
foreign branch limitation amount, the taxpayer is not permitted 
to use those excess foreign tax credits to offset residual U.S. 
tax on the foreign-source royalty income in the general 
limitation category. If, by contrast, the royalty income were 
instead derived by another foreign branch (``Foreign Branch 
2'') subject to little foreign tax, the taxpayer would be 
permitted to take into account foreign tax attributable to, and 
foreign income derived by, the high-tax foreign branch in the 
same foreign tax credit limitation computation as foreign tax 
attributable to, and foreign income derived by, Foreign Branch 
2.

                            Effective Dates

    The provision is effective for taxable years beginning 
after December 31, 2017.

C. Source of Income from Sales of Inventory Determined Solely on Basis 
of Production Activities (sec. 14303 of the Act and sec. 863(b) of the 
                                 Code)


                        Explanation of Provision


Background on prior law

    Income from the sale of inventory is generally sourced 
based on where title to the property and risk of loss pass to 
the purchaser (the ``title passage'' rule).\1794\ For example, 
income from the sale of inventory where title passes outside 
the United States generally is foreign-source income. Income 
from production activity, conversely, is generally sourced 
where the taxpayer's production assets are located.\1795\
---------------------------------------------------------------------------
    \1794\ Secs. 861(a)(6), 862(a)(6), and 865(b); see also Treas. Reg. 
sec. 1.861-7.
    \1795\ Treas. Reg. sec. 1.863-3(c)(1)(i)(A).
---------------------------------------------------------------------------
    Prior law sourced gross income from the sale of inventory 
manufactured or produced within and sold without the United 
States, or vice versa, by attributing some gross income from 
the sale to the production activity and the remainder to sales 
activity. While not the only sourcing method provided in the 
applicable regulations under section 863(b), a commonly used 
approach under prior law was the ``50/50 method,'' under which 
gross income was apportioned one-half to production activity 
and one-half to sales activity. Where inventory was produced in 
the United States and sold outside the United States, or vice 
versa, the 50/50 method resulted in 50 percent of the income 
being treated as U.S. source and 50 percent as foreign source. 
This general rule is modified where a sale of personal property 
made by a nonresident was attributable to its office or fixed 
place of business in the United States.\1796\ In those cases, 
all of the income is U.S. source except in the case of 
inventory sold for use, disposition, or consumption outside the 
United States if a foreign office or other fixed place of 
business of the nonresident materially participated in the 
sale.\1797\
---------------------------------------------------------------------------
    \1796\ Sec. 865(e)(2).
    \1797\ Ibid.
---------------------------------------------------------------------------
    As a general matter, if sales income is treated as foreign 
source, the U.S. tax on such sales income generally can be 
reduced by excess foreign tax credits on other business income 
in the same foreign tax credit basket.

Changes to section 863(b)

    The provision overrides the general title passage rule and 
the 50/50 method and provides that gains, profits, and income 
from the sale or exchange of inventory property that is either 
(1) produced (in whole or in part) inside the United States and 
then sold or exchanged outside the United States or (2) 
produced (in whole or part) outside the United States and then 
sold or exchanged inside the United States, is allocated and 
apportioned solely on the basis of the location of production 
activity.\1798\ For example, income derived from the sale of 
inventory property outside the United States is sourced wholly 
within the United States if the property was produced entirely 
in the United States, even if title passage occurred elsewhere. 
Likewise, income derived from inventory property sold in the 
United States, but produced entirely in another country, has a 
foreign source even if title passage occurs in the United 
States. If inventory property is produced partly in, and partly 
outside, the United States, the income derived from its sale is 
sourced partly in the United States regardless of where title 
to the property passes.
---------------------------------------------------------------------------
    \1798\ The provision does not modify section 865(e)(2). 
Furthermore, the rule addressing sales of inventory property purchased 
in the United States and sold in a U.S. possession was not changed by 
the Act.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

D. Election to Increase Percentage of Domestic Taxable Income Offset by 
Overall Domestic Loss Treated as Foreign Source (sec. 14304 of the Act 
                      and sec. 904(g) of the Code)


                        Explanation of Provision


Background on prior law

    If a taxpayer has an overall domestic loss (``ODL'') for 
any taxable year beginning after 2006, then in a succeeding 
taxable year an amount of the taxpayer's U.S.-source income 
equal to the lesser of (1) 50 percent of the taxpayer's U.S.-
source income or (2) the amount of the ODL (to the extent not 
recharacterized under this ODL rule in prior taxable years) is 
treated as foreign-source income (the ``ODL recapture 
rule'').\1799\
---------------------------------------------------------------------------
    \1799\ Sec. 904(g)(1). Any U.S.-source income recharacterized under 
the ODL rules 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 ODLs.
---------------------------------------------------------------------------
    An ODL means 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.\1880\
---------------------------------------------------------------------------
    \1800\ Sec. 904(g)(2)(A). 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 for any 
taxable year unless the taxpayer elected the use of the foreign tax 
credit for such taxable year. Sec. 904(g)(2)(B).
---------------------------------------------------------------------------

Election to increase percentage of domestic taxable income offset by 
        ODL

    For any pre-2018 unused ODL taken into account under the 
ODL recapture rule in an applicable taxable year, the provision 
allows a taxpayer to elect to have the ODL recapture rule 
applied by substituting for the 50-percent limitation a 
limitation with a percentage greater than 50 percent but not 
more than 100 percent.\1801\ The term pre-2018 unused ODL means 
any ODL which: (1) arises in a qualified taxable year \1802\ 
beginning before January 1, 2018, and (2) has not been used 
under the general rule set forth in section 904(g)(1).\1803\ 
The term ``applicable taxable year'' means any taxable year of 
the taxpayer beginning after December 31, 2017, and before 
January 1, 2028.
---------------------------------------------------------------------------
    \1801\ Sec. 904(g)(5)(A).
    \1802\ For this purpose, qualified taxable year means any taxable 
year for which the taxpayer elected the use of the foreign tax credit. 
Sec. 904(g)(2)(C).
    \1803\ Sec. 904(g)(5)(B).
---------------------------------------------------------------------------
    For example, assume that a taxpayer has a $100 pre-2018 
unused ODL. In its 2019 taxable year, taxpayer earns $75 of 
U.S.-source income and $100 of foreign-source income, resulting 
in $175 of total taxable income. For purposes of taking into 
account its $100 pre-2018 unused ODL under the ODL recapture 
rule, the taxpayer may elect to increase the percentage of 
U.S.-source income treated as foreign source to a percentage 
greater than 50 percent but not more than 100 percent for 
purposes of determining the foreign tax credit limitation under 
section 904 for its 2019 taxable year, meaning that, in this 
case, up to $75 of U.S.-source income may be recharacterized as 
foreign-source.

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

                     PART II--INBOUND TRANSACTIONS

  A. Base Erosion and Anti-Abuse Tax (sec. 14401 of the Act and sec. 
                  6038A and new sec. 59A of the Code)

                        Explanation of Provision

In general
    Section 59A of the Act imposes a tax on certain corporate 
taxpayers in addition to any other regular tax liability the 
taxpayer may have. Several new terms are defined to effectuate 
this tax. These terms and the mechanics of this base erosion 
and anti-abuse additional tax are explained in more detail 
below.
    Liability for this additional tax is generally limited to 
those taxpayers with substantial gross receipts and is 
determined, in part, by the extent to which the taxpayer has 
made deductible payments to foreign related parties. Taxpayers 
potentially liable for this additional tax have three-year 
average gross receipts in excess of $500 million and a ``base 
erosion percentage'' exceeding a specified threshold. The base 
erosion percentage is generally determined by dividing ``base 
erosion tax benefits'' by the amount of deductions allowable to 
the taxpayer for the taxable year.
    The taxpayer's additional tax is computed by comparing the 
taxpayer's ``modified taxable income'' to the taxpayer's 
regular tax liability (as defined in section 26(b)) after the 
regular tax liability has been reduced by certain credits 
against tax. Modified taxable income is the taxpayer's regular 
taxable income increased by any base erosion tax benefit with 
respect to any ``base erosion payment'' and an adjustment for 
the taxpayer's NOL deduction, if any. The taxpayer has an 
additional tax liability equal to the difference between 10 
percent of the taxpayer's modified taxable income and the 
taxpayer's regular tax liability after adjustment has been made 
to account for certain credits against the taxpayer's regular 
tax liability. Special rules apply in the case of banks and 
securities dealers. Special rules also apply in the case of the 
taxpayer's taxable year beginning in 2018 and for taxable years 
beginning after December 31, 2025.
Applicable taxpayer
            In general
    With respect to any taxable year, an applicable taxpayer is 
a taxpayer: (1) which is a corporation other than a RIC, a 
REIT, or an S corporation; (2) which has average annual gross 
receipts of at least $500 million over the three preceding 
taxable years; and (3) which has a base erosion percentage for 
the taxable year of three percent or higher.\1804\ All persons 
treated as a single employer under section 52(a) are aggregated 
and treated as one person for purposes of applying the $500 
million gross receipts test and determining the base erosion 
percentage, except that in applying section 1563 for purposes 
of section 52, the exception for foreign corporations under 
section 1563(b)(2)(C) is disregarded.
---------------------------------------------------------------------------
    \1804\ Sec. 59A(e).
---------------------------------------------------------------------------
            Gross receipts test and foreign persons
    A foreign person's gross receipts are generally taken into 
account for purposes of applying the $500 million gross 
receipts test only if they are taken into account in 
determining income effectively connected with the conduct of a 
U.S. trade or business.\1805\ In other words, if the foreign 
person has a foreign branch, gross receipts of that foreign 
branch are generally not taken into account in the $500 million 
gross receipts test. In contrast, the gross receipts of the 
foreign branch of a U.S. person are generally taken into 
account in the $500 million gross receipts test. In cases where 
the gross receipts of a taxpayer that is a foreign person are 
aggregated with the gross receipts of any U.S. person, the 
gross receipts from all sources of those U.S. persons are 
included in the aggregation with the foreign person's gross 
receipts in applying the $500 million gross receipts test to 
determine whether the foreign person is an applicable taxpayer. 
For example, if the gross receipts of a taxpayer that is a 
foreign person are aggregated with the gross receipts of a U.S. 
person with a foreign branch, gross receipts of that foreign 
branch are generally taken into account for purposes of 
applying the $500 million gross receipts test to the foreign 
person.
---------------------------------------------------------------------------
    \1805\ Sec. 59A(e)(2)(A).
---------------------------------------------------------------------------
Base erosion payment
            In general
    A base erosion payment is generally any amount paid or 
accrued by a taxpayer to a foreign person that is a related 
party of the taxpayer and with respect to which a deduction is 
allowable under Chapter 1.\1806\
---------------------------------------------------------------------------
    \1806\ Sec. 59A(d)(1). Chapter 1 encompasses section 1 through 
section 1400Z-2 of the Code.
---------------------------------------------------------------------------
    A base erosion payment includes any amount paid or accrued 
by the taxpayer to a foreign related party in connection with 
the acquisition by the taxpayer from the related party of 
property of a character subject to the allowance for 
depreciation (or amortization in lieu of depreciation). A base 
erosion payment also includes any premium or other 
consideration paid or accrued by the taxpayer to a foreign 
related party for any reinsurance payments that are taken into 
account under sections 803(a)(1)(B) or 832(b)(4)(A).
    Base erosion payments do not generally include any amount 
that constitutes a reduction in gross receipts, including 
payments for cost of goods sold. However, base erosion payments 
include any amount that constitutes a reduction in gross 
receipts of the taxpayer that is paid or accrued by the 
taxpayer with respect to: (1) a surrogate foreign corporation 
that is a related party of the taxpayer, but only if the person 
first became a surrogate foreign corporation after November 9, 
2017, or (2) a foreign person that is a member of the same 
expanded affiliated group \1807\ as the surrogate foreign 
corporation. A surrogate foreign corporation has the meaning 
given in section 7874(a)(2)(B) but does not include a foreign 
corporation treated as a domestic corporation under section 
7874(b).
---------------------------------------------------------------------------
    \1807\ The definition of expanded affiliated group follows the 
definition in section 7874(c)(1), under which an expanded affiliated 
group is an affiliated group as defined in section 1504(a) but without 
regard to the exception for foreign corporations and applied by 
substituting ``more than 50 percent'' for ``at least 80 percent'' each 
place it appears.
---------------------------------------------------------------------------
            Foreign persons and related parties
    For purposes of section 59A, a foreign person is generally 
any person who is not a U.S. person within the meaning of 
section 7701(a)(30).\1808\
---------------------------------------------------------------------------
    \1808\ Secs. 59A(g), citing 6038A(c)(3). Under section 6038A(c)(3), 
any individual who is a citizen of any possession of the United States 
(but is not otherwise a U.S. citizen) and who is not a U.S. resident is 
not treated as a U.S. person.
---------------------------------------------------------------------------
    In addition, for purposes of section 59A, a related party 
is, with respect to the taxpayer, any 25-percent owner of the 
taxpayer; any person who is related (within the meaning of 
sections 267(b) or 707(b)(1)) to the taxpayer or any 25-percent 
owner of the taxpayer; and any other person who is related 
(within the meaning of section 482) to the taxpayer.\1809\
---------------------------------------------------------------------------
    \1809\ Sec. 59A(g). The 25-percent ownership threshold is 
determined by vote or value. In addition, section 318 applies in 
determining who is a related party except that (1) the threshold for 
attribution of corporate stock ownership under section 318(a)(2)(C) is 
reduced from 50 percent to 10 percent and (2) the rules of section 
318(a)(3) are not applied so as to consider a U.S. person as owning 
stock that is owned by a person who is not a U.S. person.
---------------------------------------------------------------------------
            Base erosion payment exceptions
                Certain payments for services \1810\
---------------------------------------------------------------------------
    \1810\ Sec. 59A(d)(5).
---------------------------------------------------------------------------
    A base erosion payment does not include any amount paid or 
accrued by a taxpayer for services if (1) such services meet 
the requirements for eligibility for use of the services cost 
method under section 482 (determined without regard to the 
requirement that the services not contribute significantly to 
fundamental risks of business success or failure) and (2) such 
amount constitutes the total services cost with no markup 
component.
                Qualified derivative payments
    A base erosion payment does not include any qualified 
derivative payment.\1811\ A qualified derivative payment is any 
payment made by a taxpayer pursuant to a derivative with 
respect to which the taxpayer: (1) recognizes gain or loss as 
if such derivative were sold for its fair market value on the 
last business day of the taxable year (and such additional 
times as are required by the Code or by the taxpayer's method 
of accounting), (2) treats any gain or loss so recognized as 
ordinary, and (3) treats the character of all items of income, 
deduction, gain or loss with respect to a payment pursuant to 
the derivative as ordinary.
---------------------------------------------------------------------------
    \1811\ Sec. 59A(h).
---------------------------------------------------------------------------
    No payment is treated as a qualified derivative payment for 
any taxable year unless the taxpayer includes as part of the 
reporting requirements under section 6038A(b)(2) \1812\ 
information identifying the payments to be treated as qualified 
derivative payments for the taxable year and any other 
information that the Secretary determines is necessary to carry 
out the exception for qualified derivative payments.\1813\
---------------------------------------------------------------------------
    \1812\ A clerical correction may be needed to reflect this intent.
    \1813\ Sec. 59A(h)(2)(B).
---------------------------------------------------------------------------
    The exception for qualified derivative payments does not 
apply if (1) a payment with respect to a derivative is in 
substance, or is disguising, the kind of payment that would be 
treated as a base erosion payment if it were not made pursuant 
to a derivative, including any interest, royalty, or service 
payment, (or any other payment subject to this provision) or, 
(2) in the case of a contract which has derivative and 
nonderivative components, the payment is properly allocable to 
the nonderivative component.
    For purposes of determining whether a base erosion payment 
is a qualified derivative payment, the term ``derivative'' 
means any contract (including any option, forward contract, 
futures contract, short position, swap, or similar contract) 
the value of which, or any payment or other transfer with 
respect to which, is (directly or indirectly) determined by 
reference to one or more of the following: (1) any share of 
stock of a corporation,\1814\ (2) any evidence of indebtedness, 
(3) any commodity that is actively traded, (4) any currency, 
(5) any rate, price, amount, index, formula, or 
algorithm.\1815\ A derivative does not include any item 
described in (1) through (5) above or any insurance, annuity, 
or endowment contract issued by an insurance company to which 
subchapter L applies (or issued by any foreign corporation to 
which such subchapter would apply if such foreign corporation 
were a domestic corporation).
---------------------------------------------------------------------------
    \1814\ Except as otherwise provided by the Secretary, American 
depository receipts and similar instruments with respect to shares of 
stock in foreign corporations are treated as shares of stock in such 
foreign corporations.
    \1815\ Sec. 59A(h)(4)(A).
---------------------------------------------------------------------------
Base erosion tax benefit
    A base erosion tax benefit generally reflects the reduction 
in taxable income arising from the associated base erosion 
payment.
    A base erosion tax benefit is: (1) any deduction allowed 
under Chapter 1 for the taxable year with respect to a base 
erosion payment; (2) in the case of a base erosion payment with 
respect to the purchase of property of a character subject to 
the allowance for depreciation (or amortization in lieu of 
depreciation), any deduction allowed under Chapter 1 for 
depreciation or amortization in lieu of depreciation with 
respect to the property acquired with such payment; (3) any 
reduction under section 803(a)(1)(B) in the gross amount of 
premiums and other consideration arising out of indemnity 
insurance and any deduction under section 832(b)(4)(A) from the 
amount of gross premiums paid for reinsurance; and (4) in the 
case of a base erosion payment the amount of which constitutes 
a reduction in gross receipts, any reduction in gross receipts 
with respect to such payment.\1816\
---------------------------------------------------------------------------
    \1816\ Sec. 59A(c)(2).
---------------------------------------------------------------------------
    In the case of a taxpayer to which new section 163(j) 
applies to limit a taxpayer's interest deduction for the 
taxable year, the reduction in the amount of interest for which 
a deduction is allowed by reason of section 163(j) is treated 
as allocable first to interest paid or accrued to persons who 
are not related parties with respect to the taxpayer and then 
to related parties.\1817\
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    \1817\ Sec. 59A(c)(3).
---------------------------------------------------------------------------
    Any base erosion tax benefit attributable to any base 
erosion payment on which tax is imposed by section 871 or 881, 
and with respect to which tax has been deducted and withheld 
under section 1441 or 1442, is generally not taken into account 
in computing modified taxable income or the base erosion 
percentage. However, in computing modified taxable income, the 
portion (if any) not taken into account is determined under 
rules similar to the rules under former section 
163(j)(5)(B).\1818\ For example, if the withholding tax rate on 
a particular base erosion payment is reduced by two-thirds from 
the regular rate of 30 percent to 10 percent (so that the 
payment is subject to withholding at one-third of the regular 
withholding tax rate), then the base erosion tax benefit 
attributable to the base erosion payment is reduced by one-
third for purposes of calculating modified taxable income.
---------------------------------------------------------------------------
    \1818\ As in effect before the date of enactment of the Act. Sec. 
59A(c)(2)(B)(ii).
---------------------------------------------------------------------------
Base erosion percentage
    For purposes of calculating modified taxable income, and 
determining whether a taxpayer is an applicable taxpayer and 
subject to the base erosion and anti-abuse additional tax, the 
base erosion percentage means, for any taxable year, the 
percentage equal to the aggregate amount of base erosion tax 
benefits of the taxpayer for the taxable year divided by the 
sum of: (1) the aggregate amount of the deductions allowable to 
the taxpayer under Chapter 1 for the taxable year and (2) the 
amount of other base erosion tax benefits to the extent they 
are not included in (1).\1819\ The denominator for the base 
erosion percentage is computed without regard to any deduction 
allowed under sections 172, 245A, or 250 and any deduction for 
amounts reflecting service payments, or qualified derivative 
payments, that are excluded as base erosion payments.
---------------------------------------------------------------------------
    \1819\ Sec. 59A(d)(4)
---------------------------------------------------------------------------
Modified taxable income of applicable taxpayers
    An applicable taxpayer's modified taxable income is its 
taxable income for the taxable year increased by (1) any base 
erosion tax benefit with respect to any base erosion payment 
and (2) the base erosion percentage of any NOL deduction 
allowed under section 172 for such taxable year.\1820\
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    \1820\ Sec. 59A(c)(1).
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Calculation of tax liability
    Under the base erosion and anti-abuse additional tax, 
applicable taxpayers are required to pay a tax equal to the 
base erosion minimum tax amount for the taxable year in 
addition to any other regular tax liability they may 
have.\1821\ The base erosion minimum tax amount equals the 
excess, if any, of 10 percent of modified taxable income over 
the amount of regular tax liability reduced (but not below 
zero) by the sum of a certain amount of Chapter 1 credits. 
Specifically, the amount of regular tax liability is reduced 
(and the base erosion minimum tax amount increased) by all 
Chapter 1 credits except for the research credit \1822\ and a 
certain portion of applicable section 38 credits.
---------------------------------------------------------------------------
    \1821\ Sec. 59A(a).
    \1822\ Sec. 41(a).
---------------------------------------------------------------------------
    Applicable section 38 credits \1823\ are credits allowed 
under section 38 for the taxable year that are properly 
allocable to the low-income housing credit,\1824\ the renewable 
energy production credit,\1825\ and the energy investment 
credit.\1826\ In general, no more than 80 percent of the amount 
of applicable section 38 credits for a taxable year can be used 
to reduce an applicable taxpayer's base erosion minimum tax 
liability, and in no case can applicable section 38 credits 
reduce the taxpayer's base erosion minimum tax liability by 
more than 80 percent.\1827\
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    \1823\ Sec. 59A(b)(4).
    \1824\ Sec. 42(a).
    \1825\ Sec. 45(a).
    \1826\ Sec. 48.
    \1827\ Sec. 59A(b)(1)(B)(i)(II)
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Special rules
            Special rules for a taxable year beginning in 2018 and for 
                    taxable years beginning after December 31, 2025
    For a taxable year beginning in 2018, the 10-percent rate 
on modified taxable income is reduced to five percent.\1828\ 
For taxable years beginning after December 31, 2025, the 10-
percent rate on modified taxable income is increased to 12.5 
percent, and the amount of regular tax liability is reduced 
(and the base erosion minimum tax amount is therefore 
increased) by the sum of all the taxpayer's Chapter 1 credits 
for the taxable year, when computing the base erosion minimum 
tax amount.\1829\
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    \1828\ Sec. 59A(b)(1)(A).
    \1829\ Sec. 59A(b)(2).
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            Special rules for banks and securities dealers
    An applicable taxpayer that is a member of an affiliated 
group that includes a bank (as defined in section 581) or 
securities dealer registered \1830\ under section 15(a) of the 
Securities Exchange Act of 1934 is subject to a tax rate on its 
modified taxable income that is one-percentage point higher 
than the generally applicable tax rate (e.g., six percent 
instead of five percent for a taxable year beginning in 
2018).\1831\ In addition, for purposes of determining whether 
they are applicable taxpayers, banks and securities dealers are 
subject to a two-percent base erosion percentage threshold 
(rather than three percent).\1832\
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    \1830\ A clerical correction may be needed to reflect this intent.
    \1831\ Sec. 59A(b)(3).
    \1832\ Sec. 59A(e)(1)(C).
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Information reporting requirements
    The provision introduces additional information reporting 
requirements with respect to certain foreign-owned corporations 
under section 6038A.\1833\ The provision authorizes the 
Secretary to prescribe additional reporting requirements under 
section 6038A relating to: (1) the name, principal place of 
business, and the country or countries of organization or 
residence of each person which is a related party to the 
reporting corporation and had any transaction with the 
reporting corporation during its taxable year; (2) the manner 
of relation between the reporting corporation and each person 
referred to in (1); and (3) transactions between the reporting 
corporation and each related foreign person.
---------------------------------------------------------------------------
    \1833\ Sec. 6038A(b).
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    In addition, for purposes of information reporting under 
sections 6038A and 6038C, if the reporting corporation or the 
foreign corporation to which section 6038C applies is an 
applicable taxpayer under this provision, the taxpayer is 
required to report (1) such information as the Secretary finds 
necessary to determine the base erosion minimum tax amount, 
base erosion payments, and base erosion tax benefits of the 
taxpayer for the taxable year and (2) any other information as 
the Secretary determines is necessary.\1834\
---------------------------------------------------------------------------
    \1834\ Sec. 6038A(b)(2).
---------------------------------------------------------------------------
    The penalties for failure to furnish information or 
maintain records under sections 6038A(d)(1) and (2) are both 
increased to $25,000.

Regulations

    New section 59A(i) authorizes the Secretary to prescribe 
such regulations or other guidance necessary or appropriate to 
carry out the provisions section 59A, including regulations 
providing for such adjustments to the application of this 
provision necessary to prevent avoidance of the provision, 
including through (1) the use of unrelated persons, conduit 
transactions, or other intermediaries, or (2) transactions or 
arrangements designed in whole or in part to (A) characterize 
payments otherwise subject to this provision as payments not 
subject to this provision or (B) substitute payments not 
subject to this provision for payments otherwise subject to 
this provision. In addition, the Secretary is authorized to 
prescribe such regulations or other guidance necessary or 
appropriate for purposes of applying the exception for 
qualified derivative payments, including rules to prevent 
avoidance.\1835\
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    \1835\ A clerical correction may be needed to reflect this intent.
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Examples

    The following examples illustrate components of the base 
erosion minimum tax calculation. Example 1 presents the base 
facts for all of the examples and shows how the base erosion 
percentage and base erosion minimum tax amount are calculated 
when the taxpayer has neither an NOL deduction nor any allowed 
credit. Example 2 shows how modified taxable income is computed 
when the taxpayer has an NOL deduction. Examples 3 through 5 
illustrate the different effects that the research credit, 
applicable section 38 credits, and other Chapter 1 credits have 
on the calculation of the base erosion minimum tax amount. 
Example 6 shows how the calculation operates for taxable years 
beginning after December 31, 2025.
            Example 1: Base Case
    Assume USCo, a domestic C corporation that is neither a RIC 
nor a REIT, has gross receipts of $600,000,000 for its 2019 tax 
year and an average of $500,000,000 in gross receipts for the 
prior three taxable years. USCo is not a bank or securities 
dealer. USCo is a calendar-year taxpayer. It has no other 
sources of income and no foreign operations, and is wholly-
owned by a foreign corporation (which has no other U.S. 
operations). For 2019 it pays its employees $100,000,000 in 
salary (all of which is deductible) and makes $50,000,000 in 
interest payments and $250,000,000 in royalty payments to its 
foreign parent. USCo has carried over no NOLs into 2019. Also, 
for 2019, assume that USCo has made no payments reflected in 
cost of goods sold, has no other expenses, and has no credits 
available to reduce its regular tax liability. All calculations 
in these examples are for USCo's 2019 tax year.
            Base erosion percentage
    USCo has base erosion payments, and base erosion tax 
benefits, of $300,000,000 ($50,000,000 + $250,000,000). Its 
base erosion percentage equals its base erosion tax benefits of 
$300,000,000 divided by its $400,000,000 in overall deductible 
payments, or 75 percent. USCo is therefore an applicable 
taxpayer and subject to the base erosion minimum tax because it 
is a C corporation that is not a RIC or REIT and has met the 
gross receipts and base erosion percentage thresholds for being 
an applicable taxpayer.
            Base erosion minimum tax
    USCo has taxable income of $200,000,000 
($600,000,000-$400,000,000). At a 21-percent corporate tax 
rate, USCo's regular tax liability is $42,000,000.
    USCo's modified taxable income is its taxable income 
determined without regard to its $300,000,000 in base erosion 
tax benefits, or $500,000,000.
    USCO's base erosion minimum tax liability equals 10 percent 
of its modified taxable income less its amount of regular tax 
liability, or $50,000,000-$42,000,000 = $8,000,000. USCo is 
required to pay its base erosion minimum tax liability of 
$8,000,000 in addition to its regular tax liability of 
$42,000,000 for a total tax liability of $50,000,000.
            Example 2: Variant of Example 1 with NOL Deduction
    Assume the same facts as Example 1, except that USCo has an 
NOL deduction (originating from a loss in tax year 2018) in tax 
year 2019 of $100,000,000. For simplicity, also assume that 
USCo's base erosion percentage for tax year 2018 is the same as 
that for tax year 2019, or 75 percent.
    With the $100,000,000 NOL, USCo has taxable income of 
$100,000,000 ($600,000,000-$400,000,000-$100,000,000). At a 21-
percent corporate tax rate, USCo's regular tax liability is 
$21,000,000.
    USCo's modified taxable income is its taxable income 
determined without regard to its $300,000,000 in base erosion 
tax benefits and the base erosion percentage of its NOL 
deduction allowed under section 172 for tax year 2019, or 
$100,000,000 + $300,000,000 + (75 percent * $100,000,000) = 
$475,000,000.
    USCo's base erosion minimum tax liability equals 10 percent 
of its modified taxable income less its amount of regular tax 
liability adjusted by credits, or $47,500,000-$21,000,000 = 
$26,500,000. USCo is required to pay its base erosion minimum 
tax liability of $26,500,000 in addition to its regular tax 
liability of $21,000,000 for a total tax liability of 
$47,500,000. Relative to the scenario in Example 1, USCo's 
$100,000,000 NOL reduces its regular tax liability by 
$21,000,000 but increases its base erosion minimum tax 
liability by $18,500,000, resulting in a tax savings of 
$2,500,000 (or 2.5 percent of its NOL amount).
            Example 3: Variant of Example 2 with Foreign Tax Credit
    Assume the same facts as Example 2, except that USCo is 
allowed a section 901 foreign tax credit of $8,000,000 for 
2019.
    As in Example 2, USCo has regular tax liability of 
$21,000,000 and modified taxable income of $475,000,000.
    For purposes of the base erosion minimum tax calculation, 
USCo is required to reduce the amount of its regular tax 
liability by the excess of all allowable Chapter 1 credits 
($8,000,000) over the sum of its research credit ($0) and a 
certain portion of applicable section 38 credits ($0).\1836\ In 
particular, USCo's base erosion minimum tax liability equals 10 
percent of its modified taxable income less its amount of 
regular tax liability adjusted by credits, or 
$47,500,000-($21,000,000-[$8,000,000-($0 + $0)]) = $34,500,000.
---------------------------------------------------------------------------
    \1836\ Sec. 59A(b)(1)(B)(ii)(I).
---------------------------------------------------------------------------
    USCo is required to pay its base erosion minimum tax 
liability of $34,500,000 in addition to its regular tax 
liability of $21,000,000 for a total tax liability, prior to 
allowed credits, of $55,500,000. USCo's total tax liability 
after allowed credits is $47,500,000 ($55,500,000-$8,000,000).
            Example 4: Variant of Example 3 with Research Credit
    Assume the same facts as Example 3, except that USCo is 
also allowed a section 41 research credit of $5,000,000 for 
2019.
    As in Example 2, USCo has regular tax liability of 
$21,000,000 and modified taxable income of $475,000,000.
    For purposes of the base erosion minimum tax calculation, 
USCo is required to reduce the amount of its regular tax 
liability by the excess of all allowable Chapter 1 credits 
($8,000,000 + $5,000,000) over the sum of its research credit 
($5,000,000) and a certain portion of applicable section 38 
credits ($0).\1837\ In particular, USCo's base erosion minimum 
tax liability equals 10 percent of its modified taxable income 
less its amount of regular tax liability adjusted by credits, 
or $47,500,000-($21,000,000-[($8,000,000 + 
$5,000,000)-($5,000,000 + $0)]) = $34,500,000.
---------------------------------------------------------------------------
    \1837\ Ibid.
---------------------------------------------------------------------------
    USCo is required to pay its base erosion minimum tax 
liability of $34,500,000 in addition to its regular tax 
liability of $21,000,000 for a total tax liability, prior to 
allowed credits, of $55,500,000. USCo's total tax liability 
after allowed credits is $42,500,000 
($55,500,000-$8,000,000-$5,000,000). While USCo's total post-
credit tax liability is $47,500,000 in Example 3, USCo's total 
post-credit tax liability is $42,500,000 in Example 4.
            Example 5: Variant of Example 4 with an Applicable Section 
                    38 Credit
    Assume the same facts as in Example 4, except that USCo is 
allowed a section 42 low-income housing credit of $6,000,000.
    As in Example 4, USCo has regular tax liability of 
$21,000,000 and modified taxable income of $475,000,000.
    For purposes of the base erosion minimum tax calculation, 
USCo is required to reduce the amount of its regular tax 
liability by the excess of all allowable Chapter 1 credits 
($8,000,000 + $5,000,000 + $6,000,000) over the sum of the full 
amount of its research credit ($5,000,000) and a certain 
portion of applicable section 38 credits (80 percent * 
$6,000,000 = $4,800,000). In particular, USCo's base erosion 
minimum tax liability equals 10 percent of its modified taxable 
income less its amount of regular tax liability adjusted by 
credits, or $47,500,000-($21,000,000-[($8,000,000 + $5,000,000 
+ $6,000,000)-($5,000,000 + (80 percent * $6,000,000))]) = 
$35,700,000.
    The portion is $4,800,000 because no more than 80 percent 
of the amount of applicable section 38 credits for a taxable 
year can be used to reduce USCo's base erosion minimum tax 
liability, and in no case can applicable section 38 credits 
reduce USCo's base erosion minimum tax liability by more than 
80 percent.\1838\ Without regard to the special rule for 
applicable section 38 credits, USCo's base erosion minimum tax 
liability would be $40,500,000 ($47,500,000-$21,000,000 + 
($8,000,000 + $6,000,000)). Applicable section 38 credits 
cannot be used to reduce the base erosion minimum tax liability 
by more than 80 percent of this amount, or $32,400,000 (80 
percent * $40,500,000). For purposes of computing its base 
erosion minimum tax liability, USCo's applicable section 38 
credit adjustment to its Chapter 1 credit amount is the lesser 
of $32,400,000 or $4,800,000. Therefore, the applicable section 
38 credit adjustment is $4,800,000.
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    \1838\ Sec. 59A(b)(1)(B)(ii)(II).
---------------------------------------------------------------------------
    USCo is required to pay its base erosion minimum tax 
liability of $35,700,000 in addition to its regular tax 
liability of $21,000,000 for a total tax liability, prior to 
allowed credits, of $56,700,000. USCo's total tax liability 
after allowed credits is $37,700,000 
($56,700,000-$8,000,000-$5,000,000-$6,000,000). While USCo's 
total post-credit tax liability is $42,500,000 in Example 4, 
USCo's total post-credit tax liability is $37,700,000 in 
Example 5.
            Example 6: Variant of Example 5 for Tax Year 2026
    Assume the same facts as in Example 5, except that the 
figures for tax year 2019 are for tax year 2026.
    As in Example 5, USCo has regular tax liability of 
$21,000,000 and modified taxable income of $475,000,000.
    When computing the base erosion minimum tax amount for 
taxable years beginning after December 31, 2025, the 10-percent 
tax rate on modified taxable income is increased to 12.5 
percent, and the amount of regular tax liability is reduced by 
the sum of all the taxpayer's Chapter 1 credits for the taxable 
year. As a result, USCo's base erosion liability for 2026 
equals 12.5 percent of its modified taxable income less its 
amount of regular tax liability (reduced by the sum of all 
Chapter 1 credits), or (12.5 percent * 
$475,000,000)-[$21,000,000-($8,000,000 + $5,000,000 + 
$6,000,000] = $59,375,000-$2,000,000 = $57,375,000. USCo's 
total post-credit tax liability is $57,375,000 + 
$21,000,000-$19,000,000 = $59,375,000, so that, in effect, USCo 
is unable to utilize any of its allowed Chapter 1 credits to 
reduce its total tax liability.\1839\
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    \1839\ To see this, note that, if USCo had no allowed Chapter 1 
credits, its regular tax liability is $21,000,000 and its base erosion 
minimum tax amount equals $59,375,000-$21,000,000 = $38,375,000, so 
that its total tax liability equals $21,000,000 + $38,375,000 = 
$59,375,000.
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to base erosion payments paid or 
accrued in taxable years beginning after December 31, 2017.

                       PART III--OTHER PROVISIONS

 A. Restriction on Insurance Business Exception to the Passive Foreign 
 Investment Company Rules (sec. 14501 of the Act and sec. 1297 of the 
                                 Code)

                               Prior Law

Passive foreign investment companies and insurance
    Under the PFIC regime, passive income is any income which 
is of a kind that would be foreign personal holding company 
income, including dividends, interest, royalties, rents, and 
certain gains on the sale or exchange of property, commodities, 
or foreign currency. However, among other exceptions, passive 
income does not include any income derived in the active 
conduct of an insurance business by a corporation that is 
predominantly engaged in an insurance business and that would 
be subject to tax under subchapter L if it were a domestic 
corporation.\1840\ In applying the insurance exception, the IRS 
analyzes whether risks assumed under contracts issued by a 
foreign company organized as an insurer are truly insurance 
risks, whether the risks are limited under the terms of the 
contracts, and the status of the company as an insurance 
company.\1841\
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    \1840\ Sec. 1297(b)(2)(B).
    \1841\ Notice 2003-34, 2003-C.B. 1 990, June 9, 2003. See also, 
Prop. Treas. Reg. sec. 1.1297-4, 26 CFR Part 1, REG-108214-15, April 
24, 2015.
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                        Explanation of Provision

    The provision modifies the requirements for a corporation 
the income of which is not included in passive income for 
purposes of the PFIC rules. The provision replaces the test 
based on whether a corporation is predominantly engaged in an 
insurance business with a test based on the corporation's 
insurance liabilities.\1842\ The requirement that the foreign 
corporation would be subject to tax under subchapter L if it 
were a domestic corporation is retained.
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    \1842\ Treasury regulations proposed in 2015 have taken a different 
approach that is based on the prior statutory rule. Prop. Treas. Reg. 
sec. 1.1297-4, 26 CFR Part 1, REG-108214-15, April 24, 2015. The 
proposed regulations provide that ``the term insurance business means 
the business of issuing insurance and annuity contracts and the 
reinsuring of risks underwritten by insurance companies, together with 
those investment activities and administrative services that are 
required to support or are substantially related to insurance and 
annuity contracts issued or reinsured by the foreign corporation.'' The 
proposed regulations provide that an investment activity is an activity 
producing foreign personal holding company income, and that is 
``required to support or [is] substantially related to insurance and 
annuity contracts issued or reinsured by the foreign corporation to the 
extent that income from the activities is earned from assets held by 
the foreign corporation to meet obligations under the contracts.'' The 
preamble to the proposed regulations specifically requests comments on 
the proposed regulations ``with regard to how to determine the portion 
of a foreign insurance company's assets that are held to meet 
obligations under insurance contracts issued or reinsured by the 
company,'' for example, if the assets ``do not exceed a specified 
percentage of the corporation's total insurance liabilities for the 
year.'' Ibid.
---------------------------------------------------------------------------
    Under the provision, passive income for purposes of the 
PFIC rules does not include income derived in the active 
conduct of an insurance business by a corporation (1) that 
would be subject to tax under subchapter L if it were a 
domestic corporation; and (2) the applicable insurance 
liabilities of which constitute more than 25 percent of its 
total assets as reported on the company's applicable financial 
statement for the last year ending with or within the taxable 
year.
    For the purpose of the provision's exception from passive 
income, applicable insurance liabilities mean, with respect to 
any property and casualty or life insurance business (1) loss 
and loss adjustment expenses, (2) reserves (other than 
deficiency, contingency, or unearned premium reserves) for life 
and health insurance risks and life and health insurance claims 
with respect to contracts providing coverage for mortality or 
morbidity risks. This includes loss reserves for property and 
casualty, life, and health insurance contracts and annuity 
contracts. Unearned premium reserves with respect to any type 
of risk are not treated as applicable insurance liabilities for 
purposes of the provision. For purposes of the provision, the 
amount of any applicable insurance liability may not exceed the 
lesser of such amount (1) as reported to the applicable 
insurance regulatory body in the applicable financial statement 
(or, if less, the amount required by applicable law or 
regulation), or (2) as determined under regulations prescribed 
by the Secretary.
    An applicable financial statement is a statement for 
financial reporting purposes that (1) is made on the basis of 
generally accepted accounting principles, (2) is made on the 
basis of international financial reporting standards, but only 
if there is no statement made on the basis of generally 
accepted accounting principles, or (3) except as otherwise 
provided by the Secretary in regulations, is the annual 
statement required to be filed with the applicable insurance 
regulatory body, but only if there is no statement made on 
either of the foregoing bases. Unless otherwise provided in 
regulations, it is intended that generally accepted accounting 
principles means U.S. GAAP.
    The applicable insurance regulatory body means, with 
respect to any insurance business, the entity established by 
law to license, authorize, or regulate such insurance business 
and to which the applicable financial statement is provided. 
For example, in the United States, the applicable insurance 
regulatory body is the State insurance regulator to which the 
corporation provides its annual statement.
    If a corporation fails to qualify solely because its 
applicable insurance liabilities constitute 25 percent or less 
of its total assets, a United States person who owns stock of 
the corporation may elect in such manner as the Secretary 
prescribes to treat the stock as stock of a qualifying 
insurance corporation if (1) the corporation's applicable 
insurance liabilities constitute at least 10 percent of its 
total assets, and (2) based on the applicable facts and 
circumstances, the corporation is predominantly engaged in an 
insurance business, and its failure to qualify under the 25 
percent threshold is due solely to runoff-related or rating-
related circumstances involving such insurance business.
    Facts and circumstances that tend to show the firm may not 
be predominantly engaged in an insurance business include a 
small number of insured risks with low likelihood but large 
potential costs; workers focused to a greater degree on 
investment activities than underwriting activities; and low 
loss exposure. Additional relevant facts for determining 
whether the firm is predominantly engaged in an insurance 
business include: claims payment patterns for the current and 
prior years; the firm's loss exposure as calculated for a 
regulator such as the SEC or for a rating agency, or if those 
are not calculated, for internal pricing purposes; the 
percentage of gross receipts constituting premiums for the 
current and prior years; and the number and size of insurance 
contracts issued or taken on through reinsurance by the firm. 
The fact that a firm has been holding itself out as an insurer 
for a long period is not determinative either way.
    Runoff-related or rating-related circumstances include, for 
example, the fact that the company is in runoff, that is, it is 
not taking on new insurance business (and consequently has 
little or no premium income), and is using its remaining assets 
to pay off claims with respect to pre-existing insurance risks 
on its books. Such circumstances also include, for example, the 
application to the company of specific requirements with 
respect to capital and surplus relating to insurance 
liabilities imposed by a rating agency as a condition of 
obtaining a rating necessary to write new insurance business 
for the current year.

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 2017.

B. Repeal of Fair Market Value Method of Interest Expense Apportionment 
            (sec. 14502 of the Act and sec. 864 of the Code)

                        Explanation of Provision

    The provision prohibits members of an affiliated group from 
allocating and apportioning interest expense on the basis of 
either gross income or the fair market value of assets for 
purposes of the income and expense sourcing provisions of the 
Code.\1843\ Instead, the members must allocate and apportion 
interest expense based on the adjusted tax basis of assets.
---------------------------------------------------------------------------
    \1843\ Section 864(e) provides that members of an affiliated group 
must allocate and apportion interest expense of each member as if all 
members of such group were a single corporation. An affiliated group is 
an affiliated group within the meaning of section 1504, with exceptions 
that take into account a foreign corporation if it is owned 80-percent 
owned by affiliated members and if more than 50 percent of its gross 
income is effectively connected with the conduct of a trade or business 
in the United States.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2017.

   APPENDIX: TECHNICAL EXPLANATION OF MODIFICATION OF DEDUCTION FOR 
  QUALIFIED BUSINESS INCOME OF A COOPERATIVE AND ITS PATRONS (ENACTED 
                  MARCH 23, 2018, PUB. L. NO. 115-141)

    Below is Part B of the Technical Explanation of the revenue 
provisions of the House amendment to the Senate amendment to 
H.R. 1625 (Rules Committee Print 115-66), as introduced in the 
House on March 21, 2018. Part B describes modifications to 
section 199A. The Technical Explanation, prepared by the staff 
of the Joint Committee on Taxation, was published online at 
www.jct.gov as: Joint Committee on Taxation, Technical 
Explanation of the Revenue Provisions of the House Amendment to 
the Senate Amendment to H.R. 1625 (Rules Committee Print 115-
66), (JCX-6-18), March 22, 2018, pages 5-28. H.R. 1625 was 
enacted on March 23, 2018, as Pub. L. No. 115-141.\1844\
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    \1844\ The section 199A modification is contained in Pub. L. No 
115-141, the Consolidated Appropriations Act, 2018, Division T, sec. 
101.
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     Modification of Deduction for Qualified Business Income of a 
                      Cooperative and Its Patrons


                               Prior Law


1. Treatment of taxpayers with domestic production activities income

In general

    Former section 199 \1845\ provides a deduction from taxable 
income (or, in the case of an individual, adjusted gross income 
\1846\) that is equal to nine percent of the lesser of the 
taxpayer's qualified production activities income or taxable 
income (determined without regard to the section 199 deduction) 
for the taxable year.\1847\ The amount of the deduction for a 
taxable year is limited to 50 percent of the W-2 wages paid by 
the taxpayer, and properly allocable to domestic production 
gross receipts, during the calendar year that ends in such 
taxable year.\1848\ W-2 wages are the total wages subject to 
wage withholding,\1849\ elective deferrals,\1850\ and deferred 
compensation \1851\ paid by the taxpayer with respect to 
employment of its employees during the calendar year ending 
during the taxable year of the taxpayer.\1852\ W-2 wages do not 
include any amount that is not properly allocable to domestic 
production gross receipts as a qualified item of 
deduction.\1853\ In addition, W-2 wages do not include any 
amount that was not properly included in a return filed with 
the Social Security Administration on or before the 60th day 
after the due date (including extensions) for such 
return.\1854\
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    \1845\ Section 199 was repealed by Pub. L. No. 115-97, An Act to 
Provide for Reconciliation Pursuant to Titles II and V of the 
Concurrent Resolution on the Budget for Fiscal Year 2018, for taxable 
years beginning after December 31, 2017. All references to former 
section 199 in this document refer to section 199 as in effect before 
its repeal.
    \1846\ For this purpose, adjusted gross income is determined after 
application of sections 86, 135, 137, 219, 221, 222, and 469, and 
without regard to the section 199 deduction. Sec. 199(d)(2).
    \1847\ Sec. 199(a).
    \1848\ Sec. 199(b).
    \1849\ Defined in sec. 3401(a).
    \1850\ Within the meaning of sec. 402(g)(3).
    \1851\ Deferred compensation includes compensation deferred under 
section 457, as well as the amount of any designated Roth contributions 
(as defined in section 402A).
    \1852\ Sec. 199(b). In the case of a taxpayer with a short taxable 
year that does not contain a calendar year ending during such short 
taxable year, the following amounts are treated as the W-2 wages of the 
taxpayer for the short taxable year: (1) wages paid during the short 
taxable year to employees of the qualified trade or business; (2) 
elective deferrals (within the meaning of section 402(g)(3)) made 
during the short taxable year by employees of the qualified trade or 
business; and (3) compensation actually deferred under section 457 
during the short taxable year with respect to employees of the 
qualified trade or business. Amounts that are treated as W-2 wages for 
a taxable year are not treated as W-2 wages of any other taxable year. 
See Treas. Reg. sec. 1.199-2(b). In addition, in the case of a taxpayer 
who is an individual with otherwise qualified production activities 
income from sources within the commonwealth of Puerto Rico, if all the 
income for the taxable year is taxable under section 1 (income tax 
rates for individuals), the determination of W-2 wages with respect to 
the taxpayer's trade or business conducted in Puerto Rico is made 
without regard to any exclusion under the wage withholding rules (as 
provided in section 3401(a)(8)) for remuneration paid for services in 
Puerto Rico. See sec. 199(d)(8)(B).
    \1853\ Sec. 199(b)(2)(B).
    \1854\ Sec. 199(b)(2)(C).
---------------------------------------------------------------------------
    In the case of oil related qualified production activities 
income, the deduction is reduced by three percent of the least 
of the taxpayer's oil related qualified production activities 
income, qualified production activities income, or taxable 
income (determined without regard to the section 199 deduction) 
for the taxable year.\1855\ For this purpose, oil related 
qualified production activities income for any taxable year is 
the portion of qualified production activities income 
attributable to the production, refining, processing, 
transportation, or distribution of oil, gas, or any primary 
product thereof \1856\ during the taxable year.
---------------------------------------------------------------------------
    \1855\ Sec. 199(d)(9).
    \1856\ Within the meaning of sec. 927(a)(2)(C) as in effect before 
its repeal.
---------------------------------------------------------------------------
    In general, qualified production activities income is equal 
to domestic production gross receipts reduced by the sum of: 
(1) the cost of goods sold that are allocable to those 
receipts; \1857\ and (2) other expenses, losses, or deductions 
which are properly allocable to those receipts.\1858\ 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 \1859\ that was manufactured, 
produced, grown, or extracted by the taxpayer in whole or in 
significant part within the United States; \1860\ (2) any sale, 
exchange, or other disposition, or any lease, rental, or 
license, of any qualified film \1861\ produced by the taxpayer; 
(3) any sale, exchange, or other disposition, or any lease, 
rental, or license, of electricity, natural gas, or potable 
water produced by the taxpayer in the United States; (4) 
construction of real property performed in the United States by 
a taxpayer in the ordinary course of a construction trade or 
business; or (5) engineering or architectural services 
performed in the United States by the taxpayer for the 
construction of real property in the United States.\1862\
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    \1857\ For this purpose, any item or service brought into the 
United States is treated as acquired by purchase, and its cost is 
treated as not less than its value immediately after it entered the 
United States. A similar rule applies in determining the adjusted basis 
of leased or rented property where the lease or rental gives rise to 
domestic production gross receipts. In addition, for any property 
exported by the taxpayer for further manufacture, the increase in cost 
or adjusted basis may not exceed the difference between the value of 
the property when exported and the value of the property when brought 
back into the United States after the further manufacture. See sec. 
199(c)(3)(A) and (B).
    \1858\ Sec. 199(c)(1). In computing qualified production activities 
income, the domestic production activities deduction itself is not an 
allocable deduction. Sec. 199(c)(1)(B)(ii). See Treas. Reg. secs. 
1.199-1 through 1.199-9 where the Secretary has prescribed rules for 
the proper allocation of items of income, deduction, expense, and loss 
for purposes of determining qualified production activities income.
    \1859\ Qualifying production property generally includes any 
tangible personal property, computer software, and sound recordings. 
Sec. 199(c)(5).
    \1860\ When used in the Code in a geographical sense, the term 
``United States'' generally includes only the States and the District 
of Columbia. Sec. 7701(a)(9). A special rule for determining domestic 
production gross receipts, however, provides that for taxable years 
beginning after December 31, 2005, and before January 1, 2018, in the 
case of any taxpayer with gross receipts from sources within the 
Commonwealth of Puerto Rico, the term ``United States'' includes the 
Commonwealth of Puerto Rico, but only if all of the taxpayer's Puerto 
Rico-sourced gross receipts are taxable under the Federal income tax 
for individuals or corporations for such taxable year. Sec. 
199(d)(8)(A) and (C). In computing the 50-percent wage limitation, the 
taxpayer is permitted to take into account wages paid to bona fide 
residents of Puerto Rico for services performed in Puerto Rico. Sec. 
199(d)(8)(B).
    \1861\ Qualified film includes any motion picture film or videotape 
(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 the film (including 
compensation in the form of residuals and participations) constitutes 
compensation for services performed in the United States by actors, 
production personnel, directors, and producers. Sec. 199(c)(6).
    \1862\ Sec. 199(c)(4)(A).
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    Domestic production gross receipts do not include any gross 
receipts of the taxpayer derived from property leased, 
licensed, or rented by the taxpayer for use by any related 
person.\1863\ In addition, domestic production gross receipts 
do not include gross receipts which are derived from (1) the 
sale of food and beverages prepared by the taxpayer at a retail 
establishment, (2) the transmission or distribution of 
electricity, natural gas, or potable water, or (3) the lease, 
rental, license, sale, exchange, or other disposition of 
land.\1864\
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    \1863\ Sec. 199(c)(7). For this purpose, a person is treated as 
related to another person if such persons are treated as a single 
employer under subsection (a) or (b) of section 52 or subsection (m) or 
(o) of section 414, except that determinations under subsections (a) 
and (b) of section 52 are made without regard to section 1563(b).
    \1864\ Sec. 199(c)(4)(B).
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Special rules

    All members of an expanded affiliated group \1865\ are 
treated as a single corporation and the deduction is allocated 
among the members of the expanded affiliated group in 
proportion to each member's respective amount, if any, of 
qualified production activities income. In addition, for 
purposes of determining domestic production gross receipts, if 
all of the interests in the capital and profits of a 
partnership are owned by members of a single expanded 
affiliated group at all times during the taxable year of such 
partnership, the partnership and all members of such group are 
treated as a single taxpayer during such period.\1866\
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    \1865\ For this purpose, an expanded affiliated group is an 
affiliated group as defined in section 1504(a) determined (i) by 
substituting ``more than 50 percent'' for ``more than 80 percent'' each 
place it appears, and (ii) without regard to paragraphs (2) and (4) of 
section 1504(b). See sec. 199(d)(4)(B).
    \1866\ Sec. 199(d)(4)(D).
---------------------------------------------------------------------------
    For a tax-exempt taxpayer subject to tax on its unrelated 
business taxable income by section 511, the section 199 
deduction is determined by substituting unrelated business 
taxable income for taxable income where applicable.\1867\
---------------------------------------------------------------------------
    \1867\ Sec. 199(d)(7).
---------------------------------------------------------------------------
    The section 199 deduction is determined by only taking into 
account items that are attributable to the actual conduct of a 
trade or business.\1868\
---------------------------------------------------------------------------
    \1868\ Sec. 199(d)(5).
---------------------------------------------------------------------------

Partnerships and S corporations

    With regard to the domestic production activities income of 
a partnership or S corporation, the deduction is determined at 
the partner or shareholder level. Each partner or shareholder 
generally takes 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 income, if 
any.\1869\
---------------------------------------------------------------------------
    \1869\ Sec. 199(d)(1)(A).
---------------------------------------------------------------------------
    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 such 
person's allocable share of W-2 wages.\1870\
---------------------------------------------------------------------------
    \1870\ In the case of a trust or estate, the components of the 
calculation are apportioned between (and among) the beneficiaries and 
the fiduciary. See sec. 199(d)(1)(B) and Treas. Reg. sec. 1.199-5(d) 
and (e).
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Specified agricultural and horticultural cooperatives

            In general
    With regard to specified agricultural and horticultural 
cooperatives, section 199 provides the same treatment of 
qualified production activities income derived from 
agricultural or horticultural products that are manufactured, 
produced, grown, or extracted by such cooperatives,\1871\ as it 
provides for qualified production activities income of other 
taxpayers, including non-specified cooperatives (i.e., the 
cooperative may claim a deduction for qualified production 
activities income). The cooperative is treated as having 
manufactured, produced, grown, or extracted in whole or 
significant part any qualifying production property marketed by 
the cooperative if such items were manufactured, produced, 
grown, or extracted in whole or significant part by its 
patrons.\1872\ In addition, the cooperative is treated as 
having manufactured, produced, grown, or extracted agricultural 
products with respect to which the cooperative performs 
storage, handling, or other processing activities (other than 
transportation activities) within the United States related to 
the sale, exchange, or other disposition of agricultural 
products, provided the products are consumed in connection with 
or incorporated into the manufacturing, production, growth, or 
extraction of qualifying production property (whether or not by 
the cooperative).\1873\ Finally, for purposes of determining 
the cooperative's section 199 deduction, qualified production 
activities income and taxable income are determined without 
regard to any deduction allowable under section 1382(b) and (c) 
(relating to patronage dividends, per-unit retain allocations, 
and nonpatronage distributions) for the taxable year.\1874\
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    \1871\ 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. See Treas. Reg. sec. 
1.199-6(f).
    \1872\ Sec. 199(d)(3)(D) and Treas. Reg. sec. 1.199-6(d).
    \1873\ See Treas. Reg. sec. 1.199-3(e)(1).
    \1874\ See sec. 199(d)(3)(C) and Treas. Reg. sec. 1.199-6(c).
---------------------------------------------------------------------------
            Definition of a specified agricultural or horticultural 
                    cooperative
    A specified agricultural or horticultural cooperative is an 
organization to which part I of subchapter T applies that is 
engaged in (a) the manufacturing, production, growth, or 
extraction in whole or significant part of any agricultural or 
horticultural product, or (b) the marketing of agricultural or 
horticultural products that its patrons have so manufactured, 
produced, grown, or extracted.\1875\
---------------------------------------------------------------------------
    \1875\ Sec. 199(d)(3)(F). 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. See 
Treas. Reg. sec. 1.199-6(f).
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            Allocation of the cooperative's deduction to patrons
    Any patron that receives a qualified payment from a 
specified agricultural or horticultural cooperative is allowed 
as a deduction for the taxable year in which such payment is 
received an amount equal to the portion of the cooperative's 
deduction for qualified production activities income that is 
(i) allowed with respect to the portion of the qualified 
production activities income to which such payment is 
attributable, and (ii) identified by the cooperative in a 
written notice mailed to the patron during the payment period 
described in section 1382(d).\1876\ A qualified payment is any 
amount that (i) is described in paragraph (1) or (3) of section 
1385(a) (i.e., patronage dividends and per-unit retain 
allocations), (ii) is received by an eligible patron from a 
specified agricultural or horticultural cooperative, and (iii) 
is attributable to qualified production activities income with 
respect to which a deduction is allowed to such 
cooperative.\1877\
---------------------------------------------------------------------------
    \1876\ Sec. 199(d)(3)(A) and Treas. Reg. sec. 1.199-6(a). The 
written notice must be mailed by the cooperative to it patrons no later 
than the 15th day of the ninth month following the close of the taxable 
year. The cooperative must report the amount of the patron's section 
199 deduction on Form 1099-PATR, ``Taxable Distributions Received From 
Cooperatives,'' issued to the patron. Treas. Reg. sec. 1.199-6(g).
    \1877\ Sec. 199(d)(3)(E). For this purpose, patronage dividends and 
per-unit retain allocations include any advances on patronage and per-
unit retains paid in money during the taxable year. Treas. Reg. sec. 
1.199-6(e).
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    The cooperative cannot reduce its income under section 1382 
for any deduction allowable to its patrons under this rule 
(i.e., the cooperative must reduce its deductions allowed for 
certain payments to its patrons in an amount equal to the 
section 199 deduction allocated to its patrons).\1878\
---------------------------------------------------------------------------
    \1878\ Sec. 199(d)(3)(B) and Treas. Reg. sec. 1.199-6(b).
---------------------------------------------------------------------------

                              Present Law


1. Treatment of taxpayers other than corporations

In general

            Individual income tax rates
    To determine regular tax liability, an individual taxpayer 
generally must apply the tax rate schedules (or the tax tables) 
to his or her regular taxable income. The rate schedules are 
broken into several ranges of income, known as income brackets, 
and the marginal tax rate increases as a taxpayer's income 
increases. Separate rate schedules apply based on an 
individual's filing status (i.e., single, head of household, 
married filing jointly, or married filing separately). For 
2018, the regular individual income tax rate schedule provides 
rates of 10, 12, 22, 24, 32, 35, and 37 percent.
            Partnerships
    Partnerships generally are treated for Federal income tax 
purposes as pass-through entities not subject to tax at the 
entity level.\1879\ Items of income (including tax-exempt 
income), gain, loss, deduction, and credit of the partnership 
are taken into account by the partners in computing their 
income tax liability (based on the partnership's method of 
accounting and regardless of whether the income is distributed 
to the partners).\1880\ A partner's deduction for partnership 
losses is limited to the partner's adjusted basis in its 
partnership interest.\1881\ Losses not allowed as a result of 
that limitation generally are carried forward to the next year. 
A partner's adjusted basis in the partnership interest 
generally equals the sum of (1) the partner's capital 
contributions to the partnership, (2) the partner's 
distributive share of partnership income, and (3) the partner's 
share of partnership liabilities, less (1) the partner's 
distributive share of losses allowed as a deduction and certain 
nondeductible expenditures, and (2) any partnership 
distributions to the partner.\1882\ Partners generally may 
receive distributions of partnership property without 
recognition of gain or loss, subject to some exceptions.\1882\
---------------------------------------------------------------------------
    \1879\ Sec. 701.
    \1880\ Sec. 702(a).
    \1881\ Sec. 704(d). In addition, passive loss and at-risk 
limitations limit the extent to which certain types of income can be 
offset by partnership deductions (sections 469 and 465). These 
limitations do not apply to corporate partners (except certain closely-
held corporations) and may not be important to individual partners who 
have partner-level passive income from other investments.
    \1882\ Sec. 705.
    \1883\ Sec. 731. Gain or loss may nevertheless be recognized, for 
example, on the distribution of money or marketable securities, 
distributions with respect to contributed property, or in the case of 
disproportionate distributions (which can result in ordinary income).
---------------------------------------------------------------------------
    Partnerships may allocate items of income, gain, loss, 
deduction, and credit among the partners, provided the 
allocations have substantial economic effect.\1884\ In general, 
an allocation has substantial economic effect to the extent the 
partner to which the allocation is made receives the economic 
benefit or bears the economic burden of such allocation and the 
allocation substantially affects the dollar amounts to be 
received by the partners from the partnership independent of 
tax consequences.\1885\
---------------------------------------------------------------------------
    \1884\ Sec. 704(b)(2).
    \1885\ Treas. Reg. sec. 1.704-1(b)(2).
---------------------------------------------------------------------------
    State laws of every State provide for limited liability 
companies \1886\ (``LLCs''), which are neither partnerships nor 
corporations under applicable State law, but which are 
generally treated as partnerships for Federal tax 
purposes.\1887\
---------------------------------------------------------------------------
    \1886\ The first LLC statute was enacted in Wyoming in 1977. All 
States (and the District of Columbia) now have an LLC statute, though 
the tax treatment of LLCs for State tax purposes may differ.
    \1887\ Any domestic nonpublicly traded unincorporated entity with 
two or more members generally is treated as a partnership for federal 
income tax purposes, while any single-member domestic unincorporated 
entity generally is treated as disregarded for Federal income tax 
purposes (i.e., treated as not separate from its owner). Instead of the 
applicable default treatment, however, an LLC may elect to be treated 
as a corporation for Federal income tax purposes. Treas. Reg. sec. 
301.7701-3 (known as the ``check-the-box'' regulations).
---------------------------------------------------------------------------
    A publicly traded partnership generally is treated as a 
corporation for Federal tax purposes.\1888\ For this purpose, a 
publicly traded partnership means any partnership if interests 
in the partnership are traded on an established securities 
market or interests in the partnership are readily tradable on 
a secondary market (or the substantial equivalent 
thereof).\1889\
---------------------------------------------------------------------------
    \1888\ Sec. 7704(a).
    \1889\ Sec. 7704(b).
---------------------------------------------------------------------------
    An exception from corporate treatment is provided for 
certain publicly traded partnerships, 90 percent or more of 
whose gross income is qualifying income.\1890\
---------------------------------------------------------------------------
    \1890\ Sec. 7704(c)(2). Qualifying income is defined to include 
interest, dividends, and gains from the disposition of a capital asset 
(or of property described in section 1231(b)) that is held for the 
production of income that is qualifying income. Sec. 7704(d). 
Qualifying income also includes rents from real property, gains from 
the sale or other disposition of real property, and income and gains 
from the exploration, development, mining or production, processing, 
refining, transportation (including pipelines transporting gas, oil, or 
products thereof), or the marketing of any mineral or natural resource 
(including fertilizer, geothermal energy, and timber), industrial 
source carbon dioxide, or the transportation or storage of certain fuel 
mixtures, alternative fuel, alcohol fuel, or biodiesel fuel. Qualifying 
income also includes income and gains from commodities (not described 
in section 1221(a)(1)) or futures, options, or forward contracts with 
respect to such commodities (including foreign currency transactions of 
a commodity pool) where a principal activity of the partnership is the 
buying and selling of such commodities, futures, options, or forward 
contracts. However, the exception for partnerships with qualifying 
income does not apply to any partnership resembling a mutual fund 
(i.e., that would be described in section 851(a) if it were a domestic 
corporation), which includes a corporation registered under the 
Investment Company Act of 1940 (Pub. L. No. 76-768 (1940)) as a 
management company or unit investment trust. Sec. 7704(c)(3).
---------------------------------------------------------------------------
            S corporations
    For Federal income tax purposes, an S corporation \1891\ 
generally is not subject to tax at the corporate level.\1892\ 
Items of income (including tax-exempt income), gain, loss, 
deduction, and credit of the S corporation are taken into 
account by the S corporation shareholders in computing their 
income tax liabilities (based on the S corporation's method of 
accounting and regardless of whether the income is distributed 
to the shareholders). A shareholder's deduction for corporate 
losses is limited to the sum of the shareholder's adjusted 
basis in its S corporation stock and the indebtedness of the S 
corporation to such shareholder. Losses not allowed as a result 
of that limitation generally are carried forward to the next 
year. A shareholder's adjusted basis in the S corporation stock 
generally equals the sum of (1) the shareholder's capital 
contributions to the S corporation and (2) the shareholder's 
pro rata share of S corporation income, less (1) the 
shareholder's pro rata share of losses allowed as a deduction 
and certain nondeductible expenditures, and (2) any S 
corporation distributions to the shareholder.\1893\
---------------------------------------------------------------------------
    \1891\ An S corporation is so named because its Federal tax 
treatment is governed by subchapter S of the Code.
    \1892\ Secs. 1363 and 1366.
    \1893\ Sec. 1367. If any amount that would reduce the adjusted 
basis of a shareholder's S corporation stock exceeds the amount that 
would reduce that basis to zero, the excess is applied to reduce (but 
not below zero) the shareholder's basis in any indebtedness of the S 
corporation to the shareholder. If, after a reduction in the basis of 
such indebtedness, there is an event that would increase the adjusted 
basis of the shareholder's S corporation stock, such increase is 
instead first applied to restore the reduction in the basis of the 
shareholder's indebtedness. Sec. 1367(b)(2).
---------------------------------------------------------------------------
    In general, an S corporation shareholder is not subject to 
tax on corporate distributions unless the distributions exceed 
the shareholder's basis in the stock of the corporation.
    To be eligible to elect S corporation status, a corporation 
may not have more than 100 shareholders and may not have more 
than one class of stock.\1894\ Only individuals (other than 
nonresident aliens), certain tax-exempt organizations, and 
certain trusts and estates are permitted shareholders of an S 
corporation.
---------------------------------------------------------------------------
    \1894\ Sec. 1361. For this purpose, a husband and wife and all 
members of a family are treated as one shareholder. Sec. 1361(c)(1).
---------------------------------------------------------------------------
            Sole proprietorships
    Unlike a C corporation, partnership, or S corporation, a 
business conducted as a sole proprietorship is not treated as 
an entity distinct from its owner for Federal income tax 
purposes.\1895\ Rather, the business owner is taxed directly on 
business income, and files Schedule C (sole proprietorships 
generally), Schedule E (rental real estate and royalties), or 
Schedule F (farms) with his or her individual tax return. 
Furthermore, transfer of a sole proprietorship is treated as a 
transfer of each individual asset of the business. Nonetheless, 
a sole proprietorship is treated as an entity separate from its 
owner for employment tax purposes,\1896\ for certain excise 
taxes,\1897\ and certain information reporting 
requirements.\1898\
---------------------------------------------------------------------------
    \1895\ A single-member unincorporated entity is disregarded for 
Federal income tax purposes, unless its owner elects to be treated as a 
C corporation. Treas. Reg. sec. 301.7701-3(b)(1)(ii). Sole 
proprietorships often are conducted through legal entities for nontax 
reasons. While sole proprietorships generally may have no more than one 
owner, a married couple that files a joint return and jointly owns and 
operates a business may elect to have that business treated as a sole 
proprietorship under section 761(f).
    \1896\ Treas. Reg. sec. 301.7701-2(c)(2)(iv).
    \1897\ Treas. Reg. sec. 301.7701-2(c)(2)(v).
    \1898\ Treas. Reg. sec. 301.7701-2(c)(2)(vi).
---------------------------------------------------------------------------

Taxpayers other than corporations with qualified business income

    For taxable years beginning after December 31, 2017, and 
before January 1, 2026, an individual taxpayer generally may 
deduct 20 percent of qualified business income from a 
partnership, S corporation, or sole proprietorship, as well as 
20 percent of aggregate qualified REIT dividends, qualified 
cooperative dividends, and qualified publicly traded 
partnership income.\1899\ Limitations based on W-2 wages and 
capital investment phase in above a threshold amount of taxable 
income.\1900\ A disallowance of the deduction on income of 
specified service trades or businesses also phases in above the 
threshold amount of taxable income.
---------------------------------------------------------------------------
    \1899\ Sec. 199A. Eligible taxpayers also include fiduciaries and 
beneficiaries of trusts and estates with qualified business income.
    \1900\ For this purpose, taxable income is computed without regard 
to the 20-percent deduction. Sec. 199A(e)(1).
---------------------------------------------------------------------------
                Qualified business income
            In general
    Qualified business income is determined for each qualified 
trade or business of the taxpayer. For any taxable year, 
qualified business income means the net amount of qualified 
items of income, gain, deduction, and loss with respect to the 
qualified trade or business of the taxpayer. The determination 
of qualified items of income, gain, deduction, and loss takes 
into account such items only to the extent included or allowed 
in the determination of taxable income for the year.
    Items are treated as qualified items of income, gain, 
deduction, and loss only to the extent they are effectively 
connected with the conduct of a trade or business within the 
United States.\1901\ In the case of an individual with 
qualified business income from sources within the commonwealth 
of Puerto Rico, if all such income for the taxable year is 
taxable under section 1 (income tax rates for individuals), 
then the term ``United States'' is considered to include Puerto 
Rico for purposes of determining the individual's qualified 
business income.\1902\
---------------------------------------------------------------------------
    \1901\ For this purpose, section 864(c) is applied by substituting 
``qualified trade or business (within the meaning of section 199A)'' 
for ``nonresident alien individual or a foreign corporation'' or for 
``a foreign corporation,'' each place they appear. Sec. 199A(c)(3)(A).
    \1902\ Sec. 199A(f)(1)(C).
---------------------------------------------------------------------------
    Certain items are not qualified items of income, gain, 
deduction, or loss.\1903\ Specifically, qualified items of 
income, gain, deduction, and loss do not include (1) any item 
taken into account in determining net capital gain or net 
capital loss, (2) dividends, income equivalent to a dividend, 
or payments in lieu of dividends, (3) interest income other 
than that which is properly allocable to a trade or business, 
(4) the excess of gain over loss from commodities transactions 
other than (i) those entered into in the normal course of the 
trade or business or (ii) with respect to stock in trade or 
property held primarily for sale to customers in the ordinary 
course of the trade or business, property used in the trade or 
business, or supplies regularly used or consumed in the trade 
or business, (5) the excess of foreign currency gains over 
foreign currency losses from section 988 transactions other 
than transactions directly related to the business needs of the 
business activity, (6) net income from notional principal 
contracts other than clearly identified hedging transactions 
that are treated as ordinary (i.e., not treated as capital 
assets), and (7) any amount received from an annuity that is 
not received in connection with the trade or business. 
Qualified items do not include any item of deduction or loss 
properly allocable to any of the preceding items.
---------------------------------------------------------------------------
    \1903\ See sec. 199A(c)(3)(B).
---------------------------------------------------------------------------
    If the net amount of qualified business income from all 
qualified trades or businesses during the taxable year is a 
loss, then such loss is carried forward and in the next taxable 
year is treated as a loss from a qualified trade or 
business.\1904\ Any deduction that would otherwise be allowed 
in a subsequent taxable year with respect to the taxpayer's 
qualified trades or businesses is reduced by 20 percent of any 
carryover qualified business loss.
---------------------------------------------------------------------------
    \1904\ Sec. 199A(c)(2).
---------------------------------------------------------------------------
            Reasonable compensation and guaranteed payments
    Qualified business income does not include any amount paid 
by an S corporation that is treated as reasonable compensation 
of the taxpayer.\1905\ Similarly, qualified business income 
does not include any guaranteed payment for services rendered 
with respect to the trade or business,\1906\ and, to the extent 
provided in regulations, does not include any amount paid or 
incurred by a partnership to a partner, acting other than in 
his or her capacity as a partner, for services.\1907\
---------------------------------------------------------------------------
    \1905\ Sec. 199A(c)(4).
    \1906\ Described in sec. 707(c).
    \1907\ Described in sec. 707(a).
---------------------------------------------------------------------------
            Qualified trade or business
    A qualified trade or business means any trade or business 
other than a specified service trade or business and other than 
the trade or business of performing services as an 
employee.\1908\
---------------------------------------------------------------------------
    \1908\ Sec. 199A(d)(1).
---------------------------------------------------------------------------
            Specified service trade or business
    A specified service trade or business means any trade or 
business involving the performance of services in the fields of 
health, law, accounting, actuarial science, performing arts, 
consulting, athletics, financial services, brokerage services, 
or any trade or business where the principal asset of such 
trade or business is the reputation or skill of one or more of 
its employees or owners, or which involves the performance of 
services that consist of investing and investment management, 
trading, or dealing in securities, partnership interests, or 
commodities.\1909\ For this purpose a security and a commodity 
have the meanings provided in the rules for the mark-to-market 
accounting method for dealers in securities (section 475(c)(2) 
and (e)(2), respectively).
---------------------------------------------------------------------------
    \1909\ Sec. 199A(d)(2).
---------------------------------------------------------------------------
    The exclusion from the definition of a qualified trade or 
business for specified service trades or businesses phases in 
for a taxpayer with taxable income in excess of a threshold 
amount. The threshold amount is $157,500 (200 percent of that 
amount, or $315,000, in the case of a joint return) (together, 
the ``threshold amount''), adjusted for inflation in taxable 
years beginning after 2018.\1910\ The exclusion from the 
definition of a qualified trade or business for specified 
service trades or businesses is fully phased in for a taxpayer 
with taxable income in excess of the threshold amount plus 
$50,000 ($100,000 in the case of a joint return).\1911\
---------------------------------------------------------------------------
    \1910\ Sec. 199A(e)(2).
    \1911\ See sec. 199A(d)(3).
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                Tentative deductible amount for a qualified trade or 
                    business
            In general
    For a taxpayer with taxable income below the threshold 
amount, the deductible amount for each qualified trade or 
business is equal to 20 percent of the qualified business 
income with respect to the trade or business.\1912\ For a 
taxpayer with taxable income above the threshold, the taxpayer 
is allowed a deductible amount for each qualified trade or 
business equal to the lesser of (1) 20 percent of the qualified 
business income with respect to such trade or business, or (2) 
the greater of (a) 50 percent of the W-2 wages paid with 
respect to the qualified trade or business, or (b) the sum of 
25 percent of the W-2 wages paid with respect to the qualified 
trade or business plus 2.5 percent of the unadjusted basis, 
immediately after acquisition, of all qualified property of the 
qualified trade or business.\1913\
---------------------------------------------------------------------------
    \1912\ Sec. 199A(b)(3).
    \1913\ Sec. 199A(b)(2).
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            Limitations based on W-2 wages and capital
    The wage and capital limitations phase in for a taxpayer 
with taxable income in excess of the threshold amount.\1914\ 
The wage and capital limitations apply fully for a taxpayer 
with taxable income in excess of the threshold amount plus 
$50,000 ($100,000 in the case of a joint return).
---------------------------------------------------------------------------
    \1914\ See sec. 199A(b)(3)(B).
---------------------------------------------------------------------------
    W-2 wages are the total wages subject to wage 
withholding,\1915\ elective deferrals,\1916\ and deferred 
compensation \1917\ paid by the qualified trade or business 
with respect to employment of its employees during the calendar 
year ending during the taxable year of the taxpayer.\1918\ In 
the case of a taxpayer who is an individual with otherwise 
qualified business income from sources within the commonwealth 
of Puerto Rico, if all the income for the taxable year is 
taxable under section 1 (income tax rates for individuals), the 
determination of W-2 wages with respect to the taxpayer's trade 
or business conducted in Puerto Rico is made without regard to 
any exclusion under the wage withholding rules \1919\ for 
remuneration paid for services in Puerto Rico. W-2 wages do not 
include any amount that is not properly allocable to qualified 
business income as a qualified item of deduction.\1920\ In 
addition, W-2 wages do not include any amount that was not 
properly included in a return filed with the Social Security 
Administration on or before the 60th day after the due date 
(including extensions) for such return.\1921\
---------------------------------------------------------------------------
    \1915\ Defined in sec. 3401(a).
    \1916\ Within the meaning of sec. 402(g)(3).
    \1917\ Deferred compensation includes compensation deferred under 
section 457, as well as the amount of any designated Roth contributions 
(as defined in section 402A).
    \1918\ Sec. 199A(b)(4). In the case of a taxpayer with a short 
taxable year that does not contain a calendar year ending during such 
short taxable year, the following amounts are treated as the W-2 wages 
of the taxpayer for the short taxable year: (1) wages paid during the 
short taxable year to employees of the qualified trade or business; (2) 
elective deferrals (within the meaning of section 402(g)(3)) made 
during the short taxable year by employees of the qualified trade or 
business; and (3) compensation actually deferred under section 457 
during the short taxable year with respect to employees of the 
qualified trade or business. Amounts that are treated as W-2 wages for 
a taxable year are not treated as W-2 wages of any other taxable year. 
See Conference Report to accompany H.R. 1, Tax Cuts and Jobs Act, H.R. 
Rep. No. 115-466, December 15, 2017, p. 217.
    \1919\ As provided in sec. 3401(a)(8).
    \1920\ Sec. 199A(b)(4)(B).
    \1921\ Sec. 199A(b)(4)(C).
---------------------------------------------------------------------------
    Qualified property means tangible property of a character 
subject to depreciation under section 167 that is held by, and 
available for use in, the qualified trade or business at the 
close of the taxable year, which is used at any point during 
the taxable year in the production of qualified business 
income, and for which the depreciable period has not ended 
before the close of the taxable year.\1922\ The depreciable 
period with respect to qualified property of a taxpayer means 
the period beginning on the date the property is first placed 
in service by the taxpayer and ending on the later of (a) the 
date that is 10 years after the date the property is first 
placed in service, or (b) the last day of the last full year in 
the applicable recovery period that would apply to the property 
under section 168 (determined without regard to section 
168(g)).
---------------------------------------------------------------------------
    \1922\ Sec. 199A(b)(6).
---------------------------------------------------------------------------
            Partnerships and S corporations
    In the case of a partnership or S corporation, the section 
199A deduction is determined at the partner or shareholder 
level. Each partner in a partnership takes into account the 
partner's allocable share of each qualified item of income, 
gain, deduction, and loss, and is treated as having W-2 wages 
and unadjusted basis of qualified property for the taxable year 
equal to the partner's allocable share of W-2 wages and 
unadjusted basis of qualified property of the partnership. The 
partner's allocable share of W-2 wages and unadjusted basis of 
qualified property are required to be determined in the same 
manner as the partner's allocable share of wage expenses and 
depreciation, respectively. Similarly, each shareholder of an S 
corporation takes into account the shareholder's pro rata share 
of each qualified item of income, gain, deduction, and loss of 
the S corporation, and is treated as having W-2 wages and 
unadjusted basis of qualified property for the taxable year 
equal to the shareholder's pro rata share of W-2 wages and 
unadjusted basis of qualified property of the S corporation.
            Qualified REIT dividends, cooperative dividends, and 
                    publicly traded partnership income
    A deduction is allowed for 20 percent of the taxpayer's 
aggregate amount of qualified REIT dividends, qualified 
cooperative dividends, and qualified publicly traded 
partnership income for the taxable year.\1923\
---------------------------------------------------------------------------
    \1923\ See sec. 199A(a) and (b).
---------------------------------------------------------------------------
    Qualified REIT dividends do not include any portion of a 
dividend received from a REIT that is a capital gain dividend 
\1924\ or a qualified dividend.\1925\
---------------------------------------------------------------------------
    \1924\ Defined in sec. 857(b)(3).
    \1925\ Defined in sec. 1(h)(11). See sec. 199A(e)(3).
---------------------------------------------------------------------------
    A qualified cooperative dividend means any patronage 
dividend,\1926\ per-unit retain allocation,\1927\ qualified 
written notice of allocation,\1928\ or any other similar 
amount, provided such amount is includible in gross income and 
is received from either (1) a tax-exempt organization described 
in section 501(c)(12) \1929\ or a taxable or tax-exempt 
cooperative that is described in section 1381(a), or (2) a 
taxable cooperative governed by tax rules applicable to 
cooperatives before the enactment of subchapter T of the Code 
in 1962.\1930\
---------------------------------------------------------------------------
    \1926\ Defined in sec. 1388(a).
    \1927\ Defined in sec. 1388(f).
    \1928\ Defined in sec. 1388(c).
    \1929\ Organizations described in section 501(c)(12) are benevolent 
life insurance associations of a purely local character, mutual ditch 
or irrigation companies, mutual or cooperative telephone companies, or 
like organizations; but only if 85 percent or more of the income 
consists of amounts collected from members for the sole purpose of 
meeting losses and expenses. Sec. 501(c)(12)(A).
    \1930\ Sec. 199A(e)(4).
---------------------------------------------------------------------------
    Qualified publicly traded partnership income means (with 
respect to any qualified trade or business of the taxpayer) the 
sum of (a) the net amount of the taxpayer's allocable share of 
each qualified item of income, gain, deduction, and loss of the 
partnership from a publicly traded partnership not treated as a 
corporation,\1931\ and (b) gain recognized by the taxpayer on 
disposition of its interest in such partnership that is treated 
as ordinary income (for example, by reason of section 
751).\1932\
---------------------------------------------------------------------------
    \1931\ Such items must be effectively connected with a U.S. trade 
or business, be included or allowed in determining taxable income for 
the taxable year, and not constitute excepted enumerated investment-
type income. Such items do not include the taxpayer's reasonable 
compensation, guaranteed payments for services, or (to the extent 
provided in regulations) section 707(a) payments for services.
    \1932\ Sec. 199A(e)(5).
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            Determination of the taxpayer's deduction
    The taxpayer's deduction for qualified business income for 
the taxable year is equal to the sum of (1) the lesser of (a) 
the combined qualified business income amount for the taxable 
year, or (b) an amount equal to 20 percent of taxable income 
(reduced by any net capital gain \1933\ and qualified 
cooperative dividends), plus (2) the lesser of (a) 20 percent 
of qualified cooperative dividends, or (b) taxable income 
(reduced by net capital gain). This sum may not exceed the 
taxpayer's taxable income for the taxable year (reduced by net 
capital gain).\1934\ The combined qualified business income 
amount for the taxable year is the sum of the deductible 
amounts determined for each qualified trade or business carried 
on by the taxpayer and 20 percent of the taxpayer's qualified 
REIT dividends and qualified publicly traded partnership 
income.\1935\
---------------------------------------------------------------------------
    \1933\ Defined in sec. 1(h).
    \1934\ Sec. 199A(a).
    \1935\ Sec. 199A(b)(1).
---------------------------------------------------------------------------
    The taxpayer's deduction for qualified business income is 
not allowed in computing adjusted gross income; instead, the 
deduction is allowed in computing taxable income.\1936\ The 
deduction is available to both individuals who do itemize their 
deductions and individuals who do not itemize their 
deductions.\1937\
---------------------------------------------------------------------------
    \1936\ Sec. 62(a).
    \1937\ Sec. 63(b) and (d).
---------------------------------------------------------------------------

2. Treatment of cooperatives and their patrons

In general

    Certain corporations are eligible to be treated as 
cooperatives and taxed under the special rules of subchapter T 
of the Code.\1938\ In general, the subchapter T rules apply to 
any corporation operating on a cooperative basis (except mutual 
savings banks, insurance companies, most tax-exempt 
organizations, and certain utilities).
---------------------------------------------------------------------------
    \1938\ Secs. 1381-1388.
---------------------------------------------------------------------------
    For Federal income tax purposes, a cooperative subject to 
the cooperative tax rules of subchapter T generally computes 
its income as if it were a taxable corporation, except that, in 
determining its taxable income, the cooperative does not take 
into account amounts paid for the taxable year as (1) patronage 
dividends, to the extent paid in money, qualified written 
notices of allocation,\1939\ or other property (except 
nonqualified written notices of allocation) \1940\ with respect 
to patronage occurring during such taxable year, and (2) per-
unit retain allocations, to the extent paid in money, qualified 
per-unit retain certificates,\1941\ or other property (except 
nonqualified per-unit retain certificates) \1942\ with respect 
to marketing occurring during such taxable year.\1943\
---------------------------------------------------------------------------
    \1939\ As defined in sec. 1388(c).
    \1940\ As defined in sec. 1388(d).
    \1941\ As defined in sec. 1388(h).
    \1942\ As defined in sec. 1388(i).
    \1943\ Sec. 1382(b)(1) and (3). In determining its taxable income, 
the cooperative also does not take into account amounts paid in money 
or other property in redemption of a nonqualified written notice of 
allocation which was paid as a patronage dividend during the payment 
period for the taxable year during which the patronage occurred, or in 
redemption of a nonqualified per-unit retain certificate which was paid 
as a per-unit retain allocation during the payment period for the 
taxable year during which the marketing occurred. Sec. 1382(b)(2) and 
(4).
---------------------------------------------------------------------------
    Patronage dividends are amounts paid to a patron (1) on the 
basis of quantity or value of business done with or for such 
patron, (2) under an obligation of the cooperative to pay such 
amount that existed before the cooperative received the amount 
so paid, and (3) which are determined by reference to the net 
earnings of the cooperative from business done with or for its 
patrons.\1944\ Per-unit retain allocations are allocations to a 
patron with respect to products marketed for him, the amount of 
which is fixed without reference to the net earnings of the 
organization pursuant to an agreement between the organization 
and the patron.\1945\
---------------------------------------------------------------------------
    \1944\ Sec. 1388(a).
    \1945\ Sec. 1388(f).
---------------------------------------------------------------------------
    Because a patron of a cooperative that receives patronage 
dividends or per-unit retain allocations generally must include 
such amounts in gross income,\1946\ excluding patronage 
dividends and per-unit retain allocations paid by the 
cooperative from the cooperative's taxable income in effect 
allows the cooperative to be a conduit with respect to profits 
derived from transactions with its patrons.
---------------------------------------------------------------------------
    \1946\ Sec. 1385(a)(1) and (3).
---------------------------------------------------------------------------

Specified agricultural or horticultural cooperatives with qualified 
        business income

    For taxable years beginning after December 31, 2017, and 
before January 1, 2026, a deduction is allowed to any specified 
agricultural or horticultural cooperative equal to the lesser 
of (a) 20 percent of the excess (if any) of the cooperative's 
gross income over the qualified cooperative dividends paid 
during the taxable year for the taxable year, or (b) the 
greater of 50 percent of the W-2 wages paid by the cooperative 
with respect to its trade or business or the sum of 25 percent 
of the W-2 wages of the cooperative with respect to its trade 
or business plus 2.5 percent of the unadjusted basis 
immediately after acquisition of qualified property of the 
cooperative.\1947\ The cooperative's section 199A(g) deduction 
may not exceed its taxable income \1948\ for the taxable year.
---------------------------------------------------------------------------
    \1947\ Sec. 199A(g).
    \1948\ For this purpose, taxable income is computed without regard 
to the cooperative's deduction under section 199A(g).
---------------------------------------------------------------------------
    A specified agricultural or horticultural cooperative is an 
organization to which part I of subchapter T applies that is 
engaged in (a) the manufacturing, production, growth, or 
extraction in whole or significant part of any agricultural or 
horticultural product, (b) the marketing of agricultural or 
horticultural products that its patrons have so manufactured, 
produced, grown, or extracted, or (c) the provision of 
supplies, equipment, or services to farmers or organizations 
described in the foregoing.

                        Explanation of Provision


1. Treatment of specified agricultural or horticultural cooperatives

Deduction for qualified production activities income

    The provision modifies the deduction for qualified business 
income of a specified agricultural or horticultural cooperative 
under section 199A(g) to instead provide a deduction for 
qualified production activities income of a specified 
agricultural or horticultural cooperative that is similar to 
the deduction for qualified production activities income under 
former section 199.
    The provision provides a deduction from taxable income that 
is equal to nine percent of the lesser of the cooperative's 
qualified production activities income or taxable income 
(determined without regard to the cooperative's section 199A(g) 
deduction and any deduction allowable under section 1382(b) and 
(c) (relating to patronage dividends, per-unit retain 
allocations, and nonpatronage distributions)) for the taxable 
year. The amount of the deduction for a taxable year is limited 
to 50 percent of the W-2 wages paid by the cooperative during 
the calendar year that ends in such taxable year. For this 
purpose, W-2 wages are determined in the same manner as under 
the other provisions of section 199A, except that such wages do 
not include any amount that is not properly allocable to 
domestic production gross receipts.\1949\
---------------------------------------------------------------------------
    \1949\ Under the proposal, because Puerto Rico is not treated as 
part of the United States for purposes of determining domestic 
production gross receipts under section 199A(g), W-2 wages do not 
include any remuneration paid for services in Puerto Rico.
---------------------------------------------------------------------------
    In the case of oil related qualified production activities 
income, the provision provides that the section 199A(g) 
deduction is reduced by three percent of the least of the 
cooperative's oil related qualified production activities 
income, qualified production activities income, or taxable 
income (determined without regard to the cooperative's section 
199A(g) deduction and any deduction allowable under section 
1382(b) and (c) (relating to patronage dividends, per-unit 
retain allocations, and nonpatronage distributions)) for the 
taxable year. For this purpose, oil related qualified 
production activities income for any taxable year is the 
portion of qualified production activities income attributable 
to the production, refining, processing, transportation, or 
distribution of oil, gas, or any primary product thereof \1950\ 
during the taxable year.
---------------------------------------------------------------------------
    \1950\ Within the meaning of section 927(a)(2)(C) as in effect 
before its repeal.
---------------------------------------------------------------------------
    In general, qualified production activities income is equal 
to domestic production gross receipts reduced by the sum of: 
(1) the cost of goods sold that are allocable to such receipts; 
\1951\ and (2) other expenses, losses, or deductions that are 
properly allocable to such receipts.\1952\ Domestic production 
gross receipts generally are gross receipts of the cooperative 
that are derived from any lease, rental, license, sale, 
exchange, or other disposition of any agricultural or 
horticultural product \1953\ that was manufactured, produced, 
grown, or extracted by the cooperative in whole or in 
significant part within the United States.\1954\ The 
cooperative is treated as having manufactured, produced, grown, 
or extracted in whole or significant part any agricultural or 
horticultural products marketed by the cooperative if such 
items were manufactured, produced, grown, or extracted in whole 
or significant part by its patrons.
---------------------------------------------------------------------------
    \1951\ For this purpose, any item or service brought into the 
United States is treated as acquired by purchase, and its cost is 
treated as not less than its value immediately after it entered the 
United States. A similar rule applies in determining the adjusted basis 
of leased or rented property where the lease or rental gives rise to 
domestic production gross receipts. In addition, for any property 
exported by the cooperative for further manufacture, the increase in 
cost or adjusted basis may not exceed the difference between the value 
of the property when exported and the value of the property when 
brought back into the United States after the further manufacture.
    \1952\ In computing qualified production activities income, the 
section 199A(g) deduction itself is not an allocable deduction. As 
under former section 199, the cooperative's qualified production 
activities income is determined without regard to any deduction 
allowable under section 1382(b) and (c) (relating to patronage 
dividends, per-unit retain allocations, and nonpatronage 
distributions). See Treas. Reg. sec. 1.199-6(c).
    \1953\ Consistent with former section 199, it is intended that 
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. See Treas. Reg. sec. 1.199-6(f).
    \1954\ Consistent with former section 199, it is intended that 
domestic production gross receipts include gross receipts of a 
cooperative derived from any sale, exchange, or other disposition of 
agricultural products with respect to which the cooperative 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 agricultural or 
horticultural products (whether or not by the cooperative). See Treas. 
Reg. sec. 1.199-3(e)(1).
---------------------------------------------------------------------------
    Domestic production gross receipts do not include any gross 
receipts of the cooperative derived from property leased, 
licensed, or rented by the taxpayer for use by any related 
person.\1955\ In addition, domestic production gross receipts 
do not include gross receipts that are derived from the lease, 
rental, license, sale, exchange, or other disposition of land.
---------------------------------------------------------------------------
    \1955\ For this purpose, a person is treated as related to another 
person if such persons are treated as a single employer under 
subsection (a) or (b) of section 52 or subsection (m) or (o) of section 
414, except that determinations under subsections (a) and (b) of 
section 52 are made without regard to section 1563(b).
---------------------------------------------------------------------------

Definition of specified agricultural or horticultural cooperative

    The provision limits the definition of specified 
agricultural or horticultural cooperative to organizations to 
which part I of subchapter T applies that (1) manufacture, 
produce, grow, or extract in whole or significant part any 
agricultural or horticultural product, or (2) market any 
agricultural or horticultural product that their patrons have 
so manufactured, produced, grown, or extracted in whole or 
significant part.\1956\ The definition no longer includes a 
cooperative solely engaged in the provision of supplies, 
equipment, or services to farmers or other specified 
agricultural or horticultural cooperatives.
---------------------------------------------------------------------------
    \1956\ Consistent with former section 199, it is intended that 
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. See Treas. Reg. sec. 1.199-6(f).
---------------------------------------------------------------------------

Special rules

    All members of an expanded affiliated group \1957\ are 
treated as a single corporation and the deduction is allocated 
among the members of the expanded affiliated group in 
proportion to each member's respective amount, if any, of 
qualified production activities income. In addition, for 
purposes of determining domestic production gross receipts, if 
all of the interests in the capital and profits of a 
partnership are owned by members of a single expanded 
affiliated group at all times during the taxable year of such 
partnership, the partnership and all members of such group are 
treated as a single taxpayer during such period.
---------------------------------------------------------------------------
    \1957\ For this purpose, an expanded affiliated group is an 
affiliated group as defined in section 1504(a) determined (i) by 
substituting ``more than 50 percent'' for ``more than 80 percent'' each 
place it appears, and (ii) without regard to paragraphs (2) and (4) of 
section 1504(b).
---------------------------------------------------------------------------
    In the case of a specified agricultural or horticultural 
cooperative that is a partner in a partnership, rules similar 
to the rules applicable to a partner in a partnership under 
section 199A(f)(1) apply.
    For a tax-exempt cooperative subject to tax on its 
unrelated business taxable income by section 511, the provision 
is applied by substituting unrelated business taxable income 
for taxable income where applicable.
    The section 199A(g) deduction is determined by only taking 
into account items that are attributable to the actual conduct 
of a trade or business.

Allocation of the cooperative's deduction to patrons

    The provision provides that an eligible patron that 
receives a qualified payment from a specified agricultural or 
horticultural cooperative is allowed as a deduction for the 
taxable year in which such payment is received an amount equal 
to the portion of the cooperative's deduction for qualified 
production activities income that is (i) allowed with respect 
to the portion of the qualified production activities income to 
which such payment is attributable, and (ii) identified by the 
cooperative in a written notice mailed to the patron during the 
payment period described in section 1382(d).\1958\
---------------------------------------------------------------------------
    \1958\ Consistent with the allocation of the cooperative's 
deduction to its patrons under former section 199 and consistent with 
the requirements for the payment of patronage dividends in section 
1388(a)(1), the cooperative's section 199A(g) deduction is allocated 
among its patrons on the basis of the quantity or value of business 
done with or for such patron by the cooperative.
---------------------------------------------------------------------------
    The patron's deduction of such amount may not exceed the 
patron's taxable income for the taxable year (determined 
without regard to such deduction but after taking into account 
the patron's other deductions under section 199A(a)). A 
qualified payment is any amount that (i) is described in 
paragraph (1) or (3) of section 1385(a) (i.e., patronage 
dividends and per-unit retain allocations), (ii) is received by 
an eligible patron from a specified agricultural or 
horticultural cooperative, and (iii) is attributable to 
qualified production activities income with respect to which a 
deduction is allowed to such cooperative. An eligible patron is 
(i) a taxpayer other than a corporation,\1959\ or (ii) another 
specified agricultural or horticultural cooperative.
---------------------------------------------------------------------------
    \1959\ For this purpose, corporation does not include an S 
corporation.
---------------------------------------------------------------------------
    Finally, the cooperative cannot reduce its income under 
section 1382 for any deduction allowable to its patrons under 
this rule (i.e., the cooperative must reduce its deductions 
allowed for certain payments to its patrons in an amount equal 
to the section 199A(g) deduction allocated to its patrons).

Regulatory authority

    Specific regulatory authority is provided for the Secretary 
of the Treasury to promulgate necessary regulations under 
section 199A(g), including regulations that prevent more than 
one cooperative taxpayer from being allowed a deduction with 
respect to the same activity (i.e., the same lease, rental, 
license, sale, exchange, or other disposition of any 
agricultural or horticultural product that was manufactured, 
produced, grown, or extracted in whole or in significant part 
within the United States). In addition, regulatory authority is 
provided to address the proper allocation of items of income, 
deduction, expense, and loss for purposes of determining 
qualified production activities income. The provision provides 
that the regulations be based on the regulations applicable to 
cooperatives and their patrons under former section 199 (as in 
effect before its repeal).\1960\
---------------------------------------------------------------------------
    \1960\ See Treas. Reg. secs. 1.199-1 through -9.
---------------------------------------------------------------------------

2. Treatment of cooperative patrons

Repeal of special deduction for qualified cooperative dividends

    The provision repeals the special deduction for qualified 
cooperative dividends. In addition, the provision repeals the 
rule that excludes qualified cooperative dividends from 
qualified business income of a qualified trade or business. The 
provision also clarifies that items of income excluded from 
qualified items of income, and thus excluded from qualified 
business income, do not include any amount described in section 
1385(a)(1) (i.e., patronage dividends). Accordingly, qualified 
business income of a qualified trade or business includes any 
patronage dividend,\1961\ per-unit retain allocation,\1962\ 
qualified written notice of allocation,\1963\ or any other 
similar amount received from a cooperative, provided such 
amount is otherwise a qualified item of income, gain, 
deduction, or loss (i.e., such amount is (i) effectively 
connected with the conduct of a trade or business within the 
United States, and (ii) included or allowed in determining 
taxable income for the taxable year).\1964\
---------------------------------------------------------------------------
    \1961\ Defined in sec. 1388(a).
    \1962\ Defined in sec. 1388(f).
    \1963\ Defined in sec. 1388(c).
    \1964\ See sec. 199A(c)(3)(A).
---------------------------------------------------------------------------

Reduced deduction for qualified payments received from a specified 
        agricultural or horticultural cooperative

    In the case of any qualified trade or business of a patron 
of a specified agricultural or horticultural cooperative, the 
deductible amount determined under section 199A(b)(2) for such 
trade or business is reduced by the lesser of (1) nine percent 
of the amount of qualified business income with respect to such 
trade or business as is properly allocable to qualified 
payments received from such specified agricultural or 
horticultural cooperative, or (2) 50 percent of the amount of 
W-2 wages with respect to such qualified trade or business that 
are properly allocable to such amount.

3. Transition rule relating to the repeal of section 199

    The provision clarifies that the repeal of section 199 for 
taxable years beginning after December 31, 2017, does not apply 
to a qualified payment received by a patron from a specified 
agricultural or horticultural cooperative in a taxable year 
beginning after December 31, 2017, to the extent such qualified 
payment is attributable to qualified production activities 
income with respect to which a deduction is allowable to the 
cooperative under former section 199 for a taxable year of the 
cooperative beginning before January 1, 2018. Such qualified 
payment remains subject to former section 199 and any section 
199 deduction allocated by the cooperative to its patrons 
related to such qualified payment may be deducted by such 
patrons in accordance with former section 199. In addition, no 
deduction is allowed under section 199A for such qualified 
payments.

4. Examples

    The following examples illustrate the provision.

Example 1

    Cooperative is a grain marketing cooperative with 
$5,250,000 in gross receipts during 2018 from the sale of grain 
grown by its patrons. Cooperative paid $4,000,000 to its 
patrons at the time the grain was delivered in the form of per-
unit retain allocations and another $1,000,000 in patronage 
dividends after the close of the 2018 taxable year. Cooperative 
has other expenses of $250,000 during 2018, including $100,000 
of W-2 wages.
    Cooperative has domestic production gross receipts of 
$5,250,000 and qualified production activities income of 
$5,000,000 \1965\ for 2018. Cooperative's section 199A(g) 
deduction is $50,000 and is equal to the least of nine percent 
of qualified production activities income ($450,000), \1966\ 
nine percent of taxable income ($450,000),\1967\ or 50 percent 
of W-2 wages ($50,000).\1968\ Cooperative passes through the 
entire section 199A(g) deduction to its patrons. Accordingly, 
Cooperative reduces its $5,000,000 deduction allowable under 
section 1382(b) and (c) (relating to the $1,000,000 patronage 
dividends and $4,000,000 per-unit retain allocations) by 
$50,000.
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    \1965\ $5,250,000 gross receipts-$250,000 expenses = $5,000,000.
    \1966\ $5,000,000 * .09 = $450,000.
    \1967\ For this purpose, taxable income is $5,000,000 and is 
determined without regarding to the section 199A(g) deduction and 
without regard to the $5,000,000 deduction allowable under section 
1382(b) and (c) relating to the $1,000,000 patronage dividends and 
$4,000,000 per-unit retain allocations.
    \1968\ $100,000 * .5 = $50,000.
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    Patron's grain delivered to Cooperative during 2018 is two 
percent of all grain marketed through Cooperative during such 
year. During 2019, Patron receives $20,000 in patronage 
dividends and $1,000 of allocated section 199A(g) deduction 
from Cooperative related to the grain delivered to Cooperative 
during 2018.
    Patron is a grain farmer with taxable income of $75,000 for 
2019 (determined without regard to section 199A) and has a 
filing status of married filing jointly. Patron's qualified 
business income related to its grain trade or business for 2019 
is $50,000, which consists of gross receipts of $150,000 from 
sales to an independent grain elevator, per-unit retain 
allocations received from Cooperative during 2019 of $80,000, 
patronage dividends received from Cooperative during 2019 
related to Cooperative's 2018 net earnings of $20,000, and 
expenses of $200,000 (including $50,000 of W-2 wages).
    The portion of the qualified business income from Patron's 
grain trade or business related to qualified payments received 
from Cooperative during 2019 is $10,000, which consists of per-
unit retain allocations received from Cooperative during 2019 
of $80,000, patronage dividends received from Cooperative 
during 2019 related to Cooperative's 2018 net earnings of 
$20,000, and properly allocable expenses of $90,000 (including 
$25,000 of W-2 wages).\1969\
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    \1969\ Which expenses are properly allocable in a given case will 
depend on all the facts and circumstances. The example assumes that the 
fraction of properly allocable W-2 wages differs from the fraction of 
other properly allocable expenses.
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    Patron's deductible amount related to the grain trade or 
business is 20 percent of qualified business income ($10,000) 
\1970\ reduced by the lesser of nine percent of qualified 
business income related to qualified payments received from 
Cooperative ($900) \1971\ or 50 percent of W-2 wages related to 
qualified payments received from Cooperative ($12,500), \1972\ 
or $9,100. As Patron does not have any other qualified trades 
or business, the combined qualified business income amount is 
also $9,100.
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    \1970\ $50,000 * .2 = $10,000.
    \1971\ $10,000 * .09 = $900.
    \1972\ $25,000 * .5 = $12,500.
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    Patron's deduction under section 199A for 2019 is $10,100, 
which consists of the combined qualified business income amount 
of $9,100, plus Patron's deduction passed through from 
Cooperative of $1,000.

Example 2

    Cooperative and Patron have the same facts as above for 
2018 and 2019 except that Patron has expenses of $200,000 that 
include zero W-2 wages during 2019.
    Patron's deductible amount related to the grain trade or 
business is 20 percent of qualified business income ($10,000) 
reduced by the lesser of nine percent of qualified business 
income related to qualified payments received from Cooperative 
($900), or 50 percent of W-2 wages related to qualified 
payments received from Cooperative ($0), or $10,000.
    Patron's deduction under section 199A for 2019 is $11,000, 
which consists of the combined qualified business income amount 
of $10,000, plus Patron's deduction passed through from 
Cooperative of $1,000.

                             Effective Date

    The provision is effective as if included in the amendments 
made by sections 11011 and 13305 of Public Law No. 115-97, that 
is, for taxable years beginning after December 31, 2017.

      
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 ESTIMATED BUDGET EFFECTS OF TAX LEGISLATION ENACTED IN PUBLIC LAW 115-
                                   97

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